Competition and choice in retail banking - Treasury Contents


Written evidence submitted by Consumer Focus

Consumer Focus is the statutory organisation campaigning for a fair deal for consumers in England, Wales, Scotland, and, for postal services, Northern Ireland. We are the voice of the consumer and work to secure a fair deal on their behalf.

We welcome the opportunity to provide evidence to the committee.

EXECUTIVE SUMMARY

Global and domestic financial policy and the impacts of the recession have resulted in the market constricting. Prevailing bank models, and the dominance of the major combined institutions, have increased moral hazard, prevented new entry and restricted choice. In looking at competition and choice in the banking sector we ask the Treasury Committee to consider the following as crucial to reform:

  • Encouragement of new models (not just new entrants) and consumer oriented innovation, including retail only models, that both provide real choice and safety for consumers.
  • Promoting a fair and competitive market place, one that ensures that consumers can have confidence in and exert choice to influence the sector through increasing transparency, providing early intervention in relation to unsafe or unsustainable products, safeguarding consumer interests and ensuring accessible and appropriate redress.
  • Guaranteeing the provision of essential services where it is clear that the market will not provide and tackling problems of social exclusion by addressing the needs of the vulnerable and disadvantaged.
  • Enhancing the social usefulness of the market by supporting a savings culture, reducing risk, and securing sustainability of financial services in a broad sense—economically, environmentally and socially.

1.  Assess the impact of the financial crisis on competition and choice in both retail and wholesale markets

1.1  In a sector that thrives on virtual products, confidence can make or break a market. Addressing people's low expectation of the sector is crucial,[1] particularly to promote the savings and banked environment necessary to replenish capital stocks and give customers confidence in exercising choice. For low income consumers a lack of trust is the primary impediment to being banked. The majority of customers without a bank account are in this position because they've had bank accounts previously and had a bad experience; or they simply don't trust the banks with their money.[2]

1.2  The market has become more concentrated, with bank failures, mergers, and state support for some major players resulting in less choice for consumers and more barriers to entry. The failure of companies like Icesave will add to the concerns about whether a new entrant can be trusted, particularly in times of crisis. There may also be a reluctance to move to new or small providers because consumers know the Government will bail out the big banks. More work needs to be done to determine how this may impact customer choices and what assurances need to be provided in relation to new entrants.

1.3  However, it is clear that some providers have benefited from consumers' lack of trust with the main providers, with the increased popularity of co-operative models and the increasing success of peer to peer platforms such as Zopa. Competition and consumer choice in this area needs to be facilitated by removing barriers to these new models and extending the appropriate assurances and guarantees.

2.  Assess the impact of widespread consolidation among banks and mutuals

2.1  The consolidation that has resulted from both global and UK financial services policy has led to a lack of diversity of models. Our recent research shows that a significant proportion of people are reluctant to switch banks because they feel there is little difference between them.[3]

2.2  Combined banking models standardise operations across their branch networks in pursuit of a "single customer view". This can make it too costly or difficult for banks to service "hard to reach" parts of the market or assess and respond to the needs of local communities and enterprises. Prices for basic services (credit, overdraft charges) have gone up while rewards for savings have gone down. Services are increasingly being withdrawn from the less profitable markets or segments while the proportion of the population rendered vulnerable by the financial crisis has increased.

2.3  Low income consumers and those who are unbanked cite the failure of the sector to cater for them, the lack of options that would provide them with a functional service that allowed them to manage their finances, and the prevailing model of hidden charges, as impediments to banking and choice.[4] Without the encouragement of different models banking will become an exclusive service for the well-off.[5]

3.  Examine the key barriers to entry inhibiting increased competition—including regulation

3.1  The impediments to competition identified in the Cruickshank report[6] have not gone away, and in fact may be more significant as a result of the recession, and therefore need revisiting and updating.

Regulation

3.2  New entrants have a significant role in changing business models and delivering value for money. We suggest consideration of more stratified regulatory approaches for different models or activity. The EU requirements for Deposit Guarantees, which permits exclusions for certain categories of authorised firms such as Credit Unions, Friendly Societies and independent intermediaries, go some way towards recognising this—as does the regulatory regime for Credit Unions more generally.

3.3  The existence of separate regulatory processes for credit and deposit taking activities adds to the cost of the application process and the subsequent regulatory burden for those wanting to carry out both activities. The current authorisation process for deposit taking activities is complex and lengthy and the requirements designed to avoid risk may also act as a deterrent to new entrants. Market evidence, reputational and consumer protection issues are not given the same emphasis they receive in consumer credit licensing. More attention to these areas across the board may deliver a better balance of offerings.

3.4  Where there have been new entrants they have tended to adopt old models, given the cost and complexity of creating branch networks and infrastructure from scratch. It seems far easier to get authorisation if you buy off the rack rather than tailor to needs, hence the takeover of existing shells or mergers rather than stand alone applications.[7] Assessments seem to favour those who take over existing networks or old systems as being better equipped. This is in effect stifles innovation and new approaches and creates the further challenge of absorbing and integrating existing branches and updating information technology systems.

Payment systems

3.5  New technology should offer great opportunities for new business models, small operators and more efficient and convenient payments methods. Firms' investment plans for information technology are broadly flat for the next 12 months, while the balance for those planning to spend more on marketing in the coming year has risen to +53%, the highest in 10 years.[8] The Faster Payments Service (FPS) is the first new payments service to be introduced in the UK for 20 years,[9] but despite three years of operation it still does not do what it says on the label. The reason often cited for lack of innovation is the slowness of systems to respond and the difficulties of unifying and upgrading these, particularly post merger and acquisition.

3.6  The Cruickshank Review identified profound competition problems and inefficiencies in the market for payment services.[10] Issues such as slow clearing cycles for cheques and automated payments, high charges for cash withdrawals and interchange fees levied by monopoly providers still prevail despite some improvements leveraged by the Payments Council.

3.7  The Payments Council is dominated by the major financial institutions and needs to do more to lead the future development of services. Historically, innovations have disproportionately arisen from small companies, however small stakeholders expressed a measure of dissatisfaction with the access and support they received from the Payments Council when proposing innovations.[11] More pro-active work in supporting innovation and overseeing adoption, and a more inclusive membership structure to enable entry to payment providers that are not financial institutions, is needed to remove barriers to innovation and market entry.

3.8  New payment methods, and in particular payment methods that may actually benefit consumers, must be fostered within the system rather than developing outside it. For example, there is support for the widespread introduction of contactless and prepaid cards which are easy to use and accessible. Prepaid cards in particular offer a number of opportunities to financially excluded consumers, particularly those without a bank account or those who are reluctant to use a standard current or basic bank account to its full potential. Being able to transfer a set amount of money onto a prepaid card can potentially help them to manage their budgeting needs while at the same time allowing them to use ATMs, buy goods on-line or over the phone or use the cash-back facility in shops. There are no credit checks and no fees for going overdrawn.

3.9  The Payments Council has been monitoring the market and has agreed to review this again by the end of 2011. Mobile payments are also being monitored. It is likely to mean that these methods will develop without consistent standards and consumer protections or will be left without support in a market that has been slow to adopt them. These systems are likely to offer less costly alternatives for small or new entrants.

3.10  There is a lack of offerings to attract customers or to distinguish financial institutions. Customers want to be able to manage their payments and so it is important that there is more certainty about clearing times and a firm commitment to a consistent service in relation to electronic transactions, as well as a range of payment options that are customer-controlled. Customer-controlled payments are a feature of the payment systems of other countries and our research has indicated that these options are key for consumers.[12]

Clearing fees

3.11  Highly concentrated markets, particularly for credit card acquiring, may enable incumbent banks to restrict new entry and charge high card fees.[13] Fees set, essentially by the two main providers Visa and Mastercard, are well in excess of the cost of processing the transactions, and contribute to rising prices and restrictions on access to these systems.[14] Large financial institutions are in a much better position to negotiate these charges whereas small organisations would not have this leverage.

3.12  Interchange fees are also an issue for ATM access and may discourage new entrants and provide impediments to alternative providers or providers of services to low income consumers. Interchange fees are likely to be an issue in DWP's willingness to offer LINK ATM access to Post Office Current Account users. Interchange fees may also be a barrier to the remaining banks offering Post Office counter access, and therefore to improving provision in areas poorly served by banks at present (eg rural and urban deprived areas).

4.  Examine whether competition is inhibited by difficulties faced by customers in accessing information about products

4.1  Most financial products, by their nature, may not be conducive to market pressure as they are purchased infrequently and their impact is often long term. The complexity and sheer volume of offerings, charging structures, and the difficulty in comparing products create further impediments to demand-side drivers. The OFT studies in relation to the current account market show that there is a lack of readily available information on the various charges involved and this is exacerbated by use of different terminology and different ways of presenting rates and charges.[15]

4.2  In the area of product regulation, the Mortgage Market Review Discussion Paper proposals[16] and the policy paper on Distribution of Retail investments[17] will help build consumer confidence that products and services are safe and fit for purpose in terms of affordability and risk. Intervention of this nature is needed at least in the short term to ensure transparency of information, some standardisation of products, and to restore balance to markets. Where there are choices they should be clear, transparent and safe.

4.3  Consumers generally would welcome a set of basic and safe products that met their needs.[18] Basic bank accounts (BBAs) are important as a potential entry level product and for those on low incomes. Their appeal might be more universal, and less stigmatised, if some of the shortcomings were addressed. These include practised and perceptual barriers to opening accounts, the gap between essential account features and the functionality some BBAs offer (or don't offer) and the perceived and actual risks associated with operating such an account.[19] These products should be readily available, not collecting dust because of lack of sales incentives, and they should not be treated as second-class products.

5.  Explore the Government and competition authorities' strategy to increase competition in banking, including the likelihood that new entrants will successfully enter the market

Public policy initiatives and essential service provision

5.1  A true safety net and real choice for those not currently being served is unlikely to be provided by the market alone. In other utilities, and in the internet market, it has been recognised that in delivering these essential services and ensuring that competition is functioning Government must play a role. Similarly the Government intervention in the banking crisis indicates the crucial role that banking plays in both economy and society and the legitimate role of Government when the market is not working.

5.2  The Conservative and Liberal Democrat manifestos and the Coalition programme have emphasised the push towards sustainable and green banking alongside greater community engagement and the promotion of social entrepreneurship. We are yet to see the "detailed proposals to foster diversity in financial services, promote mutuals and create a more competitive banking industry",[20] but this is unlikely to be achieved, particularly in the current environment, without specific incentives. Consideration needs to be given to taxes or tax incentives such as the Netherlands Green Funds Scheme.

5.3  Initiatives such as extending the services and functionality of the Post Office bank provides an option for addressing some of the defects in the market and for promoting universality and improved accessibility to banking products. Our research among low income consumers has shown that they want a custom account that is simple, convenient and offers control over their money, an account that is offered by a trusted provider. There was strong support for the Post Office Bank delivering this service, being seen as a community based and trusted institution.[21] We call on the Government to view the Post Office as part of its strategy for retail banking. This model will require Government support. It should not, however, be the only model with a customer focus.

Encouraging switching or relying on the market to fix it doesn't work

5.4  In relation to personal current accounts the OFT are seeking to rely on "significant changes in the market that will help lead to a better outcome for consumers".[22] There is no evidence of either significant changes or better outcomes to date. Indeed, since the decision by the OFT not to further pursue its action on charges, unauthorised charges have been creeping up again and authorised overdraft charges have increased significantly to ensure profit margins are retained. There has been no rush to introduce new charging models.

5.5  The consumer currently has limited choice in financial services and has intrinsically been reluctant to exercise that choice because of a loyalty to institutions once considered stable and providing an essential (not an optional or desirable) service. Our recent research shows that switching among consumers of financial services remains consistently low as compared to switching in other areas. Switching rates for current accounts in the UK has lagged at around 7% for the last 10 years, whereas utilities such as energy and phones show switching rates well in excess of this, starting at 26%. Those who are not interested in switching believe that there is little value to be gained because there is little difference in what is on offer and the switching costs, such as the potential for error and impact on credit rating, are too high.[23] It appears that the market itself is not consumer driven and unlikely to change unless motivated by external stimuli that are more compelling.

Divestment rules, are they enough?

5.6  The public interest is a vital factor in the consideration of divestment options. The return on our investment is not just about selling to the highest bidder.

5.7  The German government has been able to agree more stringent conditions for state aid with their Landsbanken. Running through all of the Landsbanken restructuring plans is the need to reduce their capital market activities and proprietary trading, while returning to their local roots and core banking business. These are the areas where the UK's divestment conditions could be improved.

5.8  Divestment conditions should take account of the public interest and aim to:

  • Promote competition and sustainability.
  • Prefer community based and controlled institutions.
  • Provide for sectors of the market not being served.
  • Focus on the provision of retail services and particularly simple and transparent products and charging models.

5.9  Public monitoring, audit and review of the divestment process to ensure conditions are being met needs to be ensured.

6.  Consider the relationship between competition and financial stability

6.1  There is not necessarily discordance between competition and financial stability. Consumers are now looking for stability and sustainability (in a social, environmental and economic sense) in their banking but choices are limited.[24]

6.2  Financial stability also involves encouraging the unbanked to be banked, encouraging savings in an environment of lack of trust, and providing essential and affordable banking services to those market segments that are not serviced by current models.

6.3  The failings of the market and competition are associated with high risk and short term gains in the eyes of consumers. Long term, sustainable models are not widely available and need some help in overcoming the significant hurdles of regulation, market power and trust on entering the market and developing their business.

7.  Consider the impact of free-banking on effective competition

7.1  Under the prevailing model of so called free banking, charges are hidden and punitive and present barriers to comparison. A consumer will not make decisions and cannot make comparisons on the basis that they are likely to encounter financial difficulties. Penalty charging is not a fair business model and is difficult for a consumer to predict or manage.

7.2  Penalty charging is also a barrier to consumers entering the market. One of the concerns among low income consumers is that the cost of having a bank account can lead to greater financial insecurity due to revolving credit and penalty charges. Respondents to our research on consumers without accounts cited lack of transparency in account based transactions as undermining budgetary control and planning.[25] Our recent research into pay day lending has indicated that many consumers chose pay day lending because they found the fee structure easier to understand, even though rates are very high and it may cost them more.[26]

7.3  The cross-subsidy model supports existing institutions and combined models, as they have the established business from which to divert resources and a wide model which allows for this to happen. The big institutions have deep enough pockets to offer products and services on terms which may not necessarily reflect cost (at least in the short term) or be a product of competitive measures. Existing players use introductory offers to lure in customers with the confidence that profits can be made once that offer ends because they can bet it is unlikely a customer will switch.[27]

September 2010


1   Antony Elliot, Financial Services for All, in Consumer Focus, Rethinking Financial Services, June 2010, 38. Back

2   HM Treasury, Financial Inclusion Taskforce, Policis, Realising Banking Inclusion: the achievements and challenges May 2010 Back

3   39% of consumers who have not switched provider believe banks are not sufficiently differentiated reinforcing OFT's evidence that consumers perceive offerings as essentially very similar. Personal current accounts in the UK 2008, 91. Back

4   Consumer Focus, On the Margins, Society's most vulnerable people and banking exclusion, March 2010 and Opportunity Knocks, Providing alternative banking solutions for low-income consumers at the Post Office, January 2010. Back

5   Financial Services for All, Rethinking financial services, Consumer Focus, June 2010. Back

6   Competition in UK Banking, A Report to the Chancellor of the Exchequer, Don Cruickshank, March 2000 Back

7   For example, Virgin bought Church House trust and Walton and Co is negotiating for Hampshire trust. Back

8   CBI/PwC Financial Services Survey, 28 June 2010. Back

9   http://www.chapsco.co.uk/faster_payments/ Back

10   Competition in UK Banking, A Report to the Chancellor of the Exchequer, Don Cruickshank, March 2000 Back

11   OFT1071, Review of the operations of the Payments Council, March 2009, 25. Back

12   Consumer Focus, Opportunity Knocks, Providing Alternative Banking Solutions for low income consumers at the Post Office, January 2010, 9 and Keeping the Plates Spinning, August 2010, 35. Back

13   European Commission, Report on the Retail Banking Inquiry, Commission Staff Working Document, SEC (2007) 106,
http://ec.europa.eu/competition/sectors/financial_services/inquiries/sec_2007_106.pdf 
Back

14   Recent figures from the British Retail Consortium estimate that the average credit card transaction costs retailers 34p, compared with 8.5p for a debit card transaction and 2.1p for cash. This is in addition to the rental of the mobile card terminal, which can be about £500 a year and interchange fees levied by the customer's bank and the retailer's bank. http://bit.ly/cmiROL Back

15   Office of Fair Trading, Personal Current accounts in the UK, 2008, 90. Back

16   FSA, DP09/3, Mortgage Market Review, October 2009 Back

17   FSA, PS 10/6, Distribution of retail investments: Delivering the RDR-feedback to CP09/18 and final rules, March 2010 Back

18   Consumer Focus, Opportunity Knocks, Providing alternative banking solutions for low-income consumers at the Post Office, January 2010 Back

19   Ibid. Back

20   The Coalition: our programme for government, May 2010. Back

21   Consumer Focus, Opportunity Knocks, Providing Alternative Banking Solutions for low income consumers at the Post Office, January 2010. Back

22   Office of Fair Trading, Personal Current Accounts in the UK, Unarranged overdrafts, March 2010 Back

23   Consumer Focus, Upcoming research report Back

24   See, EIRIS, What's needed to mainstream green and ethical finance? November 2009 and Neville Richardson, How can the consumer gain a voice in reform of financial services? in Rethinking Financial Services, Consumer Focus, June 2010, 45. Back

25   Consumer Focus, On the margins, Society's most vulnerable people and banking exclusion, March 2010, Back

26   Consumer Focus, Keeping the Plates Spinning, August 2010 Back

27   ISA Super complaint, http://www.consumerfocus.org.uk/campaigns/super-complaint-cash-isas Back


 
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