Session 2010-11
Publications on the internet

To be published as HC 612-ii




Treasury Committee

Competition and Choice in the Banking Sector

Tuesday 23 November 2010

Lord Turner of Ecchinswell and MR Hector Sants

Evidence heard in Public Questions 40 - 103



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Oral Evidence

Taken before the Treasury Committee

on Tuesday 23 November 2010

Members present:

Mr Andrew Tyrie (Chair)

Mark Garnier

Stewart Hosie

Andrea Leadsom

Mr Andrew Love

John Mann

Mr George Mudie

Jesse Norman

David Rutley

John Thurso

Mr Chuka Umunna


Examination of Witnesses

Witnesses: Lord Turner of Ecchinswell, Chairman, and Mr Hector Sants, Chief Executive, Financial Services Authority, gave evidence.

Q40 Chair: We will begin again slightly shorthanded, but I am sure we have enough of a team here to ask some reasonable questions on this very important subject.

Could you begin, Hector Sant s, by telling us whether you think the retail banking market in the UK is sufficiently competitive?

Mr Sants: I think it is a difficult question to answer. The following things are certainly true. It is obviously one of the more concentrated retail banking markets that you find around the world. It is not the most concentrated, like Canada and Australia, but it is clearly one of the more and it undoubtedly has a couple of institutions with some very significant shares of the marketplace. So, it is a concentrated one. The question then is, is it nevertheless a competitive one and are the consumers deriving all the benefit they could from that competitiveness? Of course that then leads us into the problem-and Adair can expand on this-whereby the fact that in financial services it’s not immediately obvious that conventional competition is always allowed to work to the advantages of the consumers in a straightforward way, not least because of the asymmetry of information between the consumers and the providers and the complexity of the products being offered.

Q41 Chair: Do you think we need structural reform to reduce concentration?

Mr Sants: I think there is a credible argument to be made that some benefits would accrue from reduced concentration in certain areas, whether you need-

Q42 Chair: That is a pretty guarded reply. It would be helpful to have something on balance on that.

Mr Sants: I think, on balance, yes. The question is whether we need structural reform to achieve that, as opposed to whether that could be achieved by the passage of time, and we are seeing some more entrants into the sector. I think you could achieve it in both ways.

Q43 Chair: Do you think we can privatise the holdings of the nationalised or part nationalised banks in their current form?

Mr Sants: Not in their current form at this very precise moment.

Q44 Chair: Are you talking about in terms of size?

Mr Sants: In terms of size as opposed to general capital and liquidity and other measures of investment practice.

Q45 Chair: In terms of market share and concentration, then?

Mr Sants: Yes. I don’t think that their market share and concentration is a barrier to the disposal of the stakes in them, no.

Q46 Chair: Have you discussed this personally with the OFT?

Mr Sants: Not in detail.

Q47 Chair: Was that a yes or a no?

Mr Sants: Not in any formal sense. I have informal meetings, I am sure you appreciate, with the OFT all the time. On a personal level, you would expect me to do that, in terms of co-ordination. We, of course, have general discussions, but not in a formal sense, no.

Q48 Mr Mudi e : I read your evidence, maybe it was late at night yesterday and I was ready for sleep, but I could not, from paragraphs 44 to 48, decide what you were trying to tell us about free banking. Are you for it or are you against it? Is it a barrier to competition? Have a look, Hector, and remind yourself what you have written to us.

Lord Turner: I think it probably is the case that free if in credit banking does create a bit of a barrier to new entrants, because it’s important to realise it is not just free if in credit, the current account in itself is probably for many customers loss making or marginally profitable. It is essentially a loss leader. It is just a classic loss leader, or at least low-return leader, which banks provide in order to get hold of a relationship on which they can then sell other products. There are two problems that follow from that. One is that because of that there is a desire for them to sell other products, including sometimes products that are not appropriate, and that is where we get some of the problems from aggressive selling, because they’re trying to make up for the low profitability of the core product. It is also the case that a loss leader product, almost by definition, makes it more difficult for new entrants to come in, because they can’t make profit just out of the core product. They have to immediately be able to cross-sell other products as well. The structure is probably something that tends to make it more difficult for new entrants to come into the market. There are other important barriers to new entrants, however, which I notice the OFT have also set out in their recent report.

Q49 Mr Mudi e : Let’s stop it there. Hector has had enough time to read the report.

There is o ne thing you don’t mention that w e got from our first evidence session . An important thing you’re leaving out lies between the person walking through the front door, free, being able to open an acco unt and get on to insurance and mortgages and so on, and the £8.4 billion the banks charge opaquely to customers for things like overdrawing on cheques and so on. They broke it down : £ 4.1 billion was interest for gone, with a small amount they pay on their accounts. They make £ 4.1 billion out of that and they make £ 4.3 billion out of charges. If you left free banking alone , the free entry, but you got stuck into these hidden opaque charges that the banks make so much money from, wouldn’t that be a very good area of competi ti on?

Lord Turner: When you say "stuck in", you mean regulate or control? Yes?

Mr Mudi e: Whichever you choose.

Lord Turner: This is an issue that we’ve discussed at great length, because we did discuss at great length the issue of the unauthorised overdraft charges where, you are absolutely right, the process was, you have a core product that might not make money out of the person who doesn’t go into overdraft, but the moment they go into overdraft they get hit by unauthorised overdraft charges. There was a clear legal decision, you have to remember, that the banks were justified in doing this. Even before that, this was more an issue for the OFT than us, because you have to remember we do not regulate at the moment consumer credit, and overdrafts count as consumer credit. But the answer is, when and if all that is tidied up, yes, I do think the appropriate regulatory authority should be directly looking at both the transparency and indeed the level of unauthorised overdraft charges. That should be part of our regulatory machinery.

Q50 Mr Mudi e : You don’t necessarily have to put a charge on and compete on it and see it as a competitive issue for opening the bank account. The competitiveness would come over this £8.4 billion they are taking. They can give a decent interest rate for positive balances and, secondly, they can make clear what charges they are levying, and at the moment they don’t. They just land on you and you just pay them.

Lord Turner: I agree that disclosure and transparency is a good thing, but what we have found in many other areas of the financial services market is that it’s certainly not sufficient to make the system work well. To a distressing extent, even when disclosure is clear, consumers don’t necessarily pay attention to it.

Q51 Mr Mudie: I understand that, but I don’t suppose for a second you’re arguing against openness and transparency.

Lord Turner: No, not at all. I am just saying it’s necessary but not sufficient.

Q52 Mr Mudi e : You have brought packaged accounts into these paragraphs. Why are they relevant?

Lord Turner: They are almost a further step in this process of having a product where other things are added on. Here there are sometimes explicit charges for it, which then add other products on. These are sometimes products that the consumer doesn’t necessarily need, but they are tempted to take on board because it looks like an attractive combination at the time. Wherever we see complex combinations of things, the ability of the customer to understand where they are getting value is sometimes degraded. We are clear that packaged accounts can be a valuable part of the system but we know that, for instance, we’ve had major problems where people package payment protection insurance with a loan and don’t make it clear to the purchaser that they have an absolute right to take one without the other. Package combinations are among the mechanisms that sometimes end up with consumer detriment, but not always-they can sometimes be good product combinations as well.

Mr Sants: It’s all in the same space as you’ve already alluded to. The packaged product is a perfectly valid product for some, and many consumers who are offered packaged products don’t avail themselves of the package. While it may not be a sufficient solution to the problem of improving the consumer value proposition, there is absolutely no doubt that having greater transparency and the availability of simple, unbundled banking products, which the consumers can hopefully more easily understand, has to be a helpful step in this direction, and one that we would support. It doesn’t mean there can’t be packaged products as well.

Q53 Chair: You’ve said, Lord Turner, that transparency is not enough. Have you ever tried, just as an exercise, to work out what you reckon you are paying your bank?

Lord Turner: No, I haven’t. Funnily enough, as I was reading the evidence again, various bits of it, in preparation for this, I asked exactly that question. Broadly speaking, like I suspect many people in this room or elsewhere, I took out a bank account at the age of 18, and the bank has then been bought and sold several times and ended up with a different brand and a different name, but that’s where I am. That’s what many people do.

Q54 Chair: Can we get competition without getting to a point where people know what they’re being charged?

Lord Turner: I’m sure it would be good to have greater clarity of what the charges are.

Q55 Chair: Yes, we know that. That’s the motherhood and apple pie reply. The question is, can we get to an acceptable level of competition in this market without that level of transparency on current accounts?

Lord Turner: I think I’d be willing to accept that it may well be a necessary and, therefore, we can’t. I think it will be a long way short of sufficient, because I think there are dynamics of this market, which the OFT have set out.

Q56 Chair: We have understood that point. You’re often answering a slightly different question to the one asked.

Lord Turner: I’m sorry.

Chair: The question is: is it a necessary condition? You’re now saying-

Lord Turner: My judgment is it probably would be, but it is not something that we do.

Q57 Mark Garnier: I want to carry on with the barriers to entry. The Office of Fair Trading came to the conclusion that certain aspects of the authorisation process may have acted as barriers to entry and that this may have led to a detrimental impact on price quality and range of products available to consumers. Just for absolute clarity, what I’m referring to from now on is the high street banks and retail banks, as opposed to investment banks. Also I’m going to specifically ask questions around new applications as opposed to any other type of new banking. What I want to do is get a bit of flavour about what is going on with new applications. C an you tell me how many people have put in new applications for high street banks, retail banks, in the last 18 months or so?

Mr Sants: We can, but if I may point out 1.12 in that report, "The OFT considered firms do not face significant barriers to entry arising from regulatory requirements that must be met in obtaining authorisation to accept deposits or offer mortgages." What it did observe, which is by the way perfectly reasonable, was that our authorisation process for mainstream deposit-taking banks is a relatively infrequently used process. If you look back over the statistics, which are in the document, you will see it has traditionally only been eight or nine in a year or so. We have, in the light of feedback over the last 12 months, brought in a number of changes to process to make our process easier to use.

Q58 Mark Garnier: So you do recognise that you did have a problem?

Mr Sants: I think what happened at the beginning concerned the obligation to authorise within six months if the application is fully filled out; 12 months if it’s incomplete. What we found was that the vast majority of these applications were, broadly, incomplete, so our average authorisation time for deposit-taking authorisations over the last few years varies between seven and 10 months-so within the 12 months-but obviously firms are struggling to give us the right information upfront. Plus, we have changed our standards in terms of what we are looking for in terms of business model analysis and capital and liquidity, which is what you would expect post the crisis. I think we concluded not that we had problems, but that the applicants needed more help, and that we needed to be a more positive organisation in terms of giving them more guidance and being prepared to sit down with them more regularly and work through that process. So we are now giving them a lot more help.

Q59 Mark Garnier: This is all about the pre-application briefings and-

Mr Sants: This is the pre-application process.

Q60 Mark Garnier: Getting back to the question, how many in the last 18 months?

Mr Sants: In the last 18 months, we’ve listed it in there, it’s about 12, I think, if I just turn to the right page.

Q61 Mark Garnier: Twelve new applicants for retail banks?

Mr Sants: No, not for retail. We’ve only had one that we’ve authorised. Currently in the pipeline, I think we may have about two or three, roughly.

Mark Garnier: Two or three.

Mr Sants: In the pipeline. One we’ve authorised for what you would call a mainstream conventional retail bank.

Q62 Mark Garnier: Which is where you or I would go and open a bank account when we are 18 and deposit money in and have cheque account and that kind of stuff?

Lord Turner: I would stress that across the world there just isn’t a general tendency for new start-up retail banks. They don’t often happen.

Q63 Mark Garnier: In America you have lots and lots and lots of banks that are catering to local towns, local communities, that type of stuff. Here you don’t. One of the ways that you can have competition in banking is ultimately to have more local community-focused banks. What I am getting at with this is that there are a number of different problems when you are trying to start a bank. Some of them could be to do with the fact that you need capitalisation: you won’t authorise a bank unless it has capitalisation; the investors won’t capitalise a bank unless it has authorisation. You have a Catch-22, so that is a blockage that has to be got around. There are various other things. But if the problem in opening retail banks is lying with you we need to get to the bottom of it.

Mr Sants: Yes, but it’s not. It absolutely is not. The OFT is not suggesting it is, we’re not suggesting it is, and I have talked to those people who are-

Mark Garnier: A number of people are suggesting it.

Mr Sants: What precisely are they suggesting is the problem?

Mark Garnier: They’re suggesting you’re taking a hell of a long time to get through this; you’re taking 18 months, two years to do this.

Mr Sants: Which is not correct.

Q64 Mark Garnier: Can you absolutely categorically guarantee that?

Mr Sants: We would comply with our standards, which are set for us. If you give us a completed form we would do it within the six months. I have analysis here, as I say, of the average application time over the last few years, and it varies between seven and 10 months, which is within the time we are allowed to take for all deposit-taking institutions who are applying for deposits. We basically haven’t had a mainstream retail bank apply in the pre-2008 period. Since 2008-I have the figures in front of me here-we authorised 15 deposit-taking institutions, of which eight were in the retail space and only one of which, as we said, we would describe as a mainstream bank. Basically, people are not applying. It is not a question of people applying and being-

Q65 Mark Garnier: Why do you think that is?

Mr Sants: Well, I think that’s to do with the business model and the general discussion that is now on the table about their expectations of making a reasonable return as a new entry start-up.

Lord Turner: I think the essence of it is as set out in the OFT report. As Hector has already said, the OFT report in 1.12 says fundamentally it’s not an issue about regulatory requirements, and in 1.10 it says, "New entrants face significant challenges in attracting personal and SME customers through a combination of low levels of switching, high levels of brand loyalty and consumers’ preferences for providers with a branch network." This is a market where, across the world, it’s very difficult to enter except through the acquisition of existing branch networks. People on the whole don’t go to a new bank which has 10 branches across the country. They go to one which has 200.

Q66 Mark Garnier: If someone like Tesco wanted to set up a bank, they have a branch network, they can do it. So that would take them, what, seven months to get it done?

Mr Sants: We would do it within the six months, assuming they applied to us with a fully filled-out authorisation process and, as you say, given they’re part of a wider group, the type of business model concerns that we have for standalone start-ups, where we look carefully at their sustainability and their capital liquidity position, as you would expect, obviously those risks would be significantly less in the context of a large group such as Tesco.

Q67 Mark Garnier: There are banks that are the other end of the scale. There are banks where they have two or three branches.

Mr Sants: Of course, we have seen huge growth in retail banking products being offered by groups such as Tesco, who are able to leverage off their existing established infrastructure and a strong brand name, and that type of business model appears to have been more successful in gaining market share over the last few years than a new entrant with a very limited branch network. Obviously we’re now seeing one or two people looking at that strategy and we’ll have to see how they fare. But there is no evidence at all that the regulatory authorisation process is the problem. I hear odd comments made to the media, but whenever I ask people to tell me, "What is it you would like us to change?" I never get back any specific points. I think it’s more of a sort of noise in the system.

Q68 Mark Garnier: But you’re very clear on this. You are absolutely happy that the system that you have in place, which has slightly changed over the year or two, I think, to make it more efficient, is working well, that it’s efficient, it’s opening up the barriers to entry, it’s making it easier for people to come along insofar as it is affected by the FSA?

Lord Turner: I’m very confident, in what I think is a very important issue here, that our regulatory processes are not a significant barrier to entry. I think there are other barriers to entry that are important, which might suggest that if you want more competition you would have to do it by breaking up existing banks, rather than by facilitating new entry.

Q69 Mark Garnier: How much does it cost?

Lord Turner: I think this is one of the fundamental questions that you and others and the Vickers Commission have to consider, but it may be that there is something structural about this market where you will not get significant new entrants, even if we authorise them immediately.

Q70 Chair: Let’s have a view. What’s your view?

Mr Sants: We have sub-models now starting up. As I’m sure you understand, we are reluctant to discuss firm-specific names, but it will be very interesting to see whether that approach is successful. The past clearly demonstrates it has been easier if you leverage your existing brand name and existing infrastructure, and that entering without an infrastructure, without a branch network is very difficult. It may be possible, but I think it would be very difficult in the long term.

Q71 Chair: But do we need to break up these big banks to get enough competition? It’s the same question I asked earlier. Lord Turner moved away from the earlier position to something that sounds as if he thinks that’s something we should be looking at carefully.

Lord Turner: Well, I think it should certainly be looked at. We now have-

Chair: But what’s your view?

Lord Turner: I don’t think it’s appropriate for me to have a personal view. I think this is something that is appropriately looked at by the Vickers Commission. If it were the case that we had a somewhat wider set of retail banks I think that could be a good thing, but I don’t think it’s for me to say, "I believe the concentration should be X." But it’s certainly a legitimate issue to be looked at.

Chair: Actually, I took the floor from Mark and I apologise.

Q72 Mark Garnier: I am pretty much done. The only thing I’d like to ask-and then I know Chuka is going to get stuck in in a minute-is, what is the actual cost? Obviously there’s the cost of paying your fees and all the rest of it.

Mr Sants: £25,000 or whatever, yes, for the fees.

Mark Garnier: Sorry, how much is it?

Mr Sants: The fees are £25,000 or so but, as I say, there’s an administrative cost that goes with the programme.

Q73 Mark Garnier: So the cheque that goes with the application form to you is £25,000. That’s not entirely unreasonable, and you have a job to do. What about the legal fees that are going with these organisations that are going to have to set it up? I speak as somebody who has gone through the regulatory process of two regulated firms, one under the FSA and the other under the SFA, and these are small firms, but I can tell you it’s mighty time consuming. It’s very expensive in terms of legal fees, and then obviously you have your regular fees. They’re acceptable-I’m not arguing against those-but by the time you look at all of this process and the time involved and the effort by a lot of people and the cost that you have to go into the process right at the very beginning, with the investors having to sit on non-productive business while this process is going through, what is the cost of actually getting a bank set up?

Mr Sants: I don’t know the cost to a firm of its own commitment.

Mark Garnier: It’s an incredibly important question and I’m disappointed you don’t know the answer.

Mr Sants: It’s perfectly reasonable. I know, it’s a perfectly reasonable question. I’m not in any way saying it’s an unreasonable question, I’m just saying I can’t tell you exactly what the cost was to the very small number of applicants that have applied for pure retail banking authorisations over the last couple of years. I have had conversations with the one successful authorised firm, which is listed in paragraph 17 of our submission, and in order to make sure I listened to them carefully to see if there’s any improvements we can make in our process, and this was not a factor that they brought up with me.

More generally, could I just reiterate on this point of authorisation? When I say I’m confident we are not an issue in terms of deterring entrants, I’m sure that is the case, but equally, we’re always here to improve our processes, and if anybody brings me a specific suggestion as to how our process could be improved I will take it on board. But at the moment, I’m not aware of any specific suggestions outstanding that any of the people I’ve spoken to have made to me.

Q74 Mark Garnier: Just very quickly, how would they do that? Would they get in touch with you?

Mr Sants: Yes, absolutely. I have talked to those firms who have been through the process successfully directly myself, and I have been in contact with one or two of the firms who are currently going through the process who have raised issues, to make sure that we’re dealing with those firms efficiently and fairly, and we will always respond to them. But the OFT has looked at it as an independent process, and the conclusion it reached is very clearly set out in the report.

Q75 Andrea Leadsom: Lord Turner, I’m amazed that you think it’s none of your business to say whether large investment banks, banking groups, should be broken up. Surely, as the Chairman of the Financial Services Authority, it is very much your business and very important that we know your view of whether our banking groups are too big to fail and whether they should be broken up.

Lord Turner: Let me draw a distinction. I think there is an issue of the size of banks and whether they’re too big to fail and whether they have a financial stability risk. There is a separate issue about competitive intensity. It was the issue about the intensity of competition, where I was saying that the Government has chosen to set up the Vickers Commission, which will look specifically at this, and which I welcome, and where I have expressed the point of view that I would be perfectly sympathetic to the idea that perhaps a bit more competition might be a good idea, but it’s not our core issue because we are not a competition authority.

If we go back to financial stability, the issue of how we make banks not too big to fail is not only part of our agenda, it’s probably the single most important bit on which I have concentrated my own efforts over the last year.

Q76 Andrea Leadsom: Quite. So should banks be broken up for the reasons of-

Lord Turner: No, I don’t think we need to break them up for dealing with the too big to fail problem, because I think we can deal with that through other mechanisms, through the mechanisms of having them have enough capital, through having resolution procedures which enable them to fail in a structured fashion and, if necessary-and this is going to be the big debate over the next year-through capital surcharges for larger systemically important banks, so that for those we are being even more cautious than we are for smaller banks. That is a proposal for which we, the UK, have very strongly argued in the Financial Stability Board and which is now an agreed statement of the Financial Stability Board and the Basel Committee, that large systemically important banks have to have levels of loss absorbency higher than the Basel III standards. So I don’t think that the too big to fail agenda necessarily says we have to take the big banks in the world and break them up. I think we have other mechanisms to achieve that. I draw a distinction between that and the debate which we’re having about consumers and competitive-

Q77 Andrea Leadsom: I completely disagree with you, because I think that you simply cannot divorce the issue of too big to fail from a regulatory point of view and issues of competition in the banking sector. You said yourself that the big failing, which is attributed to Greenspan but was generally held, was the sense that investment banking and banking would look after itself, that the mechanisms were all fine and would all continue to work, so long as we left them alone. That was the big regulatory failure. Now, isn’t it the case that all the way through, going right back to Adam Smith, a key requirement of capitalism is free entry and free exit of market players, and isn’t it the case that over the last 10, 15, 20 years, regulation always trumps competition? It’s all tied up with barriers to entry. You said, Hector Sants, that nobody is applying and you don’t really know why nobody is applying.

Mr Sants: I didn’t say I didn’t know why.

Q78 Andrea Leadsom: Well, very few new players are applying. Isn’t it the case that competition, this whole issue of the all powerful regulator and the regulatory powers are stopping new entrants from coming into the marketplace and allowing existing market players to dominate markets and to create barriers to entry precisely that are creating these systemic problems?

Lord Turner: I don’t agree with that. I don’t agree that regulation has created barriers to entry. I think there are naturally arising barriers to entry that may push these markets naturally towards greater degrees of concentration than we want, but I don’t think it’s our regulation that has done that. A problem that we have to fix is that where there is a perception that some banks are too big to fail, they might clearly-and this is more to do with corporate customers and institutional investors-have a slight funding advantage, because people will deposit money with them at a lower price than they would with smaller banks. That’s not the case, of course, at the retail customer level, because deposit insurance tends to even out the playing field for them.

There is a potential competitive advantage of very big banks, and that’s why we have to put a stop to too big to fail through the mechanisms of things like contractually bail in-able debt, resolvability and higher capital surcharges, which are absolutely, as I say, not just part of the agenda but probably the single biggest thing for which I’ve been arguing on an international basis over the last year. There is lots more work to be done over the next year on that. The work on improving resolvability of major banks, which Paul Tucker has led within the Financial Stability Board, is a very important way forward. I just don’t think we have to take the 100 biggest banks in the world and split them up in order to get round the too big to fail problem. I don’t think that’s necessary. I think we have other tools to get there.

Q79 Andrea Leadsom: So, do you then disagree that there is, at the very least, oligopoly-type pricing going on in certain parts of investment banking and wholesale markets-for example corporate underwriting, corporate advisory? Are you concerned about that? Do you not believe that it is part of a regulator’s role to ensure that there is fair pricing in markets?

Lord Turner: That is a very good issue, and let me tell you exactly what I believe. First of all, in relation to wholesale markets, our philosophy, which has been broadly supported, is that you have sophisticated customers and investors who may need protection against market abuse and insider dealing but who do not need protection in relation to the price at which they buy a particular product. And although we have signalled quite a significant shift to a more interventionist approach in the retail customer side, our approach and that of regulators-and so far, I think, of Governments and Committees like yourself-has been to accept that rather free market approach in wholesale markets. I would be wary of moving away from the idea that a buyer of underwriting services, which is the CFO of a major corporate, needs the same category of price protection as a retail customer.

Q80 Andrea Leadsom: So you think it’s acceptable to have oligopolistic pricing in the wholesale markets but not in the retail markets?

Lord Turner: I don’t think there is oligopolistic pricing in the sense of any collusion. I think there are naturally arising processes to do with brands and the incentives of the purchasers of these products, which do tend to produce dominant players and high degrees of profitability. I think, however, these are so inherently arising that if you went in and took the investment banks and broke them up, five years later they would have congregated again. Well, why is this? It’s because the CFO who is purchasing and underwriting a product from a major investment bank, in terms of their personal incentives, their personal self-interest, the benefit to them of negotiating down the underwriting fee is very little, and the disbenefit to them of anything ever going wrong or them being criticised for having gone away from the golden circle of the best brand names is very high. So you have incentive structures that tend to produce dominant players, but in a sense that’s no different from the old adage that nobody got criticised in the 1980s for buying IBM.

Q81 Andrea Leadsom: But you do accept then that there isn’t transparency and that there isn’t fair value pricing in the wholesale market, but yet you don’t accept-

Lord Turner: I think there’s transparency. I think these people know exactly what price they’re paying, it’s just they choose to go to dominant-

Q82 Andrea Leadsom: But there isn’t fair market value, and don’t you accept that that is one of the reasons why there are barriers to new entry? If you have a market that is artificial, that isn’t properly priced and isn’t properly valued, isn’t that one of the reasons why you don’t have new entrants to that marketplace, because it’s an artificial market?

Lord Turner: The wholesale market of investment bank advice is actually full of boutiques continually emerging, splitting off from existing banks, and in the advisory side of it is a very open competition market. It’s just that there are certain functions within it, in particular underwriting, where, because of the naturally arising risk averseness of the purchase of these customers, they tend to go to the dominant players with dominant distribution market share, because those are the ones with whom they believe the thing will go well. So I don’t think this is an issue about either collusion or transparency or, in a sense, an artificial market. I think there are some markets-and we have them elsewhere, we can have them in soap powder and so on-where dominant brands tend to arrive at a dominant position. That’s how premium brands work.

Andrea Leadsom: Just one last question.

Chair: A quick question and a quick answer, please.

Q83 Andrea Leadsom: One last question. Is it not the case then that in order to achieve at least fair pricing of risk within the banking sector that you need to reach a position where you can allow a bank to fail?

Lord Turner: We need to be able to have all banks fail in a controlled fashion, imposing losses on people above and beyond the equity owners, but in a way that preserves the fundamental functions of the bank, in particular of lending to the real economy, and that is the trick in the too big to fail debate, and that’s-

Q84 Andrea Leadsom: Are you there yet? Are you able to-

Lord Turner: No, we are not there yet, and that is why that is identified as our most important agenda item at an international level over the next year. That is absolutely the most important agenda item, which we still have to get right.

Q85 Mr Umunna: I just want to follow up on some of the questions that the Chair asked and also Andrea asked too, because I’m still not totally sure what the position is on this, and do forgive me. Can I ask you what your view is on separating out retail banking from proprietary trading-investment banking? The Governor of the Bank of England, I think, has been quite clear that he thinks there’s a strong argument for the two to be separated. The Obama administration in some senses agrees. Where are you on this? What is your view?

Lord Turner: My view, which I clearly set out last year, was that it is not acceptable that retail bank funding, and profitability-to the extent that it was the case, but it’s primarily funding-is used to support risky proprietary trading. However, I have not been convinced that it is at all easy or possible to draw a clear legal distinction between that which is commercial banking-and the key thing here is that you leave aside retail banking-and proprietary trading. Indeed, the difficulty of so doing is illustrated by the Dodd-Frank Bill and the clauses in that which translate Paul Volcker’s rule into actual action. It basically says in that bit of the legislation, "Commercial banks, things that have banking licences, must not do proprietary trading" and then immediately it says, "Proprietary trading does not include trading for the purposes of market making and customer facilitation or hedging" and then it says, "Over to you, the Fed and the OCC, to work out how you’re going to decide when trading is market making, customer facilitation and hedging, and when it’s pure proprietary trading."

I can tell you, they are scratching their heads at the moment about how they are going to do it, because here’s the challenge. If we take a product which is undoubtedly socially useful, forward foreign exchange-the ability of an exporter to buy some foreign exchange six months in advance-for that to exist you have to have a large commercial bank, which has a trading room, which is making a market in forward foreign exchange. In the course of making a market, it will take some positions and it will make some proprietary gains and losses. Our ability to distinguish that element of their market making and the related proprietary trading that was there in order to provide the useful service of forward foreign exchange to an end consumer, and that which was pure betting, is highly imperfect. I have not been convinced that there is any easy way to draw that legal distinction, and I think they will find it difficult.

What I think is a very good idea, which I know the Vickers Commission is looking at, is to consider whether within large universal banks we should more clearly put trading operations and retail or commercial banking operations into different subsidiary units so that we could, if necessary, in resolution processes, draw a distinction between what we do with the trading operations and what we do with the commercial banking operations. It’s also vitally important that we get the capital requirements right. I would not be opposed at all to us having the Dodd-Frank wording to, as it were, give reinforcement to what we want to do in regulatory terms in any case.

Q86 Mr Umunna: Just to clarify, are you saying that you would like to see banking legal entities constructed in such a way that you have clear separation of the retail function from the commercial proprietary trading function?

Lord Turner: It’s certainly an option that should be considered and I know the Vickers Commission is going to look at. It is an internal separation rather than-

Q87 Mr Umunna: You are saying it should be considered. A lot of people would say it’s an absolute necessity. Do you think it is an absolute necessity to basically ring-fence my constituents and all the constituents that we-

Lord Turner: I don’t think it’s an absolute necessity. I think we have other mechanisms to achieve the same effect. Look, for instance, at what the Swiss have done. The Swiss faced this problem on a bigger scale than anybody else with the explosion of the role of UBS before the crisis. They have gone down the route fundamentally of higher capital requirements for their two largest systemically important banks. I don’t think it’s the only route to go, and I’m sure we will use many policy levers, but it is certainly part of the suite of policy levers that we could use to address the issue of the dangers that arise from proprietary trading.

Q88 Mr Umunna: Can I just ask one other question, which I think has been mentioned already? There is quite a lot of debate at the moment about what should be done with Bradford & Bingley and Northern Rock. My own view is that we should very much consider remutualising both of them, because it will increase the diversity of providers in the sector. Historically, mutuals have a good reputation for having strong bonds and investing in their communities, and in some senses they are considered to be more stable. What is your view on the remutualisation of Northern Rock and Bradford & Bingley?

Lord Turner: Mutual credit institutions have one advantage and one disadvantage. The advantage is that they’re not paying out dividends and they accumulate money out of retained earnings. They can use all of their retained earnings to make depositors safe and build the business. The disadvantage is that if they get into trouble it’s very difficult to bring in new equity, new capital, in order to recapitalise them, which is sometimes the perfectly normal pre-market response to a bank that is in some trouble but not extreme trouble. I think the resolution is that there is a role for a mutual sector, but it is a sector which should be focused on a restricted range of activities. I think the biggest mistake we made-this is something to which Parliament could well return-was to allow our mutual sector, our building societies, in some cases to extend beyond the core business of prime real estate lending into commercial real estate lending and buy to let and other activities.

Mr Umunna: I completely agree.

Lord Turner: I think there is an unfinished part of our regulatory agenda as to whether we should reverse some of the liberalisations of the building society rules that occurred in the 1980s and 1990s, which gave us precisely the problems that we had in the Dunfermline Building Society.

Q89 Mr Umunna: Before we move to you, Hector, can I just ask what the answer to my question is: do you think the Government should give due consideration to remutualising Northern Rock and Bradford & Bingley? I hear all the useful background you’ve given, but what is the answer to that question?

Lord Turner: The answer is, since I haven’t thought about it, I don’t have an immediate answer to that.

Chair: Drop us a line.

Lord Turner: I will come back on that. It’s not a regulatory issue for the FSA. It’s not something that I’d thought about, so I’d rather not give an immediate response.

Mr Sants: I didn’t want to reopen the previous point on monetary reform.

Chair: Briefly, please.

Mr Sants: We would welcome reform of the Building Society Act being on the Government’s agenda. There is a need to change the framework and consider the overall package of how supervisors, and the PRA, which would be overseeing mutuals, would be acting in the future, for the reasons that Adair has just laid out.

Chair: The Government no doubt will welcome that, too.

Q90 Stewart Hosie: Just on that final point, Lord Turner, about reversing some of the liberalisation to stop the mortgage banks and building societies doing many of the things that they did, I understand the logic. Would it not have been better if the regulators hadn’t allowed them to make such loan to asset valuations, be it on commercial lending, residential lending or buy to let lending? Rolling back the clock, should the regulators and supervisors not have simply done their job and stopped the 125% loan to asset valuations on silly things?

Lord Turner: Well, obviously this goes to the whole debate about our internal audit report on Northern Rock. Right at the beginning of this session it was noted that the FSA had been more open than I think any other institution around the world in saying that we had made a set of mistakes and we would learn lessons, and I think we would be much more aggressive in future in challenging risky lending activities. Having said that, there are some circumstances in which it is incredibly difficult in advance to know what is lending activity. You will doubtless be interested in the background of what happened on the Dunfermline Building Society, since it comes from Scotland. The fact is that two years before that got into trouble, our supervisors were asking some questions about its commercial real estate lending. They asked questions of the auditors about the adequacy of the provisions and were told that the auditors did have some concerns because they thought that the provisions were too high, because according to the accounting rules of the time the Dunfermline Building Society was, if anything, trying to put too many provisions for things that shouldn’t have been provisioned, because there was no evidence that the loans were then turning bad.

What that illustrates is that in an area like commercial real estate it’s very difficult to see the problems except at the macro level. At the individual level, you have a loan that is still paying back, and the auditors say, "You should not be provisioning against that." So in that case, we did ask some questions, but the inquiry did not suggest that they were a problem. So, I think the answer is we will be much more aggressive in future, but I still think that in relation to the building societies, which are organisations, which particularly small and medium ones can only have a skill set across a limited range of activities, they should stick to their knitting.

Mr Sants: Can we be quite clear, looking forward again, that neither the FSA was, nor will the PRA in the future be, resourced-the FSA is now much more resourced than it was-to a level to be an inspector of small to medium-sized institutions, and if you want to pick up poor credit decisions at the point of that decision you effectively have to be in the role of an inspector and go through book by book. That’s a role which auditors are meant to do, and we’re not equipped to do that. So the way to manage those institutions is, first, to have a credible resolution regime, back to where we went, so if they do fail, they can fail without cost, other than on those who put the capital in; and secondly, to have the right set of rules. We recognise the global rules for the banks were flawed-Basel II and so forth. We are asking, and I am asking on behalf of the PRA in future, that the rules for the building societies set by Government through the Building Societies Act should be revisited to get these models back into a safer space. But the supervisors do not do detailed on the ground inspection of every single institution in this country, all 25,000.

Lord Turner: It is easier to ask quantitative questions about what is the average loan to value ratio in relation to a residential mortgage loan book-you can get information from that-than to do the same for commercial real estate. The moment you go into the corporate space you really can’t assess credit quality unless you are individually inspecting individual loans.

Q91 Stewart Hosie: I am worried about these answers and the answers earlier. We were told before the crash-I remember the Bank of England annual stability report-that risk was being managed, it was being mitigated, it was caveated with the words that, "It was being spread so widely we weren’t quite sure where it was," and all that led to. All the answers today, instead of giving me comfort that we’ll be watching the risk, managing the risk, mitigating the risk, other than at the macro level and systemic risk level, appear to be saying, "Well, if the capital ratios fail, so long as we can unwind them we’ll let them fail." Now, I would have thought there would have been a far more assertive approach, that we want to manage these risks away at least as best we can, and I’m not hearing that.

Lord Turner: But the single biggest thing we’re going to do on that is to transform the capital ratios. Let’s be clear that the capital ratios under the Basel II regime allowed a bank to run with equity equal to 2% of risk-weighted assets, so if those assets were mortgages, they could well be 1% or less of the total assets, and we have fundamentally taken that 2% up to effectively 7%. That is a non-trivial change.

Mr Sants: If you can resolve a deposit-taking institution without any cost to the taxpayer or any systemic implications, and without the consumer being disadvantaged, why are you worried about that happening? That is a perfectly fundamental question. Why do you think that is a problem? If people have put up capital for risk, that’s the nature of the system; if that capital doesn’t give them a return they have to bear the cost of failure. If that failure is orderly, without any implications for other than the capital providers, why is that a problem for you?

Q92 Stewart Hosie: Well, the answer to the question is it’s a complete collapse of confidence, which is a trigger for all sorts of other things.

Mr Sants: Why?

Stewart Hosie: Because we had a run on the Rock and people were queuing.

Mr Sants: You misunderstand my fundamental point then. I think it really is very important. We are trying to move away to a position where consumers have confidence in the system to deliver what consumers want from the system, and I’m pointing out that in an environment where failure can be orderly, without disruption of the provision of services to the consumers, that should not be seen as a regulatory failure.

Stewart Hosie: Mr Sants, trust me, real world confidence will not be enhanced by allowing a bank to fail. However, I want to ask-

Mr Sants: Small banks fail in America all the time without any evidence of diminishing confidence.

Q93 Stewart Hosie: I want to ask a completely different question as a final question. It relates to something Mark said. It was about the time it takes and the hurdles to entry for new entrants to get their banking licences, their authorisations. You quoted the OFT earlier a couple of times, but they stated that a number of respondents to their market study had said that uncertainty, length of time and cost of the application process had proved insurmountable and they decided not to apply for licences. So, although you quote 20 applications and a number approved, it would appear, at least from the OFT, a number of others have found the process insurmountable.

Mr Sants: Which paragraph are you referring to, if I may ask?

Stewart Hosie: I don’t have the reference to the quote.

Mr Sants: I have the report in front of me. Would you like to refer me to the paragraph or section? I have read it.

Stewart Hosie: I don’t have a reference to that quote in front of me. I only have the quote itself.

Mr Sants: I will happily quote you the summary paragraph again, which I think made my point clear earlier: "The FSA has recently revised its authorisation procedures to increase transparency in a more modular approach." So there is no doubt that changes were merited to make the process easier to access, but the OFT’s headline conclusion out of its summary in paragraph 1.12 is as I set out.

Q94 Stewart Hosie: So you don’t recognise the quote I gave you? I can find the reference to it.

Lord Turner: Well, we can’t find the quote.

Mr Sants: I am happy to respond to it if you would like to refer me to the relevant paragraph.

Stewart Hosie: I think we might have to come back to this with the reference.

Q95 Chair: Thank you very much for your answers on that point. I was astonished by a number of answers that we’ve had today, I have to say, Lord Turner, not least-and I am quoting what you said, I wrote it as you said it-"A bit more competition might be a good idea." You are under a statutory duty to have regard to competition. Don’t you accept that the kind of remark you make there is exactly why people have come to us saying that competition should be elevated to the level of objectives of the regulator?

Lord Turner: Yes, I think that is an open issue as to whether competition should be an objective of the regulator. The situation so far is that within the operation of the powers that we have, which are not structural break up banks type powers, we have to have regard to competition. So, for instance, in our authorisation process, one of the things that we are concerned about is the speed at which people can get through it, precisely in order to have ease of entry into the system. So we do have regard to it, but we have not been set up as a competition authority where it has been asked or has the remit or the powers to say that there should be an increase in the number of players within a particular market. I think all I would say is that the degree of concentration of UK retail banking has now got to the stage where it raises the issue as to whether there might be a need for a structural response, and that is precisely why the Vickers Commission has been given that issue. So I think it is an open issue, and if I was on the Vickers Commission I would find it very interesting to go all the way through that and end up with a conclusion on it. It’s not for us to conclude, because that’s not part of our legal remit, but I guess we now have a significantly more concentrated market than we had 15 years ago, so the issue is clearly before us, with the caveat to remember that-

Q96 Chair: Lord Turner, we had been hoping to get some sort of indication from you about where you think policy should go and, to be frank, we’ve had virtually nothing from you at all. After all, is it not reasonable to you to offer a view that the Vickers Commission can take account of?

Lord Turner: I am not sure that it is for me to offer a view, which would probably be seen as a personal view rather than the view for which the FSA, of which I’m Chair, has a legal responsibility. I think we’re very happy to answer questions about what we think should be the approach of the CPMA to competition and, indeed, the many other issues about competitive effectiveness, which our FSMA powers relate to. But the specific issue of should we have a break up to have more retail banks in the UK than we have at the moment, I think it’s reasonable for me to say, given the degree of concentration, that’s certainly an issue that’s on the table, but I don’t think it’s something where I need to have a personal view to share with the Committee.

Q97 Chair: You also said, and I quote, "Regulation is not a barrier to entry." A lot of people will be very surprised by that remark as well. Do you want to qualify that, now or later, either now very briefly, or later, as long as you like, in writing?

Lord Turner: Well, I don’t want to qualify it because not us but the OFT has concluded-

Q98 Chair: You have already quoted the OFT. You don’t think regulation acts as a barrier to entry in markets?

Lord Turner: Well, in general it could be the case. It clearly can be the case that regulation will act to a degree as a barrier to entry.

Q99 Chair: But in a specific case not; that’s your point?

Lord Turner: The fact that there is health and safety legislation makes it somewhat more difficult for somebody to set up a new restaurant. As a generic fact it must be true.

Chair: Yes. We’re not going to go into lengthy theoretical examples.

Lord Turner: But, Mr Chairman, with respect, the OFT, which is a neutral body, not a set of anecdotes, nor the FSA, has reached a conclusion, which we have clearly quoted.

Q100 Chair: You have referred to it now five times, and I think we have that piece of evidence firmly on the record. Can I end by asking you or by pointing out to you that the Nationwide Building Society described the UK market as, "Effectively a mature low-growth market". Do you agree with that assessment?

Lord Turner: It is bound to be the case that, compared with some of the markets in which some of our banks operate, in China or Brazil, this will be a low-growth market. We would not expect, and indeed we would not want, the degree of credit in the UK over the next 10 years to grow faster than, say, nominal GDP, which, if we are successful, will grow at 5%. That’s not a fast-growth market. So I think, broadly speaking, we’re a mature economy with a developed financial system. So, yes, that must be right.

Chair: Thank you for that. Stewart has one very last quick question.

Q101 Stewart Hosie: A final reference to the OFT, page 80, paragraph 5.33, "A small number of respondents indicated that the uncertainty and length of time of and cost of the application process had proved insurmountable and that they had decided not to apply for a licence. Others proceeded with an application, but had experienced delays in the process or revised their business plans. Overall, therefore, it appears that certain aspects of the process may have acted as barriers to entry and that this may have led to a detrimental impact on price, quality and range of products" and so on. That’s quite clear, I think.

Mr Sants: Can I just respond to that?

Stewart Hosie: Yes, of course.

Mr Sants: I think they’re making a comment about process, and we agreed with the OFT, and I had some discussions with the OFT personally afterwards, that there were process improvements we could make to make the authorisation process easier, and we have made those. Those comments referred to the period before we made the process changes. But specifically, in 2009 there was only one withdrawal and my understanding of that withdrawal, I think it was a perfectly reasonable withdrawal to be made. No doubt firms often comment as to reasons why they withdraw applications, but there was only one in 2009 and there were seven in 2008. So it is not that there is a whole raft of firms withdrawing.

Stewart Hosie: I appreciate that.

Mr Sants: Quite often they withdraw because it is a polite way of exiting out of the application because we’re not comfortable with it.

Q102 Stewart Hosie: I appreciate that, but you spoke previously about the applications submitted and approved, and you’re now talking about one that was withdrawn in application. The point is that a number of respondents decided not to apply for licences. This may only be perception, but the OFT were clear from this small number that uncertainty, length of time and cost was an insurmountable barrier to their even applying.

Mr Sants: Yes. I have responded to that point.

Q103 Stewart Hosie: Is there not an issue there at all?

Mr Sants: No, because I responded to that point by saying I discussed that issue personally with the OFT and I have satisfied myself that the points that led to those comments being made are the ones that we have now addressed. I’m answering the question, "Going forward, do you think your process is a barrier to proper firms, which we would like to see offering retail banking services in this country, being authorised?" and the answer is no. That reflects the current process we have in place. I’ve said if you have any specific comments from any firms to improve the current process, as opposed to the process that was operating 12 months ago, then come back to me and I’ll make those changes. But I’m not aware, having had detailed follow-up discussions with the OFT, that there are any other process changes we should be making which we have not made.

Stewart Hosie: That’s helpful.

Chair: I am going to bring things to a close there. We’ve had a very long evidence session and I’m very grateful to you both. I think that a great deal has come out of it and I’m sure this won’t be the end of our exchanges on this very large subject. Thank you very much for your evidence this morning.