Written evidence submitted by Intellect
EXECUTIVE SUMMARY
Intellect believes that the current regulatory focus
on the banking sector in the UK must be supplemented by
a greater understanding amongst policy-makers and regulators of
the critical role that technology plays in the functioning of
this critical industry.
Technology and financial services are inextricably
linked. A durable and effective regulatory programme that tackles
the issues of competition, transparency, systemic risk, and lack
of capital for SMEs (amongst other issues) must reflect what technology
can facilitate today and, crucially, what it will enable in the
future.
Intellect believes that there are a number of competition
challenges that need to be dealt with by Government and industry
together if issues such as lack of choice for consumers are to
be rectified. These include:
— Customer
inertia—how can competition be increased (and new entrants
be encouraged to participate in the market) when customers are
not inclined to change banks?
— Poor
flows of financial risk information on SMEs—an untapped
market that banks do not currently want to tap.
— Costs
of complying with regulation and high capital requirements.
— High
cost of establishing a branch network—how can this be overcome
by new entrants?
— Banks
that are unable/unwilling to exit unprofitable markets.
Intellect believes that there are a number of ways
that competition and choice within the retail banking market could
be improved. These include:
— Individual
bank account numbers that can be taken from bank to bank—to
facilitate easier switching.
— Offer
innovative, convenient, technology-facilitated banking products
for customers that do not necessarily have to rely on a branch
network.
— Use
of innovative back-office IT to reduce up-front capital expenditure
and counter-balance other high entry costs.
— Increase
the quantity and accuracy of financial risk information (especially
on SMEs) that is collated and flows between banks.
— Engagement
with industry, via a continuing dialogue, to maximise the opportunity
for innovative technologies to improve the process - be it in
payments, online access, or, fundamental for all services, flows
of information.
1. INTELLECT
FINANCIAL SERVICES
PROGRAMME
1.1 Intellect is the UK trade association for
the IT, telecoms and electronics industries. Our members account
for over 80% of these markets and include blue-chip multinationals
as well as early stage technology companies, and play a crucial
role in virtually every aspect of our lives. In the UK these industries
together generate around 10% of GDP and 15% of trade, directly
employing over one million people.
http://www.intellectuk.org/content/view/23/3/
1.2 We are a trusted partner for Government,
both in terms of policy development and policy implementation
across numerous sectors. We look to ensure that all relevant engagement
of policymakers and regulators with industry is both easy and
as valuable as possible in order that the technology industry
may play the fundamental role it merits in the success of UK plc.
1.3 Intellect's Financial Services Programme
brings together over 150 suppliers of information systems, services
and consultancy to the financial services sector. Global IT service
providers sit alongside many specialised smaller companies and
all play an active role in imparting their expertise and experience
to better inform the development of financial services policy
at a cross roads in the industry's development.
1.4 Many of Intellect's members are heavily involved
in providing the fundamentally important technology platforms
upon which the UK's financial services industry is built. For
example, these members help facilitate the 5.7 billion automated
payments that are made through the banking system on an annual
basis. Indeed, through Intellect our members are working with
the Payments Council to develop the future technology that will
afford consumers and businesses alike more convenient, secure
and efficient ways to conduct their transactions. Similarly, the
40 million online bank accounts that are registered in the UK
would not function without the technological capability that our
members design and supply.
1.5 The relationship between the financial services
industry and the technology sector is one of fundamental importance.
Technology not only plays a critical role in the functioning of
the financial services industry, it is a hugely important factor
in ensuring that these institutions can operate more responsibly
and remain competitive in the global marketplace.
1.6 Consequently, if the UK's banking sector
is to be reformed to meet the challenges posed in recent years
and provide the backdrop to economic recovery, policy not only
needs to reflect what technology can facilitate today, but what
it will enable in the future. Regulation will only be effective
and durable if it takes into account how it will be implemented
and how the application of technology can be complementary. For
an industry like financial services that relies so heavily upon
technology, it is essential that policy is developed at all stages
with a full understanding of it.
2. INTELLECT
RESPONSE TO
THE INQUIRY'S
TERMS OF
REFERENCE
2.1 Please note: Intellect has not responded
to all the issues set out in the Inquiry's Terms of Reference.
Answers that are given to questions below are based upon Intellect's
Members' expertise in the field of financial services.
2.2 Given the word limit for this response,
Intellect is unable to cover the wide spectrum of issues in great
detail. However, more detail on issues of interest to the Select
Committee is available upon request.
3. FINANCIAL
SERVICES REFORM
& TECHNOLOGY—INEXTRICABLY
LINKED
3.1 Intellect welcomes the focus that the Government,
Independent Banking Commission and other authorities are taking
on competition within the banking sector. However it is clear
that there needs to be a shift in attitude amongst policy-makers
and regulators about the role that technology has in this particular
industry. Whether it is because of the dominance of the "traditional"
stakeholders in this industry, or a prevailing misconception that
technology is merely a means to implement legislation and is treated
as an afterthought, to date there has been insufficient attention
paid by the Government to how technology can offer solutions to
many of the challenges the financial services industry currently
faces.
3.2 Technology has played a significant role
in the development of the banking market in recent years. The
banking system as we know it would not function without the fundamental
technology platforms that underpins all activity, both customer-facing
and back office. This will continue to be the case as consumer
technology converges and organisations (not necessarily just retail
banks) develop a variety of technologies to provide banking services
to an increasingly digitally-native market. In the future, how
technology is applied will be a key differentiator between operators
in a market that is in a state of flux. Those willing and able
to embrace new technologies (both front-end and in terms of infrastructure
and back-office) will be able to adapt to accommodate changing
consumer demands and expectations. Not only can technology
reduce systemic risk and increase flows of capital to SMEs, it
can increase competition and provide a platform for new entrants
to expand within the retail banking industry.
3.3 As the UK's financial services sector is
reformed to meet the challenges posed by the recent banking crisis
and provide the backdrop to economic recovery, the development
of policy must reflect an understanding of how technology continues
to be the driver of change in the financial services industry.
Understandably there may be an inclination in some quarters to
move from principles-based regulation to a rules-based approach.
Whilst not offering arguments in favour of either, Intellect
believes that before committing to any changes to the regulatory
system, the possibilities that technology offers for increasing
competition (and increasing transparency, stability and consumer
protection) should be examined in detail by policy-makers and
the financial services industry alike.
3.4 Currently the level of understanding amongst
policy-makers and regulators about the technology systems that
provide the fundamental platforms for nearly every transaction
across the financial services industry, is poor. It is common
sense that if policy-makers and regulators are to ensure that
regulation is effective, but not unnecessarily restrictive, they
need to have an understanding how banks operate. It is now impossible
to do this without appreciating the technology that not only underpins
existing institutions in this sector, but will also underpin new
entrants to the market as well and is constantly evolving.
Intellect provides an ideal source of neutral expertise for policy
makers and regulators to tap into, representing the aggregated
expertise of the companies that provide the platforms which underpin
much of the financial services industry.
4. BARRIERS TO
ENTRY AND
TECHNOLOGY SOLUTIONS
4.1 As outlined above, the application of technology
will afford new entrants the opportunity to build up a foot print
within the retail banking market. This increase in competition
will have resulting benefits for customers (both individuals and
SMEs) and will have the effect of diversifying the risk that is
posed to an economy that has been overly reliant upon a small
number of large banks.
4.2 Intellect believes that there are a number
of competition challenges that policy-makers will have to deal
with over the coming months. However, more often than not there
is a technology solution that can complement or even reduce the
need for regulatory activity. Some of these challenges and solutions
are set out below:
Customer inertia
4.3 Both the Office of Fair Trading and HM Treasury
have identified customer inertia as a key barrier to competition
within the retail banking industry. As noted in HM Treasury's
Reforming Financial Markets consultation paper of 2009, both the
reality and the perception of the difficulty of switching bank
accounts increase customer inertia. Nearly two-thirds of people
have held their current account for more than 10 years and 60%
of people are still using the first current account that they
ever opened (HM Treasury).
4.3.1 In the banking sector especially, customer
inertia represents a significant challenge not only to potential
new entrants, but to any provider of financial services that is
looking to expand their customer base. If banking providers are
aware that customers are more inclined to stay with them than
leave, then there is less motivation to ensure that its customers
are its number one priority. However, there are a number of technology-based
means to reduce customer inertia:
Individual, portable bank account numbers
4.3.2 Intellect believes that by creating a bank
account number that is specific to the individual rather than
the bank and that could also be transferred from one bank to another,
market stagnation that results from customer inertia will be alleviated
to a significant degree and competition within the banking sector
will be enhanced (with knock on benefits for the availability
of capital for SMEs and individuals - through greater choice).
There has been significant regulatory focus in recent years on
the porting of individual phone numbers as a means to increase
competition in the mobile phone industry and from April 2011,
mobile phone customers will be able to transfer their existing
number to a new provider in just one working day rather than the
current two days. That switching of bank accounts takes a matter
of weeks, not days and is a significant barrier to competition
suggests that this should be a priority issue for Government.
"3 Cs" technology-facilitated products
4.3.3 By using technology to provide banking
products and services of convenience to their customers, such
as mobile payments, online banking and use of social media, financial
services providers will challenge customer inertia in some sectors
of the market where "digitally native" consumers look
for banking services that encompass the "3 Cs" - Customer
Focused; Convenient and Converged. The development of these
products will ideally be demand-led. Those banking providers that
are able to accurately anaylse customer sentiment and quickly
develop technology-enabled products that cater for a relevant
market sector will find that they are in a good position to increase
their market share. The challenge for established banks (as outlined
below) is that their legacy IT systems, which are comprised of
layer upon layer of IT platforms that have been built upon over
many years, do not easily allow new systems for new products to
be easily added without significant disruption to existing services.
New entrants will find that because of their "technological
blank slate" they are more agile when it comes to rolling
out innovative technology-led services for their customers.
Flexible and efficient payment systems
4.3.4 The main objectives for new entrants into
the banking sector will be simplification, quality of service
and lowering costs. It is anticipated that new entrants, because
of their technological blank slate, will drive towards integrated
systems that can handle payments from any channel, whether consumer
or corporate, from start to finish—with no redundancy of
technology or duplication of processes and labour. This type of
integration will enable financial institutions to manage transactions
quickly and effectively, with less need for manual intervention
and costly interfaces between different systems. Crucially, it
will allow these new entrants to consider all payment forms -
from smart phone applications to contactless payments - based
on customer demand. This will be tied in with the likelihood that
new entrants will turn away from large traditional back office
IT departments which require an initial high outlay of capital,
to outsourced IT operations that can expand as the new entrant
expands. Increased use of Software as a Service (SaaS) and cloud
computing, provided by IT outsourcers directly to new lenders,
will mean that their services are scalable, easily updatable and
importantly, new entrants will only pay for what they use. In
the short to medium term this will represent significant cost
savings as new entrants will be able to "rent" the services
they require without any upfront capital costs.
Costs of compliance and capital requirements
4.4 With such a wide ranging raft of regulation
on the horizon, all of which requiring changes of varying cost
to individual financial services providers' internal systems,
coupled with the huge cost that capital reforms (Basel III) will
have across the industry, the drain on resources is going to be
acute over the coming months and years. Such high costs, in addition
to the costs of setting up a bank, will act as a deterrent to
entry to potential new entrants to the retail banking market.
4.4.1 It is therefore critical that if new entrants
are to be encouraged to participate in the retail banking market,
that they are not over burdened with compliance costs for regulation
whose objectives could be achieved through other means. Lessons
can be learned from recent regulation which, in some cases, is
still being implemented. The estimated costs of changes to the
IT infrastructure of deposit takers to implement the Financial
Services Compensation Scheme's Single Customer View (SCV) initiative
- circa £1 billion - is huge. Although Intellect welcomes
technology investment by financial institutions, there is a question
whether the requirements of the FSCS's SCV could have been met
by the commercially focused SCV that many banks were already working
towards, with a reduction in associated compliance costs. New
entrants, if they are to comply with this specific legislation
and develop a means to better identify their individual customers,
will therefore have to pay to implement two versions of a Single
Customer View.
4.4.2 Whilst Intellect fully supports regulatory
efforts to improve the stability, transparency and performance
of the financial services industry, we believe there is a responsibility
for regulators and industry to take a broader view of how proposed
policy/regulation is going to be implemented in reality - especially
with regard to likely impact that changes will have upon financial
service providers' IT systems. This should be undertaken at
an early stage to avoid unnecessarily expensive or time-consuming
changes that could further add to the start-up costs for potential
new entrants, and indeed reduce disruption to existing institutions,
the market and customers. A means to achieve this could be through
an adaption of Intellect's Government-supported Concept Viability
scheme.
Inability of established banks to exit specific
markets
4.5 One of the major obstacles to competition
in the banking sector stems from a specific barrier to exit -
large incumbent banks offering products and services that are
loss leaders, but whom are unable/unwilling to exit the market
for these products and consequently allow other actors to enter
and expand.
4.5.1 As banks on the most part do not employ
detailed analytics that can offer information on product profitability
they are, in many cases, unable to determine which products to
discontinue and which to actively promote. Amongst other reasons,
products may be failing because they do not reflect the needs
of customers or that they may not be targeted at the right sectors
of the market. However, the real issue is that a market awash
with similar products combined with a public that is, generally
speaking, more inclined to take up products from their incumbent
banking provider than shop around (regardless of whether or not
these products are the best fit for them), makes it hard for new
entrants to compete on a level playing field and gain a foothold
in the banking market. If banks can be encouraged to identify
their unprofitable products, it would be better for them, the
wider market and the consumer.
4.5.2 Where products have been removed from a
market, there has not been enough importance attached to learning
how and why these projects failed. By establishing what could
be done better, there is an opportunity to ensure that new entrants
to the retail banking market can offer technology-facilitated
banking products and services with a reduced chance of them failing.
Product failure at an early stage of a new entrants' existence
could also have significant negative consequences on its reputation,
its resources and its ability to gain a foothold in the retail
banking market.
4.5.3 Intellect believes that there could be
a role for regulators to ask banking providers for their views
on why particular projects did not succeed so that the wider market,
and indeed the consumer, can benefit from this hindsight. Similarly,
for the sake of greater competition and efficiency, Intellect
believes that retail banks should be encouraged to actively
evaluate the performance of their products in this sector. State-owned
retail banks should, in the interests of reducing costs, be compelled
to do so. In both instances, a short term investment in appropriate
analytics software would be required, but the longer term savings
made from leaving unprofitable markets and greater insight on
how to target more profitable products would justify this expenditure
many times over.
Legacy systems
4.6 In the instance that an unprofitable product
is identified, it is often difficult for banks to remove them
from the market because of the effect that doing so would have
upon their interdependent legacy IT systems. These legacy systems,
the multiple layers of IT platforms within banks that have been
built upon over many years, are at the heart of established financial
service providers' operations. They are business critical, intertwined
with other elements of a bank's IT infrastructure and are often
running 24 hours a day. Adding new elements or removing them from
these legacy systems (ie to remove IT systems that facilitate
specific banking products or services) is a very complex and expensive
process that will impact upon a multitude of different aspects
of the bank's operations. In many cases it is not in the broader
interests of a bank to remove a product from the market because
of the costs and the disturbance to core systems that unwinding
these un-needed systems would incur.
4.6.1 A lack of information about the performance
of specific products can be addressed more easily than the issue
of IT legacy systems. For this very reason Intellect believes
that regulators should do more to understand the impact that
legacy systems have upon banks' abilities to provide high standards
of customer service and remove loss-making products from the market.
Incentives, such as capital tax breaks, could be made for banks
to replace their ageing legacy systems and allow them to become
more efficient and customer friendly. For state-owned banks, a
reduction in the repayment of public debt could be made in the
immediate term so that investment could be made in banks' IT systems.
This would allow a quicker repayment of public money in the medium
term as the banks become more efficient and more commercially
viable.
4.6.2 However, as outlined above, where legacy
IT systems reduce established banks' abilities to innovate, their
existence does provide a significant opportunity for new entrants
to the retail banking market to establish a foothold. Every year,
banks invest hundreds of millions of pounds in new technology,
yet it can take years before a new product reaches the consumer.
New entrants without these legacy systems hold a distinct advantage
as they are able to adapt quickly to changing customer demands
or the availability of new technology.
FSA licensing regime - auditing of ICT suppliers
4.7 Intellect fully supports the "litmus-testing"
of organisations wanting to enter or expand their provision of
banking services and the protection of the customer (and of the
wider economy) is of paramount importance.
4.7.1 However, Intellect does believe that there
should be a balance between transparent and appropriate auditing
of suppliers to potential entrants in the retail banking market,
and unnecessary and costly oversight that prolongs the licensing
process (extending "go to market" time for the entrant)
and which ultimately will itself act as a barrier to entry. The
role that the Financial Services Authority (FSA) currently plays,
whilst necessary, should be evaluated and refined where appropriate
(especially if this role is passed on to a new prudential regulator
within the Bank of England) to ensure that it does not suffer
from "mission-creep". A specific issue is the FSA's
"adopted" role of scrutinising the contractual relationships
between the market entrant and its service suppliers - especially
ICT suppliers that supply its systems and infrastructure. This
could potentially cause a barrier to entry as the FSA does not
have the necessary level of technical expertise to adjudge what
ICT technology is appropriate, what represents a satisfactory
level of risk and what is in the consumers' best interests with
regards to ICT provision. A solution to this would be the development
within the FSA (and its successor) of a greater level of technology-based
knowledge amongst relevant staff. Intellect provides an ideal
source of neutral expertise for policy makers and regulators to
tap into, representing the aggregated expertise of the companies
that provide the platforms which underpin much of the financial
services industry.
4.7.2 This prolonged time frame, as a result
of increased FSA scrutiny, could also have the effect of discouraging
smaller ICT providers from forming commercial relationships with
prospective and new entrants to the retail banking sector. It
is simply not as profitable for smaller ICT providers to be involved
in such projects as it would be for them to be involved in other,
less scrutinised markets. If it is taken that innovative IT-enabled
customer services and infrastructure are important to new entrants'
entry and expansion in order to differentiate themselves from
incumbents a reduced field of suppliers to choose from will harm
this ability. The public sector has, in recent years, seen a similar
problem where smaller, innovative suppliers were discouraged from
tendering for government contracts because of the costs of embarking
on a time consuming and administration-heavy process. There is
a danger that through increased regulatory scrutiny of ICT suppliers,
the financial services industry could be sleep-walking into a
similar situation.
5. THE ACQUISITION
OF SME CUSTOMERS—AN
UNTAPPED MARKET
FOR NEW
ENTRANTS?
5.1 Intellect acknowledges that the limited availability
of capital for SMEs from banks is a separate (but related), ongoing
concern for Government at the current time. However, it is also
the case that by addressing this issue, a side benefit could be
an increase of competition within the banking sector.
5.2 Financial services organisations generally
have a good track record on information sharing. For example,
the advent of increasing customer applications for credit, have
heightened the industry's interest in information sharing. Furthermore,
collaborative events to tackle financial crime have increased
the speed in which information sharing can take place. However,
these incidences typically relate to data sharing on individuals,
a similar flow of information between institutions on potential
SME customers is not nearly as developed. Generally, ) larger
incumbent banks have been guilty of viewing SMEs as one large
group (or groups by sector & size), all posing the same level
of risk regardless of their own specific business models, financial
health etc. This has led to a reduction in the availability and
cost of credit to SMEs - a lack of detailed information sharing
on SMEs has led to risk-averse banks becoming even less likely
to lend to SMEs, and the conditions that are attached to the loans
that they are willing to make are often so high that they do not
represent realistic options for SMEs.
5.3 Now, more than ever, it is critical that
access to financial risk information is available to all operators
in the financial services market. On a general level, higher levels
of data interoperability can facilitate better credit flows between
banks, ensure greater accuracy of data and consequently more informed
decisions on lending can be made. Technology has a crucial
role in facilitating the flow of credit to individuals and SMEs
in the UK, but has to be accompanied by a change in mindset within
the banking community - ie that SME's are an important source
of business for the retail banking industry, and that the availability
of credit will beget more business for banks that are willing
(and able) to lend to them.
5.4 The challenge for smaller and new entrants
to the retail banking sector is to expand their information base
to gain as comprehensive a picture of their potential SME customers
as possible. If the range and quality of information that can
be gleaned can be increased, not just from potential customers
but also from other financial institutions, smaller and newly
established banks will be able to make more informed decisions
about who they lend money to in the SME sector and, in theory,
acquire more SME customers. In order to achieve this, data interoperability
standards across the financial services ecosystem need to improve
significantly.
5.5 Additionally, the issue of data accuracy
is also applicable here. However effective the ability to share
information might become, it can only be as useful as the accuracy
of the information being shared. The greater the ability to make
an accurate assessment of the credit worthiness of individual
SMEs, the greater the ability of new or less-established entrants
to attract more commercially-viable business from SMEs. This will
lead to greater competition and choice in the banking sector,
with a beneficial effect on the UK economy in the longer term.
Lack of a Single Customer View (SCV)
5.6 Competition in the retail banking sector
will be restricted if new entrants are unable to form a SCV of
their individual SME customers. As outlined above, a SCV is a
longstanding commercial aim of the retail banking industry and
will allow lenders to not only build up a detailed view of a customer's
individual credit risk, but also to identify other services and
products that can be sold to the customer. It is equally important
to have a similar SCV of SME customers if a new entrant is seeking
to grow its business. Generally, in the experience of Intellect's
members, new entrants in the retail banking field do not have
a common facility management system in place that can facilitate
a single point of access to information about a specific SME customer.
Consequently they are not as adept as more established operators
at spotting risk, increasing processing efficiencies and generally
providing customers with a more tailored customer service. This
has a knock on effect on customer retention and growth of existing
customer business.
5.6.1 The simple solution to this is that a common
loan origination system should be in place for all new entrants
to the retail banking sector. If better flows of information between
banks on SMEs can be supplemented by better use of information
within individual banks, it will have benefits for the banks themselves,
SMEs and ultimately the economy.
6. CONCLUSIONS
6.1 Intellect believes that three is currently
an opportunity to ensure that efforts to safeguard the future
safety of the wider financial services sector also act as a catalyst
for greater competition and benefit for consumers. As Intellect
has looked to demonstrate in this submission, technology must
be the foundation upon which competition is enabled—as it
is the foundation upon which the banking sector is already built
and upon which it will continue to be developed.
6.2 The aim for all parties must be to facilitate
a retail banking market that encourages participation from new
entrants, has unhindered opportunities for expansion and does
not artificially block retirement from specific markets for banks
or products that are commercially unsustainable.
6.3 Intellect would urge the Treasury Select
Committee to recommend that the Government thinks laterally in
its approach to competition in the banking sector (as new entrants
to the retail banking market will be doing). It should consider:
— A greater focus on the
fundamental technology platforms that the banking system is built
upon, as a means to increase competition. The appropriate application
of technology within the banking sector will go a long way to
increasing competition and it should be considered alongside and,
potentially, instead of some legislative remedies.
— A greater focus on increasing
the quality of the analysis and flows of information, both within
and between banks.
— Ensuring that financial
services regulators and policy makers have a greater understanding
of how technology impacts upon the functioning of the banking
sector.
6.4 Those banking providers that are able to
harness convenient, demand-led banking products, greater analysis/information
and cost efficiencies that the application of technology can bring,
will give themselves a greater chance of establishing themselves
in this market. This is to the benefit of the consumer, the shareholder
and, of course, UK plc.
September 2010
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