Competition and choice in the banking sector

Written evidence submitted by the Co-operative Financial Services

Executive Summary

§ The Co-operative Financial Services’ (CFS) merger with Britannia, in August 2009, created a strong business with £70 billion of assets, 13,000 employees and nearly nine million customers.

§ Our purpose is to be a pioneering business delivering sustainable financial services for members, customers and society, while our vision is to be the UK’s most admired financial services provider.

§ We’re the most diversified member-owned financial services business in the UK, operating in both retail and corporate markets and with the scale and strength to offer a real alternative to the shareholder and government-owned banks.

§ At the heart of our ownership model are our values which define our business and shape the decisions we make.

§ We have not been immune to the impact of the banking crisis but during the recent period of economic turmoil, CFS has continued to deliver strong profitability and growth. While other banks received government bail-outs, we operated a sustainable model that didn’t lend out more than we had in customer deposits. This strength and trust in our brand has enabled us to attract even more customers.

§ There is a place for different types of banks and financial services businesses in our market. Our financial success shows that a balanced scorecard approach, which values customer advocacy, colleague engagement and social responsibility alongside profitability, drives our business’ performance.

§ Being member-owned, customer-led and ethically-guided has served us well throughout the recent economic turmoil, demonstrating our positive contribution to improving competition and diversity in the banking sector.

§ Throughout the credit crisis CFS has been able to continue lending to both personal and business customers due to high levels of liquidity and little reliance on the wholesale markets.

§ The banking crisis resulted in a shake-up of the financial services landscape, which in turn has resulted in new entrants and the growth of challenger brands such as CFS. This new landscape should offer the opportunity for more consumer orientated behaviours to develop in the sector.

§ Regulation, such as increased capital and liquidity requirements, is a significant barrier to growth, particularly for mutual businesses such as CFS which cannot turn to shareholders to raise additional capital.

Introduction

1. The Co-operative Financial Services (CFS) is part of The Co-operative Group, the UK’s largest mutual retail business with around five million members, more than £14 billion turnover and core business interests in food, financial services, travel, pharmacy and funeral care. The Co-operative Group has more than 5,000 trading outlets.

2. CFS’ merger with Britannia, in August 2009, created a strong business with £70 billion of assets, 13000 colleagues and nearly nine million customers.

3. This submission aims to show how our business, which is the most diversified member-owned financial services business in the UK, operating in both retail and corporate markets, has the scale and strength to offer a real competitive alternative to the shareholder and government-owned banks.

4. The banking crisis resulted in a shake-up of the financial services landscape, which has resulted in new entrants to the market and the growth of challenger brands such as CFS.

5. However, whilst new entrants to the market should lead to increased competition and a better deal for the consumer, the experience of the failed Icelandic Banks, which were clearly not good for consumer trust in the industry, shows that this is not always the case. It is important to ensure that the new financial services landscape offers the right regulatory framework for more sustainable consumer orientated behaviours to develop in the sector.

6. We welcome the coalition government’s commitment to ‘bring forward detailed proposals to foster diversity in financial services, promote mutuals and create a more competitive banking industry’. It is vital that this commitment is translated into meaningful actions, supporting a vibrant mutual sector that results in a healthy competitive and consumer focused banking sector in the UK.

Putting our members and customers first

7. Our ownership model means that we manage our business in the interests of our members and customers.

8. At the heart of our ownership model are our values which define our business and shape the decisions we make:

§ We put our members and customers first in all we do

§ We take personal and social responsibility

§ Together we will create a great place to work, grow and develop

§ We strive relentlessly to be faster, better, more successful

§ We are open and fair and are committed to excellent communication

9. We place customer advocacy, social responsibility and colleague engagement alongside financial performance as measures of our business success using a balanced scorecard approach.

10. The balanced scorecard measures our performance across four areas: financial, customer, people and process. This ensures that we do not just focus on financial performance when measuring the performance of our business.

11. Thanks to this focus we’re leading the way in customer service and advocacy and this has been recognised by the industry:

§ In 2009, CFS won the Which? Award for Best Financial Services provider and was shortlisted for the same award again in 2010

§ Both The Co-operative Bank and Smile were named in the top three in the Which? People’s Choice survey – 15,000 members asked to rate their satisfaction with their current accounts, savings and credit cards.

§ The FSA recently announced that The Co-operative Bank has the lowest ratio of complaints with just 2.1 for every 1000 accounts and that over 95 per cent of the complaints received were closed within eight weeks.

12. Our strength in customer service and advocacy is underpinned by our unique customer council, which provides a forum for customers to engage with executives to discuss all aspects of the business including strategy, products, ethics and people policies, and provides an essential ‘sense check’ on business proposals.

Ethical finance – the world’s most sustainable bank

13. Our commitment to principled finance, which takes account of our social and environmental responsibilities, is stronger than ever and an overarching theme of sustainability permeates every aspect of our business.

14. Most notably, The Co-operative Bank is the only UK high street bank with a customer-led ethical policy which sets out the way we do business, including, who we will, and will not, lend money to.

15. The ethical policy covers all of the bank’s corporate, business and wholesale market assets and is reviewed regularly to ensure it continues to reflect our customers’ views. We’ve turned away more than £1billion of lending since 1992, based on customer’s ethical concerns.

16. CFS also provides a comprehensive portfolio of sustainable products and services targeted to specific sectors, including free banking to the co-operative, voluntary, charity and social enterprise sectors, basic bank accounts, and affinity products which raise millions for partner charities.

17. Meanwhile, our dedicated Social Banking Unit directs finance towards social enterprise, charity, social housing, microfinance, energy and co-operative and credit union sectors. We are one of the leading financiers for community scale renewable energy schemes.

18. Our ethical leadership and financial strength culminated in the business becoming the Financial Times’ Sustainable Bank of the Year in 2010, outperforming 110 financial institutions from 44 countries.

19. Such recognition is not built on a few good deeds, nor a year’s achievements alone, but a longstanding approach to sustainability that is embedded and uncompromising.

CFS position in the financial services market

20. During a time of great economic turmoil, CFS has continued to deliver strong profitability and growth. While other banks received government bail-outs, we operated a model that didn’t lend out more than we had in customer deposits. This strength and trust in our brand has enabled us to attract even more customers.

21. In 2009 we saw major sales increases across core product lines including current accounts, savings and motor insurance. Current account sales saw a year on year increase of 38%, with a big increase in customers switching from the big four banks - overall new current account market share has doubled in the year to 4%. This year we have seen that growth continue, with an increase in total current account balances of 5.8% in the first half of 2010. Mortgage applications have also increased by 31% and our new policies in our General Insurance business were up 32%.

22. We have increased our lending to corporate business customers by over 40% over the last 3 years and plan for further growth in 2011 and beyond -because we have maintained high levels of liquidity from customer deposits, rather than relying on wholesale markets, as customers continued to trust us with their savings.

23. In recent months, we were one of the first mortgage providers to bring back an affordable 90% loan-to-value option across our mortgage range, which has proved popular with first time buyers.

24. We are investing heavily to ensure our members and customers receive the products and services they rightly expect from The Co-operative, with some £250 million of improvements planned in 2010.

Banking at the margins

25. CFS takes a lead in promoting social inclusion and providing access to financial services including for the most marginalised in society.

26. As a socially responsible organisation, we already offer basic bank accounts and understand they are an important way to give access to banking for those who are otherwise financially excluded, whilst also helping to tackle wider social problems in society.

27. Unfortunately there are discrepancies in the basic bank account market, with some providers offering much more than others:

§ Our Cashminder account basic bank account is available to any adult. However we are one of only two providers offering basic bank accounts to undischarged bankrupts and have no restrictions on branch counter access to our basic bank account holders. We contributed to the recent Citizens’ Advice report, Called to Account, which highlighted the need for other banks to provide access to undischarged bankrupts.

§ We believe that other measures must be introduced to ensure all banks , including new entrants, genuinel y perform on this issue. These measures would include compelling all banks to publish their market share figures for existing and new basic bank accounts, in addition to offering their basic bank accounts to undischarged bankrupts and reducing restrictions on branch counter access.

28. We have also introduced a pioneering project which enables prisoners to open a basic bank account prior to release. The scheme has had a positive effect on reducing prisoner re-offending rates as the provision of a bank account is often essential for an offender to get a job or accommodation on release from prison.

29. The Co-operative Bank is also the largest provider of banking to the credit union sector, providing facilities to more than 60% of credit unions in the UK. With the credit union movement, we pioneered the credit union current account. The current account forms part of our contribution to supporting the scaling up strategy for the provision of affordable credit through mainstream financial products.

30. We firmly believe that to tackle the wider problems of financial exclusion, the industry should work together to look at what has been learned so far and what different types of action may be needed going forwards.

Financial Education and Capability

31. We recognise the need for the next generation of consumers to be better informed and more confident so that they are able to take greater responsibility for their financial affairs and choose products and services that meet their needs.

32. Our Skills4Schools programme supports young people of different ages and mixed ability to be prepared for the future by helping to develop essential financial skills for learning, life and employment. The programme is delivered with the support of over 1000 members of staff, who volunteer through Skills4Schools.

33. In 2009, CFS’ Skills4Schools programme enabled over 8000 young people to improve skills such as numeracy, money management, employability and even safe driving.

34. Our aim is to focus on skills linked to the National Curriculum – to develop financial skills through their work in Mathematics, Physical Social Health Education (PSHE) and citizenship.

Accessing information about financial products

35. Informed and more confident consumers will make the best financial decisions when financial services products are easy to understand and compare. This is critical to a competitive financial services market, as a return to a higher number of competitors in the banking market is likely to result in a more complex range of products.

36. At CFS we support efforts to develop simple and transparent products and focus on ensuring that our communications with customers are straightforward, whilst using our financial education activities to grow an informed base of future consumers.

Competition concerns / opportunities

Sale of parts of government-owned banks

37. The on-going sale of parts of the government-owned banks offers a real opportunity to ensure that the needs of the customer are put at the forefront of the asset sale process.

38. The sales should not just be predicated on the highest bidder winning, but should make it a pre-requisite that: there is a clear commitment to maintain the branch estate; there is an obligation to provide all types of bank accounts including basic banking services; and that a fixed percentage of current accounts held in that branch estate are basic bank accounts.

39. When banks, or parts of banks, are sold we believe there should be conditions, including a requirement that branches remain open for five to ten years.

Regulatory Environment

40. Regulation is a significant barrier to growth. For example, increased capital and liquidity requirements can have a disproportionate impact on mutual businesses such as CFS.

41. We believe that any banking levy should be proportionate to the risk of the bank’s activities.  There is a risk that the banking levy, as currently proposed, will disproportionately penalise deposit taking institutions such as ourselves.  We also believe that the application of the threshold for inclusion on the levy disproportionately bites on those institutions which are only marginally over the threshold. Finally, the inclusion of lower tier 2 capital in relevant liabilities does not reflect the long-term stable nature of this funding.

Infrastructure

42. In addition to the regulatory environment, one of the main barriers to entering and expanding in the banking sector are the substantial set-up costs relating to systems, branches and staff. CFS is investing £250m in customer service and a new banking platform, which will significantly increase our capability to bring products to market more quickly and efficiently and provide the potential for significant growth.

Financial Services Compensation Scheme

43. Mutuals such as CFS, which have maintained a high level of balance sheet funding from retail deposit balances, have had to bear a disproportionate impact of the cost of funding the Financial Services Compensation Scheme (FSCS). This is due to the current allocation of FSCS levies, which are based on the size of each contributor’s retail deposit balances. This is proportionately more than those banks that have relied on wholesale funds from the markets – even though such a reliance on wholesale funding was one of the main causes of the financial crisis.

44. We believe that there need to be new depositor protection arrangements, which accurately reflect the relative risks faced by institutions with different types of balance sheet funding and some consideration needs to be made on managing the unpredictability of levy increases. We are particularly concerned by requirements proposed by the European Commission to build up a deposit guarantee fund (equivalent to 1.5% of eligible deposits), which will place an additional and unsustainable burden on businesses such as us.

Current Account Switching

45. Despite our recent experience of a 3 8 % increase in current account customers switching from the big four banks, we acknowledge that the UK continues to have one of the lowest current account switching rates in the EU and more needs to be done as this is a key barrier to competition in the sector.

46. We believe that there is a need to set-up a dedicated working group to find a way forward to make current account switching easier. We need to find a solution, which makes it as easy to switch current accounts, as it is now for people to switch utility providers or to port their mobile telephone number.

47. In the meantime, we have reviewed and improved our own processes to make the switching process smoother for customers wanting to move to and from the Bank and further, we believe that ongoing industry and regulatory communications to increase customer awareness in terms of the ease of switching and how products and services differ by bank would help.

Identification and Verification

48. A further constraint on consumer ability to benefit from the range of competition within the banking industry is the requirement for repeated provision of identification, either within a single banking entity or between entities. We would support investigation into options to ease this requirement for consumers, possibly through use of electronic methods of identification such as electronic signatures.

Conclusions

49. Our recent performance has shown that being member-owned, customer-led and ethically-guided has served us well throughout the recent economic turmoil and that we offer a positive contribution to improving competition, diversity and stability in the banking sector.

50. Despite our recent successes we recognise that there are barriers to improving competition in our sector. The regulatory environment needs to take account of different ownership models so that businesses such as ours are not impacted disproportionately in efforts to create a more stable and prudent regulatory regime.

51. We have also highlighted the need to set-up a dedicated working group to find a way forward to make current account switching easier, which will enable improved competition in the crucial current account market.

52. There is a need to introduce measures so that all banks, including new entrants, genuinely perform on basic banking and the discrepancies in this market are addressed. These measures include the provision of accounts to undischarged bankrupts and disclosure of each banks’ basic bank account market share.

53. We have also suggested that the sales of parts of the government owned banks should not be predicated on the highest bidder winning but there should be a pre-requisite that there is a clear commitment to maintain the branch estate and an obligation to provide all types of bank accounts including basic banking services.

54. We believe that we have demonstrated the contribution that a member- owned, customer-led and ethically-guided business can bring to a vibrant and competitive banking sector.

September 2010