Conclusions and recommendations
The landscape of retail banking in the UK
1. The
financial crisis has resulted in significant consolidation of
the UK retail market. Well known firms such as HBOS, Alliance
& Leicester and Bradford and Bingley have either exited the
market or merged with rival firms. A large number of building
societies have merged, undermining the diversity of provision
in the sector. Whilst these 'rescues' were necessary in order
to preserve financial stability, the consequence has been to reduce
competition and choice in the market. (Paragraph 27)
2. There
has been a clear increase in concentration levels in parts of
the retail market. Indeed, concentration in many sectors of the
market is now higher than when Sir Donald Cruickshank examined
competition in retail banking, particularly in the personal current
account and SME markets. The five large banks—Lloyds Banking
Group, RBS, Barclays, HSBC and Santander—have an overwhelming
85% share of the personal current account market. In 2008 the
market for SME liquidity services was dominated by just four firms
who shared 80% of the market. Other parts of the retail market
such as those for savings products and loans, where the number
of participants is larger, are less concentrated. (Paragraph 38)
3. Whilst
the level of concentration is just one measure of competition
in a market, it is important. Concentrated markets also make it
easier for firms to collude by making it easier for competitors
to monitor each other. If banks imitate the products and services
of their competitors the intensity of competition is reduced and
this can lead to a consumer perception that there is no real difference
in the products and services of the major banks. (Paragraph 39)
4. Lloyds
Banking Group said utilities, grocery retail and mobile telecommunications
are more concentrated than the retail banking sector. However,
we note that all the industries highlighted for comparison are
either directly regulated (such as utilities) or have themselves
been subject to multiple competition inquiries and regulatory
interventions (grocery retail, mobile telecommunications, retail
broadband and Pay TV). (Paragraph 43)
5. We
disagree strongly with the assertion that the UK retail banking
market is contestable. A market is contestable if entry and exit
barriers are low and whilst this may be the case in certain parts
of the retail market, it does not appear to be the case in parts
of the personal current account and SME markets. Furthermore,
the financial crisis has demonstrated that exit barriers in the
UK banking market are anything but low. (Paragraph 44)
6. We
note the argument of the large banks that there is no necessary
link between concentration levels and the degree of effective
competition. Indeed, we agree that certain markets are highly
competitive whilst on some measures also being highly concentrated.
Nevertheless, the bulk of our evidence argued that the banking
market was not competitive. Like the Independent Commission on
Banking we consider there is "a tendency, all else equal,
for markets to be less competitive when more concentrated";
it is legitimate to be concerned about the state of competition
in the retail banking sector. (Paragraph 50)
7. Competition
policy should maximise the benefit to the consumer. Our evidence
suggests that this is not happening. The large banks perform poorly
on many consumer satisfaction surveys relative to other providers.
Survey evidence consistently shows customers are dissatisfied
by service quality and the lack of real choice on offer in the
marketplace. In a genuinely competitive market we would expect
firms which provide superior service, choice or prices to gain
significant market share from rival firms, but we see little evidence
that this is happening. (Paragraph 58)
8. The
large banks have told us that ultimately consumers will benefit
from lower prices resulting from the economies of scale and synergies
provided by larger more diversified banks. We agree that there
are economies of scale/minimum efficient scale in retail banking
which will ultimately limit the total number of firms in the market.
However, we question whether the need for economies of scale justifies
banks having a 30% share of the market or whether such benefits,
if they exist, will be passed onto consumers in a market where
competition is deficient. Indeed, such economies of scale benefits
are likely to be outweighed by the negative impact on competition
by those providers who are perceived to be 'too big to fail'.
(Paragraph 61)
The current account market and switching
9. We
are concerned by the significant increase in concentration in
the personal current account market in particular and the dominance
of a handful of large banks. Despite the larger banks' protestations,
we consider the current account remains a "gateway"
product which means dominance in this market by the large banks
has competition implications elsewhere in the sector. This means
that barriers to competition in the personal current account market
need to be scrutinised particularly carefully. (Paragraph 65)
10. The
distinguished list of financial services experts unable to tell
us the cost to them of their current account indicates a serious
problem. If they cannot estimate the cost of their accounts, we
hold little hope that members of the public are able to do so.
Greater disclosure of information on cost is a pre-condition to
greater competition in this market. (Paragraph 77)
11. So-called
free banking is not free. The term free-in-credit banking is a
misnomer, given that consumers with positive balances pay through
interest foregone. It misleads the consumer. It is also clear
that so-called free banking has important distributional consequences.
A minority of consumers, often those on lower incomes, pay explicit
charges associated with overdrafts. This results in high prices
and poor outcomes for a sub-set of consumers. Meanwhile, other
consumers, often on higher-incomes do not pay explicitly for their
current account provision, in spite of the fact that their PCA
provision clearly does incur a cost to the provider. Whilst it
is undesirable from the perspective of 'fairness', cross-subsidy
is not always wrong. For example, cross-subsidy exists in the
airline industry where customers who book early are cross-subsidised
by those who book later. However, pricing is far more transparent
and customers can easily switch airline provider. These conditions
are not currently present in the personal current account where
cross-subsidy is opaque and switching costs are high. (Paragraph
80)
12. Sir
Donald Cruickshank identified problems with price transparency
and the difficulty of comparing products in his 2000 report on
competition in the banking sector. Over a decade on those problems
remain acute. The OFT is working with the banks to try to ensure
greater transparency. It is vitally important to ensure information
is provided in a way which enables meaningful comparability. We
believe that, as a matter of priority, the OFT and the banks must
examine how best to present information to consumers on net interest
foregone. 'Information overload'—the tendency to simply
'flood' consumers with information, acting to increase consumer
inertia must be avoided. (Paragraph 87)
13. The
predominance of so-called free banking in the UK appears to suggest
a clear consumer preference for this particular model. However,
consumers are not provided with sufficient information about charges
to make an informed choice. The predominance of this model prejudices
competition in the personal current account market by obscuring
those costs, and probably also by increasing the advantages enjoyed
by existing banks. Greater transparency will alter consumer behaviour
not least by revealing the hidden charges inherent in the free-in-credit
model. Complex regulatory interventions in the market to constrain
free banking could well be counterproductive to competition and
are likely to increase costs to business and the consumer. However
measures to increase transparency do not carry these disadvantages.
We strongly support the OFT's efforts to improve the information
that banks give on costs and charges. We recommend that the Independent
Commission on Banking should examine the impact of free-in-credit
banking on competition in the personal current account market,
and, in particular, what is appropriate action to ensure the provision
of adequate information to consumers to enable them to make meaningful
choices. (Paragraph 98)
14. Given
that a much greater share of the market is likely to be taken
in by the internet in later years it is surprising how little
work has been done to improve security, and the lack of detail
apparently available to the police concerned us. We recommend
that the regulatory and competition authorities return to this.
(Paragraph 109)
15. Competition
can only be effective if consumers feel confident in switching
to new providers. Although there is evidence that the system has
improved, the perception remains that there are still risks involved
in switching, and levels of switching remain low. We believe it
should be possible to find technical ways of making switching
easier without excessive cost—one such suggestion has already
been submitted by Cut Loose. We recommend an independent technical
study should be done into how account portability could operate.
There are also ways in which switching can be made easier without
new technical infrastructure. These need to be explored more urgently
by the regulator. This should include provisions that the provider,
not the customer, should be penalised if things go wrong. (Paragraph
121)
Competition for SME business
16. The
Merlin Agreement is welcome. We hope that it does deliver the
amount of SME lending that it promises, and given that there remains
scepticism about this we shall examine the Bank of England's reports
carefully. We are also concerned that the FSA's requirements on
capital may inhibit the lending that is needed. (Paragraph 130)
17. The
debate on SME banking has often only been focused on the availability
and cost of credit. Good customer service for SMEs can be as,
or even more, important to SMEs. Competition and the ability to
switch, is the most important spur to better service. (Paragraph
134)
18. There
are still very high levels of market concentration for SME banking
even though the sale of some of the RBS branches to Santander
means the 'Big 4' in the SME sector could in future become the
'Big 5'. Two 'challenger' banks which were cited in 2007 as a
sign of improving competition have since been subsumed into larger
banks. (Paragraph 135)
19. The
importance of branches to many SME customers presents a significant
barrier to new entrants and therefore to competition. We recommend
that the Independent Commission on Banking considers solutions
such as an improved Inter Bank Agency Agreement and neutral shared
branches as part of its remit to promote competition in banking.
(Paragraph 139)
20. Potential
entrants to the SME market are faced with the same problems of
customer inertia and fear of the switching process as face those
entering the personal current account market. SMEs need access
to a branch network and staff who understand their circumstances.
It is unsurprising that the growth of new entrants in this market
is slow. It is all the more important that Government policies
positively encourage them and are designed in ways that recognise
the challenges they face. (Paragraph 142)
21. While
we welcome the Government initiatives to increase equity investments,
they are very small in comparison to the £10 billion extra
lending pledged from large banks as part of the 'Merlin' agreement.
Non-bank funding such as equity or web based lending may increase
the competitive pressures on banks but there may be limits to
their attractiveness. SME owners may not wish to dilute their
equity or may find debt financing more tax effective; lenders
may consider direct lending to small businesses unduly risky.
We recommend that the Independent Commission on Banking consider
the extent to which non-bank lending can offer competition for
banks and whether there are ways to increase the attractiveness
of other sources of financing. In particular they should consider
the effects of the regulatory and fiscal framework—such
as the different tax treatment for debt and equity. (Paragraph
146)
Encouraging greater competition and new entry
22. 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. (Paragraph 156)
23. 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.
(Paragraph 157)
24. 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. (Paragraph 167)
25. 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. (Paragraph 168)
26. 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. (Paragraph 173)
27.
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. (Paragraph 174)
28. 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. (Paragraph
180)
29. 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. (Paragraph 181)
30. 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."
(Paragraph 188)
31. 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. (Paragraph 189)
32. 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. (Paragraph 196)
33. 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. (Paragraph 205)
34. 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. (Paragraph
208)
35. 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. (Paragraph 212)
36. 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. (Paragraph 216)
Barriers to exit
37. Banks
which are seen as too important to fail are also too big for fair
competition. They receive an implicit subsidy to their funding
costs placing them at an unfair competitive advantage to other
smaller and less systemically important banks. It also means that
providers who offer poorer quality or over-priced products face
little threat of being forced out of the market, as they would
do in any other industry. Solving the too big to fail problem
is critically important from a competition as well as a financial
stability perspective. The Independent Commission on Banking must
address this problem which is crucial to achieving the objectives
outlined in its terms of reference. We are encouraged by signs
that it is already considering ring fencing as a possible solution
which would provide a more level playing field to all market participants.
Furthermore, we expect the Government to respond to our predecessor
Committee's Report on this issue when it responds to the ICB.
(Paragraph 222)
38. Our
inquiry has led us to conclude that further measures are required
to promote competition in the retail banking sector and ensure
improved outcomes for consumers. Poor consumer outcomes can be
addressed by reducing barriers to entry and expansion—in
order to promote greater competition between existing players
and to encourage new entry. A focus on tackling concentration
without tackling these issues would do little to promote a more
competitive market. New and expanding entrants will only succeed
in growing in key markets, such as the current account and SME
markets, if impediments to their expansion—primarily problems
with switching and the lack of transparency and comparability—are
tackled. (Paragraph 223)
39. New
entry and reductions in barriers to entry and expansion may alone
prove insufficient to tackle the problem of ineffective competition.
As a result, we would urge the Independent Commission on Banking
to also seriously examine whether there is a case for further
structural reforms, over and above the RBS and Lloyds Banking
Group divestments, to reduce concentration and promote competition.
In particular, we call on the Commission to ensure that the Government's
need to maximise revenue from the sale of the wholly or partly-state
owned banks does not trump the creation of a more competitive
environment or a more resilient banking sector. Indeed we believe
that such a trade off does not exist in the long run—maximising
competition through the divestments will ultimately bring longer-term
economic benefits to the UK through a higher overall GDP and subsequent
higher tax yield. (Paragraph 224)
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