Competition and choice in retail banking - Treasury Contents

5  Encouraging greater competition and new entry

147. In this chapter we examine how concentration levels could be reduced and how new entry into the market could be encouraged, as well as how barriers to entry and expansion can be reduced and barriers to exit made credible. Reduction in concentration levels in the retail banking sector could be achieved in two ways: firstly, through new entry or secondly through what Hector Sants described to us as "structural reform". Mr Sants told us a reduction in concentration levels could be achieved "in both ways", but did not express a view as to which route would be most effective or which he preferred. [229]

New entrants—the new kids on the block

148. It has been argued that the financial crisis has created opportunities for potential new entrants, especially given the damage done to the reputation of some incumbent firms.[230] Recently, new firms have entered retail banking in the UK and others are expected to enter the market.

149. We took evidence from three new or growing entrants to the sector: Metro Bank, Virgin Money and Tesco Bank, who are sometimes referred to as 'challenger' banks. Of the three firms, only Metro Bank has already entered the personal current account and SME market; the other two firms have plans to enter the personal current account market over the next few years.

  • Metro Bank describe themselves as the first new entrant into the UK market in 100 years.[231] Their Vice-Chairman is Vernon Hill II, who was the founder and former Chairman and president of Commerce Bank in the United States. Metro Bank received authorisation from the FSA in March 2010 and opened its first branch in Holborn in London on 29 July 2010. At the time of writing, the company has five branches—the others located at Earl's Court, Fulham, Borehamwood—and Tottenham Court Road. The company envisages growing to 200 stores by 2020, located largely in London and the surrounding areas, and is considering an Initial Public Offering in 2013.[232]
  • Virgin Money was established in 1995. It now has over two and a half million customers and offers a range of financial products, including credit cards, savings and insurance. It plans to enter the current account market in the next twelve months and is also considering entering the SME market.[233] It also has plans to "open a limited national branch network" with the aim of opening 70 branches over the next five years.[234]
  • Tesco Bank currently offers insurance products, savings accounts, unsecured loans, credit cards and travel money. It has over 6 million customer accounts, a loan book worth £4.8bn and total savings deposits of £4.5bn.[235] It plans to enter the mortgage market in the middle of 2011 but do not yet have a fixed date for entry into the personal current account market.[236]

Other aspiring new entrants to the UK retail market include NBNK, who have recently appointed former Northern Rock Chief Executive Gary Hoffman as their CEO and who have received initial City capital backing. [237]

150. Despite the evidence that new firms were seeking to join the market, John Fingleton cautioned against expecting immediate competition effects from new entrants saying that "even in other, highly competitive markets [...] the entry process and the process by which firms grow is slow." He used the analogy of the airline sector:

    If you think about airline liberalisation, the first liberalisation measures happened in '87 at a European level, and they happened from '87 through to '97. The low-cost airlines business model really only took off in the last decade as a serious phenomenon; even in that market, with very high levels of switching and very high levels of customer transparency, the incumbents retained market share for quite a long time. But what we have seen there is that the incumbents brought down their prices and became much more efficient over time.[238]

The OFT Review of barriers to entry, expansion and exit in retail banking concluded that "new entrants face significant challenges in attracting personal and SME customers" and "expanding their market share in retail banking." They argued that this was "through a combination of low levels of switching, high levels of brand loyalty and consumers' preference for providers with a branch network."[239] We examine switching separately.


151. Although the OFT report identified brand recognition as a key barrier to entry and expansion,[240] Jayne-Anne Gadhia observed that "so much trust has broken down in the banking sector" and that customers "were looking for a trusted brand". She quoted external analysis which showed "people are as likely to buy from a Virgin bank as they are from any of the big five."[241]


152. Adam Phillips explained that the "big banks" derived "an advantage" through their branch networks. He explained that this was because, whilst "you can do a lot on the internet", many "people need access to branches at various times."[242] Mr Phillips believed this meant that whilst Tesco Bank could draw on their extensive store network, other new entrants would not have this advantage.[243] Mr Phillips concluded that he did not believe anything could be done about this.[244]

153. Metro Bank plan to open 200 branches in the Greater London area by 2020[245] whilst Virgin Money plan to open 70 branches over the next five years.[246] By comparison, Lloyds Banking Group had 3000 branches in 2009, RBS had 2,280, Barclays 1,700[247] and Nationwide approximately 700.[248]

154. Jayne-Anne Gadhia told us that Virgin Money's new branches would "be distributed across the nation."[249] She stressed "growing branches [...] takes time" and that they intended to be "as accessible as possible" through other distribution channels such as "online [...] over the telephone and on digital phones if people want it."[250] Metro Bank's decision to focus on the Greater London area has led to accusations that some new entrants will merely 'cherry-pick' affluent parts of the country. Vernon Hill was unapologetic about Metro Bank's plans, telling us that:

    You have to start some place and, as a retailer, we know the more stores we put in the same market, the better those stores all do. You wouldn't do a model in New York, with 10 stores in New York, 10 in Chicago and 10 in Los Angeles. You would concentrate in certain markets, build them out, then begin the next one. We had to start some place in Britain and London is the obvious place.[251]

155. We received evidence from The Campaign for Community Banking Services (CCBS) who told us that nearly a 1,000 communities had lost all their bank branches whilst a further 1,050 communities had only one bank branch. This they said meant "effectively [...] no choice of bank unless they are prepared to lose time and incur cost in banking elsewhere." CCBS said "the 500 communities with only two banks remaining offer limited competitive choice."[252] The Financial Services Consumer Panel also raised the issue of variations in banking provision, telling us that "the issue of regional monopolies in both Scotland and Northern Ireland warrants specific attention."[253] They also told us that not all consumers were well provided for and raised the issue of branch closures which were detrimental for certain consumers.

    There is little differentiation according to needs of different communities or different segments of the population. The recession and failures of firms has seen services increasingly being withdrawn from less profitable areas, evidenced by branch closures, rationing of credit provision, and withdrawal of products that were less risky propositions for low income consumers such as the National Savings and Investment scheme.[254]

156. Some new entrants, for entirely sound commercial reasons, initially plan to restrict their branches to certain geographical locations. This means that competition and choice may improve in certain areas whilst other areas will benefit much less from new entry into the market. This is an issue of particular importance given evidence we have received that concentration levels and so-called 'regional monopolies' are higher in areas like Scotland and Northern Ireland or certain English regions than in other parts of the country.

157. Given the continuing importance many consumers attach to a branch network especially for current account services, new entrants without access to an extensive branch network will be at a considerable disadvantage to established banks for the foreseeable future.

Breaking up the banks on competition grounds

158. In normal circumstances new entrants might be expected to acquire one another. However, although this would add scale in 'transactional' products such as credit cards and insurance, it would not address the strategic objective of establishing a branch network, or of acquiring current account lending; for that more radical measures could be necessary.

159. The Independent Commission on Banking is examining the structure of the UK retail banking market as part of its examination of the UK banking system. In its September 2010 issues paper, it noted that some divestiture of bank assets in the UK had been required by the European Commission to meet conditions for the approval of public support to Lloyds Banking Group and RBS under EU Treaty provisions on state aid. The Independent Commission on Banking, however, raised the possibility, that "such divestitures could, in principle, go further", arguing that "the Government's ownership stakes in RBS, Lloyds Banking Group and other banks may provide a means for pro-competitive restructuring." Amongst the options floated by the Commission were:

  • requiring the UK's largest banks to divest assets with a view to creating a more competitive market structure
  • imposing a limit on the size of bank's overall operations, for example, through limiting the maximum size of a bank's balance sheet to no more than a certain percentage of GDP.[255]


160. As a condition for approving the Government recapitalisation of RBS and Lloyds Banking Group, the EU using its state-aid powers required both banks to make a number of divestments to reduce their share of certain markets.

161. To meet the EU conditions RBS will divest the Royal Bank of Scotland branch-based business in England and Wales, the NatWest branch network in Scotland, its Direct SME customer base and certain mid-corporate customers across the UK. This will result in the divestment of 318 branches and supporting infrastructure and services. The business will include approximately 1.8 million retail customers, 230,000 SME customers, 1,150 corporate customers and £20bn of assets. The divestment represents 2% of the UK retail banking market and 5% of the UK SME and mid-corporate markets respectively.[256] The terms of the State Aid agreement required that the buyer of the divestment must, in combination with the divestment business, have a UK SME market share of no more than 14%.[257] Santander won the bidding process for the RBS divestments on 4th August 2010,[258] but has yet to assume formal ownership of the assets. The formal transfer is expected to be completed by the end of 2011.

162. Lloyds Banking Group's final approved restructuring plan consists of the divestment of a retail banking business with at least 600 branches, a 4.6% share of the personal current accounts market in the UK and up to 19% of the Group's mortgage assets. The number of branches to be disposed of represents approximately 20% of the current Lloyds Banking Group network. The business would consist of:

  • The TSB brand
  • The branches and branch based customers of Lloyds TSB Scotland and a related banking licence
  • The branches, savings accounts and branch based mortgages of Cheltenham & Gloucester
  • Additional Lloyds TSB branches in England and Wales with branch based customers
  • The Intelligent Finance brand and all its customers and accounts.

The divestment must be completed by November 2013. Under the agreement with the European Commission, it is a requirement that the buyer or buyers of the divested business have a post-acquisition current account market share of no more than 14% in the UK. Lloyds Banking Group have stated that "the assets [...] if sold today, would enable a new entrant to the UK market to become the 7th largest bank in the UK".[259]

163. Virgin Money stressed the importance of the divestments as a means to increase competition in the retail market. They explained that growth through acquisition was "challenging" for a new entrant. This meant the RBS and Lloyds Banking Group divestments and the sale of Northern Rock were "critically important if further competition is to be introduced into UK banking".[260]


164. Virgin Money explained that they had "expressed strong interest" in the sale of the RBS assets, but that the eventual sale of the assets to Santander showed "that a new entrant can be beaten by an incumbent which is able to deliver cost-saving synergies and funding benefits by integrating the acquisition with its existing business, while meeting the market share threshold set by the EU regardless of other competition issues".[261] Peter Vicary-Smith, Chief Executive of Which?, was critical of the decision to award the RBS divestments to Santander, since he considered they "could have been used to kick-start a new player in the marketplace".[262]

165. When challenged as to whether the disposal to Santander had increased competition in the UK market, Stephen Hester replied he had "sold it to someone [Santander] who came within those [EU] requirements".[263] Mr Hester claimed some of the other (potential) bidders were "people cherry-picking with specialist business models in specialist areas". Mr Hester said that he had always thought the divestment would be sold to an in-market player and that there wouldn't be demand from others unless "at knockdown prices".[264] He said that, if this had happened, it would have been "a straight giveaway from the taxpayer to other people to subsidise them".[265] HM Treasury told us the sale of the divestment to Santander would have a positive impact because "Santander UK currently have a small presence in the UK SME market and the sale will serve to increase competition in that sector."[266]

166. The previous Chancellor of the Exchequer, Alistair Darling, in a statement to the House on Banking Reform on 3rd November 2009, had also stressed the importance of using the Lloyds and RBS divestments to kick-start competition:

    Together, these businesses could potentially amount to about 10% of the retail banking market in the UK. And, Mr Speaker, in each and every case, we will insist these institutions should not be sold to any of the existing big players in the UK banking industry. So Lloyds and RBS will each be required to sell their retail and SME businesses, as a single viable package, to a smaller competitor or new entrant to the market. And this, together with Northern Rock, will potentially create three new banks on our high-street in the space of five years.[267]

Table 9 below shows the market shares of Santander and RBS in a number of (non-SME) retail markets prior to Santander's acquisition of RBS. They show that, whilst Santander may have only had a small share of the SME market (figure), in a number of other key market segments they were in 2nd or 3rd position with respect to market share.

Table 9: Market shares of RBS Group and Santander across retail banking markets.[268]
Personal current accounts Mortgages (gross lending) Mortgages (amounts outstanding) Personal loans Savings accounts Credit cards
Santander 12% (5th) 18% (2nd) 13% (2nd)10% (3rd) 12% (2nd) 6% (7th)
RBS16% (2nd) 13% (3rd) 7% (joint 4th) 9% (4th)10% (joint 3rd) 19% (3rd)

Source: Oft, review of barriers to entry, expansion and exit, pp35-48

167. The sale of the RBS divestments to Santander was a missed opportunity to inject more competition into UK retail banking. Whilst Santander may have met the EU state aid criteria and enjoyed only a small share in the SME market, it was already a leading player in other areas.

168. The RBS divestment goes to the heart of the trade off between maximising revenue and increasing competition. If the divestments had been sold to some of the other potential bidders it might (in the words of RBS) have represented "a straight giveaway from the taxpayer." However, whilst acceptance of an alternative bid may not have maximised short-term revenue for RBS and the taxpayer as the majority shareholder, it might have provided a greater impetus to competition in the sector.


169. The Lloyds Banking Group divestment, as well as the sale of Northern Rock, are still to come. Lloyds is required to approach potentially interested buyers no later than 30th November 2011, and is required to complete the divestment by 30th November 2013.[269] A number of organisations—including Which? and Virgin Money—have proposed the introduction of a public interest test for the sale of these assets. Peter Vicary-Smith believed that the divestment "should not just be a matter of looking for the absolute highest price. It needs to get a good return, but not the £1 more than the nearest bidder". He argued the test should also look at "what is this going to do to competition within the banking sector and is it going to enhance competition". Mr Vicary-Smith pleaded that:

    we have a once in a generation opportunity to increase competition through enabling a new entrant to get to scale quickly through these disposals, and it would be tragic if we didn't use that opportunity and instead flogged it off to one of the existing incumbents.[270]

Virgin Money argued that the public interest test should not be "judged just on the short term economic value they deliver to shareholders, but also on the long-term value they create for society, including stimulating greater competition". Additionally, they said consideration should be given to factors such as "the retention of jobs and the commitment to lending made by the potential acquirer".[271]

170. We asked Eric Daniels about whether a public interest test should be applied to the Lloyds disposals. He replied that he was "not sure what the shape of that public interest has to be" and so "would find it very difficult to answer the question." When pressed on this issue he said one:

    of the conditions of the European accord was in fact to sell to a party that had no more than 14% current account market share. So I believe there is already some thought toward trying to create a new competitor in the marketplace.[272]

Mark Hoban, when asked about the introduction of a public interest test, side-stepped the question, and told us that the Government had been "very clear that we are prepared to use the sale of our stakes in the banks that we own to facilitate competition."[273]


171. The sale divestments raises the issue of the role of UK Financial Investments Ltd (UKFI) which was set up in November 2008 to manage the Government's investments in financial institutions including the Royal Bank of Scotland, Lloyds TSB/Halifax Bank of Scotland (Lloyds Banking Group), Northern Rock and Bradford & Bingley. As well as managing the Government's stakes in the banks, UKFI's mandate also charges it with developing and executing an investment strategy for disposing of the Investments in an orderly and active way through sale, redemption, buy-back or other means within the context of protecting and creating value for the taxpayer as shareholder and, where applicable, as provider of financial support, paying due regard to the maintenance of financial stability and acting in a way that promotes competition.[274] Peter Vicary-Smith reminded us that 'competition' was one of UKFI's objectives, but he saw "scant evidence that anything that it's doing is increasing competition in banking" going on to say that "the prime example of that was the sale of the RBS branches and payment centre to Santander."[275]

172. UKFI is charged with drawing up and executing a disposal strategy, but as Mr Robin Budenberg, the Chief Executive, told us

    ultimately, it will be our decision to make a recommendation to the Chancellor. In relation to disposals such as the disposal of Northern Rock, the Chancellor does have the ultimate decision-making power, so he will assess the basis on which we have made our recommendation.[276]

173. The RBS divestment to Santander illustrates the importance of giving greater consideration to competition when considering divestment policy. There may be a trade off between maximising revenue from the divestments by the part-state owned banks, and maximising the increase in competition through the divestments. The creation of a more competitive retail market is essential to secure lasting benefits for consumers. Maximising competition through the divestments will ultimately bring greater longer-term economic benefits to the UK through a higher overall GDP and subsequent higher tax yield.

174. Whilst none of the large five banks will be able to bid for the Lloyds divestments, we still believe a public interest test based on competition considerations should apply both to the Lloyds divestments and the sale of Northern Rock. A failure to introduce such a test would be tantamount to admission that the Government has no real interest in promoting competition and is concerned solely with revenue maximisation.


175. RBS and Lloyds Banking Group are in the process of divesting assets as a condition for EU approval of the Government recapitalisation of the two banks. The Independent Commission on Banking has raised the possibility of going further and "requiring the UK's largest banks to divest assets with a view to creating a more competitive market structure".[277] Subsequently, Clare Spottiswoode, a member of the Commission, has raised the possibility of reversing the Lloyds TSB/HBOS merger, stating "we might suggest reversing what happened on that day a few months back when Lloyds took over another bank."[278]

176. The Lloyds TSB/HBOS merger was announced in September 2008[279] at the height of the financial crisis amid serious concern that HBOS would collapse without some form of external support. The OFT submitted a report to the Secretary of State on the proposed merger, concluding that they:

    found a realistic prospect that the anticipated merger would result in a substantial lessening of competition in relation to PCAs and banking services for SMEs. The OFT's concerns on PCAs were nationwide, while its concerns about SMEs were focused on Scotland.[280]

However, the then Secretary of State, using new powers, concluded that the stability of the UK financial system outweighed the competition concerns identified in the OFT's report, and decided not to refer the case to the Competition Commission.[281]

177. We asked John Fingleton whether the merger had resulted in a diminution of competition as the OFT had feared at the time of the merger. Mr Fingleton explained that he did not know because the OFT had not "gone and looked at measuring competition in the market since the Lloyds-HBOS change."[282] He explained that if "we do an ex post analysis of what has happened in a merger, typically we would wait three to five years to see how the market has settled down", going on to stress that "this market is anything but settled down. We would have great difficulty in separating out contraction of supply issues, divestment issues and other issues, and in working out what the marginal impact of the Lloyds-HBOS merger is on competition."[283]

178. Mr Fingleton stressed that "at the time, we were pretty damn convinced this merger was going to reduce competition", but explained that since then the EU had required Lloyds Banking Group to make a number of divestments. He also explained that opposing an original merger decision did not necessarily mean supporting its reversal:

    once a merger has gone through and been consummated, if the answer to the question, "Would the merger have been a bad idea in the first place?" is a clear "yes", it doesn't obviously mean that undoing the merger later is the right thing to do, because there could be very big costs associated with doing that.[284]

When asked whether consideration should be given to breaking up one or both of Lloyds Banking Group and RBS in the interests of increasing competition, Mr Fingleton said he agreed "that consideration should be given to it", but said he did not "know what the right answer to that question is."[285]

179. Eric Daniels, then CEO of Lloyds Banking Group, reacted to the possibility of reversing the Lloyds/HBOS merger by stating in a newspaper interview that:

    One of the things that characterises most modern governments is that when you make an agreement with the state, it's an agreement with the state, independent of which political party is in power [...]

    There was a sentiment [then] that financial stability was more important and that the issue of competition took second place. As a result of that, the secretary of state signed off the deal. That is a matter of public record.[286]

John Fingleton sketched out some broader points about competition policy from the Lloyds/HBOS merger. He referred to "the signal it sends more broadly" about "the incentive it creates for others to lobby for political protection from anti-competitive mergers", adding that:

    I think that people feel that getting an anti-competitive merger through by political clearance can create incentives for lobbying and rent-seeking, long term, and I think if people feel that is not a lifelong guarantee for a business, that it's an important consideration as well. So that is another factor to be weighed in the balance. So it's not just the impact within the banking market but the broader signal it sends about merger policy.[287]

180. Lloyds Banking Group is currently the market leader in most parts of the retail market. In some segments, Lloyds market share is almost double that of its nearest competitor. As yet, there has been no assessment to see what impact Lloyd's strong position has had on competition in the retail market. We are concerned by the emergence of such a powerful player in the retail market and the potential competition implications. The divestments required by the EU will go some way towards addressing this concern as well as (in conjunction with the RBS divestments) reducing concentration levels in the sector. That said, Lloyds Banking Group will retain a leading position in many market segments even post-divestment.

181. Government credibility would be undermined if a merger arrangement approved by one administration was unpicked by another. This would risk politicising competition policy, create incentives for political lobbying and create considerable uncertainty for business. However, we do not believe that the need to respect the merger should inhibit the Independent Commission on Banking from proposing radical changes to the market as a whole, if it thinks this is necessary to promote competition and choice.

Promoting mutuals

182. The Coalition Agreement said:

    We want the banking system to serve business, not the other way round. We will bring forward detailed proposals to foster diversity in financial services, promote mutuals and create a more competitive banking industry.[288]

The Building Societies Association in its written evidence provided a number of areas where they felt they were different to banks. These included:

  • Mutuals bring diversity. They pursue alternative strategies to banks as a consequence of the customer being the primary stakeholder.
  • Mutuals tend to take less risk than banks. Mutuals have been less reliant on wholesale funding than plc banks and the proportion of mortgage loans that is in arrears is typically much lower at mutuals than across the market as a whole.
  • Mutually owned financial firms deliver higher levels of satisfaction and trust. Research conducted in 2010 showed that mutuals outperformed plc banks across eleven aspects of customer service.[289]

183. Some witnesses suggested that in some cases the diversity brought by the mutual model could be overstated. Sir Donald Cruickshank pointed out that "diversity is good as long as conditions of mutuality are real and not just a brand."[290] Lord Turner felt that it had been a "mistake [...] to allow our mutual sector [...] in some cases to extend beyond the core business of prime real estate lending".[291] He told us that reversing some of the liberalisations of the 1980s and 1990s should be considered.

    I think there is an unfinished part of our regulatory agenda as to whether we should reverse some of the liberalisations of the building society rules that occurred in the 1980s and 1990s, which gave us precisely the problems that we had in the Dunfermline Building Society.[292]

Mr Beale disagreed and said that any major changes would mean Nationwide would be unable to compete with the banks.

    I am very comfortable with the parameters in which we operate at the moment, but I think you took evidence from Lord Turner a couple of weeks ago where he was talking about deliberalising building societies. That would have very severe consequences for our business model in narrowing it and making us unable to compete with the banks. So I think the first thing is that I want a level playing field with the banks. I am not looking for any additional powers in terms of what we can do as a business, but I do not want any constraints either.[293]

In written evidence Nationwide told us that there was already a "more restrictive legislative framework" for Building Societies which along with other differences to banks meant they were "inherently less-risky".[294]


184. It is clear that the Government wishes to see a diverse financial sector, even though there may be arguments about the extent to which mutuals are radically different from plcs. Our witnesses were concerned that they had yet to see any actions to 'foster diversity' and 'promote mutuals', and considered many aspects of the regulatory approach were biased against them. Graham Beale, Chief Executive of Nationwide Building Society, felt more could be done by the Government.

    I think that there are a number of things that the Government can do. I think the first thing is that the Coalition statement about fostering diversity and promoting mutuality, at the moment I have not seen any substance that sits behind that as a comment, is the first point I would make.[295]

Neville Richardson, the Chief Executive of The Co-operative Financial Services, considered that regulators were sometimes slow to considering the mutual sector, telling us that "legislation is being discussed by the regulators with the plcs in mind, and then as an afterthought, the mutuals."[296] In particular both Mr Richardson of the Co-operative and Mr Beale of Nationwide drew our attention to the issue of capital requirements.[297] The Building Societies Association made this point clearly in their written submission to the Committee:

    Regulatory changes should not discriminate against mutual institutions. It is essential that the Government ensure that amendments to the Capital Requirements Directive enable mutuals to raise external capital that is consistent with mutual ownership.[298]

Mr Beale felt that progress had been made in this area explaining that "we have seen the HMT material in terms of their positioning on this, and it is very supportive."[299]

185. Yorkshire Building Society also raised the issue of new and proposed regulation pointing out that it typically represented "a greater proportionate cost to small firms".[300] They also noted that some of the government support mechanisms had not been suitable for smaller institutions.

    YBS was in a position to utilise the Credit Guarantee Scheme (CGS), which was for it a potentially suitable vehicle. Although in principle the scheme was the perfect vehicle to strengthen depositors' and broader market confidence in the mutual sector, in practice, it was much less accessible to the mutual sector than to banks, when the need arose, because many building societies were too small to issue debt securities which this initiative sought to underwrite with State support.[301]

They also pointed out the disadvantageous treatment of a consolidated group of businesses within a mutual compared with a plc with numerous banking licences.

    In particular, the way in which building society regulation has developed over time has created an anomalous position in which the FSCS—and, [...]—applies to the consolidated group of businesses within a mutual, whereas for a plc with banking licences per brand, the consumer protection is multiplied by the number of banking licences it possesses. This could sustain an existing behavioural incentive for understandably risk-averse depositors to see banks rather than mutuals as the best home for their savings.[302]

They felt that this and other issues resulted in regulators giving the "impression that they find it easiest to deal with large deposit-taking institutions, based on a plc model" and considered that this had "the effect of further legitimising the plc model in preference to the mutual one."[303]

186. Another issue raised by both the Co-operative and Nationwide was the Financial Services Compensation Scheme (FSCS). Mr Beale felt it was unjust that Nationwide's members were paying the price for the recklessness of banks with riskier business models.

    The failure of Bradford and Bingley and the Icelandic banks will cost Nationwide, in the full term, we think between £250 million and £330 million, i.e. between a quarter and a third of a billion pounds. It is the cost to Nationwide, to Nationwide's members, for the failure of those institutions. That is because the compensation scheme is driven by the proportion of retail liabilities—i.e. savings deposits—that you have on your balance sheet. Of course in the mutual sector, and Nationwide in particular, we hold very large quantities of retail deposits. So it seems wrong that failures in much riskier models—take the Bradford and Bingley model—are paid for by the much less risky organisations such as the mutual sector.[304]

Mr Richardson suggested that the Co-operative was low risk, as its loans were fully covered by retail deposits and told us that "quite bizarrely [...] we have to pay more towards the compensation scheme because it is based on retail deposits, and that just seems wrong to us."[305]Mr Beale felt that the levy contribution to the Financial Services Compensation Scheme "should be risk-based so that the higher-risk entities pay a greater proportion of any failure than the lower-risk entities."[306] When we put this point to the Financial Secretary his response was that he was "very wary of making some statements about the level of risk associated with particular institutions", pointing out that Dunfermline Building Society had got into trouble. He also pointed out that:

    It is very easy to say, "My sector shouldn't get hit now for the levy because it's somebody else's problem". The time may come when it is members of that sector who have to pick up all the bill and they would be grateful for some of the cross-subsidisation that is on offer through the FSCS.[307]

187. In its Report The run on the Rock, the Treasury Committee in the previous Parliament recommended both a pre funded Deposit Protection Fund and that once the Fund had been established, there could be a case for introducing risk based premia. In its 2008 response the then Government told us that "The Financial Services Authority is planning further consideration of risk based levies and to consult on any changes to the criteria for calculating deposit contributions if appropriate in due course".[308] To date a risk based levy has not been introduced, although last year the European Commission proposed draft Directives on deposit guarantee and investor compensation schemes. The Government has indicated that it does not support the Commission's risk based levy.[309]

188. We welcome the Government's intention to foster diversity and promote mutuals. This will only be possible if both Government and regulators take the sector into account from the very beginning of the policy making process. The evidence we received from the sector confirms our concern that this is not the case. In the Plan for Growth the Government has said it will "assess whether changes are required to update building societies legislation." We will study that assessment carefully. All market participants should be consulted at all stages on the basis that a level playing field exists for mutuals compared to companies based on the PLC model. To clarify matters and allay the concerns of the mutual sector the Treasury, working with the regulator, should set out the terms of the Government commitment to bring forward "detailed policies to foster diversity in Financial Services and promote mutuals."

189. The Committee also took evidence regarding the arguments over whether mutuals are treated fairly by the FSCS, where the arguments are finely balanced. We recommend the FSCS levy should be reviewed as a matter of priority. We accept there is work going on at European level, but an assessment of the United Kingdom scheme would help inform consideration of Commission proposals.


190. We explored the possible remutualisation of Northern Rock with a number of witnesses. Neville Richardson, Chief Executive of The Co-operative Financial Services explained he thought it "would be a good idea, but there are issues that would have to be dealt with"[310] Mr Beale, Chief Executive of Nationwide, expressed a similar view.[311] The Building Societies Association in written evidence said that "remutualisation would help to foster diversity and promote mutuals, and deserves serious consideration by the Government."[312] The New Economics Foundation felt the Government should look wider than Northern Rock and should "seriously consider remutualisation as part of any forced demergers or sales by large banking groups".[313]

191. Other witnesses did not feel it was such an important issue. Sir Donald Cruickshank told us:

    I would personally be indifferent as to whether the business of Northern Rock was floated as a separate entity on the markets, was created as a new mutual or, indeed, was sold to a new entrant.[314]

192. Lord Turner declined to give an "immediate response" when asked about the possible remutalisation of Northern Rock. He considered it was "not a regulatory issue for the FSA".[315]

193. All witnesses asked about a potential remutualisation agreed that it could provide a return to the taxpayer but do so over the longer term than other divestment routes. Mr Beale argued that it was therefore a political decision.

    I think there would be a return, but it would be over a much, much longer period. I think that is the choice, in terms of, do you want to have a socially useful animal—to quote somebody else—or do you want to have an early payback of taxpayers' money? That has to be a political decision, at the end of the day.[316]

Mr Beale explained to us that if Northern Rock were to be remutualised there were two possible methods.

    It could be remutualised directly, which I think would be quite complicated to achieve, or it could be merged with an existing mutual entity.[317]

He agreed that if it were to be directly mutualised there would be a large debt on the balance sheet to be paid back over many years which would place constraints on Northern Rock. He felt that the constraint of having to pay back the taxpayer over many years could be better managed if it were to be done by a new larger mutual formed from a merger with Northern Rock to take place.[318]

194. UK Financial Investments confirmed that the remutualisation of Northern Rock was an option that they were considering. Keith Morgan, Head of Wholly Owned Investments told us:

    I think it is a realistic possibility, and the reason for saying that is that we have to take account of value to the taxpayer—that's what we've been asked to focus on, and we've been asked to focus on paying due regard to competition. So value will be very important. I think there are some elements of value that would have to be looked into very carefully with regard to mutualisation. Not least among those would be the ability for mutuals to raise capital—clearly, that's an important factor in the mutual market—the rate at which Government would get its money back, and the value that represents to taxpayers. We would have to assess those, let's say, characteristics of mutualisation against the other options, the full range of which would include sale to other companies, IPO, or merger with other smaller players. I think it's a realistic option to evaluate.[319]

195. While Mr Morgan explained the value obtained for taxpayers would have to be carefully scrutinised he agreed that "it's entirely possible that the characteristics of that would be seen to be value-creating".[320] When we raised possibility of remutualisation with the Financial Secretary he also felt it was an option which had "elegant circularity" and told us "my mind is not closed to that". He emphasised that the "taxpayer has a £1.4 billion holding in that and I think that the taxpayer would expect some return on its investment".[321] He did however suggest that the longer time frame for taxpayer repayment could be a stumbling block for the mutualisation telling us that "taxpayers have a limited degree of patience."[322]

196. There are attractions to the mutual model. A remutualisation would certainly lend credibility to the Government's desire to foster diversity and promote mutuals. We would urge UKFI, notwithstanding the timescales for a return on its investment to the taxpayer, to honour that commitment by giving due consideration to a mutual option when considering the disposal of Northern Rock. This should be facilitated by taking expert advice on re-mutualising Northern Rock, placed at the appropriate time in the public domain.

Other barriers to entry

197. A number of other barriers to entry or growth were raised by our witnesses, and we discuss them below.


198. Obtaining authorisation or approval from the appropriate regulatory authority (bank authorisation) is another potential barrier to entry. It is important that the process is rigorous, but also that suitable applicants are approved without undue difficulty or delay.

199. Under the Financial Services and Markets Act 2000, a firm that wishes to accept deposits in the UK must be authorised by the FSA (often referred to as a banking licence) or be exempt.[323] A firm wishing to offer credit must obtain a consumer credit licence from the OFT. Applications for a banking licence must be accompanied by supporting documents including a business plan, policies and procedures, governance arrangements, a risk assessment and capital requirements.

200. As part of the authorisation process, the FSA carries out approved person checks on key staff, typically including the Chairman, the Chief Executive Officer, the Head of Risk, the Chief Financial Officer and the Head of Treasury as well as other executive and non-executive directors.

201. The FSA has a statutory obligation to make a decision as to whether to grant a licence or not within the earlier of six months of receiving a complete application or 12 months of receiving an incomplete application. Mr Sants said that the average time to process an application form varied "between seven and 10 months" and that this was because "the vast majority of these applications were, broadly, incomplete."[324]

202. Mr Sants considered the authorisation process was not a barrier to entry, quoting the OFT's conclusion that "firms do not face significant barriers to entry arising from regulatory requirements that must be met in obtaining authorisation to accept deposits or offer mortgages."[325] Lord Turner concurred—"our regulatory processes are not a significant barrier to entry", suggesting there were, however, "other barriers to entry that are important".[326] Mr Sants explained that the FSA had recently made significant changes to its licence application process and that the criticisms of the process predated those changes.[327] Mr Sants was responding to the OFT's observation that "a small number of respondents indicated that the uncertainty, length of time of and cost of the application process had proved insurmountable and that they had decided not to apply for a licence."

203. Clive Maxwell told us that the OFT had been speaking to people about the FSA's authorisation process and the message they received was that "things probably had improved over recent months."[328] The OFT in Review of barriers to entry, expansion and exit was slightly more cautious, concluding that "it is too early to tell whether the changes introduced recently by the FSA [...] have reduced the extent to which current and future applicants will face the barriers outlined above."[329] Those who had recently sought a licence felt that the process was not a significant barrier: Benny Higgins did not see this as "a leading issue," citing other non-authorisation barriers to entry and expansion he considered more significant.[330] Anthony Thompson felt "the FSA was extremely good to deal with."

204. The one exception was the 'catch 22' situation identified by the OFT where potential entrants are unable to obtain a banking licence without making capital investments to meet licensing requirements, but have had difficulty in raising the capital required without some assurance that this would lead to them becoming licensed. Vernon Hill told us that he "had to invest a very substantial amount of money in leases and IT, with people not knowing that we were sure of getting the licence." However, Mr Hill welcomed the fact the FSA had looked again at its rules in this area and changed them to give applicants a 'minded to' letter subject to conditions.[331]

205. The Financial Services Authority has made changes to the bank authorisation process which appear to have improved the process for firms seeking authorisation, though it remains difficult for applicants to be certain of the rules on suitability. We welcome these changes and will monitor their effectiveness.


206. Some of the smaller banks also considered that they were disadvantaged in some areas. Tesco Bank told us that regulation was "resource intensive, particularly for smaller banks" and that it "posed a disproportionate burden on small banks".[332] Jayne-Anne Gadhia explained to us that the current Basel regime that allowed big banks with many years of experience to hold less capital requirements disadvantaged newer and smaller providers.

    The point that we're trying to make in our submission is that the regulatory capital regime, understandably in some cases, clearly differentiates between the big incumbents and the smaller providers, and for smaller providers, therefore, there's a requirement to hold more equity. At one level, I understand that, but if we look at what's happened in the recent crisis, quite clearly the Basel II regime that has allowed the big banks to reduce their capital requirement because of historic experience, has—I would go as far as saying this—failed to identify the systemic risks that those banks themselves introduce to the system, and that capital should be held against those systemic risks, especially at particular times of the cycle.[333]

207. The OFT in their report on retail banking of 2010 also considered the effect of regulations and capital requirements on smaller firms. They concluded

    Capital and liquidity requirements are currently undergoing significant change as a result of the Basel III process and associated changes to EU law. It appears that new capital requirements, along with liquidity standards, could have the potential to exacerbate differences between incumbents and new entrants, for example, by imposing higher fixed costs of compliance. However, some parties have argued that other proposed changes may also reduce any discrepancies, such as removing certain financial instruments most commonly used by large banks from the list of permitted capital. As the new requirements take effect, it may be appropriate for the prudential regulators to consider and monitor the impact on competition of these changes.[334]

208. We have been told that the Basel II capital requirements currently disadvantage small banks. The move to Basel III may remove some of the disadvantages smaller banks face compared to their larger competitors. However smaller banks may suffer higher fixed costs of compliance which will disproportionately affect them. The Government and regulators should ensure that any competitive advantage accruing to incumbents is not unfairly reinforced through regulation.


209. The industry itself may take actions which while intended to address real problems or make service improvements incidentally inhibit competition. For example, Tesco Bank raised the issue of 'access to information' in their submission to this inquiry. The information they were referring to concerned financial information—for example, around income and expenditure—about consumers which enables providers to offer appropriate products to consumers as well as the appropriate level of credit. Tesco described access to such information as "important to 'ensure that we lend responsibly.'" Tesco Bank said that they faced barriers to acquiring such information about consumers because:

    the established banks routinely share current account data which can be used to calculate income and expenditure, as well as wider product holdings, through a closed user group.

concluding that this placed "smaller players at a disadvantage."[335]

210. We quizzed Benny Higgins about this when he appeared before us. Mr Higgins told us that "unequivocally, there is a closed user group made up of the large banks and some of the other banks."[336] The eligibility criterion he told us was "one million current accounts" and that was why he described it as "a closed user group."[337] He argued the importance of having access to such data lay in "understanding affordability" and that, as a result, "anyone who is lending in the UK should have access to that affordability data".[338] Tesco Bank later confirmed that they had indeed raised the issue with the OFT.[339]

211. RBS Chief Executive Stephen Hester appeared to think it ironic that Tesco Bank were complaining about 'access to information' given that:

    Tesco's great claim to fame in trying to penetrate financial services markets is their incredible database, which is no doubt proprietary to them, with the tens of millions of people who shop with them, which they intend to use to attack our market. I think that's terrific. That's their competitive edge. Let them use it. It will keep us on our toes, but it seems to me it's much more likely to be the other way around in terms of benefit of access to data. That's why they're coming into the market, to use that.[340]

Subsequently, Callcredit—a Credit Reference Agency described on their website as experts in UK and international consumer information management—wrote to the Committee, explaining that "just over 4 years ago, Callcredit launched its unique Over-Indebtedness Initiative (OII) created in association with the UK's leading high street banks" and in response to "growing concerns about borrower over-commitment". The role of Callcredit is to facilitate the sharing of debt and income data which they told us "is available to both current account and non current account providers". Such "credit data is shared by banks with Credit Reference Agencies (CRA's) under the rules governing Principles of Reciprocity" and the banks do not "share data directly with each other." The letter did not address Mr Higgins's central charge that this was a closed user group with eligibility restricted to firms with over one million current accounts. Since then, Tesco Bank have sent a supplementary memorandum stating:

    As outlined in our written and oral evidence to the Treasury Select Committee's inquiry into Competition and Choice in Banking, Tesco Bank remains concerned that access to information remains an advantage to large incumbent players. As a result of their evidence to the inquiry, we will discuss further with Callcredit to establish what can be done to create a more level playing field.

212. We have heard evidence that suggests smaller banks are denied access to information about consumers that the large banks share with one another. We urge the OFT keep a close watch on the extent to which differential access to information disadvantages smaller banks.

Competition and the new regulatory framework

213. In our inquiry into Financial Regulation we considered whether the Consumer Protection and Markets Authority (as the proposal then was, now renamed the Financial Conduct Authority (FCA)) should have a competition remit and concluded that "The CPMA should have competition as a primary objective. This will benefit consumers directly and indirectly. Not only will there be a greater choice available for consumers, but the transparency which effective competition brings should reduce the need for heavy-handed regulation."[341]

214. The Government's most recent paper proposes that the FCA should have a strategic objective "protecting and enhancing confidence in the UK" and three operational objectives:

"a. facilitating efficiency and choice in the market for financial services;

b. securing an appropriate degree of protection for consumers;

c. protecting and enhancing the integrity of the UK financial system".

In addition there should be a general provision that "The FCA must, so far as is compatible with its strategic and operational objectives, discharge its general functions in a way which promotes competition."

215. The Government claims that its approach is appropriate because:

  • it focuses on the positive outcomes of greater competition, rather than on competition per se;
  • it reflects the fact that actions taken in pursuance of any of the operational objectives may impact on competition
  • it reflects the Government's approach of providing each authority with a single strategic objective to ensure clarity of purpose and focus—given this approach, the FCA's competition mandate needs to be balanced carefully alongside its primary objective. The FCA will not be expected to pursue greater competition in a way that is incompatible with its strategic objective, or indeed any of its operational objectives;
  • furthermore, in key regulatory areas potentially impacting on competition, the PRA will have a major role, over which the FCA will have limited or no responsibility or locus —accordingly the proposed approach realistically reflects the way the FCA will be able to achieve better outcomes for consumers; and
  • it reflects the continuing role in this area of the competition authorities.

216. We are disappointed that the Government has not gone further in making competition at least one of the operational objectives of the FCA. We repeat our earlier recommendation that the FCA should have competition as a primary objective. This will benefit consumers directly and indirectly. Not only will there be a greater choice available for consumers, but the transparency which effective competition brings should reduce the need for heavy-handed regulation. We do not understand how the FCA will be able to facilitate efficiency and choice in the market while treating competition as a secondary consideration.

229   Q 42 Back

230   Ev 216 Back

231   Ev 248 Back

232   Metro Bank Website; Q462 Back

233   Ev 180 Back

234   Q 659 Back

235   Ev 175 Back

236   Qq 422-423 Back

237   Ev 220 Back

238   Q 806 Back

239   OFT, Review of barriers to entry, expansion and exit in retail banking, November 2010, p 6, para 1.10,  Back

240   Ibid., p 154, para 7.74 Back

241   Q 664 Back

242   Q 3 Back

243   Q 3 Back

244   Q 5 Back

245   Q 462 Back

246   Q 659 Back

247   Q 659 Back

248   OFT, Review of barriers to entry, expansion and exit in retail banking, November 2010, Table 7.4, p152 Back

249   Q 657 Back

250   Qq 661-662 Back

251   Q 461 Back

252   Ev w1 Back

253   Ev 230 Back

254   Ev 247 Back

255   ICB, Issues Paper: Call for Evidence, September 2010, p38, para 4.29 Back

256   Ev 216 Back

257   Ev 264 Back

258   RBS Group PLC Press Notice, RBS agrees sale of branches to Santander, 4 August 2010 Back

259   Ev 220 Back

260   Ev 183 Back

261   Ev 182 Back

262   Q 39 Back

263   Q 312 Back

264   Q 312 Back

265   Q 313 Back

266   Ev 264 Back

267   Statement by the Chancellor of the Exchequer, Alistair Darling MP, to the House of Commons, 3 November 2009 Back

268   This table shows the market shares of Santander and RBS in five retail banking markets. All numbers are market shares based on the data reported in the OFT barriers to entry study, however the credit card data is the percentage of customers who have a credit card with that provider and therefore the totals in the OFT document sums to more than 100% due to multiple product holdings. Back

269   Ev 220 Back

270   Q 39 Back

271   Ev 183 Back

272   Q 294 Back

273   Q 1155 Back

274   UKFI, UKFI Shareholder relationship framework document, Para 3.1, p2, January 2010 Back

275   Q 39 Back

276   HC 766-i, 27 January 2011, Q28 Back

277   ICB, Issues Paper: Call for evidence, Para 4.29, September 2010 Back

278   'Lloyds chief in HBOS appeal', Financial Times, 25 November 2010 Back

279   The proposed merger came into force in January 2009. Back

280   Ev 243 Back

281   Ev 243 Back

282   Q 776 Back

283   Q 791 Back

284   Q 791 Back

285   Q 793 Back

286   'Lloyds chief in HBOS appeal', Financial Times, 25 November 2010  Back

287   Q 794 Back

288   HM Government, The Coalition agreement: our programme for government, May 2010, p9 Back

289   Ev w9-10 Back

290   Q 136 Back

291   Q 88 Back

292   Q 88 Back

293   Q 1001 Back

294   Ev 186 Back

295   Q 1001 Back

296   Q 924 Back

297   Q 925, Ev 1005 Back

298   Ev w9 Back

299   Q 1005 Back

300   Ev w27 Back

301   Ev w26 Back

302   Ev w28 Back

303   Ev w26-27 Back

304   Q 1006 Back

305   Q 924 Back

306   Q 1039 Back

307   Q 1135 Back

308   Treasury Committee, Eleventh Special Report of the Session 2007-08, The run on the Rock: Government response to the Committee's Fifth Report of the Session 2007-08, HC 918, para 50 Back

309   Twenty-first Report from the European Scrutiny Committee Session 2010-11, Documents considered by the Committee on 9 March 2011, HC 428-xix, para 5.7 Back

310   Q 926 Back

311   Q 1014 Back

312   Ev w11 Back

313   Ev w45 Back

314   Q 138 Back

315   Q 89 Back

316   Q 1015 Back

317   Q 1018 Back

318   Qq 1030-1036 Back

319   HC 766-i 27 Jan 2011 Q124 Back

320   Ibid,Q 125 Back

321   Q 1095 Back

322   Q1096 Back

323   For example providers authorised in other European Economic Area States may use a 'passport' from their own stat regulatory without obtaining authorisation from the FSA. Back

324   Q 58 Back

325   Q 57 Back

326   Q 68 Back

327   Qq 101-103 Back

328   Q 818 Back

329   OFT, Review of barriers to entry, expansion and exit in retail banking, p 80, para 5.34, November 2010 Back

330   Qq 403-404 Back

331   Q 495 Back

332   Ev 214 Back

333   Q 636 Back

334   OFT, Review of barriers to entry, expansion and exit in retail banking, p 102, para 5.102, November 2010 Back

335   Ev 212 Back

336   Membership of closed user group Back

337   Q 392-396 Back

338   Q 397 Back

339   Tesco Bank raised this issue with the OFT in written evidence submitted in response to the review of barriers to entry. Back

340   Q 362 Back

341   Financial Regulation: a preliminary consideration of the Government's proposals, HC (2010-11) 430-I, para 118 Back

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