Session 2010-11
Publications on the internet

To be published as HC 612-v

House of commons



Treasury Committee

Competition and Choice in the Banking Sector

Tuesday 14 December 2010

Vernon W Hill II and Anthony Thomson

Evidence heard in Public Questions 434 - 517



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Oral Evidence

Taken before the Treasury Committee

on Tuesday 14 December 2010

Members present:

Mr Andrew Tyrie (Chair)

Michael Fallon

Mark Garnier

Andrea Leadsom

John Mann

Mr George Mudie

Jesse Norman

John Thurso


Examination of Witnesses

Witnesses: Vernon W Hill II, Vice Chairman, Metro Bank, and Anthony Thomson, Chairman, Metro Bank, gave evidence.

Q434 Chair: Thank you very much for coming to see us this morning. You are that rare thing, a retail banking entrepreneur. We don’t have many of those in the UK.

Vernon Hill: You have one now.

Chair: We are going to have an interesting exchange I hope on what your plans are and what you think about the UK retail market. Can I just ask you, what led you to conclude-and you are quoted as saying this-that the British hate their retail banks? "Hate" is a pretty strong word?

Vernon Hill: Thank you, Mr Chairman. We’re happy to be here this morning. I’m pleased to answer the questions. I just want to make one statement first; I’ve been involved in four new banks in America and this is my fifth new bank. I’ve had a lot of experience in America, so I look through these questions to my American experience and now my British experience.

We want to make it clear, first of all, that this is an investment in the future of Britain. We could have done a new bank in Chicago or LA or other parts of the world, but we’re very excited about the opportunity here. The reason we chose to do this venture in London, there are many reasons but to your point exactly, our model is built on convenience and service, not product sales and price. The customer dissatisfaction rates in Britain for banks are at the levels that I had never seen in America. The customers say in many ways in many surveys that they’re very dissatisfied with the British banking system.

Q435 Chair: The picture is mixed, is it not, Mr Hill?

Vernon Hill: No, not that I can see.

Q436 Chair: I have one of the surveys in front of me here that’s showing 50% to 60% of satisfaction for the conventional accounts and 80% satisfaction with internet accounts. It would be helpful for you to give your view.

Vernon Hill: Yes, Sir. One survey that’s available-and I’m getting it out as we talk-is on customer dissatisfaction rates and I believe the latest one was put out by MoneySavingExpert in 2010. This survey says, "In Britain 42% of the customers are dissatisfied or very dissatisfied with their banks." Then we look at the reports about the dissatisfaction rates with each bank, and by my American experience they are very, very high. Santander has a dissatisfaction rate in this survey of 67%. No retailer over time can survive with customer dissatisfaction rates that high.

To get back to the question, we saw an opportunity to redefine the model, to reinvent how retail banking is delivered and that’s what the Metro Bank model is about.

Q437 Chair: Okay. Well we will be coming on to some of the points you have raised, for example, price versus service, later on. Could you just say a bit about the SME market in the UK? Do you think that that is well served by the existing bank networks?

Vernon Hill: When Metro Bank opened about five months ago, I had read about, and all our British management team-and our entire management team is British-had informed me about the general level of dissatisfaction and non-service in the SME. I was shocked by the level of SME response we got, both in opening cash management accounts and in credit.

We frankly had understaffed to serve the response we got to SMEs and we all heard the same story from various sources, "The big banks don’t want my business. The big banks can’t serve my business." I would say in America, as in Britain, it’s almost a rule that the larger the bank the more poorly they serve the SME segment. In America, where there are still 8,000 banks, most small business credit is supplied by the midsize and small banks. It’s difficult for large banks to be effective in the SME world.

Anthony Thomson: It is interesting to observe that of the SMEs that have approached us, by far the majority are approaching us because they want service, and they want a human being to talk to. Very few are actually seeking credit.

Q438 Chair: So the shortage of credit is-

Vernon Hill: That’s a much wider issue in Britain about shortage of credit. I’m sure your Committee has been briefed on the general shortage of credit; a problem I predict gets worse in Britain. Your question was more about how credit is delivered to the SME segment, and we would repeat that it’s not just the credit side, it’s the cash management, and it’s the regular current account side of the business, which in many cases is more important to an SME than the credit side. It’s difficult to open an SME basic account with a large banker.

Chair: Okay, well, we will be exploring some of these issues over the next hour.

Q439 Jesse Norman: Mr Hill, the British banking market, as you know, is extremely concentrated overall in these segments, and yet when we have had its executives up they insisted it is highly competitive in many different regards. Particularly Mr Hester of RBS suggested that you do not get any greater competition with 10 banks than you would with five. Could you tell us a little bit as to why you think there is a great opportunity here for you, and whether that claim is true, or whether in fact the British banking market is rather uncompetitive?

Vernon Hill: I did see that hearing and I did see his comments. Let me repeat, I come from the American model where there are still 8,000 banks in America. When I started my first bank, there were 24,000 banks, so you could almost look at the Anglo-Saxon banking model as developing in two extremes: Britain has developed very few, very large banks and America still has a large number of relatively small banks.

Somebody asked me, "Well there’s going to be some new names in British banking, and isn’t that going to make it tougher for us?" I went back and checked in the New York market, where there are 173 different banks. Frankly my opinion of the idea that this is a very competitive banking market, from my experience I do not find that to be true. I think it’s about giving customers choice, freedom of choice, and my view is that all the major banks are essentially offering the same products in the same way.

Q440 Jesse Norman: Thank you. It would be good at some point in the questioning to explore what aspects of the banking system inhibit freedom of choice at the moment, and how that could be opened up and that has been a topic we have discussed as a Committee elsewhere. But what I would like to focus on now, if I may, is the basis of your own competitive offering, which of course seems to be built on service rather than on pure price competition. Could you talk about how that is going to work, why it is going to be effective, and where the weaknesses in the current system are?

Vernon Hill: Yes, I’d be happy to do that. Let me go back to my American experience. When I was relatively young I started a bank from scratch in America with one office and a staff of nine, and it grew to 500 stores and became the 18th largest bank in America on a very simple model. Customers in the retailing business-and we see ourselves as a retailer that happens to sell bank products-care about the whole experience, and we would define that as service and convenience.

Customers care about pricing, they somewhat care about rates but that’s not the most important thing. I use this example all the time: people don’t buy Apple phones because they’re the cheapest phone; they use other determinants to decide they like an Apple phone, and Apple has reinvented the phone business, we could say. There has been a lot written about my experience in America. They often call us the anti-bank bank. We do things in a reverse way. We care about service. We care about convenience. We care about hours. We care about call centres with human beings. It’s almost the anti-banking view of life.

I would note one other difference here in Britain and listening to your hearings. The American model developed-and ours would be the extreme version-as a consumer centric model. We focus on information and service to a customer. Here, it’s developed as a product-driven model, "What products are we going to sell to our customers?" The simple idea is that the bank would have what we call single client view: you can pull up one computer screen and look across the whole screen and see all the interrelationships you have. That’s vanilla in America and most of the large banks here don’t have it. I would say that this is a different view of life.

Anthony Thomson: If I may just add to your point about competition, Mr Norman. Vernon said we think of ourselves as a retailer. The UK retail market is highly competitive, so retailers are open from early in the morning until late at night, they are open seven days a week, which is our view, if you like-we’re open from eight until eight Monday to Friday, eight until six Saturday, 11 until four Sunday. The existing banks are open from nine until five. I think if there was a competitive market we would see changes in that.

Q441 Jesse Norman: Do you think that this preoccupation with product causes banks to ignore the customer, disinvest in branches and adopt inhuman approaches? Is that the kind of thrust of what you are suggesting?

Vernon Hill: Yes, yes and yes.

Q442 Jesse Norman: Could you just explain how that works? Why should that be so?

Vernon Hill: If your model is product-driven and not service-driven, you design your whole model around that-you design your IT around product sales, you design the compensation around product sales, you don’t design it around service. In our model, for example, we don’t compensate our people for product sales. We reward them for delivering our model and the service results they deliver-how big we build the entire model. In America, for instance, in our bank, we didn’t do outbound sales calling. I don’t believe in outbound sales calling.

Is your focus about building your model on what product you’re selling this week, or customer service? Our model in Britain, as it was in America, is this idea of building customers as fans. Great companies build fans who stay with the company and recommend them to a friend. Again, Apple is a great example. Those of you who have an Apple product here are convincing everybody you know to switch to Apple. That is the core of our model.

Jesse Norman: A final very quick question, Mr Chairman-

Vernon Hill: Could I just answer one other thing here?

Jesse Norman: Yes, of course.

Vernon Hill: One of the things that was surprising, when I came here, is that the real core of a customer relationship is the current account, and you would measure that in deposit balances per store. In America, we have to report our deposits per branch on a public website-so I know all the deposits per branch at every Chase office in America-because that tells you the strength of that store and the relationship. The British banks don’t even know the deposits per branch and have very limited information about how it all relates together. When we recruit people-and as you can imagine, we’re recruiting only British people-all we hear is product sales, product sales, product sales.

Q443 Jesse Norman: So it would be a pro-competitive move for us to explore the question of whether or not deposits should be made public for branches across the UK?

Vernon Hill: First of all the banks don’t know their deposits per branch, so they can’t make it public until they know it. My point is, not only is it not public, but they don’t know it because that’s not an important number. It would be like a retailer not knowing sales per store-we’d never run a retail business that way. If you could make it available, as we do in the States, that would be certainly a pro-competitive move, but I’m not sure it can really happen here.

Q444 Jesse Norman: Thank you. Finally a very quick question, in your model, will you still have to do things like credit scoring for customers or for clients?

Vernon Hill: You do credit scoring as a positive, not a negative, and I will give you an example. When you open an account with Metro Bank-and tens of thousands of people have already-we open your account in 15 minutes or less and you walk out with your debit card and your credit card. It doesn’t come in the mail. Your pin number is not mailed to you. It all happens in real time. We are doing the credit checks and the anti-money laundering checks in real time.

In that sense, credit scoring is a plus, because it allows you to give instant reaction. It’s what you do with the credit scores that don’t meet the first hurdle. Do you automatically say, "No" or do you give it to a human being to decide what the next step is? So credit scoring itself I believe is a plus, it’s how you use it.

Jesse Norman: Thank you very much.

Q445 Michael Fallon: Mr Hill, Donald Cruickshank told us in evidence last week, "Making it easier for new entrants into retail banking may be missing the fundamental point." He suggested to us that really it is the control that existing banks exercise over the money transmission system that needs to be tackled. Do you agree with that?

Vernon Hill: I read his report and there is some truth to it. I wouldn’t say that has been a particular problem for us. The money transmission system is controlled by the major banks. It’s not controlled by the banks in America except in an indirect way. I don’t think that that’s a major issue. Our people haven’t pointed that out to us as a major restraint.

Q446 Michael Fallon: Will you share in that influence over the money transmission system now that you are licensed?

Vernon Hill: I’m sure we won’t, just like the small banks in America don’t share in the money transmission centre. In both countries, it’s always been controlled by the major banks.

Q447 Michael Fallon: Will you have any ownership of it at all? Do you have a stake in it?

Vernon Hill: No, we do not.

Michael Fallon: You have no stake at all in it.

Vernon Hill: No, we clear through one of the major four.

Q448 Michael Fallon: Do you think there will be any benefits to consumers from reforming the money transmission system?

Vernon Hill: I just don’t know enough on that question to be helpful to you.

Anthony Thomson: I think the challenge is making the account-switching process smoother. That’s what needs to be addressed.

Michel Fallon: Thank you.

Vernon Hill: On this account, of course that’s what we want. We want to make it easier to switch accounts. What makes it structurally harder in Britain than in America is the direct debit system you have or standing orders. That doesn’t exist in America so it’s easier to move accounts. When people move to us-and they’re moving every day to us-we have to line up their direct debits and their direct credits to make it happen. It takes more effort and it takes more time. We do it by doing it for the customer but your system of direct debits does inhibit accounts moving.

Q449 Michael Fallon: But if the whole money transmission system was policed by an independent regulator, rather than being indirectly owned by the major banks, would that not at least be a start to making all this easier?

Vernon Hill: I might agree with you in theory. but I’m not sure of the mechanics. I’ve read some of the hearings here about the fact that all your account information would be in one central place and you can move your account from bank to bank with the same account number. I think that’s a good idea, but I think it’s very unlikely to happen. We all have different IT systems, they’re all based differently, so that would be a major job.

Q450 Michael Fallon: But on the principles-we do not allow telephone companies to own a telephone transmission system, or electricity distribution companies to own the grid-should major banks really exercise any degree of ownership over the transmission system?

Vernon Hill: Let me answer it a different way. If you want freedom of choice in a retail banking market you have to get new players into the market and whatever the Government can do to make it easier and more convenient for customers to switch banks will help the new players.

Michael Fallon: Thank you.

Q451 Andrea Leadsom: Thank you Chairman. Can I just press a little bit further on that, Mr Hill? Customer inertia is a big problem in the UK. You have said yourself our system of direct credits and direct debits makes it rather more difficult to switch accounts than in the States. What do you put customer inertia down to, because certainly a lot of the evidence we have heard does suggest that it is the complexity of switching accounts, and that therefore the answer might be to be able to transfer your account number with you, in spite of the immediate technological difficulties?

Vernon Hill: Of course all the things we’re talking about are half-truths, so we put a couple of halves together and maybe we’ll get a truth. It is a little harder to switch, but the basic core of the reason for people not switching in Britain, in my opinion, is that they’ve had no choice. The major four banks offer the same product. You need entrants in the market, such as us, offering a different choice. This is about freedom of choice.

My bank in America, before we sold it, was opening 150,000 accounts a month. They were all coming, switching from Chase and Citibank and all the names that you know, but even then it was hard to get people to switch banks-it’s work. No matter what we do and no matter how easy we make it, no matter what people we give them there is a little bit of work involved, but the situation, in my view, in Britain is completely different; you have no choice.

Q452 Andrea Leadsom: How long would it take if I moved my account today to Metro Bank? What sort of length of time would it take?

Vernon Hill: We open your account in 15 minutes or less-you walk out with a debit/credit account. To move over all of your direct credits and your direct debits and standing orders, it takes four to six weeks to line that all up. The customers are scared to death that something is going to go wrong. The story we hear all the time is, "Oh, my God, the Sky TV payment is not going to get moved over, my Sky is going off."

On the particular issue of Sky, we guarantee we’ll pay the Sky bill if you miss a month. Those are the issues you have to deal with. In America, it’s somewhat different in that we don’t have direct debits but online bill paying serves that purpose, so in America we have to help them move their online bill paying. I don’t think we’re ever going to come up with a reason or way for people to switch banks without some work involved.

Q453 Andrea Leadsom: Would you agree that the way to do that is to be able to transfer your bank account number with you? In other words, the money transmission system could be changed-clearly the technology exists because it has happened in other sectors-so you could be able simply to have an account number and if you choose to transfer everything, lock, stock and barrel, with all the direct debits in place and so on, to another bank.

Vernon Hill: As a new player in the market we would love that to happen-make it happen tomorrow morning for us-but I think that that’s very difficult.

Q454 Andrea Leadsom: Why is it difficult to make it happen?

Vernon Hill: It’s the IT systems. Just to give you a simple example, Lloyds account field for current accounts may have eight numbers; Harrods may have nine numbers; another bank may have seven numbers. We all have completely disparate IT systems and switching things over is not easy.

Q455 Andrea Leadsom: Is it harder than changing to the euro in 1999, or preparing for the year 2000?

Vernon Hill: I wasn’t here; I’ll have to leave that to you. Probably not.

Q456 Andrea Leadsom: Is it of that order of complexity? Is it a three or four year IT project, would you say, or do you not know the answer to that?

Vernon Hill: I don’t know the answer to the euro question but I will repeat this-I’m sure you’ve heard it. The FSA said to the major banks that they had to be able to give the FSA, on request, a list of their account holders and their account balances. That is the definition of what a bank is; I’ve just defined a bank for you. The banks said it would take five years at £800 million, so that’s a simple example.

Q457 Chair: The suggestion that there are wonderful synergies obtainable from scale are likely to be outweighed by the fact that many of these banks don’t really know what is going on inside them and what their customers are really doing anyway.

Vernon Hill: There’s no proof that scale gets you economies of scale.

Q458 Chair: You flatly dispute what RBS said when they told us, "Large or more diversified companies have the ability to achieve greater synergies and can create economies of scale, enabling banks to provide service at lower cost to the consumer."

Vernon Hill: Let us look at that statement: they fail, they don’t provide service and their cost is higher. There’s no proof in America that these large banks can deliver better service at lower cost-in fact the reverse is true.

Q459 Chair: Just to be clear on cost, can you describe the typical customer that you are looking for and the income of a typical customer, and then tell us how much it is going to cost you to service that straightforward account per annum?

Vernon Hill: No one knows what it costs to service an account per annum, and any number you get from any bank is based on assumptions that have little meaning.

Q460 Chair: You mean this whole industry goes forward without ever knowing what its true cost base is? That must be unique.

Vernon Hill: Let me just talk about British banking, if I can, for a minute, and again, I have an American perspective. The IT systems of British banks are incredibly bad, and when they tell you about efficiencies and cost numbers there’s just no proof of that whatsoever. If you were going to ask me, "What’s the biggest barrier to being a new bank in Britain?" I would say it’s the IT side of the business.

In America, there are outsource providers that are ready to put you in business almost immediately, here you almost have to build it from scratch. I just don’t think there’s any support on either side for the comments that RBS made. You asked me about the customers we’re seeking: first of all, our business over time should be half-consumer and half-SME. That’s what it was in America and we certainly hope it is here.

We do not believe there is such a thing as a high-profit customer or a low-profit customer. First of all, we can’t tell what’s a high profit customer and what’s a low profit customer, and RBS can’t either. We believe every customer has real value. They may have low value when they are students and they may have higher value over time but we’re out to serve as wide a market as we can get, from wealthy people to students. I just don’t believe that there is a segmentation strategy that has ever been proven to work.

Q461 John Mann: There is a segmentation strategy, based on where your branches are. What percentage of your branches is going to be in and around London?

Vernon Hill: You have to start some place and, as a retailer, we know the more stores we put in the same market, the better those stores all do. You wouldn’t do a model in New York, with 10 stores in New York, 10 in Chicago and 10 in Los Angeles. You would concentrate in certain markets, build them out, then begin the next one. We had to start some place in Britain and London is the obvious place.

Q462 John Mann: Where will you end with your business model?

Vernon Hill: I don’t know where we’re going to end. We’ve announced that we’re going to put 200 to 250 locations in the Greater London area, and there’s no reason we’re not going to go north and south. But again, the more stores you put in the same market the better each store does.

Q463 John Mann: In terms of the small business market, one of the complications here is the issue of currency transactions and expanding into foreign markets for small businesses, because the more you expand the more you hit currency issues. The banks have been notoriously bad at doing anything other than profit hugely from giving advice on that. How will you be different? We’re talking about the micro-businesses, one to 10 people who are beginning to try and expand outwards into overseas markets. What is the difference that you would make in dealing with those complexities?

Vernon Hill: I have to admit that I am certainly not the expert on currency exchange in Britain. That’s something we’re going to have to deal with in America, and we’d be happy to provide you with the information from our management team. Let me answer the question in a completely different way. For the SME segment-and in fact the middle market segment-their first concern is not about the price. What they care about is-and we have a phrase-"local lenders making local loans". They want an old-fashioned banker who handles their £1 million credit, their house mortgage and their kid’s car loan.

Our model in America and our model here is going to be an SME segment. As you go up it’s going to get one banker, whether they’re based in a store or based in a centre in London, who handles their entire relationship, and they’ll bring experts in to talk about foreign exchange and so on. That is a completely different model from the one you see in large banks-whether large banks in America and Britain-and it’s why the American small banks end up serving the majority SME segment, because the customer wants a banker and not a phone number.

Anthony Thomson: I can add an anecdote that might amplify that point. We had a small business come in to open an account-two individuals-IT consultants who had come together and formed a limited company. Over three months, they had amassed a number of cheques. They had been unable to open a bank account with one of the large banks over a three-month period. One bank at least was able to acknowledge that they had an application in, the other bank couldn’t find their application.

They were able to open an account with us on a Sunday and bank the cheques. They had not been able to draw any money because they had all these cheques they were unable to bank. However, we were able, on a Sunday, to open their account and give them their credit. I think the challenges facing SMEs, as you say, are quite complex. There are some very fundamental issues to resolve first, such as just giving them service, giving them a human being to talk to who can address their issues.

Vernon Hill: We approach these issues from a fundamentally different view of life. We are not going to tweak the products; we are not going to be a little bit better on this. We are fundamentally changing. When I started this process several years ago with my partner Anthony, I was shocked by the concept here, and it is more true in the SME segment, that the banks here have the concept of a customer applies to open an account. The American concept is you have money you want to deposit, you are not a crook, give us your money, we will get the account open. It is a fundamentally different view of life.

Q464 John Mann: If you are in the SME sector here, in a micro-business, it is worse than that because of course a majority of the banks will refuse to give you an account. Are you going to turn down people who apply?

Vernon Hill: Only if these people don’t pay us the anti-money laundering cheques that the FSA makes us do, or if they have particularly bad credit. This idea of turning down a business because it is new is foreign to my way of thinking.

Q465 John Mann: One final question. Your view is interesting, because it is an issue that seems to preoccupy parliamentarians here at the moment, so well beyond this Committee. As a new bank what future do you see for the cheque? Do you see it having a future?

Vernon Hill: Again, I come from the American view of life where cheques are still very strong. Our philosophy is we want to deliver banking and banking services in any channel that the consumer or the SME wants. If they want cheques, I’m thrilled to give them cheques. If they want credit cards, we are thrilled to give them credit cards. My outside view of life-this is just an opinion-is that this drive to kill the cheque appears to be maybe a self-serving effort by the main banks. We print your cheques in the branch when you open your account.

Q466 John Thurso: Mr Thomson, a little earlier on you said that what people want is a human being to talk to, and listening to you, Mr Hill, it is quite clear that your model relies on intelligent human contact as the heart of service delivery. You also went on to say that in this country, all the banks are producing the same product the same way-they are product driven. That is to say that they are trying to get rid of the human beings. What I am interested in goes back to the Chairman’s question on cost, because it seems to me that the typical British institution, which does not value human service, sees the human being as a cost and is seeking to drive that cost out, whereas anybody from a background in service sees the human being as the deliverer of profit. Is that an encapsulation of the model that you are seeking?

Vernon Hill: Absolutely 100%. Let me just go one step further. When we started this process and I talked to the press, I got the same question all the time. How can you deliver service and still make money? I finally said to some reporter, "The banks have you convinced that the only way they can make money is to deliver bad service". Our model in America was the most rapidly growing model in the country in the banking business, and one of the highest performing stocks in America. There is no truth in the assertion that you have to endlessly cut costs to deliver returns and service. You said it-it is the disinvest issue. If you believe you are in a no growth model, the major American banks to major British, you are going to try to cost-cut your way to prosperity. If you believe that you have a differentiated growth model you can invest and over-invest in your model, and that is how we build our model in America and that is what we expect to do here.

Q467 John Thurso: This strikes a lot of chords with me because I am from a hospitality industry background. What we sought to do was not necessarily cut costs but to understand it and control it because you have to be aware of your costs-you cannot let it get out of control. You are clear that you are putting people in, people will deliver your profit; where are your costs? How do you control them, how do you measure them?

Vernon Hill: There are two costs in the banking business that matter. Remember-and I should have started this earlier-we are in the old-fashioned simple core banking business. We accept deposits and we make loans. That is our core business. Everything else is noise. In the core banking business you have two costs-you have your cost of money, what you are paying on deposits, and your cost to run. Our experience in America is that customers will accept a somewhat lower return on their deposits within a band for this whole service experience. So we had a lower cost to money and accommodation, offset by a higher cost to run; operating costs and hotel costs. In that model, because we were delivering this different experience, we were growing 25% a year for ever. So the typical big bank model is relatively high cost of funds, relatively low cost to deliver, no growth. Our model was lower cost of funds, higher cost of delivery, high growth.

Q468 John Thurso: Okay, let’s go to the one that I think is one of the most difficult issues- the current account. The UK model is basically free current account banking. Interestingly I think you have chosen to go down that same route. Why did you make that decision to follow the big banks, with free in-credit banking?

Vernon Hill: You are correct; the current account is the core relationship with the customer. It wasn’t so much that I followed the major banks here-that is the model we use in America too. Our bank was free cheque-ing, free current accounts, almost from the beginning. I have always believed that is the correct model, so that has just been our experience.

Q469 John Thurso: So where is the cost of delivering that recovered? Typically if we talk to, as we did, RBS, the lady told us it is the cost of a cup of coffee, or whatever it was, to run it a week, and they get it from cross-selling the products. Where do you seek to make your return?

Vernon Hill: We expect to make our return, as we did in America, in two ways. The net interest margin-the cost of the yield on our investment less our cost of money gives you the net interest margin-I would argue has historically been too low in Britain, which gives you some of these problems. Then you make some up on fees. So it’s those two things.

We are not a product seller generally, but if somebody wants a product we’ll sell it to them. The fees are current account fees and commercial loan fees and those kinds of things. That is the basic business. This is business is not as hard as they represented to you. This is the business of taking deposits and making loans.

Anthony Thomson: I think your American experience suggested that if people come to you for service they are prepared, as Vernon said, to accept a slightly lower rate on their money. More importantly, they stay longer. We have the funds for a longer period of time. What was the average in America?

Vernon Hill: We knew that the average life of a current account in America was five to six years, yet our current account life was 13 years. That is a tremendous difference and has major ramifications as you build your model.

Q470 John Thurso: I almost hesitate to ask this question, because it’s the opposite of everything you’re saying. Of the big banks that we have seen, it is very clear that the current account is like a hook with a worm on it, in the hope that they’ll trap the fish with some financial products that they’ve got dangling around the place. Basically, it’s "Let’s get hold of them. It is something we have to do." What you have been saying is the core of banking is the core of the service you give and you’re not product driven. So how are you not missing out on those lucrative sales they are talking about?

Vernon Hill: We believe you can make more than a fair return on the core business of accepting deposits and making loans. We believe people will buy other products from you if you have fair products-not if you are aggressively out to sell them, but because they have faith in your brand. I go back to Apple again, if Apple comes out with a new product, because it’s Apple you just go out and buy it. So in America we had a cross-sell rate just as high as Wells Fargo which is the king of cross-selling in America, aggressively cross-selling, because our customers would come to us when they had a need, and we had people there to take care of the need. But it was not, and will not be, through a product driven market.

Anthony Thomson: On Mr Thurso’s point specifically on current account opening, a report by the OFT said that only 7% of people move their current account because of rate, for 93% it’s around service and convenience. So the banks, I think, seem to have persuaded everyone that this is a rate driven environment. The reality is it is not rate driven. People want value, they want fairness, they want transparency and value is an amalgam of many, many different things, not just rate.

John Thurso: What the French call "rapport qualité - prix " , I think; the relationship between quality and price.

Vernon Hill: Correct.

Q471 John Thurso: At the heart of it, if I have this right, you are saying get the basic model of cost of capital right; create trust in the relationship between your people and the customer; and the rest looks after itself?

Vernon Hill: That’s almost it.

Q472 Mr Mudie: From an American perspective, as someone coming in, have you a view on whether the existing banks, for competition reasons, should be broken up? In the same question, have you a view on whether the HBOS Lloyds merger was good or bad for their customers?

Vernon Hill: I’m not really qualified to comment on the Lloyds HBOS merger, it is just out of my sight and my realm. Generally, I believe that the larger a retail bank is, once they get past a certain point the poorer they serve the consumer. The numbers in Britain say that, the numbers in America say that. Breaking up banks involves lots of different things. Does breaking up banks mean you are selling part of a bank and the sign is painted blue instead of green and nothing else changes, so what have you really gotten? I think we would say you should look at differentiated models. If Santander gets part of the RBS Group, what have we really gotten but new signs?

My outside opinion is-I am an outsider looking in-you’re focusing a little too much on the parts rather than freedom of choice. You could look at this in other businesses-the hotel business is a good example. Everybody serves the hotel segment in a different way, at different price points, and customers have a real choice whether they want a low-price room or a high-price room. Here you really have very little choice.

Q473 Mr Mudie: Have you given evidence or are you intending to give evidence to the Vickers Commission?

Vernon Hill: The Independent Commission on Banking? Anthony was there last night.

Anthony Thomson: I was there last night, yes. I’m very happy to contribute if asked. We’ve certainly been attending their meetings and observing and contributing where we can.

Q474 Mr Mudie: When you were in the States, at one stage you were described as a regional bank; did you break out of being a regional bank at the end ?

Vernon Hill: We had 500 locations on the east coast of America. Other than the top three or four banks, almost all the banks are regional or community banks in America.

Q475 Mr Mudie: Are you bringing that regionalism to Britain ? I see in the FT today you are expanding, but instead of going north, where the real wealth is and the real people are, you seem to be going east.

Vernon Hill: I get asked that question all the time. Retailers know the more stores you build in a market the better each store does. So it makes sense for us to concentrate in London and build a group of stores here before we go to Manchester or Birmingham or even further north. So it’s not a question of ignoring those markets-the more you group the stores over time the better they do.

Q476 Mr Mudie: You’re intending to come the better parts of the UK ?

Vernon Hill: No place in Britain is safe from us trying to change banking.

Q477 Mr Mudie: I see in the paper you have a Yorkshire Terrier called Duffy.

Vernon Hill: I have a Yorkshire Terrier-I should have brought him here today.

Mr Mudie: I think you should commend the idea of taking him back to his homeland , and having a look.

Vernon Hill: And I will come and see you.

Anthony Thomson: I should declare that I’m from Newcastle.

Q478 Chair: Just on this question of switching, when people find themselves switched as a consequence of divestment, on the evidence that you have, are they happy or unhappy?

Vernon Hill: They’re very unhappy, and we’re hearing about Santander and RBS right now.

Chair: That is why I asked the question.

Vernon Hill: We are hearing about it on the SME segment first. That is where you’re going to hear it first. Let me go back to the American experience, where we have lots of bank sales and mergers, every time there was bank merger in our market it helped our growth because customers say to themselves, "Let see, my account’s going to be moved, let me make the choice. Do I want to go to where I’m being moved to or do I want to make my choice?" Customers are not happy with having their account moved, and we like it. It gives them another opportunity to think, "Is this the time to switch banks?"

Q479 Chair: So maybe your answer to the Vickers Commission all round is, "Leave things just as they are, we will pick up the crumbs"?

Vernon Hill: There is some truth to that.

Chair: Yes, that is what I was beginning to worry about.

Q480 Mark Garnier: I just want to follow up on something which John Mann talked about a bit earlier. You’ve made a great deal about this idea of local bankers making local loans, which I think is very much the US model. For us in the UK, we are not necessarily that familiar with the concept of how this works. Can you talk a bit through the nuts and bolts of how you devolve that lending process to an individual manager?

Vernon Hill: Well, you have them at different levels depending on the size of the loan. You train your store managers to make the smallest of the loans, then you have a group of people based in a region, let’s say the west of London, who would handle the next size up, and then you’d have a group that would do the very large loans. I had a $30 billion loan portfolio in America, and 95% of the loans were made at the local level-one of those three levels.

Q481 Mark Garnier: The traditional model 20 or 30 years ago was one in which the local bank manager would go and have a drink with the local accountant after work, and they’d chat to the local lawyer and this kind of thing , and they all had good intelligence about the local situation.

Vernon Hill: Correct.

Mark Garnier: Is that what you are focusing on?

Vernon Hill: Yes, it starts like that. You can’t train a store manager to make £10 million loans, but you can train them to start the process, handle the smaller relationships, then move it to a local team, maybe even based in his branch, to deal with it. What you said about intelligence with the local accountant, the local lawyer, that’s the essence of our model. It’s the community bank model in America. The community bank model means not only what you said but it means the high street branch manager is back, it means we’re engaged in the local community, its means we’re supporting a local event. I was at Earls Court last night where we had an event with 70 or 80 people. We talked about local people and local businessmen and their needs. That’s very much the community bank model and, and as you point out, that is the American model.

Q482 Mark Garnier: I have certainly seen some of the bigger banks such as Lloyds Bank holding charter events, I think, with customers a year ago, which seemed to be simply in response to the Government putting pressure on them to go out and engage. But you are seeing this very much as the core of your business model.

Vernon Hill: That’s our model. Let me just make one other comment that might be helpful to you. Great retailers run their business from the store up-hoteliers run it from the store up-but big banks run their model from the top down. That’s a fundamentally different view of life. Our model in America and in Britain is running from the store up. The action happens first at the store.

Q483 Mark Garnier: Sure. Can I talk a little bit about your funding capital as well?

I think you have £75 million in capital.

Vernon Hill: We have just raised another £50 million.

Mark Garnier: So you have £125 million.

Vernon Hill: Correct.

M ark Garnier: And you are anticipating an IPO in 2013 raising £250 million?

Vernon Hill: Correct. Something like that.

Q484 Mark Garnier: But between now and then you’re going to be expanding, notwithstanding that, an extra £50 million out of organic growth. However, because you are not going and buying in loans-you know, other banks making acquisitions-it is all going to take quite a lot of time. Do you see that as a problem?

Vernon Hill: My experience in America started with one store and grew slowly, and then we got the machine rolling and it grew to 500 stores buying almost zero. My opinion is that great retailers never grow by acquisition. They refine their model and learn to roll it out over time. If you see yourself as a retailer delivering an unusual service, acquisitions are the easiest way to kill your model. So, yes, it is slower, although we are growing at a fairly rapid rate here in new stores. It is slower, but you get what you want at the end. You get a group of locations and a group of people running your model, not somebody else’s model.

Q485 Mark Garnier: And you are certainly not buying anybody else’s problems by accident.

Vernon Hill: You’re buying nobody else’s problems.

Q486 Mark Garnier: How has it gone? I think it was 29 July that you opened.

Vernon Hill: Great, unbelievably well.

Q487 Mark Garnier: Are you ahead of time?

Vernon Hill: Holborn was our first office and I’ll give you an example. We made it public that our plan was to open 2,000 deposit accounts in the first year. That branch opened over 3,000 in the first month. I have been very pleasantly surprised by the level of acceptance at all of our locations in Britain.

Q488 Mark Garnier: Is that growth continuing?

Vernon Hill: Oh yes.

Q489 Mark Garnier: So it is going at the same sort of rate. So you are well ahead of target?

Vernon Hill: Well ahead of target.

Q490 Mark Garnier: Are people coming to you because they are excited by this concept or are they coming because they are so fed up with the other banks?

Vernon Hill: Yes and yes. They’re coming for choice. I sit down and talk to them when they’re opening accounts, and I ask them why they’re switching. The press, when we first opened, made a big deal, because we’re not the highest rate payer on the high street- we’re not and we’re happy to say that. They would say that on TV and then they’d go to the people sitting at desks opening new accounts, and they would say, "You know Metro’s not the highest rate" and they would say on TV, "We don’t care. We want a bank that understands us, that we can call up on the phone and get something done". So it’s a combination of total dissatisfaction and this model.

Anthony Thomson: Nine out of 10 of our customers who open accounts would recommend us to a friend, and eight out of 10 people who open accounts currently are recommendations.

Vernon Hill: Let me get this point in. As you gather, I’ve been doing this for a long time, and over the years there have been lots of marketing studies and the one that I’ve come to learn from the most is this idea of net promoter score. What percentage of your current clients will recommend you to a friend? This is the essence of what a service business is about. Would our current customers recommend us to a friend? In America, Commerce, which is a very large bank, 67% of its customers would recommend us to a friend. The typical big bank in America is in the teens. Already at Metro Bank our net promoter score, on a very small base, is 84%.

Let’s talk about the net promoter scores in Britain. None of you will be surprised that the bank most loved in Britain is First Direct, where 57% of customers recommend it to a friend. Lloyd’s number is minus 19%. I had never seen a minus number until I came here. Barclays is minus 35%. These are incredibly bad numbers. I’ll be happy to leave those with you.

Q491 Mark Garnier: We had Lloyd’s in last week and, well, I’ll move on. This is question is probably more for you, Mr Thomson, as it is about the regulatory process-I am slightly changing the subject. How have you found it with the FSA getting a banking licence?

Anthony Thomson: I think the FSA was extremely good to deal with. It was really an application of three parts. There was the pre-Lehman Brothers period-the period about three months post-Lehman Brother,s where I think they had bigger issues to look at, and then post that, I think we are the first new bank for almost 150 years. So there were some changes they needed to make internally.

Q492 Mark Garnier: So they did not know how to process a new banking application until you came along?

Anthony Thomson: No, they had a series of processes, some of which I think needed to change slightly. We found them very positive and very responsive.

Q493 Mark Garnier: That is very encouraging. How long did the process take?

Vernon Hill: It took about 18 months.

Mark Garnier: It was 18 months.

Vernon Hill: That’s not different from the American experience.

Q494 Mark Garnier: No, no, sure. I was just very interested, because I was asking Hector Sants about this last week and I said it’s taking 18 months and he said, "No, that’s not correct, it takes seven months". So he was lying, was he?

Anthony Thomson: In our case, it took us 18 months.

Q495 Mark Garnier: In your case it took 18 months, right, that is fantastic. The OFT has also referred to a-I suspect you are going to say the answer to this is no-catch-22 situation whereby anybody who wants to set up a new bank has to raise the capital to go into it and then has to get a banking licence afterwards. So therefore you are stepping into the abyss without necessarily knowing you have got a landing point.

Vernon Hill: If I may answer. That was a flaw in the approval procedure and they chatted with us and I believe they have changed it. They made us raise all the money, build the whole IT system, tested the IT system, and then gave us the final licence. They know that’s a procedure that cannot work. I believe they have gone to the procedures with some steps along the way. They give the applicant a "minded to" letter subject to conditions and then you can begin to raise money and do all the things you have to do.

In our case, I had to invest a very substantial amount of money in leases and IT, with people not knowing that we were sure of getting the licence. That is an absolutely anti-competitive way to do it and I believe they have changed that already.

Q496 Mark Garnier: So the good news out of all of this is that they are learning by their mistakes.

Vernon Hill: That’s what I hear.

Mark Garnier: It would be very helpful if you heard otherwise if perhaps you could let us know.

Q497 Andrea Leadsom: Just to be completely clear about this, do you think that the FSA, the regulatory environment, creates any barriers to entry?

Vernon Hill: Of course, there is a barrier to entry in this business. This is a very hard business: you need capital, you need technology, you need trained people, you need compliance, you need experience. This is not an easy business to enter. We had a unique set of facts, with people and capital and experience. You’re never going to have lots of new people, no matter how easy they make it. Even in America, in the best years, we only got 100 to 200 new banks a year. So is the FSA a barrier? Absolutely. Should they be a barrier? Absolutely. Should they approve applications that make sense? Absolutely. But they have to do it in a way that encourages applications that have merit to move forward.

Q498 Andrea Leadsom: And you feel that they do?

Vernon Hill: Well, that’s what I hear. We haven’t engaged in that, but that’s what they tell us. The American model is you apply, it takes four or five months, they review your plan, they look at your people, they give you a "minded to" letter and then you get serious.

Anthony Thomson: I think immediately post-authorisation, the FSA did come and ask us to feed back to them our experience of the process, and from our perspective what would have made it easier. So they’ve certainly talked to us about that.

Vernon Hill: They were fair and open with us during this whole process and, as Anthony mentioned, this is during the Lehman crash where the world was going to end, so I have nothing but good things to say about the FSA.

Q499 Jesse Norman: Mr Hill, returning to one thing my colleague Mr Mudie said, we have seen the impact of putting two Scotsmen in charge of the Scots banking system, and if you would ever like to come to Hereford where I come from we will show you a very warm welcome.

Vernon Hill: Thank you very much

Jesse Norman: Can we focus back on the issue? You said something extremely interesting en passant, which was that one of the reasons why the British system had become so product driven and product dependent, was because of structurally thin net interest income. Can you talk about why that should be the case?

Vernon Hill: The net interest margin is the difference between what you earn on your assets and what you pay on your fund, and it’s the key number that drives the banking business. In America, I would say that the net interest margin is about 100 points higher than here.

Jesse Norman: Basis points?

Vernon Hill: Yes, basis points-1%. This is an observation I’ve made, not a scientific analysis, so don’t ask me too many hard questions about this. It looks to me that here, as in some parts of America, the banks inflated the cost of deposits and deflated the interest rates on loans. What happened in America is they gathered deposits and then the corporate loan guys made all these large corporate loans at prices that made no sense, because all the glamour in the banking business is making the £100 million loan, not the £1 million loan. The margins never got as compressed in America as they are here, but when you compress margins by demanding higher deposit rates and the borrowers demanding and getting lower loan rates the effect is you’re depressing margins.

Now, the banks have to earn a profit. The generally accepted number is we had to earn 1% on our assets over time. If we don’t earn something around that number you’re not going to have a bank, you’re not going to have a banking system. So we have all this talk about pricing and fair pricing; the banks have to earn a return on their capital or they have no capital, as we’ve seen. So everybody looks at it in a different kind of way but that’s my view, if you like.

Q500 Jesse Norman: Just a point of clarification on that. You have just said that you have to earn 1% percent?

Vernon Hill: 1% of the assets and somewhere-that’s on assets. Another way to look at it is return on capital, and the numbers have generally run from 10% to 20% return on capital. If a bank, like every other company, doesn’t get an acceptable return on capital, the capital goes.

Q501 Jesse Norman: That is helpful. So that is a very interesting analysis. Can we just talk very briefly about why it should have happened-why the banks have converged on this model? One of one’s worries might be that you could have a nominally competitive system in which essentially all the players are signalling to each other that they will be happy to settle on a certain set of rates.

Vernon Hill: It does seem that way, doesn’t it? If I may answer that question. Our view is completely different from that of the major banks in America and Britain. The major banks have turned this into a commodity business where pricing is the only element. Our view of life is it can be a service non-commodity business as I described, and people deal with you for non-commodity pricing reasons.

Q502 Chair: Could you do a bit better than, "does seem that way"? That is bureaucratic speak, is it not, for "There is an oligopoly out there"?

Vernon Hill: That’s so unlike me to use that kind of speak too.

Chair: That is what was worrying me earlier.

Vernon Hill: We have a very concentrated market with a small number of banks essentially offering the same products and the same services, and the customer has very little choice here. You can judge what I just said but those are the facts.

Q503 Jesse Norman: Just a quick follow up question. Are you aware of any serious service-based innovation in British retail banking over the past 20 years?

Vernon Hill: Of course, they always relate to First Direct as a service innovator, and some of us may remember that was a Midland Bank innovation. First Direct is a good example of how they started as a rate-based model and moved to a service-based model and their customers love them. Everybody knows they’re not the highest rate payer in the market, but they like to talk to human beings on the phone. This is not a hard business. I think First Direct is maybe the only change I can point to.

Q504 John Thurso: Can I ask about the thorny question of remuneration and bonuses in banking? What is your policy regarding the people you employ on remuneration and bonuses?

Vernon Hill: First of all, let me make a comment generally about remuneration-and I have watched your hearings. Commercial banking and investment banking are two entirely different businesses, and I listen to you talk, and you merge the two together. I think you do a disservice to this discussion by talking about bond traders as opposed to branch managers. In America, the banks aren’t in the investment banking business as much as they are here, and I think that we have to look at those two groups; it is completely different.

Q505 John Thurso: If you have read my questions you will see that is what I have always been trying to do-separate the two.

Vernon Hill: Right. To answer your question, we bonus our people down to the branch manager level on a subjective basis. When I had 15,000 people working for me in America, we did a subjective analysis on every store manager upwards; about how they did on their plan, how they delivered service, how they recruited people-a whole measure of subjective things. We rewarded them with salary and cash options. But I may be the last person in the world to believe that stock options are the key to delivering a unified customer experience. They get their options based on their performance, but the value of the options is determined by how the company does as a whole.

I might add that the British system discourages stock options because our employees are taxed when they receive the option. In America they are taxed when they exercise. So if there was one change I would make in the compensation system, it would be that.

Q506 John Thurso: Broadly speaking, what percentage of a salary might somebody be able to earn on an annual basis through incentive plans or bonuses? Would it be a multiple of salary or a percentage of salary?

Vernon Hill: It would be a percentage of salary. It would be a percentage of salary. The American tradition is more that way than the British tradition, I might say, but my American experience is a bonus for a high performer might be 20% or 30% of his salary.

Q507 John Thurso: Looking at the top end of the company, as you grow, you will start to have executives. What is your view on what the executive package should be?

Vernon Hill: It should be salary, discretionary cash bonus and options. If I had my way, I would make the majority of it in options.

John Thurso: Thank you.

Vernon Hill: Mr Chairman, I just want to repeat the value of stock options. The number of options they get is based on their performance. The value of the options over time is based on the company as a whole. That encourages people to work across lines in different segments to support the company as a whole rather than their particular line.

Q508 John Thurso: Just to follow up, I think it is very interesting you are keen on options. There is a view, but it is probably to do more with investment banking than retail banking, that the person who puts the capital in should get the return. Every time you give away stock options you are giving away the capital I have invested in your company.

Vernon Hill: Of course, that’s true.

Q509 John Thurso: So how do you work out the balance between handing out the stock options and diluting my return? You can look at some big American companies and you could consider that remuneration committees have pretty well looted the shareholder interest in stock options to senior executives.

Vernon Hill: Well, using the American example, take the tech guys out of the equation, they’re on some other planet. In a financial segment, we would get options outstanding no more than 5% to 10% of our shares, our total shareholding. So over time they would ramp up to 5%, 10%, and we would give options in the year on 2% or 3% of the share account. That’s generally what the investment community looks at.

Q510 John Thurso: Would you go into the market to buy the shares or would you issue them?

Vernon Hill: I issued new shares. Remember I was a rapidly growing company. If you’re not a growing company and you’re worried about the share count, you might go into the market.

Q511 Andrea Leadsom: I just want to check you are talking only in your proposal to remuneration about the retail banking sector?

Vernon Hill: The commercial banking sector, not the investment banking sector.

Q512 Andrea Leadsom: Exactly, because I just want to come back to your point on options. Obviously one of the attractions of being taxed on the way in, rather than at the end, is if you think the stock price is going to go up, then your tax bill is lower if you pay it up front than on realisation of the capital value.

Vernon Hill: That’s not right, because you award the options at the current market price, so there is no value when you go in. So for your point to be right, the employer would have to buy the shares then?

Andrea Leadsom: Yes.

Vernon Hill: That’s not what happens.

Q513 Andrea Leadsom: So you just award them and they do not buy the shares until the end?

Vernon Hill: Until they have a value.

Q514 Andrea Leadsom: So what are they paying tax on at the beginning?

Vernon Hill: Here, they’re taxed on the value of the shares. I’m not an expert on British taxation, but I believe they pay value on the gross number-X shares times X price.

Q515 Chair: We will come back to this perhaps, but I don’t think we’re going to go too deep into the detail.

Vernon Hill: Yes, right, and I’m not an expert on that. But I know my Brits don’t like options as much as the Americans do.

Chair: Yes, there are some good reasons for not favouring them, but we are not going to go into them now.

Q516 Jesse Norman: I am sorry to keep coming back on this. A couple of very quick questions. One of the things that has been suggested to this Committee on several occasions is that commercial bankers are best paid in subordinated debt rather than in equity, because that, as it were, focuses their eye where it should be, and also that there’s a tacit subsidy if you pay people, even directly or indirectly, in equity because people just ramp up the balance sheet and take the profits. How can we prevent that happening?

Vernon Hill: I don’t know about the debt side-the subordinated debt, I’ve never heard that theory and I don’t have any comment on that. But your theory about options assumes that nobody’s at home running the bank. Obviously, all these things have to be managed and they have to be done right. For instance, if you pay commercial loan options on loan production, you’re going to encourage them to make bad loans. So you have to design your system where you have controls and you pay them over time, not only on what they produce but the quality of the credit. So all these things can be used to the extreme but they have to be managed.

Q517 Jesse Norman: So you accept the possibility of the hazard, if you like, of leveraging up a balance sheet.

Vernon Hill: No, I don’t.

Chair: Anyway, let’s not go down that way any further just now. I just want to end by telling you we embarked on this inquiry because people have told us that this market is fundamentally flawed, but you are disproving this, aren’t you? What you are showing is that the market has imperfections, but you’re going to pile in and take advantage of them and the barriers are not so big that you cannot do that. So it is just a matter of the entrepreneurs getting in there and getting on with the job?

Vernon Hill: Yes, on that part, for sure. But there are barriers to entry in the market; we’re a unique set of facts. I think you should provide more freedom of choice to the customers with new entrants, and I think this focus on product and pricing, not only by the banks but by this Committee, is not focusing on the real issue.

Chair: Well, you had better drop us a line with some further detailed evidence about exactly what you do think we should be focusing on. We will be listening very carefully. We are also very interested in the survey you have done.

Vernon Hill: I’ll leave it with you.

Chair: It appears to contradict a good amount of the other material we have received. Thank you very much for coming before us today and we wish you a merry Christmas, whether you take it here or in the States.

Vernon Hill: Thank you.