House of Commons - Treasury - Written Evidence

Competition and choice in retail banking - Treasury Contents

Written evidence submitted by Which?

SUMMARY

1. Which? is an independent, not-for-profit consumer organisation with over 700,000 members and is the largest consumer organisation in Europe. Which? is independent of Government and industry, and is funded through the sale of Which? consumer magazines, online services and books.

2. Which? welcomes the Treasury Select Committee focus on competition and banking. We have consistently advocated for significant reform of banking to establish, once and for all, the necessary pre-requisites for effective competition. The financial crisis has seriously harmed the prospects for competition. As a result, the crises has also brought to light fundamental flaws in the underlying public policy and regulatory approaches to banking that the Future of Banking Commission reported on in May this year.

3. Which? consider that four primary factors prevent and distort competition:

The size and market concentration of banks;
Distortionary subsidies, direct through state aid bailouts and indirect by reducing funding costs, to the largest market incumbents;
No effective regime to enable market exit by failing banks while preserving financial stability; and
Consumer inertia where, perhaps more than in any other industry, consumers have an inbuilt tendency to remain with their existing providers. This in turn reduces the incentives for firms to actively compete against each other.

4. These first three factors effectively make the largest incumbent banks immune to market discipline. This leads to inefficiency, weak prospects for meaningful competition and significantly contributes to the underlying causes of the financial crises. The fourth factor, the role of consumers in driving the competitive process, remains as an impediment to competition. Unlike the first three factors that uniformly affect each and every market in which banks supply services, the impact of consumer inertia, however, differs from market to market.

5. The Government has a real opportunity to affect a permanent and one-off step change in the competitiveness of banking services benefiting consumers and the UK economy. Only the Competition Commission has the necessary powers to affect substantial and lasting reform. We hope the Committee will find this submission helpful.

Structure of this response

6. The response is structured as follows:

First, we define the types of banking services considered in this response;
Second, we set out the experience of consumers using banking services. This includes the largely anecdotal evidence from individual consumers, including views gathered during the Which? Big Banking Debate, relating to their direct experience of banks. We also set out the results of our own satisfaction surveys of key banking services, based on quantitative surveys of Which? members over recent years;
Third, we summarise the changes to market outcomes including a review of key product performance, bank performance and the impact on market structure, which has lead to a significant concentration of banking services in part due to the response to the financial crises; and
Fourth, we review the impact of regulation on the development of competitive retail banking services, including the effect that government support and state aid has had on competition for banking. We consider the role regulation has to play in promoting competition, and reject the notion of a "trade-off" between competition and financial stability, noting the measures that regulators should take to build consumer confidence in financial services markets.

7. We conclude by noting the harms that arise from not taking banking competition seriously, and suggest two remedies:

Significant structural reform considering the economic market power of banks, and those reforms necessary to address financial stability. This may best addressed through a reference to the Competition Commission, which is the only body with the necessary powers to enforce structural change, but must be considered by the Vickers inquiry; and
Significant reform of public policy and regulation of banks to enable poor performing banks, whether due to poor management or customer dissatisfaction, to fail and thus become subject to market discipline.

DEFINITION OF BANKING SERVICES FOR THE PURPOSE OF THIS RESPONSE

8. The Committee's terms of reference for its inquiry are broad, covering both retail and wholesale products. Which? has focussed on retail or personal banking services, with particular emphasis on three economic markets: personal current accounts, deposit savings and mortgages.[35] These three products form core banking services that consumers are likely to use on a frequent basis and which may be commonly "cross-sold" by banks. Banks also supply a range of other financial services, including medium-long term savings and investment products, personal loans, credit cards, general insurance, life and pure protection products and access to some specialised services like share-dealing. Each of these products is likely to form a discrete economic market affected by the distortions to competition affecting banks' core services.

9. Which? is concerned that an inquiry into competition should go beyond the various individual economic markets and also give detailed consideration to the institutional and structural nature of banks. Banks, especially the largest, operate similar business models, are regulated via a banking licence and the FSA's conduct of business rules and have received similar levels (or offers) of aid—on an institutional level—during the financial crises. Banks operate multi-product, vertically integrated firms that intrinsically link essential "utility" aspects of banking, on which we all rely, to wholesale markets and more speculative activity. This has a key bearing on competition and affects the scope and nature of regulatory interventions necessary to promote competition.

10. We have not considered banking services for small and medium sized enterprises (SME). Banking services to SME have often been considered to form part of the same market given the common set of banks that supply retail and SME customers and, in many cases, the similar scale of business. From a supply-side perspective, there appears to be little to differentiate retail customers from SME customers with similar needs (holding, accessing and transferring money).

CUSTOMERS' EXPERIENCE OF BANKING SERVICES

11. Poor outcomes for consumers have been found in a host of competition enquiries relating to banking:

The OFT's personal current account (PCA) study found that "the PCA market as a whole is not working well for consumers".[36]
The Competition Commission, in its investigation of Northern Ireland Banks, found that: banks' charging structures are unduly complex; too little is done to explain charging structures to customers; and customers are largely indifferent to the product, considering PCAs as "all the same".[37]
The Competition Commission's investigation of Payment Protection Insurance found rivalry was weak with a significant "point of sale" advantage by incumbent banks and considerable concern over sales practices.[38]

12. These findings are reflected in the day to day experience of ordinary banking customers. Which? has collected views directly from members of the public and users of banking services that form a picture, albeit anecdotal, of peoples' experiences of and expectations of banks. We also set out results from Which?'s regular satisfaction surveys of members.

Evidence from members of the public and bank customers

13. Since October 2009 Which? has actively sought the views of ordinary members of the public, bank customers and Which? subscribers to understand how the banking crises has affected them and to hear their demands for change.[39] This culminated in the Which? Big Banking Debate on 4 February 2010 attended by over 300 people.[40]

14. Which?'s dialogue with consumers of retail banking services has made two messages clear:

Consumers want change, including structural reform of banks to promote competition and tackle the risks created by banks that society has had to pay for; but.
Consumers feel disempowered, subject to complex products and hard-selling and unable to affect change in the face of "all powerful" banks.

15. Nearly three-quarters of participants of the Which? Big Banking Debate considered banks should be broken up to create more competition, while nearly 50% consider separating investment banking from day to day banking is essential.[41] These views reflect an overall impression that the banking system serves banks not consumers. The banking crisis has brought to light issues that many consumers may not have previously considered: the implications of a potential collapse in the entire banking system brought home just how fragile and disastrous the situation could have been.

16. Despite the strong preference for change, in particular structural reform, customers of banks feel individually powerless to change the banking industry. This powerlessness arises from unilateral and market wide worsening in terms: savings rates have fallen, interest on credit has increased (for example on credit cards where effective interest rates have increased significantly above base rate[42]), credit is less easily available and terms of existing products have moved against customers interests (see paragraphs 31 to 38). The most recent financial statements from banks support these observations, confirming that profit margins on products are widening (see paragraphs 39 to 41).[43]

17. When seeking help and advice from banks, consumers are faced with hard-sell tactics and a lack of personal service or "localisation" of services: banking today is not tailored to one's needs. A number of people reported to Which? a noticeable shift away from a more personalised banking service to one driven by sales targets:

"Why does my bank only want to talk to me when it wants to sell something?" Participant, Which? Big Banking Debate

"I phoned Santander to ask advice regarding my mortgage. Although most of my questions were answered, I was put through a very hard sell by an employee of the new zero account. I felt pressured into swapping to this account but managed to say no for the third time and it was accepted. I have looked up the details of this account and it is not suitable for me anyway, although he kept saying it was!" www.which.co.uk/banking/yourstories (2 April 2010)

18. Which? has received many anecdotal examples from consumers that whenever they visit a branch for "day-to-day operations", they are subjected to sales promotions. Not only have consumers reported disappointment with this approach it can also impose real detriment. Hard-selling is stressful for some customers, especially if they rely on their bank for impartial advice from expert staff. Sales targets and commission based sales incentives mean consumers lose the benefits of independent and tailored advice, while there is a risk of mis-selling in some cases.

19. Consumers have reported frustration over the complex terms and charging methods employed by banks, with a sense that individual service comes second to any opportunity to "gouge" customers. Consumers clearly accept that there are inevitably going to be costs associated with any financial product, but they do not feel they are always a true reflection of the actual costs and are disproportionate to what they would expect to pay:

"Most ordinary customers borrow from banks for their mortgages. Banks are not transparent on their lending because they load up front end fees in the guise of valuation fees etc. which bear no resemblance whatsoever to reality. They should simply state the interest rate and forget about all other complicated costs". Consumer, which.co.uk/banking

"In October 2008, I took out payment protection insurance on a loan with Lloyds TSB. I took it out because I was advised that I had to buy the insurance to take out the loan. I asked the bank to cancel the insurance several times but they failed to stop taking my money." Krystyna, via Which? Customer Services

20. Consumers frequently cite the Lack of transparency in financial services as a particular problem. This includes the terms and conditions, small-print associated with products, the perceived unfair charges levied which often take people by surprise, and lack of information on monthly statements about the current interest rate for their product. There is a perception that charges are "sneaked" into the small-print of products, making it difficult for consumers to get adequate clarity on what they are buying and leaving some feeling as if they are purposely designed to trip you up.

21. Many people value the idea of having face-to-face contact with an old-fashioned-style bank manager who you recognise, and who recognises you. People feel there is a lack of ownership at their bank when it comes to dealing with any issue or complaint, with complaints and redress handled inadequately.

22. Overall, the poor service, hard-sell, complexity of product terms and ineffectiveness at addressing problems, alongside a unilateral worsening of product terms, has all reinforced consumers' feeling of disempowerment.

Customer satisfaction surveys and complaints

23. Which? has conducted satisfaction surveys of its members for savings, current accounts and mortgage providers in 2008, 2009 and 2010. Results for these surveys have shown both significant variation across different banks, with new entrant or internet-only banks performing especially well, and a consistent story with continued poor performance by the largest of the high-street banks.

24. For current accounts, our surveys have found the main high street banks performing poorly compared to internet banks and many of the smaller or new entrant banks and building societies. Table 1 below summaries these results:

Table 1

SATISFACTION RESULTS FOR PERSONAL CURRENT ACCOUNT BRANDS[44]

Bank	2008	2009	2010
Lloyds Banking Group (a)	59%	55%	49%
(HBoS)	56%
RBS (b)	61%	57%	55%
HSBC	57%	60%	58%
Barclays	53%	55%	53%
Santander (c)	44%	58%	52%
Average "Big 5" (excluding Santander for 2008)	(57%)	57%	53%
Banks achieving 70% or greater satisfaction results
First Direct*	85%	90%	88%
Virgin One	-	-	88%
Co-operative bank	82%	84%	86%
Smile	88%	91%	85%
Nationwide	79%	79%	72%
First Trust	-	-	72%
Cahoot*	82%	84%	71%
Intelligent Finance*	72%	74%	-

Notes:

(a) Lloyds TSB, Halifax and Bank of Scotland, except for 2008 when the results exclude HBoS

(b) Royal Bank of Scotland, Natwest

(c) Santander (Abbey & Bradford and Bingley), Alliance and Leicester, except for 2008 when results are for Abbey brand alone

* = Internet-only brands operated by one of the Big 5 banks

The results are the un-weighted average across high-street brands, excluding the results for internet-only banks operated by the Big 5 banks.

Source: Which? annual satisfaction surveys 2008, 2009 and 2010.

25. The satisfaction performance of the Big 5 banks' high street brands has consistently been below the best performing banks. This is despite the fact that some of these banks also operate successful stand-alone internet banking businesses such as First Direct (HSBC). It is notable that previous brands, including Intelligent Finance (LBG) and Cahoot (Santander), are now only offering savings products rather than full service personal current accounts to new customers.

26. The main areas of dissatisfaction were the level of interest payments or charges applied to accounts followed by the provision of up to date information on rates and charges. Some of the Big 5 also performed poorly for provision of internet and phone banking services and resolution of problems. Customers of the Big 5 were most satisfied with the accuracy and timelines of statements and availability of branches.

27. Similar results are reflected for savings and mortgages.[45] The average satisfaction score amongst the Big 5 for savings accounts was only 47%, First Direct and Co-operative Bank were the only brands to score 70% or higher. The worst performing bank brands were Santander at 39% followed by Cheltenham & Gloucester, Bank of Scotland and Halifax (all operated by Lloyds Banking Group). As for current accounts the main areas of dissatisfaction were the level of interest and keeping customer informed on rates and charges. Customer satisfaction in the mortgage market is similar, with the Big 5 scoring an average of 55% satisfaction compared to the best result of 87% (First Direct). The main reported reason for dissatisfaction was lenders failing to pro-actively inform customers when more suitable or better mortgages were available.

28. Despite the Big 5 banks', at best, average satisfaction ratings they continue to dominate the provision of key retail financial services, emerging as clear winners of the financial crisis. In particular, customer satisfaction scores are especially poor for brands operated by Lloyds Banking Group and Santander. As outlined below, Lloyds is a clear market leader with Santander having rapidly expanded (mostly due to purchases of failed or failing banking institutions throughout 2008 and 2009). We conclude that a poor quality service for customers is irrelevant to the growth of significant market power, a clear sign that normal competition is failing.

29. Which?'s findings of average to poor levels of satisfaction are reflected in the consistent, and considerable, growth in complaints to the financial ombudsmen service.[46] For example, over five years FOS has dealt with over a 5 fold increase in personal current account and deposit saving complaints, while mortgage complaints have risen by 140%.[47] The FSA has reported similar findings in the number of complaints brought to its attention.[48]

RECENT CHANGES TO THE COMPETITIVE LANDSCAPE OF RETAIL BANKING

30. Consumers have seen a real impact from changes to the competitive landscape, with worsening product terms whilst banks themselves have seen increasing margins. The financial crisis accelerated changes to market structure, which has resulted in an increase in concentration and winnowing of choice from the market. Significant entry barriers and, more importantly, exit barriers remain which seriously fetter the prospects for effective competition. These developments are reviewed below.

Product performance

31. Economic conditions have remained difficult since the beginning of the credit crunch and resulting recession. Consumers of banking services have faced considerable uncertainty. Bank of England base rates have remained low since November 2008, reaching their current level of 0.5% in March 2009. Higher than target inflation, which has made real saving rates negative, and banks' steps to recapitalise, following their near collapse, has lead to worsening product terms across the board. Some consumers, such as those on long term tracker mortgages have seen marginal improvements from pricing changes introduced by banks. However, for most current account customers, those relying on savings to support their income, or those looking to buy a home for the first time or re-mortgage, conditions have worsened significantly.

32. Two key changes have affected personal current accounts. First, the overall level of in-credit interest payments has fallen. Table 2 below illustrates the fall in the credit interest rate offered by a sample of popular current accounts. Those accounts that previously offered higher in-credit interest rates have all fallen, by over 5% in the case of Halifax (now part of the Lloyds Banking Group). Some of the low-interest paying current accounts still offer 0.1 or 0.15%, while others have fallen to zero.

Table 2

ILLUSTRATIVE CHANGES FOR CURRENT ACCOUNT IN-CREDIT INTEREST PAYMENTS

Credit interest rates on a
£1 to £1,000 balance

Bank brand or building society Account name Jun-08 Mar-09 May-10

High interest accounts

Alliance & Leicester Premier Direct Current A/c 8.50% 6.00% 5.00%

Abbey (Santander) The Abbey Current (Cr Opt) 8.00% 5.50% 5.00%

Halifax High Interest Current A/c 5.12% 0.00% 0.00%

Halifax[49] Ultimate Reward Current A/c 5.12% 2.50% 0.00%

Lloyds TSB Classic Plus 4.00% 2.50% 2.50%

Barclays Bank Current Account Plus 2.99% 0.00% 0.00%

HSBC Bank Account Plus 2.50% 3.00% 0.00%

Low interest accounts

Alliance & Leicester Premier Current A/c 0.99% 0.50% 0.50%

Nationwide BS FlexAccount 0.50% 0.00% 0.00%

Royal Bank of Scotland Royalties 0.15% 0.15% 0.15%

Abbey (Santander) The Abbey Current (Db Opt) 0.10% 0.10% 0.10%

HSBC Bank Account 0.10% 0.00% 0.00%

Lloyds TSB Classic 0.10% 0.10% 0.10%

NatWest Current Plus 0.10% 0.10% 0.10%

First Direct 1st Account 0.00% 0.00% 0.00%

Source: Moneyfacts and Defaqto

33. This fall in credit interest rates reflect the overall fall in base rate and inter-bank lending rates. Credit interest is an important revenue source for banks, estimated to represent 50% of the revenue from so called "free" bank accounts.[50] This revenue is derived from the difference in interest payments made to customers and the income banks can earn from this stock of funds, in essence the difference in the cost to banks of raising in the region of £97 billion daily directly from consumers rather than going to wholesale money markets, bond or shareholders.[51] The funding difficulties which banks have experienced will have increased the attractiveness of using the deposits in current accounts, compared to other methods of funding.

34. Second, the structure of charges has changed. This may lead to better treatment of those with very high unauthorised overdrafts but has tended to be less favourable for authorised overdrafts: the average authorised overdraft rate is 18.86%, higher than any rate for the last 15 years.[52] Some banks have introduced more significant changes, examples include: imposing a fixed charge per day of overdraft rather than a percentage interest charge; and making a gratuity payment into a customer's account if a minimum amount of funds is regularly paid-in. Consumers may find it difficult to judge whether these charging structures suit their needs.

35. For example, in December 2009, the Halifax brand of Lloyds Banking Group introduced an authorised overdraft policy of a minimum £1 per day fee for all of its current accounts.[53] Ostensibly this is a simpler, more transparent overdraft policy. However, a consumer would need to have an overdraft of nearly £2,000 in order to pay less than the average authorised overdraft rate.[54] The OFT's 2008 market study estimated that, of those accounts in overdraft, no more than 10% of accounts were over £1,000 and no more than 5% over £2,000 in debit.[55] This leaves 90-95% of consumers, that regularly use an overdraft, likely to be significantly worse off if paying £1 per day. For example the implied effective annual overdraft rate of £1 per day on a £500 overdraft is 73%.

36. Customers relying on mortgage products have been the most adversely affected by changes in product terms. In particular, those faced with high or very high loan-to-value (LTV) now face a significant challenge attempting to re-mortgage. Many of these consumers have found themselves stranded on high LTV products through no fault of their own: with some mortgage lenders were offering up to 125% LTV, mortgages with 95% LTV were widely available and many expected house prices to stay buoyant. Post-crises, house prices have fallen and are, at best, recovering fitfully. This forces many families into dependency on higher LTV mortgages. Lenders' own policies for new or re-mortgage lending have tightened, with the FSA requiring higher standards from banks in their assessment of individual credit risk. Banks have also been repairing their balance sheets, lending less and ensuring a higher margin on each product (see below). These changes mean that many ordinary families are now dependent upon their original lender offering reasonable terms with no other lender willing to offer re-mortgage terms without a sizeable deposit.

37. Changes in base rates and the decision of banks on how to re-capitalise has significantly affected the volume of lending and led to a significant growth in margins (the lender's charge net of the Bank of England base rate). Graph 1 below illustrates the dramatic impact across the mortgage market. Before July 2008 lending volumes (both secured and unsecured) were buoyant, while margins were modest or, in the case of tracker mortgages, negative at some points. Since July 2008, lending volumes have collapsed and margins grown: banks lend less but make more money for each new customer and all existing customers that must now re-mortgage or face very much higher standard variable rates (SVRs).

Graph 1

VOLUME OF LENDING AND MORTGAGE BORROWING COSTS

Source: Bank of England

38. These market changes have had specific effects on consumers:

First time buyers find it more difficult to obtain any mortgage, with significantly greater deposits now required;
Existing customers with high LTVs (ie over 60%) have significantly less choice of re-mortgage options and must remain with their existing lender paying the current SVR. When these rates rise, in due course, these captive customers will face significant mortgage costs if house prices have not recovered;
Some recent products expose consumers to an imbalance of risk, for example with the marketing of some tracker mortgages or with recent increases in SVR. For example, Halifax markets its tracker mortgage with the wording "if you want to be able to take advantage of lower interest rates if they go down, a tracker mortgage could be what you need". With base rates at 0.5% (their lowest in the history of the Bank of England) the most likely direction of interest rates is upwards. This is particularly troubling where the same bank offers term trackers, for the lifetime of the mortgage, at rates over 4.5% above base rate. Which? is also concerned with the behaviour of Skipton Building Society which raised its SVR by 1.45% in March 2010, breaking a promise to customers that its SVR would never be more than 3% above base rate;[56]
Treatment of customers in arrears, where consumers in arrears face cumulative and penal charges and banks have taken insufficient action to assist customers before they miss a payment. For example, Abbey (a Santander brand) has increased its monthly charges for mortgage arrears to £40 from £35.

Bank performance

39. In contrast to the poor performance for customer satisfaction by banks and, as outlined above, the worsening product terms for their customers, banks themselves have thrived. Margins on key retail products have significantly increased leading to greater profitability for retail banking arms. The Big 4 banks have performed especially well:

The retail-arms of the Big 4 banks remained profitable throughout the financial crises;
Those banks that have been reliant on state support—and without which would have collapsed—have recently announced significant increases in profitability:
- Lloyds Banking Group[57]—Profitability of the retail business in the first half of 2010 was £2,495 million, compared to £360 million for the same period in 2009. The increase in margins was attributed to "the continued re-pricing of risk and a decrease in the LIBOR spread to Base Rate. Low interest rates also meant that more mortgage customers moved onto, and are staying on, standard variable rates. Retail has also reduced the proportion of more expensive term deposits, while maintaining strong deposit growth."
  UK tax payers own 41% of LBG shares, managed by UKFI.
- RBS[58]—Profitability of the retail business in the first half of 2010 was £416 million, compared to £37 million for the same period in 2009. RBS noted "Widening asset margins across all products and an increasing number of mortgage customers choosing to remain on standard variable rate were the key drivers. Liability margins, however, fell as a result of lower interest rates, a competitive market place and our focus on saving balance growth."
  UK tax payers own 84% of RBS, managed by UKFI, with £282 billion of assets publicly insured under the Asset Protection Scheme.

40. Some improvement in the availability of mortgage lending has been reported.[59] However, the cost of funding mortgage lending has fallen but lenders are only passing on a fraction of this fall, retaining funds to rebuild their balance sheets. The losses for which these funds are required were almost exclusively incurred by the investment banking and wholesale arms of the largest incumbents, but the ongoing costs are borne by customers of the retail bank.[60] As noted by Sir Martin Taylor, former CEO of Barclays, to the Future of Banking Commission: "the investment banking activities of a universal bank were at all times parasitic on the retail bank balance sheet."

41. Profit performance alone is not sufficient to draw conclusions as to the competitive health of an industry. It is, however, sufficient to raise challenging questions:

Why has the retail banking industry made such significant profits, in such a short period of time, when customer service and product performance is exceptionally weak? In most industries, unhappy customers and poor quality products leads to falling profitability (and market share).
To what extent have the changes in market structure, set out below, played a direct role in increasing profitability? Market power can directly contribute to excessive pricing.
To what extent does the continued state support of banks enable exceptional profit performance?
To what extent are retail customers paying the costs of recklessness or incompetence in the investment banking arms of the largest incumbents? The largest investment banks are vertically integrated, multi-product firms, this may have a significant distortionary impact on retail market competition.

42. The weakness of competition also affects the incentives of banks to be dynamically efficient: to innovate in ways that improves customers' experience and productivity. Concentrated markets may often suffer from an "x-inefficiency", where the cost-base of firms in those markets becomes bloated or excessive. This appears to be found in the banking industry in the form of:

Persistent and high-level bonuses, especially for investment banking which is intrinsically linked to the crises. These bonuses are part of banks' cost base yet appear to be unconstrained by any market process or innovation to reduce these costs;
Industry inefficiency or incapability to improve services on which customers rely. For example the speed of cheque clearing which agreed improved clearing speeds effective from November 2007 yet concern with was originally raised with efficiency of payment clearing services in the Cruickshank report published in March 2000. The OFT recently investigated the speed of ISA savings transfers, following a complaint by Consumer Focus, and has agreed changes to speed up the system: without this intervention it seems the industry would not have adopted any improvements.

43. There are some indications of innovation, for example the Barclaycard touch and pay service that allows payment for small items with using the chip and pin device.[61] However, there has been no detailed investigation of bank efficiency since Cruickshank. Recent changes that increased market concentration, detailed below, threaten to exacerbate x-inefficiencies in the banking industry.

Market concentration

44. The financial crisis has seen a step-increase in the concentration of key retail banking services. This has exacerbated a trend that was first noted in the Cruickshank report into UK banking over a decade ago.

45. The main driver of recent changes has been a significant increase in mergers. Since April 2008, there have been 14 mergers. Nine mergers involved mutual building societies. Ten mergers arose because of concerns over capital or losses incurred through the crises. Of these, the largest by far was the merger of Lloyds-TSB and HBoS, which has resulted in a market leader for key retail banking products. This has been an exceptional number of mergers. Between 2003 and early 2008 only four mergers affecting retail or commercial banking had been considered and cleared by the OFT. In addition to mergers, two banks failed: Northern Rock and Bradford & Bingley.

Table 3

MERGERS AND ACQUISITIONS IN UK BANKING (SINCE APRIL 2008)

Year	Financial Institution	Merged with/ Acquired
2008	Santander	Alliance & Leicester
2008	Santander (Abbey)	Bradford and Bingley (savings and branches)
2008	ING Direct	Heritable Kaupthing Singer & Friedlander
2008	Chelsea Building Society	Catholic Building Society
2008	Nationwide Building Society	Cheshire Building Society
2008	Nationwide Building Society	Derbyshire Building Society
2008	Lloyds-TSB	HBoS
2008	Yorkshire Building Society	Barnsley Building Society
2009	Co-operative Financial Services	Britannia Building Society
2009	Yorkshire Building Society	Chelsea Building Society
2009	Nationwide Building Society	Dunfermline Building Society
2009	Skipton Building Society	Scarborough Building Society
2010	Barclays	Standard Life Bank
2010	Coventry Building Society	Stroud and Swindon Building Society

Source: Bank of England (2008). "Financial Stability Report", Issue 24, pgs 24-25, pub: Bank of England: London.
Office of Fair Trading (2010). "Merger Cases", accessed at OFT website http://www.oft.gov.uk/advice_and_resources/resource_base/Mergers_home/Mergers_Cases/

Market shares

46. The market share for three key retail banking services—personal current accounts, savings and mortgages—are summarised below.[62] The "Big four" banks that have historically dominated retail banking (Lloyds-TSB, Natwest (now RBS), Barclays and HSBC). For each market, recent changes have led to greater concentration and very significantly so for savings and mortgage products. The "Big four" have become a "Big 5" as Santander has grown following a series of mergers. It is notable that all de-mutualised building societies have failed (with their businesses taken-over by traditional banks or nationalised).

Table 4

ESTIMATED MARKET SHARE FOR KEY RETAIL FINANCE MARKETS

Banks / building societies	Personal current accounts 2009 (%)	Deposit savings accounts 2008 (%)	Mortgages 2009 (%)
Lloyds Banking Group (a)	28	25	25
RBS (b)	17	11	13
HSBC (c)	14	9	11
Santander (d)	12	13	18
Barclays	12	9	10
Nationwide	8	10	8
Other (e)	9	23	15

Notes:

(a) Lloyds TSB, Halifax and Bank of Scotland

(b) Royal Bank of Scotland, Natwest

(d) Abbey, Alliance and Leicester, Bradford and Bingley

(e) Other includes survey respondents that don't know which institution provides their service.

47. The scale of the changes in recent years is especially notable if considered against market share estimates from 2006, prior to the financial crises, and those measured in the Cruickshank report for the four largest banks.[63]

Table 5

HISTORICAL MARKET SHARE OF THE "BIG FOUR" BANKS

Year	Personal Current Accounts (%)	Deposit savings accounts (%)	Mortgages (%)
2009 (a)	71	59	67
2006	66	44	47
1998 (Cruickshank report) (b)	59	19	17

(a) This excludes Santander, which has grown significantly through its acquisition of failed banks over the last three years and recent purchase of branches and accounts from RBS.

(b) De-mutualised building societies held 42% share of the deposit savings account market and 48% share of mortgages, these have subsequently all failed or been acquired by the big banks.

Market entry and exit

48. Which? has identified a number of potential barriers to entry, drawn from written responses submitted to the Future of Banking Commission by smaller new entrants and representative bodies of customers (retail and SME):

Customer / consumer engagement—the perceptions and experience of consumers when dealing with banks that leads to a degree of inertia. Customer inertia is reinforced by the "utility" character of many core banking services; consumers expect these services to work trouble free but spend little time actively using or assessing product performance.
Switching costs—consumers lack information of their own use of bank accounts and struggle to make easy comparisons between different bank offers and are anxious about the switching process. As a result, consumers cannot easily experiment with or "sample" different banks' offers.
Incumbency advantage—existing banks with large customer bases gain access to privileged and detailed information about customers, facilitating cross-selling.
Price discrimination / potential cross-subsidy—all banks, but especially those with larger customer bases are able to price discriminate between customers and potentially cross-subsidise core products, such as personal current accounts which act as "gateways" to enable wider cross-selling. Existing banks may be able to take advantage of their large back books of captive / inert mortgage and savings customers.
Access to branches—branch networks remain an important part of customer contact and are valued by consumers. Developing a suitable network of branches can be costly.
Regulatory barriers—the cost of capital or solvency requirements for new entrants are higher than for (larger) incumbent banks.
Public policy affecting financial stability—financial stability has taken clear precedence over competition, leading to a preference to maintain existing banks in the market either through managed take-over that encourages growth in incumbents at the expense of smaller entrants, or through direct bail-outs with public money that distorts the wholesale funding costs of very large incumbents giving rise to an implicit subsidy (this is discussed further below).

49. The recent entry of Metro bank demonstrates that these barriers, although cumulatively substantial, may be overcome. It is not clear yet, however, whether upon entry any new bank can expand sufficiently to seriously challenge the market position of the Big 5. Two other sources of entry, foreign banks and internet banking are considered briefly below.

50. Foreign banks may be considered a competitive constraint if they can relatively quickly enter the UK. However, past entry was focussed on the savings market, without significant entry into the current account market or other key banking services. Banks within the European Economic Area (EEA) may operate in the UK under their home authorities' regulation, requiring no specific supervision by the UK's FSA (referred to as "passporting"). Despite the visible failure of Icelandic banks no significant change in EEA passporting has occurred. Consumers are protected via the compensation arrangements of the EEA member state, not the UK compensation scheme. Banks entering the UK outside of the EEA must be fully regulated by the FSA and must contribute to the Financial Services Compensation Scheme. Recent foreign entrants continue to focus on savings products. The extent that passporting of foreign firms has ever acted as an effective competitive constraint is questionable: serious entrants must operate via a UK subsidiary and develop a visible brand and high street presence, not simply an internet portal.

51. Many of the foreign operating banks were able to offer simple to use internet portals for their savings accounts. Internet banking, alongside phone banking, is an important route for consumers to access different banking services. Respondents to Which?'s current account satisfaction survey cited access to better online banking as the third most common reason for switching (equal to the number switching due to a disagreement).[64] Which? does not consider that internet banking is a unique or specific advantage to facilitate or promote market entry. It is instead an alternative but necessary distribution channel to connect with consumers. No full-service bank operates on an internet basis alone.[65] No full-service bank could remain successful without operating internet banking.

52. The internet has mainly affected the nature of price competition, especially through price comparison services. These services offer another marketing opportunity (or cost) for all banks but do not necessarily lead to clearer or easier comparisons by consumers or enable new brands to reach consumers more easily. For example, not all firms will necessarily be listed on a price comparison site, ranking of firms may be linked to payments of commission, and complex product features may not be reflected or easily compared (or firms may increase obfuscation of their product in response to the risk of price competition).[66] The effectiveness of comparison sites will remain limited for current accounts while customers continue to have limited knowledge of their own bank account use.

53. Finally, three issues require particular attention:

The existence, and impact, of barriers to "exit" that restrict or distort market discipline—this is a product of the regulatory regime and public policy towards banks and is discussed in more detail below. Which? considers barriers to exit to be of equal importance to factors that make it costly to enter retail banking markets.
The effect of consumer engagement and switching behaviour on market entry.
The effect of "free" banking on switching decisions and market entry.

Consumer engagement and switching behaviour

54. The OFT has found that customers' knowledge of their own use of current accounts and their perceived concerns over switching restricted the effectiveness of competition. This was exacerbated by complex charging structures for overdrafts and low levels of transparency for these additional charges. The OFT has since been negotiating improvements to banking industry practice to address the transparency of information about a customer's bank account and increase confidence in the switching process.[67] This includes work with Bacs, the payment system provider, to address problems with transferring accounts and improve information to consumers.[68]

55. As part of our customer satisfaction survey, we asked about members' experience with switching bank accounts. Our findings show that, overall, relatively little has changed. Switching volumes remain low and while those that do switch find the process fairly easy it is not without practical problems or errors. The majority of people are still not switching, and have doubts over the benefits to be secured and the risks of errors affecting their regular payments.

56. Overall, only 20% of Which? members have ever switched personal current account. Switching rates amongst Which? members average 6% per year (measured over a five year period), which is the same as switching rates identified by the OFT in its market study. The two main factors driving their choice to switch was to obtain better customer services or a better credit interest, although a fifth reported switching due to a disagreement with their bank or to obtain better internet banking.

57. Of those who did switch, nearly 80% found the process easy. In these cases their banks managed the switch and provided a written and often verbal summary of the switching process. Surprisingly, just over 10% of members that switched reported having to manage the process themselves, and consequently found it much more difficult to do so. Despite the relative ease of the process, nearly 40% experienced a problem with direct debits or standings orders being transferred incorrectly, a problem with the helpfulness of their old bank or with the length of the overall process.

58. Of greater concern are the large proportion of consumers that have never switched and their reasons. For those that did consider switching but chose not to the most commonly cited reasons were "I didn't think it would be financially worth while" and "I wouldn't get any better service at the new bank". This suggests that many consumers still view banks as "all the same" despite the different satisfaction performance reported between the Big 5 and smaller or internet-only banks.

59. Nearly 30% of respondents cited worries over payment of direct debits or standing orders, amongst other reasons, for why they didn't switch account and a quarter had concerns with the complexity of the switching process. Although some steps have been taken to improve consumer confidence with switching, and may have made improvements to the actual performance of the process, consumers still perceive switching as risky. Given these circumstances, the provision of "portable account numbers" allowing consumers to switch their account without the worry of transactions going wrong should be considered.

Free banking and its impact on switching

60. Which? does not consider that banking is in fact "free". The charging structure of most bank accounts in the UK follows a "free-in-credit" charging structure, where regular fees for operating the account are not charged but credit interest tends to be low and explicit charges are levied for certain types of transaction of service, which have historically been related to overdrafts. The OFT has previously, shown that "free-in-credit" banking generates £8.3 billion of revenue per year for the banking industry, with 50% of this arising from net interest payments (the difference between interest paid and the income banks earn from interest).[69]

61. Some new entrants consider that "free" banking hinders the development of competition, supporting customer inertia or apathy and making customer acquisition (and therefore market entry) more costly or difficult. Which? has found that consumers would be very price sensitive if faced with an explicit charge, such as a monthly or annual charges for operation of their current account, and would switch to a non-fee account.[70]

62. The existence of "free" banking models may appear to be a simple explanation for consumer inertia, with an obvious policy prescription to address low switching rates. This is mis-leading:

The recent entry of Metro bank challenges the extent to which "free banking" alone is a significant entry barrier.
Customers still need to be better informed about their own bank use as well as have information presented in comparable form to make a meaningful switching decision. There is little research that considered the "quality" of switching decisions, not just the volume of switching rates. Explicit fees may drive switching rates, at least in the first instance, but may not improve consumer outcomes if switching to accounts that do not meet their needs or if switching rates cannot be sustained due to poor industry switching processes and lack of meaningful, relevant information.
The only direct measure to change current account charging models would be a form of price-control: regulating banks' charging structures to ensure explicit regular charges for holding a bank account. This is a complex and significant intervention in the market. Explicit charges do not reflect consumers' own sense of value added from bank accounts (judged by their sensitivity to the introduction of an explicit charge), especially for the "utility" elements of basic services such as holding money, accessing or transferring money. Any regulation to impose an explicit fee must also then set controls on any other charging options or price structures that may also be adopted, failing to do so risks creation of both an upfront fee and continuation of hidden or opaque charging models that may be difficult to challenge for fairness, leading to a serious risk of untended consequences.

Conclusions on switching

63. There is no single measure that can improve switching rates and the quality of switching outcomes, and switching alone is not a remedy to the prevailing weakness of banking competition.

64. For current accounts, Which? would not object to banks offering a wider range of charging structures for their current accounts but this must be conditional upon: better information on customers' own use of bank accounts (building on the OFT's plans for an annual statements) and clear and transparent charging (no hidden charges) that aids comparison of accounts.

65. Although the OFT has negotiated some steps to improve product comparison and use by current account holders, its measures are largely a response to the Supreme Court's ruling that unauthorised overdrafts cannot be assessed for fairness under the Unfair Terms in Consumer Contracts Regulations 1999 (UTCCR). This has serious implications for competition. Which? considers that the purpose of such consumer rights legislation is to enable consumers to shop with confidence, allowing consumers to focus on the core elements of a product offer while knowing that they are unlikely to be seriously disadvantaged by the "small print". This is, to our minds, the purpose of the UTCCRs. Competition should drive transparency in consumer markets. However, where transparency is sub-optimal, the UTCCRs form an important measure to protect consumers and encourage firms to make charges clear. The terms of financial services products are notoriously difficult to understand. Consumers of banking services now lack another important protection from unfair practices, undermining market confidence.

66. Switching in other key product markets supplied by banks, such as mortgages and deposit savings, may be affected by recent developments. First, the prevailing levels of switching for current accounts plays a role because these form an important "gateway" to identify and cross-sell to customers. Second, the significant change to market structure seen in recent years has reduced overall choice. These may be addressed by broad structural remedies that redress the balance of market power possessed by banks and measures to improve price transparency.

THE IMPACT OF REGULATION ON COMPETITION

67. Which? is concerned with the current approach to regulation of banks and the legacy of the Government's intervention during the financial crises. These have significant effects on the prospects for competition in retail (and likely SME) banking by creating:

Distortionary subsidies, direct through state aid bailouts and indirect by reducing funding costs, to the largest market incumbents thereby strengthening their market power; and
No effective regime to enable market exit by failing banks (whether due to poor management or dissatisfied customers) while preserving financial stability of the economy as a whole.

68. These concerns relate to the public policy for regulation of banks and the role of UKFI in managing taxpayers' stake in those banks that relied upon state aid to avoid failure. Further reform should also be taken in the overall approach to regulating banks: too often regulators are held accountable for banks' decisions that create instability or put consumers at risk and those same banks remain in business regardless.

Regulation—implicit subsidy

69. Which? established a Commission into the Future of Banking early in 2010, and received evidence from key players amongst banks, regulators and government.[71] Evidence to the Commission made it clear that the banking industry enjoys a significant public subsidy, in the form of tax payers' funds used to protect failing banks from insolvency. Lord Myners noted that "the banking industry, because it's been underwritten implicitly against failure, without paying a premium, has enjoyed a huge subsidy".[72] This was evident in the approach to bank failure during the crises but also marked a long-standing trend, when dealing with risks to financial stability, of preserving the status-quo by state aid or by merger.

70. This subsidy arguably distorts decision making by banks, fostering riskier behaviour than would otherwise be acceptable, while enabling those banks to raise funds more cheaply. For those banks requiring taxpayer support, it has been necessary to support the whole bank, not just the assets and liabilities linked to essential banking activities such as the payment transmission system or securing customers' deposits. Mervyn King noted to the Future of Banking Commission: "Ultimately the heart of the problem does come down in my view to the inherent riskiness of the structure of banking that we've got, and the difficulty of making credible the threat not to bail out the system, which is what is underpinning the implicit subsidy and creating cheap funding for large banks taking risky decisions."[73]

71. It has been argued that the value of this subsidy, which distorts the cost of capital for banks, has increased over the course of the financial crisis as the implicit subsidy became explicit support, and is greater for larger than smaller banks. For example, Andy Haldane of the Bank of England estimates that the subsidy for the biggest five banks in the UK amounted to £50 billion for the period 2007-09, representing about 90% of the total implicit subsidy available to the banking industry.[74] In its submission to the Future of Banking Commission Virgin Money estimated private equity investors demanded a 10-13% higher cost of capital from new entrants than from the largest incumbents: effectively double the cost facing the largest banks.

72. This subsidy results in a significant moral hazard. It fundamentally erodes the ability of small or new entrant banks to become serious challengers to the large, established incumbents. As a result market discipline, the key mechanism of competitive markets, is made ineffectual: good banks are unable to drive out the bad, while big banks remain big.

State aid—the role of UKFI and sale of branches by RBS

73. State aid direct to the UK financial services industry has taken three main forms: public guarantees for lending, recapitalisation and impaired asset relief. The UK Government has applied all of these measures.[75] Examples include the Asset Protection Scheme (APS) where, in exchange for a fee, the APS offers insurance on potential losses to eligible financial institutions. Other measures include increasing liquidity through direct purchase of assets by the Bank of England and the credit guarantee scheme that supports borrowing by banks. Re-capitalisation of key banks has occurred with the Government taking shares as collateral, which has mainly affected Lloyds Banking Group and RBS; investments in these banks are managed by UKFI.

74. UKFI is the company established in November 2008 by the Government to manage UK shareholders interests in failed banking institutions.[76] It has three objectives:[77]

Maximising sustainable value for the taxpayer, taking account of risk;
Maintaining financial stability by having due regard to the impact of its value realisation decisions; and
Promoting competition in a way that is consistent with a UK financial services industry that operates to the benefit of consumers and respects the commercial decisions of the financial institutions.

75. Prolonged state aid can:

Encourage moral hazard, by weakening or pro-longing undue risky behaviour that is not sustainable, raising competition and systemic risk concerns;
Result in significant and sustained changes to market structure, especially concentrating market power amongst fewer institutions;
Affect the competitiveness of un-aided firms; and
Increase the barriers to entry.

76. The Government has made it clear that it will give up public ownership of banks. The provision of state aid is governed by European Commission rules to maintain cross-border trade and limit competitive distortions between and within Member States.[78] These rules require all state aid to be reduced or eliminated in due course and require three steps:

Aided banks must be made viable in the long-term without further state aid;
Banks must carry a fair share of the costs of restructuring; and
Distortions to competition must be limited.

77. The guidance issued by the European Commission notes that "safeguarding systemic stability in the short-term should not result in longer-term damage to the level playing field and competitive markets".[79] Reform of banks must therefore consider the balance between ensuring viability and any specific measures necessary to limit competitive distortions.

78. As part of the agreement to benefit from state aid RBS was required by the European Commission to sell certain branches, mainly related to banking services for SME but also affecting retail deposit holders. It was recently announced that agreement has been reached to sell 318 branches to Santander.[80] Which? does not consider this a promising outcome for consumers and view this as a huge missed opportunity.[81] As seen above, Santander has consistently been amongst the worst performing banks for customer satisfaction. Its significant growth in market position, so that it now forms part of the "Big 5" is due solely to an aggressive acquisition policy of failed or failing bank assets. Its market position is based on the deep-pockets of Santander and not on winning market share through effective competitive rivalry.

79. Which? considers that both the European state aid rules and the terms of reference for UKFI have failed to take seriously the long term interests of consumers and taxpayers (largely one and the same), which are best served by a transformation in banking services that will make banking more competitive after withdrawal of state aid than before Government intervention was necessary. This will allow competitive market forces to drive value for consumers, improve productivity and facilitate deregulation where possible.

80. UKFI appears not to have taken any active steps to meet the third of its objectives: promoting competition. We cannot expect the European Commission, through the rules for state aid, to safeguard the interests of UK consumers if UK public bodies are not minded to take such steps.

81. To achieve the necessary changes in UKFI's approach, Which? consider that UKFI must:

Play an active role in managing public investments, working with other shareholders, to ensure improvements to corporate governance and ensure sustainability of those banks in the public interest.
Apply a public interest test to its disposal of shareholdings that balances the needs of current and future consumers.

82. UKFI should take an active interest to ensure that products offered to customers and sales incentives to staff lead banks to compete "on the merits" of their products. This would contribute to safer, more sustainable, banks by limiting exposure to future compensation payments (such as payment protection insurance mis-selling) and help to restore confidence in banking markets.

83. The public interest test should include objectives to:

Make competition stronger post divestment or withdrawal of state aid than existed before taxpayers money was necessary to bail out the banking system;
Place consumers needs, both households and firms, at the heart of a transformed banking system; and
Seek any necessary wider reforms, with the co-operation of business, consumer representatives and regulatory authorities, to secure the transformation in addition to any change achieved from removal of state aid.

The role of competition in the regulatory regime for banks

84. Financial services are not subject to the same rules governing competition as most other industries in the UK.[82] This has two effects.

85. First, firms regulated under the Financial Services and Market Act 2000 (FSMA) enjoy a degree of immunity from the Competition Act 1998. Agreements, or conduct by a dominant firm, that would usually breach competition rules are not subject to enforcement if "encouraged by any of the Authority's regulating provisions".[83]

86. This immunity appears largely irrelevant as UK authorities may directly apply European Competition law, for which FSMA does not grant immunity. In addition, the need for any form of explicit immunity is questionable. Firms accused of anti-competitive conduct would usually be able to cite any regulatory obligations or restrictions as "objective justifications" as a defence against enforcement action.

87. Second, unlike many other regulators, the FSA does not have concurrent competition powers with the OFT, which enable a regulator to directly apply competition law, including referring markets to the CC. Instead, when carrying out its functions, it must have regard to "the desirability of facilitating competition between those who are subject to any form of regulation by the Authority".[84] This affects the extent to which the FSA itself must actively consider or facilitate competition in its regulatory approach.

88. The OFT has some specific responsibilities under FSMA 2000, necessary to compensate for the lack of competition objectives in the FSA's mandate. Section 160 of FSMA requires the OFT to keep the regulating provisions and practices of the FSA under review, and report any significantly adverse effects to the Competition Commission: a process known as "competition scrutiny". There have been no occasions under current legislation where the OFT has exercised this power.[85]

89. This special treatment of the financial services industry sends a clear message to both the regulator and industry that the "normal" rules of competition do not apply.

Competition and stability

90. Competition is a dynamic process of rivalry that rewards firms that deliver good value and quality to consumers. Firms that do not serve consumers well fail. Competition always occurs within an institutional framework which governs the behaviour of firms and individuals. For example, property rights and contract law are pre-requisites to effective competition. Financial regulation, where targeted and proportionate, forms another part of the necessary institutional framework in which competition occurs. This reflects the more complex nature of the services offered by banks and the "bounded" rationality of consumers. It may also be necessary in part due to the instability that may be inherent in financial markets, prone to "irrational exuberance".

91. Competition between banks, to the extent it was effective, was not the cause of the banking failure. Measures taken to ensure stability, such as the HBoS / Lloyds merger have themselves weakened competition, leading to a considerable growth in market concentration. Setting aside the competitive framework through special treatment of banks during the financial crises and within the financial regulatory structure, as set out above, has significantly distorted market structure. This in turn has left consumers exposed to worsening outcomes and, through its greater concentration, has made financial services markets less resilient or stable.

92. On this basis, Which? is not convinced that it is appropriate to consider competition as necessarily a "trade-off" against stability or other regulatory objectives. Regulations, where proportionate and targeted, should exist to serve socially desirable objectives. Competition has a key role to play in delivering value to consumers within this institutional framework. Competition is a key mechanism to deliver financial services that represent value for money, meet the needs of consumers and, where incentives and moral hazard allow, promote greater resilience. Claims that competition is having a detrimental effect on financial stability must be specific, evidence based and scrutinised carefully.

Regulation and market confidence

93. Successful markets need confident, mobile and informed consumers. The nature of consumer protection interventions in banking markets has been intermittent and inadequate, despite a series of mis-selling or other scandals. This weakness of regulation hampers effective competition.

94. The Financial Services Authority (FSA) has identified a number of weaknesses in the financial capability of consumers, affecting their ability to make informed decisions between competing financial products.[86] Overall, the FSA found that consumers take inadequate steps to plan for their financial needs and that a significant proportion fail to shop-around. For example, 33% of those holding general insurance products bought their policy without comparing it to any other product.[87]

95. Consumers of financial services may possess "bounded rationality" and/or "non-standard preferences".[88] This can result in too much reliance on personal recommendations or brand (as a proxy for quality), rather than comparing key product terms. Consumers may also perceive greater risk from switching than warranted.[89]

96. As a result, for retail banking markets to work effectively, regulatory intervention must be prompt and effective to protect consumers' interests. The active enforcement of consumer protection law promotes competition by building greater confidence by consumers in the market process.

97. Which? has responded to the Government's consultation on reform of the Consumer Rights Directive, proposing a principles-based approach to restore consumer protection from unfair prices.[90] Consumers are not at present protected from unfair price terms by the UTCCRs, following the Supreme Court's ruling. It is unreasonable and inappropriate to expect consumers to read all the small print forming part of their contract. Much of the small print is legal (rather than commercial) essentials, with many of the contractual clauses having little practical significance for the average consumer purchase. Consumers should be able to rely on businesses trading fairly so that where the "small print" becomes relevant, it treats both the consumer and business fairly.

98. Consumers should be confident that once they have entered into a contract, they will not be subjected to any unexpected charges or, if they are, such prices are fair and proportionate. But this rationale will be significantly undermined if the approach set out by the Supreme Court in the bank charges litigation remains unchecked. Under the Supreme Court approach, consumers can behave both responsibly and prudently yet still find themselves to be on the wrong end of an unexpected fee or charge.

99. More capable consumers will help build market confidence. Which? supports the current measures proposed to increase financial capability of consumers through generic financial advice and a financial health check, currently to be supported via the Consumer Financial Education Body.[91] This health check should not, however, simply become a sales channel for banks but should offer relevant advice that suits people's needs, including debt advice and financial management.

100. The FSA, or its successor, must approach consumer protection regulation both pro-actively and with a mind to the competitive benefits it can bring. Measures to improve price transparency, contract certainty and prompt redress are concrete, meaningful steps to strengthen confidence in banking markets. This can best be served by making financial services subject to an economic regulator, similar to utilities regulation, with an explicit mandate to promote competition.

CONCLUSIONS ON COMPETITION AND CHOICE IN BANKING

101. Which? considers that the evidence of poor competitive outcomes for banking services is becoming incontrovertible. Banking markets have been subject to weak competition long before the financial crises. However, the crises has exacerbated these harms to a critical level, leading to a number of harms:

Market power and concentration has increased, leading to the worsening terms for consumers of banking services described above;
A loss of "dynamic" efficiency in banking services and evasion of market discipline, damaging services to consumers and economic productivity. Banks appear to suffer an "x-inefficiency": a bloated cost base, manifesting in excessive rewards for managers (not owners), as a result of ineffective competitive pressure and a sloppy approach to assessing risk (by banks themselves and by rating agencies); and
A conflict if interest for Government with UKFI tasked to maximise returns for taxpayers but without accounting for wider public interest to ensure a balanced and more competitive banking industry after state aid than before.

102. The root causes of these harms lie in:

The size and market concentration of banks;
Distortionary subsidies, direct through state aid bailouts and indirect by reducing funding costs, to the largest market incumbents;
No effective regime to enable market exit by failing banks while preserving financial stability; and
Consumer inertia where, perhaps more than in any other industry, consumers have an inbuilt tendency to remain with their existing providers. This in turn reduces the incentives for firms to actively compete amongst each other.

103. If these issues are not addressed, then the additional measures that are necessary to make competition effective such as making switching easier or tackling comparability of information will not be successful: market discipline will still not apply to the largest incumbent banks.

104. Two remedies should be considered:

Significant structural reform considering the economic market power of banks, and those reforms necessary to address financial stability. This may best addressed through a reference to the Competition Commission, which is the only body with the necessary powers to enforce structural change, but must be considered by the Vickers inquiry; and
Significant reform of public policy and regulation of banks to enable poor performing banks, whether due to poor management or customer dissatisfaction, to fail and thus become subject to market discipline.

September 2010

35 An economic, or relevant, market defines the products and geographical area that impose competitive constraints on suppliers given the substitutability of those products by virtue of their purpose or use by consumers. It forms the basis for most competition enquiries and, alongside consideration of other factors such as market entry and technology helps determine the strength of a firm's market power. See the OFT's Market Definition, OFT403. Back

36 Page 2 Personal current accounts in the UK, July 2008, OFT. Back

37 Paragraphs 56-60 Personal current account banking services in Northern Ireland, Market Investigation 15 May 2007, Competition Commission. Back

38 Market Investigation into Payment Protection Insurance 5 June 2008, Competition Commission. Back

39 Which? set up the Britain Needs Better Banks website where consumers could record and share their experiences (www.bnbb.org/) and collected additional stories during the Future of Banking Commission (www.which.co.uk/banking/). Back

40 A summary of the Which? Big Banking Debate is available here:
http://www.which.co.uk/banking/ourevents. Back

41 Polls were taken during the Big Bank Debate via electronic key pads of key questions. Back

42 See chart 3.2 Trends in Lending, July 2010, Bank of England. Back

43 See for example the results of Lloyds Banking Group which holds a market leading position in current accounts, deposit saving accounts and mortgages. Back

44 The 2010 Which? current account survey was conducted in October-November 2009 and April 2010 and consisted of over 14,500 Which? members through an online survey. Back

45 Which? savings account research was conducted in October-November 2009 and April 2010 and consisted of over 13,500 Which? members through an online survey. Which? mortgage research was conducted in January and June 2010 and consisted of just over 4,500 Which? members through an online survey. Back