Session 2010-11
Publications on the internet

To be published as HC 612-ix

House of commons



Treasury Committee

Competition and Choice

Tuesday 1 February 2011

Douglas Flint and Joe Garner

Neville Richardson and Rod Bulmer

Graham Beale and Chris Rhodes

Evidence heard in Public Questions 833 - 1044



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Oral Evidence

Taken before the Treasury Committee

on Tuesday 1 February 2011

Members present:

Mr Andrew Tyrie (Chair)

Michael Fallon

Mark Garnier

Stuart Hosie

Andrea Leadsom

John Mann

Mr George Mudie

Jesse Norman

John Thurso

Mr Chuka Umunna


Examination of Witnesses

Witnesses: Douglas Flint, Group Chairman, HSBC plc, and Joe Garner, Deputy Chief Executive UK, HSBC plc, gave evidence.

Q833 Chair: Thank you very much for coming to see us this morning, Mr Flint and Mr Garner. Can I begin by asking you a question which flows from the evidence you put to the Vickers Commission; you fingered the institutional investors as the villains of the piece, or certainly one of them, in your evidence to the Commission, don’t you? Why is that?

Douglas Flint: I think the point we were making at that time was that during the very heady days of the mid-2000s there was a great deal of pressure coming from shareholders who were looking for enhanced returns and were pointing to business models that have, with hindsight, been shown to be flawed and in particular very leveraged business models and saying, "You guys are inefficient. You have a lazy balance sheet. There are people out there that are doing much better than you are", and there was tremendous pressure during 2006/2007.

I remember research notes being written saying we had $20 billion too much capital and that was a major subject of meetings that we had; being challenged all the time as to why we couldn’t be more efficient. There was an element of pressure coming from that which many did not resist and we took some pressure for a period for resisting.

Q834 Chair: Okay, and how are we going to get the institutional investors to analyse things more shrewdly?

Douglas Flint: A personal view – I think there is some misalignment in their own objectives. They tend to get monitored in their own industry on relatively short term performance-quarterly performance, even one or two year performance-when in fact the business cycle into which we are investing is much longer than that so it has been a conundrum for a long period of time as to whether the cycle over which they get monitored and the statistics at which funds are attracted into their particular institutions are aligned with the investment cycles of the companies in which they invest.

Q835 Chair: I have not read all the evidence you have put into Vickers yet, which is several inches thick, but I made a start; you published it late last week. I have not seen any concrete suggestions though to address this and I wonder whether you did have some concrete proposals.

Douglas Flint: I certainly think it is worth looking at the investment horizon. I also think it is, again, a personal view; a great deal of careful thought has gone into looking at the structure of compensation in the financial industry and the deferral and so on but that has touched less the investment intermediary industry and I wonder whether that is an area where, again, some alignment with the companies in which they are investing might be worthy of reflection.

Q836 Chair: Okay, worthy of reflection but this is an old story, this misalignment of shareholder interest and the boards that are running the firms they invest in; what are the concrete proposals to sort this out that you are putting to Vickers or have you not formulated any? What duty do you think one should consider imposing on institutional investors to behave differently that might assist with the reduction of systemic risk?

Douglas Flint: If it was easy to point to a single thing I guess it would be done, but I do believe some review of the incentivisation-in the broader sense of incentivisation-over the short, medium and long term would be worthy of review.

Q837 Chair: Would be prepared to set out some suggestions of that type to us?

Douglas Flint: Sure.

Chair: If I may say so your reply is still pretty general, to say the least, but it is a fairly big issue that you raised in your submission to Vickers.

Douglas Flint: I will give it some more careful thought and I will drop you a letter.

Q838 Chair: Do you have examples, other than the Icelandic banks, as examples of aggressive pricing? Excess competition would seem to be the implication of what you were saying in your submission, causing problems rather than reducing them.

Douglas Flint: Let me make the general point and then Joe, who runs our retail business in the UK, can probably give more specifics. I think the point that we were making was that some of the things that are there to protect the system, like deposit insurance, can have the unintended consequences of allowing people to compete aggressively for deposits and people can place deposits with institutions that apparently offer a higher rate without having to consider whether in fact the business model that would drive the ability to offer higher rates, is aggressive, i.e. because they’re lending to leverage property developers or to higher risk consumers and they can still attract depositors because the depositor is underpinned by the Deposit Protection Scheme.

Indeed we saw that very vividly in the United States, as the banks that failed were failing, they began to gain significant market share in deposits because they were paying up for deposits and the market was giving them deposits below the deposit insurance threshold in America because effectively it was Government risk.

Joe Garner: Another example would be the mortgage market through 2006 and 2007 where there was quite extreme price-led competition at rates which we thought at the time were uneconomic.

Q839 Chair: Did you say so publicly?

Joe Garner: We didn’t say so; it wasn’t something that-

Q840 Chair: Did you say so to the regulator?

Joe Garner: We didn’t say so to the regulator but-

Q841 Chair: Do you think you should have done?

Joe Garner: I am not sure if it is our role to-maybe we should have done, maybe we should have done. What did happen is we lost some market share in the mortgage market through that period.

Douglas Flint: We explicitly said we had lost market share because we felt the pricing in the marketplace at that time was uneconomic; we did say that publicly. I think Mike Geoghegan said that at a Merrill Lynch conference at the height of the boom, he said, "We are cutting back; we don’t think that the pricing is economic."

Q842 Chair: In markets where some players have models that are fundamentally unsound, when they go bust the sound players mop up. Here you have done better but you have not had the ability to mop up on quite such a scale as you would have done in an all conventional market because of Government support to the defective institutions; does that annoy you?

Douglas Flint: Not really, no, because I think longer term it is more important that the institutions that were beneficiaries of Government support survive because I think it is important that there is a broad based competition and therefore I think long term it is important that there is a broader base of competition in the UK. I think if it were to go on forever with the institutions receiving Government support, continuing to receive Government support, that would be irritating. But in the particular circumstances, no, I think it was the right action.

Q843 Stuart Hosie: You said that there needs to be broad based competition and that would mirror pretty much what Lord Turner and Hector Sants said that a less concentrated retail market would benefit consumers; I take it you would agree with that?

Douglas Flint: Yes.

Q844 Stuart Hosie: Do you think that competition will be driven by new entrants to the sector or will be driven by more competition between products, between the banks, however many there are?

Douglas Flint: I think it would be both institutional and product. I think it is very difficult in our industry to invent a product that gives you any real lead over your competition because it is instantly replicable, certainly if it is a market directed at the mass market. And therefore I think competition tends to be increasingly about service-perception of service and brand-but Joe is much closer to it than I am.

Joe Garner: Can I just make a point on concentration because I think there seems to be a perception at times that there are three or four major players; there are at least six major players in the UK market and national fully supported. In most of the categories in which we compete HSBC is the sixth largest. I think there are more major groups than people often think and while we look around the world and we can see markets where there are a greater number of players, they often then tend to be regionalised. If you have a greater number of players, but there is only one in your locality, it still has not improved choice. I think there are some aspects, when we look across the world, that make us think the US is a pretty competitive market.

Q845 Stuart Hosie: Just on that point of regions and nations, obviously in Scotland RBS and Lloyds Banking Group could be considered a virtual duopoly. HSBC have a Scottish Chief Executive and that is good; the Clydesdale bank continue to exist and all the rest of it, but in Scotland the competition is far less, concentration is much higher. Do you see a particular issue in a country like Scotland, or indeed some of the English regions, where there is less competition than the six that you talk about?

Joe Garner: Yes, although speaking of Scotland specifically, despite the strong presence of competition there, we see it as an opportunity. We have been opening branches in Scotland at quite a rate and we plan to continue that over the next couple of years. Even though there is a strong traditional competition we still see opportunity there.

Q846 Stuart Hosie: That is interesting. In a sense, although you are not new, you are a newish entrant in terms of a High Street profile; do you think new entrants generally will find it straightforward or will they find it difficult to penetrate markets wherever they are because of customer inertia?

Joe Garner: I think it depends on how they approach it. We, in the UK, operate through HSBC but also John Lewis, Marks and Spencer Money and First Direct and what we think we learned from our experience with First Direct-which of course was a new entrant that we grew from zero to today around a million customers-if that if you do genuinely deliver fantastic customer service, customers will switch to you.

Stuart Hosie: Thank you.

Q847 John Thurso: Mr Flint, can I follow up on the comments you were making to the Chairman-I well remember the criticism you got for being too pedestrian back in 2006-I was interested by your comment that you just thought some of the business was simply not economic which means you thought it was too risky. At that time everybody loved Northern Rock, which they thought was the absolute ultimate model to invest in; was your corporate governance better or were you just lucky?

Douglas Flint: We would obviously prefer the former. I think part of the DNA of HSBC goes back to its foundation. We were, for much of our history, bigger than Hong Kong and therefore our financial model has always been based on raising deposits and lending; so the model of Northern Rock, which was a securitisation vehicle warehousing mortgages and then funding the wholesale market, was simply not a model that was particularly in our history. I know that we did some element of that, particularly in the United States; it was a very small part of the aggregate business.

So our business model was different and we stuck to that business model, largely speaking, for the whole 145 years of our history and we have tended to avoid faddish elements of the financial markets. I am not saying we have always been successful but we have tended to avoid particular structures that don’t fit with that model. Yes, I think we are very disciplined by what we do and what we don’t do.

Q848 John Thurso: If you had to quickly say, "Here is one lesson the others could learn from corporate governance, risk management, whatever" what would you say that you could have taught them, what is the lesson we should learn from your survival?

Douglas Flint: I would absolutely come to one thing time and time again; it is funding. We run a funding model that means that our loans are about 80% of our deposits and that is probably a bit lower than we would like it to be but there is not a great deal of credit demand at the moment. But funding our long term assets with core deposits has been at the heart of our strength. It is also at the heart of the comments that were made historically about a lazy balance sheet, but I think it is a fundamental strength of banking.

Q849 John Thurso: Okay, thank you. Mr Garner, can I ask you about personal accounts and the costs; of your customers how many end up paying for current account services and what proportion are free?

Joe Garner: It is a very difficult question because I would see the current account as the way the customer chooses to have their money available for immediate access; it is akin to keeping money in a wallet and, as such, I would say that it is genuinely free to customers. It is true that the vast majority pay additionally no or very low overdraft charges and there is a small minority who do pay more in overdraft charges and those are the ones that need particular care and attention.

Q850 John Thurso: Do you know what it costs to provide a current account?

Joe Garner: It is, I would say, pretty much impossible to isolate the cost of providing a current account to an individual customer. The reason for that is that you would have to make an assumption over how much of your branch network, your ATM network, your purchasing system, your internet usage, et cetera; all of those things you would have to factor in to make an individual calculation. I don’t think that either it is really practical to do or very useful.

Q851 John Thurso: Banking must be one of the very few services or industries where you have not a clue what the cost of your product is.

Joe Garner: I wouldn’t say we haven’t a clue and although I was saying it is very difficult to attribute the product costs; if you take, as we do, a more holistic view of the customer relationship it gets a little bit easier because customers typically have more than just a current account relationship-particularly with HSBC and First Direct-and so we are able to look at the relationship at the more aggregate level and while it will always be an approximation to some degree, it is more useful.

Q852 John Thurso: You look at the cost per relationship.

Joe Garner: We try to look at the customer as an individual and look at not the cost but the value of that relationship to both the customer and indeed to us.

Q853 John Thurso: I tell you what I struggle with-and it is at the heart of working out whether or not we have competitive personal banking in this country-is that I cannot find a banker who provides personal banking, who will tell me what it costs. I cannot find a banker who does not want to wrap it up in a bunch of relationships but I can never get a straight answer as to whether that has particularly been costed and I cannot believe-what is vaunted as the UK’s biggest industry and most successful and largest single contributor to Treasury does not know what anything costs; as a sort of simple old small businessman this just does not quite fit.

Joe Garner: To help with that, two comments: first of all you can always do an average so we can always take what is the total cost of running a bank and divide it by the number of customers which gives you a number. However, that is an average and won’t be representative of the large number of customers. Each of us is unique in the way that we use our banking. Everyone here has a different pattern in terms of how you use ATMs-whether you use our ATMs or someone else’s ATMs-which means that it is really an individual thing. You can have either an aggregate or it is very hard to get down to the individual. One thing I would say; we operate in a lot of markets and so we do see other pricing models and there is an assumption I think that if everyone paid a flat monthly fee that it is somehow fairer. That is not necessarily the case because again, people use banks very differently so you are still going to find some people are paying more and some people are paying less than the true cost to the bank.

Q854 John Thurso: The trouble I have is that I do not know that. Now it so happens that is how I pay my bank charges. I pay a quarterly fee to my provider and I know that is what I pay but the majority of people in this country have free in-credit banking but they have no idea whether that is a good deal, a bad deal, whatever. That is what we cannot get at. This seems to be the blancmange that we cannot get our hands around, is what actually anybody is getting.

Joe Garner: We do show very, very clearly charges related to anyone’s account; not just on statements on the internet but also I think we are the only bank that will tell you at an ATM if a charge will be incurred from that withdrawal. However, we do also offer a £15 a month current account with no charges whatsoever and it is impossible to incur charges on that. Our customers have the choice and if, like you, they are looking for certainty over what it costs them any one of our customers can opt to pay £15 a month; clear, simple and straightforward.

Q855 John Thurso: Do you have many who take you up on that? Is that something that people use?

Joe Garner: We only introduced it towards the end of last year. It has not taken off to a great degree, however, we are now writing individually to customers for whom we think that is an appropriate product-we are writing to 20,000 of them this month in fact-to encourage them to move across to it.

John Thurso: Thank you.

Q856 Chair: When you show these charges do you show the interest forgone?

Joe Garner: We don’t show interest forgone because our view is that a current account is for daily purchases and we have savings accounts for those who want to accrue interest on their savings.

Q857 Chair: Still it is a cost to the customer, isn’t it?

Joe Garner: No more than the cost of keeping money in a wallet, I would say.

Q858 Chair: But it is a cost to the customer. Had we not better get some transparency on interest forgone? We are being told by a lot of people we should.

Joe Garner: I would still argue that the best way we can give value to our customers is if they are looking for interest on their money, to put it in a savings account where, because it is a savings account, we can offer a better rate of interest. We don’t make any bones about the current account; we don’t pay interest on current accounts, it is our position so we are trying to be clear about it.

Q859 Michael Fallon: Mr Flint, the Institute of Chartered Accountants in their January report on access to SME finance said, I quote, "Whatever trust existed between banks and SMEs in 2009 has mainly dissipated due to the ways SMEs have been treated by banks in the last nine to 12 months." Are they correct?

Douglas Flint: I don’t recognise that as an experience that the vast majority of our customers would subscribe to, no. No, I don’t recognise it.

Q860 Michael Fallon: Why would the chartered accountants say that?

Douglas Flint: They obviously spoke to a segment of customers for whom that was their experience.

Q861 Michael Fallon: How concentrated do you think the SME market now is in the UK?

Douglas Flint: I think it is fairly concentrated. Joe?

Joe Garner: A bit like the answer on the personal side; there are a significant number of major players but yes, we can look around the world and find more atomised competition.

Q862 Michael Fallon: Let us talk just about the UK for the moment; the Big Four banks, in your view, have what share of the SME market?

Joe Garner: I wouldn’t like to quote a specific number because I don’t have it in my mind; I don’t want to get it wrong.

Michael Fallon: Well, approximately; is it 70%, is it 80%, is it 90%?

Joe Garner: I would estimate it is in that range, 70% range.

Q863 Michael Fallon: 70%, is that over-concentration?

Joe Garner: I don’t think that concentration is the measure of competitiveness, there are markets where you have only two competitors but they function extremely well and give value to customers. The OFT had a good look at SME banking a few years ago and put some remedies in place which have now passed and the judgement has been that things are functioning.

Q864 Michael Fallon: But if small businesses are telling their accountants that they are being badly treated, are we not entitled to look at the degree of concentration and wonder whether the Big Four have not got too much of a stranglehold?

Joe Garner: Of course. I think like many things, however, in banking that is a general comment that is being made there about banks in general and there are differences in the way that banks conduct themselves.

Douglas Flint: I wonder if this is a question of timing, if I may, to-I don’t know, was this study 2009 or 2010?

Michael Fallon: It was the last nine to 12 months; this is the report that was published in January, so 2010 is the answer.

Douglas Flint: Okay. There was a report at the end of 2010 from the Department of Business Innovation and Skills that recorded that SMEs were able to get finance-the vast majority-from the first port of call and those who couldn’t from the first port of call got it from the second, and that the cost of finance had not gone up between 2010 and 2009. I think in 2008/2009, it is fair to say, the cost of banking did rise relative to history but I think history would show, with hindsight, that risk had been mispriced. My perception or our experience would be that customers are happier today than they were 12 or 18 months ago.

Q865 Michael Fallon: Okay, but what is the HSBC position at the moment; are you trying to do more SME lending or less?

Joe Garner: Yes, and a couple of things to evidence that, towards the end of our January sale we are promoting two years’ free banking to SMEs, we are offering a 10% discounted loan to SMEs and we are about to launch a new promotion to SMEs as well; we absolutely have the appetite.

Q866 Michael Fallon: Are you increasing the kind of conditions you impose, compared to say four or five years ago, in terms of the security and demand?

Joe Garner: No, we haven’t made any material changes in recent times, in fact the opposite; we are introducing some incentives to encourage SMEs to borrow from us.

Q867 Michael Fallon: Right, so it is now easier for small businesses to access finance from HSBC?

Joe Garner: We haven’t changed our lending criteria; I wouldn’t like to give you that impression. Our lending criteria have been consistent; what, if anything, we are doing potentially is trying to market a bit more strongly so that small businesses know that we have the appetite to lend to them.

Michael Fallon: Thank you.

Q868 Chair: I have to tell you that your suggestion that things are functioning in SME lending will be met with incredulity by some of our constituents trying to run small businesses.

Joe Garner: If they are HSBC customers I would encourage them to contact us because it is true that we are trying to lend to SMEs where we see the appropriate opportunity to do so.

Q869 Mr Umunna: I just want to pick up on this lending point; the Bank of England has estimated that the value of the subsidy to your sector was about £100 billion in 2009 and you are the sixth largest financial services group, I think, in the world. Given your importance to the sector can you just tell us, do you often meet and talk about these issues with the Chancellor of the Exchequer and the Business Secretary? Perhaps I will aim that one at Mr Flint.

Douglas Flint: That has not been a matter of discussion, no.

Mr Umunna: No. So you do not often meet with the Business Secretary or the Chancellor of the Exchequer; one would have expected-

Douglas Flint: I have been in my role for two months now and I have met them once, and that is what, eight weeks, but I would expect to meet them regularly but that was not the subject matter we talked about on that occasion.

Q870 Mr Umunna: Can you tell us, we are obviously in the middle of the current bonus round-and it is going to wind up in the next month or so-have any representations been made to you by either the Chancellor or the Business Secretary asking whether you will exercise restraint in relation to the payment of bonuses? Representations have been made?

Douglas Flint: Yes, yes, representations-

Q871 Mr Umunna: Also can I ask the same question in relation to lending to SMEs; is that something Government has spoken to you about before too?

Douglas Flint: Yes. Yes.

Q872 Mr Umunna: There has been a lot of speculation about Project Merlin and the negotiations going on, and I presume that you are involved with that, what are the prospects of a deal in that regard?

Douglas Flint: I am very hopeful there are very strong prospects. My own perception is that we are very, very close, that both sides see the advantages in concluding an agreement to mutual advantage and I believe that we are very, very close to that position. I very much hope that it concludes.

Q873 Mr Umunna: Brilliant, that is encouraging. Can I just ask you about the Independent Commission on banking and some of the comments that have been made by Sir John Vickers; in his speech at the London Business School a few days ago he said that he did not think it was credible for governments to argue that they would not intervene to save retail banking-retail banking services of any particular group-do you agree with that?

Douglas Flint: I think if the circumstances were severe enough I think it would be very difficult for a government to stand and see ordinary depositors lose money. Yes, I think governments would intervene and I think that has been the experience all the way around the world.

Q874 Mr Umunna: What do you think will be the impact on your group in the event that, say, a form of separation were pursued in this country where, for example, you were required to separate out your retail banking activities into a separate subsidiary, ring-fenced?

Douglas Flint: That is an incredibly good question and one which the Independent Commission has asked us to do some work on, in terms of how you would do the definition; how feasible would it be in terms of legality and practicality; what would be the consequences in terms of service delivery and cost; what would be the unintended consequences in terms of disruption to the economy and the financing of the economy while the separation were taking place. I think it is an extraordinarily challenging concept and it will take a considerable amount of work, even just to sort of articulate. There was something in our response to the Commission to make that separation because effectively you would be unbundling a single institution, opening up a risk that were today offset, disaggregating flows that work to the benefits of both side of the business.

People talk about resolution regimes and how difficult it would be to resolve a major institution by making a separation, so effectively you are resolving two institutions rather than one. It is an enormous task. It would be a huge, huge exercise and it would be particularly complicated for us and indeed for any large international bank, in the sense that the UK piece of the wholesale bank is not only integrated with the legal entity that is the bank in the UK but with the wholesale activities globally.

Q875 Mr Umunna: Okay. If you were to, say, look at this issue maybe a bit more conceptually and less focused on what the likely hassles are going to be for you in separating out the two, and there has been an argument that without separation there is always going to be this inevitable taxpayer subsidy and that if you went for separation-and there has been a suggestion of this in relation to your group-that that might lead to banks shopping around for jurisdictions when a separation is not required and there is, therefore, in effect, a state that is happy the underwrite the activities in that country of a bank. John Kay, in the FT, said that in that situation such banks would be the corporate equivalent of the benefit scrounger posing as an asylum seeker and are likely to receive the welcome that such migrants receive as individuals if they sought to, for example, relocate; he is right, isn’t he?

Douglas Flint: I think that is a particularly unhelpful colourful description. I think it would be very, very difficult to shop around the world for a jurisdiction to take you where you were explicitly trying to find a regime that was more benign than the one you were coming from. I just don’t think that would be possible to do.

I think it is fair to say and London has for ever-and certainly over the last 20 years-set its stall out by being the most attractive, or seeking to be the most attractive, place for wholesale market activities. Today, it dominates the foreign exchange world, the interest rate world, the equity capital market flows. It is second to New York in terms of servicing of hedge funds, largely because of the financial system and infrastructure. So London has set itself up as being a place where you get sort of the cluster effect of institutions who service those important segments of the global economy seeking to come together. If regulation or public policy were to dictate that that international activity-we are not talking about retail banking in the UK-but that cluster of international activities were going to be done somewhere else, and New York obviously already does them, because a particular jurisdiction no longer wanted to participate in that level, then the cluster effect would mean that over time, activities would migrate. I don’t think it would be a question of moving institutions. The activities would migrate to places where those clusters were welcome.

Q876 Chair: You are well placed to tell us whether Asia is picking up business it would normally be growing in the two Anglo-Saxon markets. Are we losing out?

Douglas Flint: I think, over time, Asia is going to grow in importance, just because of the scale of its economy and as they get more sophisticated, and as they build their retirement savings business for the demographics of the region. So Asia will grow anyway. There is at the moment evidence of quite noticeable-not huge, but noticeable-growth in Singapore and in Hong Kong, particularly probably Singapore.

Chair: Business that we should have had?

Douglas Flint: I don’t think anyone has the right to anything.

Chair: Business that we would have had?

Douglas Flint: Business that we would have had, yes.

Q877 Chair: Yes. On what sort of scale?

Douglas Flint: Modest at the moment. There are, to my knowledge, three 200,000 square foot buildings being taken by international banks in Singapore at the moment that might have gone somewhere else.

Q878 Mark Garnier: I want to carry on with this point, because it is incredibly important how sticky, if you like, London is as a financial centre. There is lots of speculation in the press about you relocating somewhere else in the world, and the obvious one would be Hong Kong, and you are after all the Hong Kong and Shanghai Banking Corporation, and you have a 130, 150-year history out there. It was from 1 Queen’s Road Central that Willie Purves took on the world and won, and you are there where you are. What on earth is keeping you here? Why aren’t you going back to Hong Kong or, indeed, anywhere else?

Douglas Flint: We came to London in 1992 because we acquired Midland Bank. We acquired Midland Bank partly for a diversification, as because up until that point we were a very substantial, very successful regional bank. We acquired Midland Bank to become a global bank. Midland Bank had been one of the great banks of the world, and that brought us to London, which was then, and grew into being an even more, important international financial centre. So to grow our business as an international bank was not going to be possible from a regional base, and there were technical reasons too why the regional base was more difficult to do international capital market activities. We centred those activities in London, because London was the international financial centre, and it has grown over those 20-odd years-nearly 20 years-into a much more successful international financial centre, gaining the market share lead in interest rate derivatives, foreign exchange and a whole bunch of other things, and that is why we came. So the location of our principal activities is driven by the cluster effect of where others do it and where the market is with the greatest liquidity. That has been London.

Q879 Mark Garnier: One of the issues though in 1992 was you had five years ahead of you then before the hand-back of Hong Kong to the Chinese, and people like Jardine Matheson were going off and moving their domicile to Bermuda in order to get around any potential threat, and there were lots and lots of people who were moving, getting dual listings. I think you have a dual listing: a primary listing in Hong Kong and a secondary listing in London, if I remember rightly.

Douglas Flint: Dual primary.

Q880 Mark Garnier: Dual primary, okay. We have now moved on 20 years. We now have a 14-year history of what the Chinese are doing in Hong Kong. There is no doubt about it, the centre of gravity of the global economy is moving towards the Far East and Asia. That is where the opportunity is going to go. Any economist will tell you that an economy coming from a low level with a big growth potential will continue to grow very well, which has Asia all over it. You have a very sort of sophisticated regulatory regime in Europe and in the Western world, which is quite-or can be quite-constrictive, whereas in the Far East, you have a less restrictive regulatory regime, you have the history of how the Chinese operate, you have a 15.5% tax rate, which is always going to be more competitive, and you have the global economy gravitated towards that. I ask the question again: why on earth aren’t you going to the Far East?

Douglas Flint: It is no secret. We formally go through the discipline, the governance, of looking every three years, if you were coming down from Mars with our business configuration, where would you seek to place the international headquarters of that group? London has historically, and continues to have, advantages based on not just time zone, but just the history of the tax networks that the UK has that are more expansive than any other part of the world, political stability, rule of law and the cluster effect, that in fact the markets in which we operate, the most important thing we seek is liquidity, and liquidity is most evident still in London and New York. Over time, there is no doubt that as Asia becomes stronger and the currencies in the region become more international, they will play a larger role, but today we believe, on the analyses that we do as to where you would locate, Europe-and the UK within Europe-remains very competitive.

Q881 Mark Garnier: But why do you have to be headquartered here? You can still have a very successful business. Let us go back and look at history again: Hong Kong and Shanghai Banking Corporation bought James Capel to have a quasi-investment bank that developed in London. You do not have to be in London to be able to take advantage of the cluster effect here.

Douglas Flint: No, you don’t, but there are other aspects in terms of the organisation of the international group where the UK’s history in terms of its tax treaties and therefore the free flow of capital and so on and so forth into and out of the UK makes it an international headquarters town, which is what it has designed itself to be, in a way that virtually no other city in the world, no other country in the world has quite the unique competitive edge that London has.

Q882 Mark Garnier: So why does Stuart Gulliver want to have his chief executive office in Hong Kong, or is that just false speculation?

Douglas Flint: No, Stuart’s moving to Hong Kong for his office because the growth in our business will be in Asia, and it is really important that his principal office is in Hong Kong so that he can drive the growth into the region that is growing the fastest. There is no question-being in the flow of the conversation around people who are living in the region, investing in the region and looking for opportunity in the region is considerably better than sitting in London trying to see what the mood music is about China, about Hong Kong, in the region. You can’t get the vibe of the region you are most interested for growth in by sitting in London.

Q883 Mark Garnier: This is causing a great deal of confusion to the world in general, as to where you want to be. Will you categorically say now-bearing in mind that the Chinese authorities may well be looking at this, and you obviously want to send the right mood music to them as well, I think-that you have no plans at all to move to the Far East and that you will continue to have your headquarters here in London for the foreseeable future? By foreseeable, I mean a significant amount of time, not just six months.

Douglas Flint: I can categorically say that we will continue to do what we have always done, which is every three years look at where we believe the best place to be is. On the current analysis, that continues to be the UK, and we said publicly we want to remain here, we want to work with the UK authorities to ensure that London continues to be-

Q884 Mark Garnier: When was your last three-year assessment?

Douglas Flint: We’re doing one this year.

Mark Garnier: You are doing one this year?

Douglas Flint: This year, 2011.

Q885 Mark Garnier: This year you could make a decision to move out of London or not?

Douglas Flint: There is nothing special about 2011.

Mark Garnier: No, but I am just looking at your three-year cycle. There is something, you have a Banking Commission going on; you have a new financial regulation Bill coming through. This is a big, big year, actually, you know?

Douglas Flint: It is a big year in a whole bunch of ways, and what I would say is that ultimately any decision we make will not be based upon regulatory arbitrage or anything else. It will be based upon the economics of where it is best to do our business.

Q886 Mark Garnier: So tax, legal system?

Douglas Flint: All of that, but you are right, if there were to be business model constraints placed upon us, that would have to be factored into the consideration, that there are other aspects in relation to the cost of being in London, the fact that the bank levy that is being imposed is on a global balance sheet, not just a UK balance sheet, there is a tax on being headquartered here. We are finding institutional investors routinely now in meetings asking us to explain the cost of being in the UK, and the benefits. Now, we don’t have that calculation yet, because it is all very, very new. So there are going to be more inputs into the decision going forward, but we are certainly not starting-and you are kind of leading me, trying to say we are trying to leave. We are not trying to leave.

Mark Garnier: No, I am not.

Douglas Flint: But we will look at it entirely dispassionately from an economic perspective and our shareholders in fact will do exactly the same, and it is they who will be coming to us and saying, "Explain to us what the cost of your current business model is, your geographic structure, your headquarters. You know, what are the economic consequences of the way you are structured? Is there a different way of doing it, and if there was a different way of doing it, are the benefits superior to the cost of getting you there?"

Q887 Mark Garnier: If you were to leave this country, because we will know by the end of this year exactly what you are going to do, because you have guaranteed that this year you will make the decision with all these big, big things going on-

Douglas Flint: Routinely, yes.

Mark Garnier: Sure, but it is this year, as opposed to last year or next year. We are at point zero of this three-year cycle. Will you make it very well known how you came to your conclusion?

Douglas Flint: Absolutely, absolutely.

Chair: I am sure you will.

Q888 John Mann: Mr Flint, I want to start by asking about your philosophy. Does banking exist to support democracy, or does democracy exist to support banking?

Douglas Flint: In my view, banking exists to support economic progress through facilitating economic endeavour and giving a secure home for the product of that endeavour, and providing capital so that people can pursue personal and business objectives. So banking serves society.

Q889 John Mann: Are there any values that are more important to your board than making money?

Douglas Flint: Absolutely. Absolutely, yes.

John Mann: What are they?

Douglas Flint: Playing a proper role in society. I think we started this meeting by saying that there were periods in the mid-2000s where we, as a board, were being heavily criticised by elements-elements, and not the entirety of-the shareholder community, saying that we were not taking an aggressive enough view of our balance sheet and we could make more money. We stood aside from that, because we believe that there is an optimal financial structure to enable us to have sustainable value. You know, we have a market capitalisation of around $200 billion, £120 billion. 65% of the dividends that we pay are in this country, and therefore roughly, as a proxy, 65% of our shares are owned by people in this country. They passionately care about our success, and our success is more than just our profitability in a single year, it is our long-term sustainable value creation and the dividends that come from that.

Q890 John Mann: So in terms of playing a proper role in society, you then would support moves and urgent moves towards democracy in China?

Douglas Flint: I am not sure how that has a relevance to banking.

John Mann: Well, you are a big player, you want to play a proper role in society.

Douglas Flint: Absolutely, and our business-

John Mann: You operate in China-

Douglas Flint: We do, and-

John Mann: -and China is not a democracy. So in terms of democracy in China, would you support, as a bank, moves to democracy in China?

Douglas Flint: I think that is outside of my ability to comment. We have 100 branches in China. We have opened rural branches so that we can bring banking services to the most remote parts of China and therefore-

John Mann: So if your-

Douglas Flint: -our focus is on the economic progress within China.

John Mann: -customers in China want to have a say about the banking system in China, how would they express that view?

Douglas Flint: If our customers in China have a view of the banking system, they choose to bring their business to us or not. That is the way they express their opinion.

Q891 John Mann: No, but if they want to have a view on the system, they have to join the Chinese Community Party. Do you regard that as an appropriate form of government for those people?

Douglas Flint: I am sorry, I don’t have a view. I don’t have a comment.

Q892 John Mann: You do not have a view. It is just that you said your role is to play a proper role in society. Over the centuries, have any of the underlying ethics or moral principles of banking changed?

Douglas Flint: I don’t believe so, no.

Q893 John Mann: Where does the word "bank" come from?

Douglas Flint: You’ve got me.

John Mann: Well, you are the banker, not me, but the word "bank" comes from "bench" because all transactions were carried out on a low bench so everyone could see them. So on transparency, is there any information in terms of the pay of your senior executives that is requested by this Committee that you would not be prepared to provide?

Douglas Flint: Well, you haven’t made a request. We already gave more information than any other bank based in the UK, because our Hong Kong listing requires us to show, in addition to the board pay, the pay of the five highest-paid executives in the group, and we set that out-and have done forever-in our annual report and accounts. So we already give more information than any other bank. I am totally relaxed about transparency.

Q894 John Mann: So if we want to know how many of your employees earn over $1 million, we can find that out?

Douglas Flint: We would be very happy to provide that information, assuming we were not alone, i.e. if this was something that was going-we would not resist an industry disclosure of that information, no.

Q895 John Mann: You would not resist it as an individual bank either?

Douglas Flint: I think we wouldn’t like to be on our own, simply because it would give undue attention to us, but if you ask me do I have an objection in principle to transparency, absolutely not.

Q896 John Mann: Would there be any problems for you as a bank in doing that?

Douglas Flint: I think there are potentially unintended consequences that would come from greater transparency internally, in the sense that I think it could have the unintended consequences of putting pressure on pay rising, because a bunch of people would see where they fell in the pecking order and they might be somewhat disappointed that they were at a lower rung than they thought they were. So I think the risk is with much more granular disclosure of pay is that people begin to get information that they didn’t otherwise have to negotiate their relative value. They don’t have that at the moment. That is the one downside I can see.

Q897 John Mann: You have reportedly doubled the fixed salaries for your investment bankers. Is that the case, and how many people does that cover?

Douglas Flint: I don’t believe it was across the board that we doubled. There were some, I guess, but it wasn’t-the move to more fixed pay was in response to regulatory concerns around the leverage of incentive compensation, as to whether it leads to excessive risk-taking. Therefore the industry has gone through a process of not changing total compensation, but changing the leverage to the base as a-

Q898 John Mann: So how much more are you paying out then in fixed salaries for your investment bankers, roughly?

Douglas Flint: I can tell you. $150 million was moved from the bonus pool, or what would have gone into incentive compensation, to fixed compensation.

Q899 John Mann: How many people did that cover?

Douglas Flint: I don’t have that figure.

John Mann: But we could have that figure?

Douglas Flint: Yes.

Q900 John Mann: Why should your investment bankers be paid so much more?

Douglas Flint: They are not being paid any more. The structure of the pay is changing. Their total compensation is not changing as a result of this. The ratio of fixed to variable is changing.

Q901 John Mann: I think people can see what is going on. You are trying to manoeuvre around the systems that are there.

Douglas Flint: No, we are responding to concerns that excessive leverage in variable pay could lead to unintended consequences of people taking excessive risk. I don’t necessarily agree with that, but that was the conclusion of a number of reports into how to better align shareholder and societal interests with the compensation structures and we have adjusted accordingly.

Q902 John Mann: A final question: if the pressure for democracy in certain countries around the world spreads to China this year, how will you deal with that unintended consequence?

Douglas Flint: We deal with all these situations as they arise. We have a substantial number of branches in Egypt and one of the things I will do when I leave here is get another update as to what is happening to our many thousand people in Egypt. So, you know, there are a number of situations that we have to deal with and we respond to economics, not politics.

Q903 Chair: On the transparency issue, you will have seen Eric Daniels’ letter to us, and my letter to the Chief Executive of the FSA. Do you think that the approach taken in that letter will pose any difficulties for HSBC or do you feel able to give it a fair wind?

Douglas Flint: I personally don’t have any difficulty. If that was a proposal put forward, we wouldn’t resist it.

Chair: You will co-operate with the FSA in helping them put it together?

Douglas Flint: Yes.

Q904 Jesse Norman: You have said almost in terms that you see the bank as motivated by certain moral values or certain ethical positions, and of course in this country historically banks have been set up by dissenters and Presbyterians and non-conformists for exactly that kind of reason, to express a moral position as well as a commercial one. Is that your view?

Douglas Flint: Sorry, I missed the bit in the middle of your question.

Jesse Norman: That the bank is infused with a certain kind of moral-

Douglas Flint: Absolutely.

Jesse Norman: -position and values.

Douglas Flint: Yes.

Q905 Jesse Norman: Why then are you planning to take a decision about where you locate purely on economic grounds? Why not think of the character of the institution and the values that it has always stood for, its relationship to British history and take it on those grounds as well?

Douglas Flint: I don’t think there is any possibility of our moral or ethical character changing depending on where we locate, and indeed, we wouldn’t relocate-I find this difficult, because we don’t have an intention to relocate, but were we to relocate, it would not be to any part of the world where the character of the organisation would in any way be impacted. So that would be one of the considerations. We would not go anywhere where there was a risk to the character of the organisation and, you know, I should say out of 145 years of history, we have been in the UK for 18.

Q906 Jesse Norman: In thinking about Merlin, does Project Merlin cover not merely asset lending or lending and compensation, but also transparency?

Douglas Flint: It does, yes.

Q907 Jesse Norman: Can we expect positive moves in the direction that the Committee has indicated on that issue?

Douglas Flint: Obviously the discussions in Merlin didn’t have the benefit of the letter you have just written, but part of the dialogue with Government has been about transparency and there are proposals to go further than we go today, and as I said, we already go further than our peers in the UK because of the Hong Kong listing requirements.

Q908 Jesse Norman: That would fit with the ethos, the values of the institution?

Douglas Flint: Yes.

Q909 Jesse Norman: Have you looked at the possibility of paying staff in CoCos or in subordinated debt or other things that would align their incentives more with the interests of the asset base as a whole?

Douglas Flint: For the last couple of years, the vast majority of our more senior and highly-paid people have been paid in equity, which is obviously the most responsive form of instrument to the future prospects of the institution. So CoCos are higher up the capital structure, as is subordinated debt, than equity. We pay staff in equity and I suspect that is what we will continue to do for a large part of their remuneration.

Jesse Norman: Thank you very much.

Q910 Mr Mudie: It is just a question in response to something you said to the Chairman and something you have just said to Mr Norman, which is this: you were very forthcoming and positive in terms of transparency and information to the Chairman, which is welcome. One gets the impression that Merlin is struggling to reach agreement, and if Merlin reached agreement that is just to cover over the fact that they could not really do a deal in a positive way, but they cobbled something together, would you feel bound to accept the transparency arrangements agreed in Merlin and the statement you made to the Chairman would be, "Sorry, but I have to be part of this agreement"?

Douglas Flint: I think we would take our own view. I mean, we already, as I said, do more than UK banks, so we are already further forward. We have only had the benefit of seeing the Chairman’s letter this morning, so we will take that on its own merits, independent of Merlin.

Q911 Mr Umunna: I just wanted to follow up on the response you just gave in relation to the composition of remuneration and how you are moving towards fixed salary, as opposed to high bonus payments, and you said that $150 million had been moved from the bonus pot to the fixed salary component. How big is the bonus pot, roughly, in billions?

Douglas Flint: We haven’t determined what it is going to be this year, but it is around two.

Q912 Mr Umunna: Billion? So transferring $150 million from your bonus pot to your fixed salary component is not that much, is it?

Douglas Flint: No. But the point of the transfer is to reduce the leverage, which is what it has done, but also we should remember that the bonus pot is there to incentivise people for delivering against the objectives they have been set at the beginning of the year, which are much more broad than a profit. Nobody’s paid a percentage of their profit, and therefore it is to achieve the alignment that shareholders have asked us over a long period of time to deliver. So what we are trying to do is-

Mr Umunna: I understand where-

Douglas Flint: -manage the structure of the compensation, so that it means that we don’t end up paying a large amount of fixed pay in periods where the performance is weaker and individual behaviours aren’t what we wish, so there is this balance all the time.

Q913 Mr Umunna: I understand that balance, but I am just saying to you that this $150 million transfer, in the context of your overall bonus pool of $2 billion, is not that much, and so you have not changed a great deal, have you?

Douglas Flint: On that basis, no, but I am not sure we tried to. What we were trying to do was get the appropriate mix that we think works for the business.

Q914 Chair: Would you be prepared to tell us what proportion of the bonus pool is going in payments over $1 million?

Douglas Flint: I am happy to tell you.

Chair: When it does, when it does.

Douglas Flint: I don’t know the figure off the-the Remuneration Committee doesn’t sit until the end of this week or next week, so-

Chair: Yes, I am very grateful for that. Thank you very much for coming to give evidence and being so frank with us. It has been helpful. You have agreed to give us some further information and we look forward to receiving that, and also to your further participation in Merlin, not least looking at the transparency issues that we have been raising this morning. We will now take a five-minute break before we take our next witnesses. Thank you very much.

Examination of Witnesses

Witnesses: Neville Richardson, Chief Executive, The Co-operative Financial Services and Rod Bulmer, Managing Director, Retail, The Co-operative Financial Services, gave evidence.

Q915 Chair: Thank you very much for coming to give evidence to us this morning. We have a number of relatively crisp questions, and it would be helpful if we have some crisp replies. Unless something you say that we feel needs quite a long follow up, I do not think it needs to be a long session, and we have another one following, as you know. Could you first of all tell us your assessment of the impact that recent consolidation within the sector has had on the retail market and retail competition?

Neville Richardson: You mean consolidation in the plc sector or across the entire financial services sector?

Chair: Let’s concentrate on the area in which you have the greatest expertise.

Neville Richardson: Okay. I think in the mutual sector, the history of the sector has been very much one of consolidation and I think that has given the strength that we have across the sector today. The Co-operative Group, which is the one that I speak for, mainly, has been the result of many-

Chair: Could you speak up? I am sorry, I am only just hearing you.

Neville Richardson: Yes. The Co-operative Group, which is the part that I speak for, is as strong as it is today because of those many mergers that have taken place. Having said that, there is strength in the local part of the mutual movement, and long may it continue.

Q916 Chair: The overall competition coming from other players: less, greater, the same that it was?

Neville Richardson: I think when we look at competition, we look at it across financial services, so if I just say a word or two about the size of our organisation, we have about 1.25 million current account customers and about 8 million customers in total, so I don’t look on competition as being within the mutual sectors, I look on competition being across the whole sector, and effectively what the mutual sector does is bring significant diversity and challenge to the plc sector.

Q917 Chair: When Eric Daniels said that competition was, "Enormously competitive in the retail sector" did that ring a chord, did that strike a chord, ring a note?

Neville Richardson: It is competitive. It is a competitive market, but I think what the mutuals and the Co-operative bring in particular is a challenge to the traditional model, and I think when you look at the service awards, we just recently came out as top bank, top high street bank in the JD Power survey. Under that survey, when you look at the pricing of products, so if you look at the products that appear in the top quartile, whether it’s mortgages or savings or current accounts, invariably you find mutuals and ourselves in those highest echelons. If we were not around, then I believe that there would be far less pressure on the plcs to deliver, and so there would be less competition and less diversity.

Q918 Chair: You may have heard the previous evidence session, in which we discovered HSBC does not know what each individual customer is costing them. Do you know what each individual customer is costing you?

Neville Richardson: Yes. Perhaps if I can ask Rod, who is my Managing Director of Retail, to say a word on that.

Rod Bulmer: Yes, so each individual current account customer we believe costs us £85 per year. While that is a specific figure, it is an average. As you will understand, different people use different services, but I think it is appropriate we give you the figure, which is £85. Clearly, though, the marginal cost is not £85 and we think that is very important, because growing our share will allow us to grow much more competitively, because the networks lodge their fixed costs, the ATM infrastructure, the very high investment in IT. But last year, about £85.

Q919 Chair: It seems we have travelled a longer way there than we did an hour ago.

Q920 Mr Umunna: I was going to say exactly the same thing. Can I just go back to this issue of consolidation, because you said that in your sector, if you are looking at the mutual sector, it has given you strength, but I have to say, paradoxically, this Committee has listened with some incredulity to in fact HSBC, I suppose, Lloyds and RBS, all have come here and argued that increasing consolidation across the financial sector as a whole has not adversely impacted on competition. I am just not totally sure from-I understand you were kind of asking, when you were talking about the mutual sector or the financial services sector per se. Let’s start looking across the board. How can increasing consolidation not have adversely impacted on competition? That is something that I think we are all struggling with at the moment.

Neville Richardson: There is a point at which the consolidation starts to take significantly away from competition.

Q921 Mr Umunna: Have we reached it?

Neville Richardson: I think we are probably close to reaching it, but if I give you an example, we are at present replacing our core IT systems. We are the first UK clearing bank to do that. None of the plcs have done that, so many of the systems were written in the 1970s, 1980s and 1990s and are therefore inflexible and difficult to work with from a customer point of view. We are spending £0.5 billion on replacing our core IT systems. If we were a much smaller organisation-so the two predecessor organisations that formed what is now Co-operative Financial Services, which was Co-op Bank and Britannia Building Society-neither in isolation could have afforded to spend that £0.5 billion.

Q922 Mr Umunna: You mentioned the benefits of the customer satisfaction levels; you referred to the Which? survey and the costs. What are the other benefits that you see for having a more diverse retail market? What in particular do mutuals like yourselves bring to that?

Neville Richardson: If I can talk about the background to our organisation. The Co-operative Group is very much a membership-led organisation. In fact, our main board is made up entirely of elected members. The members are customers, so our customers-

Mr Umunna: A bit more democratic, if you like?

Neville Richardson: Yes. Our customers are democratically elected effectively straight to the main board, so that means that views that are taken are taken straight from the customer. Now, when we assess our performance, we assess across the balanced scorecard, and our balanced scorecard is one that does take in financial measures, but it also takes into account customer measures, employee measures and social goals. Social goals, to our organisation-because we are very much a values-driven organisation-are of critical importance to the way in which we do business.

Q923 Mr Umunna: What are those social goals? What do you mean by that?

Neville Richardson: We have a whole spread of social goals, whether it is the way in which we invest in local communities, or whether it is the type of lending that we do. We have a whole load of values-driven objectives, so for instance, in my part of the business, in the financial services part, they were a significant lender into renewable energy, and that is something that my board believes is the right thing to do. We are also significantly investing back into local communities, so many of our local Co-operative stores have local representatives, who will receive donations and will use monies for local benefit.

Q924 Mr Umunna: The Government, in the Coalition Agreement, has said that it will promote mutuals and organisations like yourself. Do you think it is doing enough in that respect or do you think there is scope for it to do more?

Neville Richardson: I think there is scope for it to do more, and if I can give two examples of that-

Mr Umunna: Please.

Neville Richardson: -and the examples I would give would be in the areas of capital, and there is significant attention paid to levels of capital of financial services organisations, more so than ever. We have on occasions, as mutuals, been looked on as the end of the train of thought and we want to be there at the start of the train of thought, so quite often legislation is being discussed by the regulators with the plcs in mind, and then as an afterthought, the mutuals. Now, if we want to have a diverse financial services sector, then we need to be right at the table at the time that thinking is going on about capital. The second example would be the Financial Services Compensation Scheme, where we are a prudent organisation. The deposits that we take in from customers are greater than the loans that we lend out to customers, so we are around about 105% funded from customer deposits. That makes us a lower-risk organisation. Conversely, and quite bizarrely, that then means that in compensating for the Icelandic failures and so on, we have to pay more towards the compensation scheme because it is based on retail deposits, and that just seems wrong to us.

Q925 Mr Umunna: Can I just go back to the capital issue? My understanding is that those of you in the mutual sector are going to struggle somewhat with the Basel III capital requirements. Is that right, and how are you addressing that with Government?

Neville Richardson: It is not a case of struggling with it. It is a case of making sure that we have new instruments available to us that we can raise further capital from. So we are a well-capitalised organisation. What is happening in the market is a perception that the capital should be higher because of the problems of the past, when many of the plcs, who were under-capitalised, had a problem. We have always maintained high levels of capital, but as both market perceptions of the requirement of capital and regulatory requirements increase, we want to have continued access to new forms of capital, and so as I said, we want to work with Government and with regulators to work out what are the best solutions for the mutual sector.

Q926 Mr Umunna: Do you think that one way-this is my last question-in which we could promote mutuals would be to remutualise Northern Rock? That is obviously a topic that is rising up the agenda very fast at the moment. Would you like to see Northern Rock be mutualised?

Neville Richardson: I think in terms of bringing another mutual into the sector, another competitive mutual into the sector, that would be a good idea, but there are issues that would have to be dealt with, such as the capital.

Mr Umunna: The capital.

Neville Richardson: The Government is providing that capital at present, and I think in terms of diversity, that would be a good move.

Mr Umunna: Thank you.

Q927 Chair: Just to be clear, have you written to Sir John Vickers with your points about the compensation scheme and Basel III?

Neville Richardson: We have, and in fact I am giving evidence on Friday of this week, so I will do that in person.

Q928 Chair: Okay, and that is already in the public domain, although we have not yet had a chance to read it. Thank you.

Q929 Mr Mudie: A good friend of mine, Robin Smith from Leeds, has been bending my ear about this capital instrument. I had the impression it was under way in terms that adversely affected the mutuals. Can you be specific about it, because at the beginning it was almost as though you were feeling you were not at the table and you were the last they thought about? Certainly Nationwide have included it in their evidence. Is there something happening now that it is crucial it is put on the table and drawn to the Ministers’ attention?

Neville Richardson: I think the answer to that is that in the initial stages, it did feel like we were left on one side. It now is feeling like we are being represented at the table, but it feels like it has been an effort to get there. So, yes, I think that the appropriate discussions are now taking place, but the point I was raising was in order to give an example of situations where I think we were being thought of after the event as opposed to at the same time as the plcs.

Q930 Mr Mudie: When you say that discussions are taking place, who is party to them? Which parties are there to these discussions and where are they? Is it Europe or here?

Neville Richardson: Both.

Q931 Mr Mudie: Are they going sufficiently well that we should not be concerned?

Neville Richardson: I think the answer that I’d have to give to that is they are in progress. So, at present, progress is being made.

Q932 Mr Mudie: We are having the Minister here tomorrow. Is it something we should press the Minister on or draw to his attention?

Neville Richardson: I think you should draw to his attention the advantage that diversity in the overall market, the diversity given by mutuals gives to the market, and therefore encourage him very strongly to continue to support moves for new capital.

Q933 Mr Mudie: Do you think before tomorrow you could just do a note on it and pass it to the staff so we can be quite specific with the Minister and so that we do not lose the opportunity?

Neville Richardson: I would be delighted, yes.

Mr Mudie: Thank you.

Q934 John Mann: How many employees have you got, under all definitions of payment, getting over £1 million a year?

Neville Richardson: We have zero employees over £1 million, although I am the highest paid employee and if on a very good year we achieve our targets and our bonuses, then I could be over £1 million, but it is highly unlikely anybody else would be.

Q935 John Mann: I have over 20,000 members of the Co-op in my constituency. I have had a Co-op Visa card for 30 years. My grandma only ever shopped at the Co-op in her entire life, for 92 years, and was buried by them, the Leeds Industrial Co-operative Society. You have never bothered asking me or my constituents to join your bank, so what is wrong with you?

Neville Richardson: I will ask my Managing Director of our retail business to answer your question.

Rod Bulmer: I think the Co-operative as a broader group has not been as good as it should have been in working its businesses together for the benefit of all of its members and customers. It has operated in too siloed a way. I think the examples you give of the funeral business, the food business and the bank business not working well together are very valid and appropriate. We believe over recent years we are starting to make progress, and indeed over the last three to four months we have announced a new group structure with a single group chief executive to exactly deliver on those promises to customers under a banner of Project Unity. Our plan is to achieve 20 million members by 2020 with a real cooperative community approach in each and every community in the UK. I think that the challenge is very valid. We hopefully have plans to address it-

Q936 John Mann: I have loads of Co-op stores in my area, over 20,000 members, but you are not getting any of them into your bank.

Rod Bulmer: Yes.

Q937 John Mann: At the current time, if this is not your opportunity, with the unpopularity of bankers, when will it ever be? So, isn’t it the case that your business model is so weak that you are not capable of moving into that space?

Neville Richardson: I think actually our business model has been demonstrated incredibly well over the past three years to be a very strong model. At the time that the plcs were failing, the fact that we take a values-based approach to life, the fact that we look medium term and are not chased by the short-term vagaries of this quarter’s profit has meant that we are a strong organisation there for the future.

Now, to address your point specifically, then what we believe that we need to do is we do need to grow as an organisation, but growth is not a target that is uppermost in our minds. Providing service to our customers is uppermost in our mind. What we are doing is we are now experimenting with a number of branches within food stores, which will enable us to expand in areas of the country where we are not well represented at present. We believe that provides a big opportunity. We as a group have 5,000 stores across the UK. We only have 350 bank branches, and we think we have a significant potential to grow and provide financial services into areas like your constituency in the future.

Q938 John Mann: I was going to say, because you can get money out in my local Co-op but you can’t put money in, and that is why nobody joins. Is there any other financial institution that has the names and addresses of 20,000 members that does not ever mail them out and then go after them as potential customers for the bank? If your competitors had this, they would be all over areas like mine investing in order to get those people in and they would get a good section of them. I do not understand why you are not doing it.

Neville Richardson: I think you are pushing very much on an open door. It is exactly what we are doing at present. The strength of the brand of the Co-operative Group has grown immensely over the past few years and in particular the Co-op Bank side of things following its merger with Britannia is a much bigger and stronger organisation. The investment in the-

Q939 John Mann: Yes, but people do not want brands, they want branches.

Neville Richardson: Absolutely, but people want to feel confident they are going to get a good service and good products, and that is what they get from us. Now we need to expand into more locations for that competitive alternative to the plcs.

Q940 John Mann: So we can look forward to you doing a full review of my area on whether or not it is commercially viable for you to move in when others are exiting it to try and get some of these 20,000 as customers?

Rod Bulmer: Absolutely. Apologies, John, I do not know your specific area. I would comment, though, on Horbury. This is a location in Yorkshire. We had 1,500 Co-operative members write to us and say, "No other banks in town. We are prepared to switch our account to you if you open a branch". We are in the process of opening a branch in our Horbury food store and we genuinely believe-and I am glad you do as well-that with the Co-operative in renaissance we have a huge opportunity to expand our banking business as part of that broader business and, in particular, expand our network from the 350 to above 500.

John Mann: Well, if it is good enough for Mr Balls’s area, it is good enough for mine so-

Chair: I did not expect to find John bidding for the job of head of marketing, but-

Q941 John Thurso: Quick technical question: is there any difference between the building society mutual model and the co-operative bank mutual model and, if so, quickly, what is it?

Neville Richardson: Quite largely it is the legislation that set them up. The principles behind them are very similar, but the legislation that set them up is different. That is the principal difference.

Q942 John Thurso: Is there anything in that legislation and the differences between the two that you would draw our attention to as a barrier to going forward? You have talked about tier 1 capital; you have talked about the relationship. Is there anything else in the legislation besides that you should draw-

Neville Richardson: I think a real move forward two or three years ago was the Butterfill Act that brought through the ability of different forms of mutuals to merge with each other. It was under that Act that the Britannia Building Society was able to merge with the Co-operative Group. So I do not think there are specific restrictions within the legislation that I would draw your attention to, no.

Q943 John Thurso: To what extent does the Co-operative Bank work in commercial lending as opposed to personal lending?

Neville Richardson: We are very much a corporate lender as well as a personal lender. We have a very successful-

Q944 John Thurso: Roughly, business-wise mix?

Neville Richardson: In terms of our so-called balance sheet, around about a quarter of our balance sheet is corporate and business lending. Over the past three or four years, we have very much stayed open for business to SMEs and to corporate business in general.

Q945 John Thurso: One of my colleagues I think is going to ask you about that. Can I ask you about the three-quarters, the individual? You get consistently some of the highest scores from your customers, and I mean markedly higher than the Big Four, Five, Six or whatever they are. How much of that is down to your status as a mutual and how much is down to the style you choose to use for management?

Rod Bulmer: We think the mutual model gives us a good head start but, to be blunt, I think simply a good head start, and actually we are a business that is centred around clear values. As Neville said before, we run our business across the balanced scorecard. Indeed, I am incentivised not on profit or explicitly the profit make, I am incentivised across the whole scorecard, which includes how well we perform financially, profit, liquidity and capital, how we perform in our customer advocacy against our peer group, how we employ employee satisfaction and how well we manage our risk. Each of those components contributes to my bonus, and every one of our 12,000 employees are orientated around that same scorecard. I genuinely believe that the mutual model, the member-orientated model, gives us a real point of focus, but actually it is the way we run the business around the values and the way we measure and remunerate the business that makes the difference.

If you would tolerate just a return to the earlier question, the point on competition to me is the following. If there is such dissatisfaction with the banks, why would only 7% of people switch per year? That really is the point of competition. There is a fear and a lack of transparency that means despite the dissatisfaction that exists people are not inclined to take that journey. So it might be a tough market, but is it competitive from the eyes of the consumer? I think the answer to that simply is no, it is not.

Q946 John Thurso: If we go back not that long ago, my first house, 80%-plus of the mortgage market was in mutual hands. Today, what is it, 18%, if that? Something like that.

Rod Bulmer: Yes.

Q947 John Thurso: That is a massive change in the market. Then, banks were just not interested in mortgages. That was beneath them; that was something that was done by other people. Today, they are falling over themselves to grab it. We have clearly had a massive change. How preferable is it to think of some reversal in that and how important is it that we should be seeking to achieve it?

Neville Richardson: I think the answer is not one that would change via legislation. It would change by the actions of the mutuals. There was a stage the mutuals went through, which was quite a defensive stage, the carpetbagger stage. The demutualisations that did happen have subsequently proved to be disastrous, if you look at what has happened to those demutualised organisations. But I think we have to stand on our own two feet and prove to people that we are better. When you think about it, we are owned by our customers. We do not have to pay out to external shareholders. We have an absolute requirement in my eyes to be commercial as a business, to be efficient as a business for those customers, and it is up to us to keep demonstrating that it is better being part of a mutual than a plc that is only really interested in making profit for external shareholders. But we have to do that.

Q948 Michael Fallon: What share of the local authority account market do you have?

Neville Richardson: It is around about 30% to 40%.

Q949 Michael Fallon: 30% to 40%?

Neville Richardson: Yes, in terms of banking with us.

Q950 Michael Fallon: You have only 2% of the SME market?

Neville Richardson: Slightly more than that, but it is around about that size.

Q951 Michael Fallon: Why is that? You have been trading rather comfortably off all these council accounts and not getting your jacket off with the SMEs.

Neville Richardson: Well, no, in fact, as far as the local authorities are concerned, they tend to be banking with us more than us lending to them. I think we have-

Q952 Michael Fallon: Do you make money out of that?

Neville Richardson: We make some money, but you asked how many as opposed to the balances that are being held. But if we look at the SME market, that tends to be people wanting to borrow from us and that is where we have continued to be active over the course of the last three years, in fact increasing our-

Q953 Michael Fallon: But if you have only got 2% you have not been very active, yet you have been sitting on a third of the local authority business and coasting.

Neville Richardson: Well, the local authorities on the whole are not wanting to borrow from us and so-

Q954 Michael Fallon: No, but you are making money out of them. You are servicing their accounts.

Neville Richardson: Yes, we are comparing two different markets. One is the people investing with us and the other is the people who want to borrow from us. The local authorities on the whole do not want to take significant borrowings from us. Now, the separate question is would I like to grow our SME and corporate banking side. Yes, I would, and that is why we have been active and open, in fact grown our SME and business banking by over 40% over the last three years. That is a real statement of intent to grow.

Q955 Michael Fallon: But it is only 2%. It is tiny.

Neville Richardson: We are a small player, but minorities can be effective.

Q956 Michael Fallon: But you are a big player in the council account business?

Neville Richardson: I think a lot of that reflects the values that people see in us as an organisation. They see the service that we provide and they see the consistency of values that we demonstrate.

Q957 Michael Fallon: Why don’t small businesses see that?

Neville Richardson: If I could do, I would grow by more than we currently are doing, but we have been constantly an organisation that has been prudent in the approach that we have taken and I expect to be taking larger shares at times in the future.

Q958 Michael Fallon: What are the barriers between you getting that right up, from 2% up to a more respectable figure?

Neville Richardson: I think there are two. I think the first one is the market in general, because to lend money out to SMEs we have to take money in. Over recent times, the wholesale markets have become very expensive, so to borrow money is becoming expensive as banks are having to repay the SLS and the other government schemes. So, to lend out to them we have to borrow in.

I think the second is regulation, where the regulators are increasingly asking organisations such as ourselves and across the financial services sector to hold more capital and more liquidity. The more capital that you hold, the more liquidity that you hold, the less you can lend out.

Q959 Michael Fallon: Is that happening at the moment or is this something you fear will become a requirement?

Neville Richardson: It is happening at the moment.

Q960 Michael Fallon: Which requirement is this that is specifically restricting you? Is this the FSA requirement or is this Basel III?

Neville Richardson: It is the FSA.

Q961 Michael Fallon: That is on small business lending or is it on mortgage lending?

Neville Richardson: No, across the piece. So across small businesses, across all firms, the requirement to hold more capital and more liquidity is more intense now than it has been for a considerable time.

Q962 Michael Fallon: Does it damage you particularly vis-à-vis your competitors?

Neville Richardson: No, I do not believe that it does. I believe it is a fairer approach. It is a sector-wide question as opposed to a specific one to us.

Q963 Michael Fallon: Do you believe the OFT is right that there are significant barriers to entry for new competitors in the SME market?

Neville Richardson: I think in the SME market probably not. I think if people want to set up-the difficulty actually is of entering as a bank as a whole, I think. I think it is quite difficult to get into the market. We are demonstrating our wish to grow as an organisation and it is probably becoming easier as time progresses. But I just mentioned earlier the amount of money we are investing in new systems and as a small new entrant it is very hard to do that.

Q964 Mark Garnier: Can I just turn to those in our society who are slightly more financially excluded and just I think frame my next line of questioning? Would you just briefly outline the difference between a basic bank account and a normal PCA just so we can-

Rod Bulmer: Yes. So, largely and in simple terms, a basic bank account from Co-operative, you do not have the ability to have an overdraft facility. We do offer a full Visa debit card, we offer full branch access, but you do not have the ability to go overdrawn. With a personal current account you do have the ability to have a formal overdraft arrangement. It is largely the difference in how we run it. We have about 300,000 cash manager-as we call-basic bank accounts in our population. We have 1.25 million current accounts.

Q965 Mark Garnier: That is quite a significant number. That is a quarter, basically.

Rod Bulmer: We think there is about 30,000 to 35,000 basic bank accounts opened per month. We open 5,000, so we think we open about 14% of the market and we have stock share in aggregate of 2% and a 4% share of flows on primary current accounts, to give you a sense of the market.

Q966 Mark Garnier: I think I am slightly lost a bit on that. How many people do you think in the country need basic bank accounts? I remember hearing a figure from the Post Office that their equivalent was something in the region of 4 million. Does that sound about right to you?

Rod Bulmer: Yes, I think my broad answer would be everyone should have a bank account, should have the ability to access a banking relationship. I think it is a cornerstone of how people should operate and orientate. If you then looked at the appropriateness of the types of accounts, I think I would probably concur 3 million to 4 million would be appropriate on a basic banking.

Q967 Mark Garnier: Just out of interest, what happens if somebody makes a payment that was going to result in them going overdrawn? Do you charge them like normal banks or are you much more gentle about it?

Rod Bulmer: No, we do not charge and we do not allow those payments to go through. We have a very small "pencel" limit and what that is is to avoid people who are going to go pence over the limit being embarrassed or uncomfortable, but we do not allow anything beyond that "pencel" limit. So it is impossible beyond that "pencel" limit to go overdrawn.

Q968 Mark Garnier: There are a lot of accusations, certainly from the New Economics Foundation, that this Committee is not looking into this type of market enough and that the general banking debate is not looking into competition for this section of the market. Do you think that is a fair criticism?

Neville Richardson: Yes, I do. In fact, some evidence that we have from that is two or three years ago we started to open basic bank accounts for prisoners coming out of prison. There was a study carried out by Liverpool John Moores University after a couple of years and that showed there was a significantly lower reoffending rate from those prisoners who had taken up the basic bank account because they had come back into financial inclusion and back into more mainstream activity.

Q969 Mark Garnier: What do you think about competition among the basic bank account market? Do you think there is sufficient competition? Do you think we need to increase it or is it irrelevant?

Neville Richardson: My own view is that others should be encouraged to supply basic bank accounts. We supply significantly higher than our market share. We think it is the right thing to do, going back to social goals.

Q970 Mark Garnier: What is your market share, sorry?

Neville Richardson: It is about 14%.

Rod Bulmer: 14%.

Neville Richardson: So significantly higher than our stock share of overall accounts. We think that the plcs should be strongly encouraged to provide basic bank accounts. One of the opportunities that will throw itself up is when the part-nationalised banks sell off a number of their branches. There could be a condition attached that requires them to open a certain number of basic bank accounts.

Q971 Mark Garnier: So none of the Big Four or Five are offering them at the moment?

Neville Richardson: They provide them but do not encourage them.

Q972 Mark Garnier: Why do you think they do not encourage them?

Neville Richardson: Because there is very, very little money to be made in a basic bank account service.

Q973 Mark Garnier: There are an awful lot of these banks are coming in to see us and talking about their moral fibre and how good they are for communities, and yet they are denying huge numbers of people. You said up to 4 million people who need these types of things. That is a shocking indictment on these big banks.

Neville Richardson: I would encourage you to ask them why they do not provide the basic bank accounts. We do. We think it is the right thing to do, and yet we have a significantly high market share because we encourage people to have those accounts. We think it is the right thing to do and clearly if they do not make much money they are not encouraged by the plc competitors.

Q974 Mark Garnier: To a certain extent, do you think-because, of course, it comes back to this whole question about the cost of having a current account, but presumably somebody who is socially excluded is not going to necessarily want to go off and take out loans or savings plans. Do you think a lot of it is to do with this cross-selling element?

Neville Richardson: Yes. We make very, very little money out of these basic accounts. In terms of organisations that are predominantly aiming towards profit maximisation and return on capital, these accounts show very little interest to them.

Q975 Mark Garnier: So, in fact, looking back to the New Economics Foundation’s comments that we are not as a Committee looking at this stuff, it is actually a very fair comment and perhaps if you had come in first it would have been one of the questions we should have been asking?

Neville Richardson: Yes.

Rod Bulmer: I think it is very fair.

Mark Garnier: Perhaps we ought to write to them.

Q976 Jesse Norman: Mr Richardson, you have spoken about the demutualisation process and it is very striking to independent observers that the financial sector has been transformed by the corporatisation of a wide range of existing institutions, including mutuals but also including brokerage firms and other forms of financial institution. How do you think we can improve the diversity in the banking sector? It is almost as though we have taken a view that the portfolio effect works even if you have a number of institutions that all think the same thing and behave in the same way, so how are we going to improve that?

Neville Richardson: I think I said earlier that we are very much a valuesdriven organisation. We are just a different type of organisation. So the question then, I think, gets back in terms of current accounts-which is the staple product, I suppose, of retail banking-to how can we encourage more people to switch to our accounts rather than to other types of organisation. That has to happen over a period of time and it has to be encouraged. As Rod said earlier, the number of people who switch bank accounts is actually very low at present.

Q977 Jesse Norman: But your view is, is it not, that a diversity not merely of institution but of ethos is a positive value in the system, that it should be something that Government should be aiming to increase and improve?

Neville Richardson: Absolutely. I believe the culture of an organisation is absolutely central to the decisions that are subsequently made. So organisations that are taking on more risk have a culture that is aimed towards risk.

Q978 Jesse Norman: Thank you. It is very striking that there is a wide degree of crossparty support now for the cooperative sector and for mutuals, and I have written a lot on this topic. What three things do you think Government could do to promote cooperatives and mutuals in the financial sector?

Neville Richardson: I think I have already said one of them, which is very much about when legislation is being looked at, then look at cooperatives and mutuals at the same time and with the same enthusiasm. So, no matter what the legislation then, do not look first at plcs and then at co-operatives.

Q979 Jesse Norman: Do you think the Treasury has, as it were, been cooperative blind or mutual blind when it has been thinking about framing financial legislation?

Neville Richardson: I think blind is probably a stage too far, but certainly in need of a little bit more vision I think is probably the answer. I think otherwise there is a general enthusiasm, and your colleague here raised it earlier, to move towards cooperatives in the market at present. I think the Government could do more to speak about it. When the Government speaks about big society, then we are an organisation that has many of those attributes in place at present. So, our links with local community-and I can give an example in a very tiny scale of a local hydroelectric scheme close to one of our branches, which is benefiting the local community in New Mills, Derbyshire, at this point of time. Now, that is the big society approach and I think it could be clear that actually a cooperative could be at the centre of that.

Q980 Jesse Norman: So better legislation, more advocacy; is there anything else, specific initiatives, removal of impediments? What kinds of things in those areas do you think?

Neville Richardson: I am not sure of anything else. Rod?

Rod Bulmer: I would push very strongly for the transparency agenda. I think you have to ask: is the current banking sector transparent to customers and, if not, is that the reason why customers are showing apathy to act? My belief is it lacks sufficient transparency and any support to increase transparency to make people aware and, therefore, make them have the ability for informed choice would be hugely beneficial to us.

Q981 Jesse Norman: That would include transparency on, for example, compensation arrangements within the Co-op itself?

Rod Bulmer: Yes, absolutely.

Jesse Norman: Thank you very much.

Q982 Chair: Thank you very much for coming to see us this morning. We found that extremely valuable and you fulfilled what we requested, which was crisp and detailed replies. If there is anything further you would like to add please do put it to us in writing, but we are grateful for this evidence. We will take a two-minute break and go straight on to the next session as soon as the witnesses are in their seats.

Rod Bulmer: Thank you.

Neville Richardson: Thank you.

Examination of Witnesses

Witnesses: Graham Beale, Chief Executive, Nationwide, and Chris Rhodes, Executive Director, Group Product and Marketing, Nationwide, gave evidence.

Q983 Chair: We are going to begin. Thank you very much for coming before us in what is almost this afternoon, still this morning. Thank you very much for the evidence that you have put to us. In that, you say, "In the short to medium term, greater competition in banking is more likely to come from existing participants than from new entrants". Why, then, are Tesco, Virgin, Metro and others looking to enter this market?

Graham Beale: The reason we said that is because the cost of establishing a fullblown banking service is very, very large. It requires an investment in infrastructure; it requires an investment in expertise; you need to have the necessary financial resource in terms of capital and liquidity; you need access to distribution and you also need a brand. When you put all of those components together, they are all necessary to have a full impact so that you are something more than a niche player. I think the only entities that I can see in the UK that could actually attempt to satisfy all of those conditions are actually the supermarkets, and that is why I think of the most likely entrants it would be the likes of Tesco that could achieve that. But they have been looking at this for a long, long time and I think even for an organisation with the resource of Tesco, they are still on the edge of deciding whether they are to make a full-blown entry into banking in the UK or not. What you do see are lots of entrants offering the simpler products, general insurance, loans, cards, et cetera, where you will find that the market is much more fragmented because they are much easier products to offer, but, particularly if you intend to offer a personal current account, mortgage products, investment products, they require very substantial investment and that is, I believe, a significant hurdle for new entrants into the marketplace.

Q984 Chair: What about the barriers at the point of consumer perception to switching, we have just heard in previous evidence, which we have heard so much about, and also the lack of transparency on price?

Graham Beale: I think there are a number of issues there, and I will ask Chris to respond to one of them. I think in the first instance, though, the brand and the strength of your franchise is hugely important because banking revolves around trust. If you do not have a brand that is credible in the marketplace, I think consumers will think twice before they would contemplate moving their financial affairs.

Q985 Chair: Brands have just taken a bit of a knock, haven’t they?

Graham Beale: Brands have taken a huge knock, but at the moment there is limited choice in the UK and, therefore, it is probably the best of a bad job in terms of the choice that does exist.

Q986 Chair: Inadequate choice?

Graham Beale: Possibly. In terms of the specifics at the individual level of moving, can I ask Chris in terms of the perceptions of switching?

Chris Rhodes: I think there is-

Q987 Chair: Sorry, just before we go into that, when you said "possibly", either there is enough choice or there is not?

Graham Beale: I think there is a lot of choice in the UK but it is very heavily polarised between-you have effectively the banking model, and you have the four or five larger players, and then you have the mutual model. Really, within the mutual sector, there are only two institutions that offer the full array of personal financial products, which is Nationwide and the Co-operative.

Q988 Chair: Sorry to interrupt, Mr Rhodes.

Chris Rhodes: That is okay. I think, talking about the personal current account market, I think there are two perceived and in some respects actual barriers to customers changing their accounts. I think the first is the switching process because there is a concern that your direct debits are going to get messed up and effectively you will incur charges and that will not be an easy process. I think the second one, though, is the charging structure and the way it operates, not necessarily in that it is not transparent, because I think if you look at each individual component of the charge you can work out what you will pay if a cheque is not paid. But it is the overall impact in terms of the total cost because customers actually believe that a current account, with the exception of the interest forgone on any balance, is free. The reality is for 80% of the population that is correct. Your forgone interest cost is a very few pounds. So for 80% of the population the personal current account is free. But for those who have unauthorised overdrafts, who have cheques or direct debits that are not paid, then it is a significant cost.

So, to create what I would call pull demand in a market where 80% believe it is free is incredibly difficult. Because I am saying, "Come to Nationwide because you have your free account", so we have to add on a whole range of other incentives, which makes it very expensive to recruit new personal current account customers. Then your earnings only occur at the back end of the process when customers start to incur the overdraft structures that we know so much about. So, unless you have a back book of current account customers, day one you have no income.

Q989 Chair: The front-end loading of-

Chris Rhodes: Of the investment costs of establishing. From a marketing earnings point of view-

Q990 Chair: To attract the new customers?

Chris Rhodes: I think is a very significant barrier.

Q991 Chair: That is made possible because once people are there there is inertia and you will make money out of them by just-

Chris Rhodes: And 80% never pay a charge. They have a few pounds worth of lost interest. So there is no real push to push them out of an institution because 80% are paying very little.

Q992 Chair: Can’t we require financial institutions to publish interest forgone on current accounts?

Chris Rhodes: You can. If you take the average-

Q993 Chair: Wouldn’t that increase competition?

Chris Rhodes: No. Let’s be clear, the average in credit balance in-

Q994 Chair: The OFT are wrong on that?

Chris Rhodes: Let me give you a few facts and then you can, I think, reach your own conclusion. The average in credit balance in a UK current account is about £1,500. So if you put base rate as an anchor rate to do a calculation, you get £7.50 a year.

Q995 Chair: That is a very unusual low rate. What about doing it at the average over the last 10 years?

Chris Rhodes: If you put your best instant access rate that you could get from a high street provider, about £30 a year. That is your forgone interest cost. That is not a lot in terms of convincing you to move your account even if you put an in credit interest-even if you disclosed that number, worked out the price, it is not a significant driver to cause you to switch your current account. I will let you judge, but that would be my view. Whereas the charges are more significant but most people believe they will never pay them, and 80% in reality never do.

Q996 Chair: What people need is an aggregate of all these numbers, isn’t it, so they can see annually what it is costing them to run their account?

Chris Rhodes: They do.

Q997 Chair: Then they could go to another bank and say, "Will you do this more cheaply"?

Chris Rhodes: But for 80% of the customers, it would be £30 of in credit interest rate and, as you have heard, it costs the Co-op £84; it costs us £64 to run an account. So it does not work on in credit interest alone, and I reiterate as 80% of the population never pay the other charges and most believe they never will, you cannot create competition in that way. You have to have other incentives to encourage you to switch accounts.

Q998 Mark Garnier: Can we talk about your mutual status? How do your customers benefit from the fact that you are a mutual as opposed to a plc?

Graham Beale: The philosophy that sits behind being mutual is to give back longterm good value on a consistent basis. I would define value as being the offering of the quality of service, the quality of the products, strong access, a competitive price. We do not hold out to be the cheapest in town but we like on a consistent basis to give that good value through pricing. That is the relationship, and it is very much about relationship banking. We try to give value back in a focused way to the members that create it by having exclusive offers for our longterm members. So, again, we are giving value back. The overall model, and I would contrast this with the banking model, is that we are a commercial entity and it is necessary for us to make a profit to meet our capital prudential requirements and so on. But we seek to optimise the level of profit in the business so that we make just enough to meet our prudential requirements. We do not seek to maximise profit, which is more akin to the banking model.

Q999 Mark Garnier: It is very interesting that when you read that list out, you were looking at service, product, access and then price. You see that as being very important, do you, that you are actually delivering a very good quality of service before-

Graham Beale: It is the collective in terms of all of the things that we offer. The market is very price driven and has been excessively price driven over the last few years, so it is always difficult for us, where you see market distortions, to be able to match on price. In those situations, we tend to retract from the marketplace until we feel that it is a price that is fair to our membership.

I will give you an example. In the previous financial year, and we are a March year-end so to the year March 2010, the UK market was dominated by a very aggressive fight for retail deposits. This in part was driven by certain institutions that were repositioning their balance sheet to try to reduce their dependency on wholesale funding. The pricing for retail deposits went way beyond the economic parameters that would mean that if we were to compete we would make a financial loss. That is not in the interests of our membership, so we stood back from the marketplace and we had an outflow in excess of £8 billion from our balance sheet. So that was a rather extreme example and, therefore, when we find that the market is not operating in a normal fashion we will stand back, which is I think again one of the virtues of a mutual model in that because we are not driven by shortterm profit desires, we can take a much longer medium-term view. We try to be very fair with our members, but we cannot be uneconomic and it is not in anybody’s interest if Nationwide was to make a financial loss. So we have had to take some rather extreme decisions in the last two or three years.

Q1000 Mark Garnier: You do talk a lot about time horizons in terms of medium term and long term and this sort of stuff, and you are obviously very clear about that. You refer to obviously short-term profits as being on the better side of it. Can you give us some more examples about how this long-termism manifests itself in the way you run yourself?

Graham Beale: I come back to our philosophy in terms of the members that we have is to try to establish true relationship banking. So, our desire is not to prospect for lots and lots of new members. Our desire is to establish a relationship with individual members so that they have their personal current account with us, that they take a mortgage, they do a personal loan, their insurance, et cetera. That is very much an investment in the long term with our members and trying to establish that relationship and serving the members. As I said a moment ago, we try to give value back to the members that have the broadest relationships with Nationwide through price rebates, through special offers, through access to savings products that are specific for loyal members, et cetera.

Q1001 Mark Garnier: The Government is looking at proposals to promote the mutual sector. What realistically do you think the Government can actually do to do that?

Graham Beale: I think that there are a number of things that the Government can do. I think the first thing is that the Coalition statement about fostering diversity and promoting mutuality, at the moment I have not seen any substance that sits behind that as a comment, is the first point I would make.

What we have been asking for, and we have given evidence to the Independent Commission on Banking, is first of all I would hope that the Government would resist any attempts to narrow the mutual business model to restrict what we can and cannot do beyond the current constraints. I am very comfortable with the parameters in which we operate at the moment, but I think you took evidence from Lord Turner a couple of weeks ago where he was talking about deliberalising building societies. That would have very severe consequences for our business model in narrowing it and making us unable to compete with the banks. So I think the first thing is that I want a level playing field with the banks. I am not looking for any additional powers in terms of what we can do as a business, but I do not want any constraints either. That is the first thing.

The second thing is that the emerging regulation over the last couple of years, and I think Neville made this point, has been very much orientated around the plc model. I think it overlooks the fact that the building society model is different. It is typically a much lower risk model than the equivalent banking model and, therefore, my second request would be that any regulation is in some way risk based so it recognises the fact that building societies that are co-operative are much lower risk entities than the mutual sector. The third request, and again George Mudie referenced this, is the importance of capital for the mutual sector. We have been working very hard with the FSA for many, many months now to debate the definition and the creation of a capital instrument for the mutual sector because I think it is very important that we can proactively manage our balance sheet. The FSA started with a definition of capital that was entirely driven by the plc model, and I think that would have compromised the mutual status by having equity shareholders sitting on the mutual balance sheet. So we have resisted that and I think it is important that the Government again ensure that the mutual sector does have access to a capital instrument that does not compromise the mutual business model.

Q1002 Mark Garnier: How do you find the FSA?

Graham Beale: I would echo what Neville said in that the FSA have been very focused on issues within the plc sector and, therefore, their attention to the mutual sector and I think their-

Q1003 Mark Garnier: So not very helpful is what you are saying?

Graham Beale: I think their understanding has been limited at times. I do not think they have fully recognised that there are quite distinct business models with different characteristics and certainly different risk profiles. I think they have been very narrowly focused on the problems within the plc sector and I think as a result we have found ourselves after the event trying to deal with probably unforeseen consequences but nevertheless having to, if you like, rectify positions that the FSA have created.

Q1004 Mark Garnier: Are they willing to learn? Are they paying attention to what you are saying?

Graham Beale: Yes, they have. I would say in the last few months there has been a distinct change in attitude, certainly in terms of dealing with the point about capital. I would say that we do now have a meeting of minds, although it was very disappointing when we had the comments in this Committee just a few weeks ago about deliberalising the building society model, which I think would be a very retrograde step.

Chair: We are very grateful, actually, for those frank remarks about the FSA. We do find that a number of witnesses come before us very reluctant to say anything critical in public and then pour forth privately but in a form that is very difficult to take up with the FSA afterwards. So, thank you for those remarks.

Q1005 Mr Mudie: You could understand it, Chair, when Hector said the financial world would fear him in the end, so when you introduce fear into it…

The business of capital instruments you have mentioned again. When I questioned Neville about it he seemed to feel it was-I am not putting words in his mouth-under control. Is that your impression or is it heading in the right direction?

Graham Beale: Yes, it is. I can expand-

Mr Mudie: Do we need to do anything-sorry?

Graham Beale: Well, the debate within the UK I think now we have got to a point where there is a common understanding of what is required and I think we have definitions that do not compromise our model that satisfy what the FSA are looking for. Ultimately, the definition of capital will be determined in Europe and the Capital Requirements Directive 4 will be the directive that contains the absolute definitions. I am content that in the UK the FSA have briefed HMT and we have seen the HMT material in terms of their positioning on this, and it is very supportive. But clearly we now need to go through the European process. Our logging in Europe suggests that actually Europe is probably more pro-mutual than we experience in the UK, so my expectation is that it will go through, but we are several months away from debate in Europe, before we can confirm the point.

Q1006 Mr Mudie: So we want to keep an eye on it. I want to raise another thing that you raise in passing, but the Co-op raised more fully, was the compensation scheme and the effect on the mutuals. Can you just tell us the difficulties this is causing in mutuals?

Graham Beale: Yes, it is huge as a cost burden. The failure of Bradford and Bingley and the Icelandic banks will cost Nationwide, in the full term, we think between £250 million and £330 million, i.e. between a quarter and a third of a billion pounds. It is the cost to Nationwide, to Nationwide’s members, for the failure of those institutions. That is because the compensation scheme is driven by the proportion of retail liabilities-i.e. savings deposits-that you have on your balance sheet. Of course in the mutual sector, and Nationwide in particular, we hold very large quantities of retail deposits. So it seems wrong that failures in much riskier models-take the Bradford and Bingley model-are paid for by the much less risky organisations such as the mutual sector. I have been arguing for a long time, and there was an early day motion that we had over 170 MPs signing up, to have some modification of the compensation rules. It has not gone anywhere, it seems to have just stalled in the long grass. We are not saying we should not make a contribution, I think we absolutely should, but again it should be proportionate to the risk that we have as a financial institution. It is very clear that mutuals, by virtue of the nature limits contained within the Building Societies Act, the business restrictions in terms of what we can and can’t do; we can’t trade for example, we could not have investment banks even if we wanted them, it is not permitted. That should be recognised in terms of the regulation and the cost of things like the compensation scheme. The bank levy is another example where the impact on the mutual sector is disproportionate relative to our risk, and disproportionate relative to the cost to the banks.

Mr Mudie: You got a lot off your chest there.

Graham Beale: I have been frustrated for many, many months, Mr Mudie.

Q1007 Mr Mudie: No, I think that is very useful. It seems to me that when the Government was setting it up, we in this Committee put on record something about the review, and I do not know what time frame it was, but it seems to me that they have had a good period of working and things that have been thrown up should be looked at. Now, last thing, testing your courage with the FSA again, I am horrified by the mortgage market review. I think the FSA have lost their balance. To guard against, "You were weak and you are still weak", they have swung the other way, and it seems to me they could damage the building industry, they could damage the mortgage industry, they could damage young kids getting a start with a new house because of all the regulations. Are they micromanaging it, and is it not your job and the borrower’s job to work out risk and the terms of the mortgage?

Graham Beale: Yes, to the second point of your question. It is our job to manage the risk and-

Chair: What about the first bit?

Graham Beale: In terms of the first bit, I don’t think the FSA did a full economic assessment in terms of understanding the implications of the mortgage market review, in terms of what it would do to the ability of borrowers in the UK to borrow from either banks or building societies. So I don’t think they fully understood that and I think when they eventually did, they found that there were an awful lot of unintended consequences, which is why it has now gone into consultation again with a view to trying to get something which is more pragmatic in its application, that will achieve some of the extra safeguards that the FSA want to achieve, but without undermining the market to the extent that the original draft did. While I have expressed some forthright views on the FSA, I think they are also right in wishing to eradicate a repeat of the state of the mortgage market prior to the crisis, where the lack of constraint around lenders like Northern Rock, where they were lending at 125% loan-to-value, where they were lending against incredibly high loan-to-income multiples, et cetera, went clearly beyond the realms of reasonable and responsible lending. I think it is right that we do not have an environment where that could repeat itself.

Q1008 Mr Mudie: I totally agree with that, but I think that the scheme is far from that, the scheme seems almost personal and would rob the building societies of any discretion in terms of individual customers. It is one thing building a mortgage book up of doubtful loans but another taking a chance on a young couple who you can see clearly are in work but cannot get that deposit. Are you satisfied with the RDR?

Graham Beale: Do you want to answer that one, Chris?

Chris Rhodes: Obviously, we saw some news last week about one institution pulling out from the provision of financial advice. I think Nationwide remains absolutely committed to the provision of financial advice and indeed, we will both widen our product range and grow the number of advisors, and I think lots of what is in the RDR is very positive: increasing the skill level of advisors is very good news; I think the removal of commission, in the sense of agreeing explicit charges with consumers, is good news. But let us be clear, it will change the economics for a number of providers of advice out there and therefore could ultimately restrict the availability of that advice, and the institution that withdrew last week made the comment with respect to their return on capital. Now, as a mutual, we have a different set of values, we have a different requirement from an overall profitability and return point of view, therefore it is viable, in the new world, for us to provide advice and we will do so.

Q1009 Mr Mudie: A last question, going back to mortgages. At the moment, there seems to be real difficulty in some people getting a mortgage. Is this because the industry is trying to second guess where the FSA are going with the mortgage review, or is it simply market conditions?

Graham Beale: I would say that there has been a shift in attitude to risk, if you were to compare the mortgage market today with four years ago. Four years ago about 40% of the total mortgage market was based around buy-to-let and self-certified mortgages, very high loan-to-value. I think quite rightly, in my opinion, a lot of those extreme forms of lending have disappeared from the marketplace, and anybody today who does not have a sufficient deposit or has a seriously impaired credit history, is going to struggle to find a mortgage, and I think that is a response to risk. If you have good credit credential and you have a deposit, I think there is plenty of choice in terms of finding provision of mortgage within the UK.

Q1010 Chair: George is asking a slightly different question, which is not, have the FSA restricted imprudent lending, but is uncertainty about their review of that market itself having a depressing effect on lending?

Graham Beale: I don’t think so.

Q1011 Mr Mudie: Do you genuinely think that the widespread imposition of large deposits is something you can sustain without doing tremendous damage socially as well as to the building industry?

Graham Beale: I think the size of the deposit is-there are some lenders, including Nationwide, for our existing customers we will accept as little as 5%. It is the market norm to be typically seeking anything between 10% to 15% as a minimum to get access to a mortgage. I do not think that is unreasonable. I think it is quite reasonable to-

Q1012 Mr Mudie: On an average house of £100,000, that is two young kids saving up £10,000. But how long does it take two young kids on the sort of wages youngsters have at that time of their career to save up £10,000? To me, it is horrifying.

Graham Beale: I accept it is a lot of money, but equally, you are taking on a very substantial financial commitment. I think part of the responsibility of a borrower in taking up that commitment is that there is some equity that goes into the transaction and that they are very clear that they can afford to service the debt. Good underwriting revolves around affordability, because it is not in anybody’s interest to put either an individual or a couple into a position where they have undertaken a loan that they then can’t service. I think we have to recognise that it is a very serious undertaking when you take out a mortgage. It is a substantial loan and they will require a personal commitment from the borrower as part of that bargain.

Q1013 Mr Umunna: Mr Beale, listening to your evidence, one slightly gets the sense that you are a little bit-how can I put it-unhappy with what has turned out to pass over the last couple of years, in that in many senses your sector have been angels of prudence. I get the sense from you that you do not think that has been sufficiently recognised by Government. On the other hand we have these villains of the piece, we have had several of these large banking groups in front of us who-there has been £1.2 trillion worth of support put into the sector from which they have benefited and probably would not be operating without. The Government raises a bank levy, they complain about that. We all want to see greater transparency, they complain about that. Do you think they have been treated with kid gloves?

Graham Beale: I don’t think that is for me to comment. Everybody can draw their own conclusions. What I would say is that in terms of understanding the mutual sector and in particular its contribution over the last three or four years, which has been one of stability and endurance through the conditions-and I am not saying there weren’t issues within the sector but they were predominantly dealt with by the sector and the only institution requiring taxpayer support was the Dunfermline Building Society. Compared with the banks, that was a tiny, tiny amount of support. So I think the mutual sector has behaved incredibly well throughout the financial crisis. I think it has demonstrated the resilience of the model, and I do not think that has been reflected either in some of the attitudes coming from the regulators or indeed the Government, who have made the sounds of wanting to promote mutuality but have not put any substance behind that declaration.

Q1014 Mr Umunna: In terms of putting substance behind declarations of promoting mutuals and diversity, do you think one way of doing that would be by remutualising Northern Rock?

Graham Beale: I think there is an opportunity to do that and the Government has a choice. You can turn Northern Rock back into a mutual, and you would then have all of the positive attributes of a mutual entity: consumer focus; retail orientated; low risk, and so on. So that is the plus. I think the cost of doing that is that the return of taxpayers’ money will-I think it would be returned, but over a much more extended window than the other options, which would either be an IPO or a trade sale. So I think there is a very clear choice there.

Q1015 Mr Umunna: But you certainly see there being a return?

Graham Beale: I think there would be a return, but it would be over a much, much longer period. I think that is the choice, in terms of, do you want to have a socially useful animal-to quote somebody else-or do you want to have an early payback of taxpayers’ money? That has to be a political decision, at the end of the day.

Q1016 Mr Umunna: Would you argue that, when making that decision, obviously, Government in some senses would have to take a more medium to long-term view of the benefit of remutualisation?

Graham Beale: I think they actually would have to, yes.

Q1017 Mr Umunna: Would you say that their attitude to that would perhaps be indicative of whether they are going to take a medium to long-term view of the overhaul of the sector in general?

Graham Beale: I think it would be a very substantive gesture if they were to remutualise Northern Rock.

Q1018 Mr Umunna: Given your experience of the sector, what would be the most effective way of remutualising the Rock, in your view?

Graham Beale: There are two ways. It could be remutualised directly, which I think would be quite complicated to achieve, or it could be merged with an existing mutual entity. There are a number of players who are large enough, including Nationwide, to be able to take that sort of transaction on.

Q1019 Mr Umunna: But do you think that would be helpful, though, because in some senses-I am not sure if you were here earlier in our exchanges with the Co-op-increasing consolidation is not necessarily always the most desirable thing, and one could perhaps understand why the Nationwide would like to gobble up Northern Rock, but do you think there would be a benefit in greater diversity in your mutual sector if either Northern Rock were remutualised stand-alone, or maybe one of the smaller participants in the mutual market were to merge with it?

Graham Beale: I think in terms of the consolidation within the sector and whether Northern Rock should be a stand-alone or merge with a smaller player, it is an interesting point. I believe that you need a number of very large mutuals in order to have the right level of fail, the right power of distribution, the right spread of product to be able to compete with the banks effectively. There are really only two mutuals at the moment that into that category, which are Nationwide and the Co-operative, your third one is possibly the Yorkshire Building Society, but they do not offer personal current banking. Therefore, to a degree, I think consolidation is a benefit within the sector, because we are more likely to create mutuals with sufficient scale that they can take the banks head-on. That is not to say-and I think this is where we need to be very clear here-that there is not a place for the very small mutual sector, where you have a mutual that is dominant in their geographic area, it serves the local community, it is a very simple model serving not broad requirements from the local population, and I think there is a place for that as well. So the mutual sector operates, if you like, at the two ends of the spectrum, offering very local service, but also the ability to offer a national service as well. I think the Northern Rock would fall within that national category.

Q1020 Mr Umunna: Thank you. Can I just ask one final question? You talked about there needing to be a capital instrument available to mutuals so you were not looking to having equity infecting your model. What would the best capital instrument be?

Graham Beale: The capital instrument that has been defined so far is called a permanent loss-absorbing deferred share-you asked me. Broadly, it is an instrument that allows investors to invest in building societies, and the coupon, the dividend that is paid on that investment, would be capped. So rather than being open-ended, which is what you have with an equity investment, where your dividends can grow to whatever level, this has a ceiling. But in all other respects, it absorbs losses, the capital is at risk, it is permanent, and those were the key features that the FSA were looking for. So we had all the debate around whether we could have something with a capped distribution. They now recognise that, one, that does not compromise our model, and therefore that is a plus. And, secondly, it prevents an over-distribution of reserves from the mutual sector. On that basis, we have now reconciled our respective views, and I think we have a definition that everybody is comfortable with.

Q1021 Stewart Hosie: Just a question to follow up George Mudie in terms of mortgages, notwithstanding loan-to-value ratio, notwithstanding deposit levels, is the truth not that mortgage availability is driven-there is a direct correlation between that and savings deposits? Given savings deposits, or the savings ratio rather, is due to fall every year for the next five years, is that not an underlying concern in your ability to provide mortgages?

Graham Beale: I think it is an issue, but both the structural size of the mortgage market and the retail savings market are both falling quite significantly, and, if anything, the size of the mortgage market is going to shrink more than the size of the savings market. So in terms of access to longer term liquidity, we see the issue as one of: if we raise retail deposits, how can we apply it in a way that generates a yield from that, rather than the converse, which is, will there be a shortage of liquidity for the mortgage market? We do not see that, we see it the other way around.

Q1022 Stewart Hosie: That is helpful, thank you. Just to go back to what the Chairman was speaking about at the beginning. In terms of competition, in terms of switching, there is a lot of talk about transparency, particularly price transparency. The OFT said much has been done but there is more to do. I take it that is where you are, broadly, at the moment?

Chris Rhodes: Yes, the switching process, as I said, I think is a barrier to customers switching their current accounts. To some extent there is a limited amount the banks can do, because this process works by, effectively, the bank that the account is coming from giving you the direct debit details for the customer, then you going off to the utility companies and others, to get those direct debits transferred. There is not the process to tie those people down to service levels and make them perform in the same way that the banks perform between each other. So I think there is more can be done in the switching process. I think the whole charging structure is a much bigger debate because, as I said, 80% pay very little, we can debate the right level of in-credit interest. The bulk of charges are only paid by 20% of the population. That is the challenge to creating a competitive market. I think that is what the OFT are referring to.

Q1023 Stewart Hosie: So in terms of that then, what changes would you want to see for that 20%, in terms of current accounts, current account pricing transparency? What would you like to see presented or provided, so that there was clear transparency?

Chris Rhodes: I think on that we are largely there, so it is simplification of the charges, so you know what you will pay in individual circumstances, and, within the overall disclosure of the information you get when you buy an account, the cost of certain scenarios. Because I think what customers don’t believe is that they will ever fall into a position where they will incur these charges. Therefore, they do need to understand what it might cost them if they were to do certain things.

Q1024 Stewart Hosie: Yes. You are saying, "We are almost there", but you have also warned against the potential for information overload.

Chris Rhodes: Correct.

Stewart Hosie: The spurious information that may or may not be useful but might even add to the inertia because it is too complicated. In terms of that, what would you like to see removed then, from the information which might be provided?

Chris Rhodes: I am not sure there is anything you can remove. Ultimately, you would not start from here. You would start from the perspective of, this is an expensive service to provide, it is a valuable service, run on the right basis, and you should ultimately pay for what you consume. But that is not the market we have in the UK and the competition therefore responds to the market reality in the UK.

Q1025 Stewart Hosie: So by and large then, in terms of information upon which people will make a choice either to open an account or to switch an account, notwithstanding the complexities of switching, you think we are almost there?

Chris Rhodes: Except the 20% who pay never-there is a lot of research that basically says you leave your current account provider because either you have had poor service or you have been charged. There is no evidence in the research that we do that suggests that the customers then look at the charging structures of the new provider and see whether they are any different to the one they have just left. So they will find themselves in the same circumstances with the new provider that they had with-

Q1026 Stewart Hosie: So the reasons for changing are many and varied, but when they change, they may not look at-

Chris Rhodes: Correct. At the reason that caused them to leave in the first place.

Q1027 Stewart Hosie: But in terms of the ease of transfer, you would back a single portable account?

Chris Rhodes: In principle, it sounds great, but the cost of changing the account numbers right across 65 million UK current accounts to achieve a portable number is massive, and I am not sure it would be economically viable to do that. I really don’t. The cost of getting everyone to align would be absolutely huge and it would take many, many years.

Q1028 Stewart Hosie: Could you give us a figure, an estimate, of the billions we are talking about to deliver that?

Chris Rhodes: We are bringing in a new current account system and it has a few hundred million pound price tag on it, and that is without changing the payment systems.

Q1029 Stewart Hosie: So the likelihood of this single portable account is?

Chris Rhodes: My personal view is it will never happen.

Q1030 Jesse Norman: Can I just ask about the discussion you had earlier with my colleague about the remutualisation of Northern Rock, something which I am extremely sympathetic towards? How, specifically, would it take place? Say you went down the direct route, would you be then going to the account holders of that institution and asking them to put up capital to buy out the Government’s stake? How would that work?

Graham Beale: I think this is the difficulty, and I think the likelihood of being able to deal with it on that basis is low.

Q1031 Jesse Norman: Because they simply would not have enough capital or interest to take the initial risk?

Graham Beale: If you just think of the broad mutual model, there is no cost to entry. If you want to become a member of Nationwide, provided you take out the right product, which is either a savings account or a mortgage loan, that then conveys membership rights. I think the way it would happen is that the-

Q1032 Jesse Norman: Sorry, just on that. So the way it would be mutualised by the direct route would simply be to give the shares to the account holders at Northern Rock?

Graham Beale: Correct.

Q1033 Jesse Norman: Which would be a transfer of, presumably, £5 billion, £10 billion? A substantial amount of money.

Graham Beale: Possibly. You are asking quite a difficult structural question here. I think basically, if you put the structures to one side, the only way that I can see it happening is that over many, many years, as the Northern Rock generates profits, that profit is used to effectively extinguish the taxpayers’ liability. So there would be a very long earn-out. I think you would be talking a long, long period of time for this, 10, 20 years to get the right level of profits going through the Northern Rock so you have an earn-out and a long drawn payment of the taxpayers’ funds. Which is why, while it may be socially attractive, from a financial perspective I think it is very complicated.

Q1034 Jesse Norman: Presumably, this would be a whacking piece of debt sitting in the Northern Rock balance sheet which would then impose its own strains on the capital structure and so on?

Graham Beale: Correct.

Q1035 Jesse Norman: So what would happen on the other route then? Say, not necessarily Nationwide but you or the Co-op, someone were, as it were, invited to get involved, what would the structure be there?

Graham Beale: The same sort of principle, where you have to have a long-term earn-out because nobody is in a position to effectively replace the capital that is currently in there by virtue of the taxpayers’ investment in the Northern Rock.

Q1036 Jesse Norman: The difference would be that, as it were, you would have the initial capital to be able to withstand the many billions of pound loan hit that would sit there through that instrument?

Graham Beale: Yes.

Q1037 Jesse Norman: That is helpful, thank you. You have talked about transparency. Could you just tell the Committee how many employees you have earning over £1 million in compensation?

Graham Beale: Two.

Q1038 Jesse Norman: Two, thank you. When we were thinking about the Bradford and Bingley-I took the point you made, very interestingly, about that-why was there not, or maybe there was and could you help us with this, as it were, a bit of an uproar within the industry beforehand, that the structural compensation system that had been created, essentially, discriminated against big, solid players and in favour of wild, risk-taking players?

Graham Beale: I don’t think anybody could foresee the sort of consequences that occurred when the crisis started to impact players like Bradford and Bingley and the Icelandic banks. You have to remember that the Bradford and Bingley transaction was done over a weekend, so on the Friday it was up and running and by the Monday it had gone through the resolution process and was in the hands of Santander and a liability for the taxpayer. So it was very difficult to respond to what was a very, very fast-moving event. I think the anomaly within the compensation scheme and the disproportionate impact on the mutual sector, it has always been there, was a structural defect, but had never been applied in anger and therefore was not apparent or was not contemplated prior to the crisis.

Q1039 Jesse Norman: Would it have been better, as it were, to have run this scheme across the whole of the retail banking and mutual sector, on the grounds that they, as it were, equally drew on the taxpayer funding?

Graham Beale: Anybody who is a retail deposit-taker in the UK has got a liability to the compensation scheme. The point that I continue to make is that the amount of contribution should be risk-based so that the higher-risk entities pay a greater proportion of any failure than the lower-risk entities. I think that is the risk-based approach to regulation that I have been trying to promote as an argument for a long time now.

Q1040 Jesse Norman: One of the things that was so striking about the Northern Rock in particular was that the regulators saw that it was leveraging itself up and taking market share, but did not seem to do very much. The non-executive directors were missing, presumed dead. The industry did not seem to be taking any great interest in watching this person hoovering up market share. Why wasn’t there any more, as it were, internal whistle-blowing and regulation from within, if you like, or pressure for regulation from within?

Graham Beale: I think it was just a feature of that time in the economic cycle. The Northern Rock was the darling of the stock exchange, it could do no wrong for many, many years. So there was a huge amount of momentum and support for that business model. I sat through a number of presentations to institutional investors, who provide some of our wholesale funding, and I can always guarantee getting the question, "Why are you not taking a greater proportion of the market share, why are you not following the Northern Rock model?" We never went to the high levels of 100% loan-to-value lending or any of the other extremes, things that they did, because we just saw it as being wrong. I go back to my earlier point that there are times, if we are not comfortable in terms of market conditions and how it relates to our business model, we pull back from the marketplace, and that is what we did.

Q1041 Jesse Norman: My final question. One of the things that is coming through so strongly to this inquiry is the importance of culture in these different institutions. Within a bank, particularly a large bank, what are the kinds of cultural moves that could be made to restore a sense of sobriety in the balance and a good ethos, more of a traditional ethos, to our banks?

Graham Beale: I think you are asking me as a chief executive of a building society to tell the banks how to run their business.

Q1042 Jesse Norman: I am asking you if there are any lessons from your experience which would transfer over. It is a very live issue, I can assure you.

Graham Beale: I can relate to what we do in Nationwide. We never lose sight of the fact that we put our members first because our members are our customers and they are our owners, and that is a very simple relationship. We reward relationships, we try to maintain our brand so that there is trust in Nationwide, we focus very much on the delivery of good service and the quality of our product, and that combination of events is hugely important to us. We have an internal acronym called PRIDE which captures all of those features, and I would be very disappointed-if you were to talk to anybody who works for Nationwide, be it somebody who works in the post room, to somebody who works in a branch in Aberdeen, to somebody who works in the head office, and you asked them about the values of Nationwide and they will be able to articulate most of those points. They may not use the same language as me, but it goes all the way through the organisation. That is hugely important and our focal point is around the membership and giving value back to our members. I think the banks have a more complicated set of arrangements because they have the customers on the one hand and they have their shareholders on the other, and their interests do not always align. That, I think, is some of the issue that they have.

Q1043 Jesse Norman: You have been very frank about the shortcomings of the FSA in regard to your model. Would you consider writing to us if you have any further thoughts on how these kinds of lessons and ideas could be transferred across?

Graham Beale: Yes, yes.

Q1044 Chair: A moment ago you were having a go at the institutional investors who saw Northern Rock as the darlings of the market, and we have had evidence from HSBC and numerous others that the institutional investors have been part of the problem. If you have concrete proposals on how they can be more heavily engaged in activities as shareholders which can improve the quality of monitoring of systemic risk, we are very interested.

Graham Beale: Okay. Well, I do not have institutional shareholders because we do not have any equity stock. We will give it some thought and if we can come up with anything that is useful, we will certainly let you have that.

Chair: Thank you very much for giving such clear evidence here this morning. It has been extremely valuable for our inquiry, and I think you have one or two points off your chest you have been eager to have in the public domain. Thank you.