Session 2010-11
Publications on the internet

To be published as HC 612-viii




Treasury Committee

Competition and Choice in Retail Banking

THURSDAY 20 January 2011

John Fingleton and Clive Maxwell

Evidence heard in Public Questions 758 - 832



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Oral Evidence

Taken before the Treasury Committee

on Thursday 20 January 2011

Members present:

Mr Andrew Tyrie (Chair)

Michael Fallon

Mark Garnier

Andrea Leadsom

Mr Andrew Love

Jesse Norman

Mr David Ruffley

John Thurso

Mr Chuka Umunna


Examination of Witnesses

Witnesses: John Fingleton, Chief Executive, Office of Fair Trading, and Clive Maxwell, Executive Director, Office of Fair Trading, gave evidence.

Q758 Chair: Good morning. Thank you very much for coming to give evidence to us this morning. You will have seen we have already collected a large body of evidence on this subject, and you’re particularly well placed to help us with our inquiry.

The first question, given all that evidence, is to ask you which side of the line you come on the views that have been expressed to us. A very large body of evidence has been put to us that competition is inadequate in retail banking , and there is a rather smaller body of evidence that everything is pretty much all right and is very competitive indeed. Where do you stand on that?

John Fingleton: I think probably on the side of thinking that the market could be more competitive. We have done a lot of work across a range of financial markets, but personal current accounts and small business lending in particular, which share some common features within the market, could be more competitive. Unlike some other markets, the primary focus of our attention has been on consumer switching and consumer inertia as one of the biggest barriers to competition, but we’ve also looked at barriers to entry and we’ve also looked at market structures. I’ll let you dig into some of those issues in more detail as you prefer.

Q759 Chair: You have been looking at this for a long time. Why hasn’t the OFT been able to sort it out?

John Fingleton: We have applied every single tool we have in this market in one way or another. A number of mergers have come before the OFT and the Competition Commission in the last decade. No large merger has been approved by the competition system in the last decade. The original Lloyds-Abbey deal was not-and, of course, we expressed our view on the Lloyds-HBOS merger at the time. On competition enforcement, for example, we did a case last year; RBS has agreed to pay a fine of £28.5 million on a competition infringement. So we have used competition enforcement in the sector. We have brought the bank test case, which went up to the Supreme Court. We were surprised-as many other people were-that we lost at the Supreme Court. We have to accept the Supreme Court’s interpretation of the law, but that also robbed us of an important instrument that we thought we had to deal with this market. And of course we also regulate the credit market.

I should probably say that the OFT doesn’t regulate the banking sector. Our job is to enforce consumer and competition law. We do that selectively where we see breaches of it and where we think the issue will raise broader precedential issues. The way the consumer and competition law works is: businesses themselves are accountable for complying with the law and for making the market work; we intervene when we think they’re falling shy of what is required by law for them to do that, and we have really pushed our instruments as hard as we can in many of these areas.

One of the central points that I want to get across today is that I do think the CPMA needs to take seriously some of the issues around consumer switching and consumer inertia in the market going forward, and also have a top-line duty to promote competition in the setting of its rulings, which the FSA currently doesn’t have.

Q760 Chair: So you have done your best and it’s now up to the regulators to do better, and in that respect-

John Fingleton: That doesn’t mean we will stop taking an interest in this market, but put it this way: we would like some help.

Q761 Chair: The help, if I could summarise what you have said, should come in two forms: one is we need action on the concentration in the market and the other is that we need something to deal with inertia, which may involve more action on transparency. Is that correct?

John Fingleton: Yes. We have come quite a long way on inertia. The banks have become more transparent in the pricing of personal current accounts over the last two years, even since the Supreme Court decision. We got the banks to agree to changes in how they present the information to customers.

Q762 Chair: Do you think that is enough, or do we have to go further, and in what respect do we need to go further?

John Fingleton: We think it needs to go further. When people talk about transparency it’s important that we’re clear about what we mean, because there is a tendency-it can be well intentioned-simply to flood consumers with information and say then, "Everything is transparent." So, in some senses maximum transparency-giving consumers lots and lots of information-is not necessarily any better than giving them no information. You’re catching a waterfall with a teacup; it’s not very helpful. So, it’s giving consumers the information that is relevant to them.

For example, when we did the market study in banking, and that came out two and a half years ago, we discovered that the bulk of the revenues on current accounts came from two sources: foregone interest on the one hand and the overdraft charges on the other. They were probably two of the areas the consumer had the least information on which to make an assessment of what they were paying their existing bank, or to compare prices between banks. It is very difficult for consumers to choose between competing suppliers if they can’t see the prices of the aspects where the most revenue is earned.

Q763 Chair: To get to the price, what do we need to know?

John Fingleton: For foregone interest, which of course is a different issue in the current interest rate climate, and of a different magnitude, one of the things we have got the banks to agree is to publish an annual statement setting out the average balance over the year, which I think is a good step, because if you don’t have your average balance, it’s very difficult to have a quantity to apply the interest rate to.

Q764 Chair: Okay, but is that enough?

John Fingleton: One could go further with that. We have gone as far as-

Chair: I am trying to try to pin you down on what the measures are that you think the regulator now has to pick up.

John Fingleton: Foregone interest would be one aspect of it-being clear about if one bank is offering a higher rate of interest than another bank. Given your transaction pattern, how could you compare those two prices? There are a number of ways you could go about that, but that would be one. On overdraft charges, I think our focus has been slightly more on the choice and control that the customer has, and trying to push the banks towards giving consumers information so that they can make informed choices. Having the money taken out of your bank account without necessarily being aware that it’s happening is part of the problem there. You were going to-

Clive Maxwell: Yes. I was simply going to add that I think sometimes thinking about how this sort of data can be used by third parties to help inform consumers is another way of looking at it. So, for example, having information about your average account balance might be quite similar, if you’re thinking about changing utility supplier, to knowing how much gas you used in a particular year or something like that. It’s the sort of information that might help people use things like comparison websites and the like.

Q765 Chair: Did I understand you correctly to say that there are two legs to what you want the CPMA or the regulators to do: one is the issue we have just been discussing and the other is the issue of concentration and the structure of the market?

John Fingleton: Yes.

Q766 Chair: In a nutshell, what do you want to happen there?

John Fingleton: On concentration and structure of the market, I think first we will await-as everybody else will-with interest the Independent Banking Commission’s views on the retail banking market. Having said that, we think that the CPMA should have a top-line duty to promote competition; in other words, in setting its rules, in thinking about how it regulates the industry, it should promote competition in what it does.

Q767 Chair: It should be an objective of the body?

John Fingleton: It should be an objective. At the moment it is not a top-line objective set for the FSA; it is a secondary objective of the FSA, but we think it should be a top-line objective for the CPMA. I think that is consistent with the intention of the Government that the CPMA should be a consumer and market-facing regulator.

That is a different issue from concurrent competition enforcement powers. We don’t think that there should be concurrent competition enforcement powers for the CPMA. That is used where there is a monopoly supplier and the regulator has to regulate access of, for example, energy companies or telephone companies to some essential facility, and where competition law issues may also come up, the regulator may be best placed to deal with both simultaneously. We don’t have that type of situation in banking, and we feel perfectly competent to apply general competition law in that sector, but we do think that, in the setting of the rules, the top-line duty should be to promote competition.

Q768 Chair: What is your response to the view that we need to address the increase in concentration that has taken place as a consequence of the emergency action to bail out the banks, and does this have a bearing on the way the Government should divest itself of those holdings?

John Fingleton: There are two ways to look at this: one is to say if we sort out the inertia and get consumer switching working better, we look at the outcome of the divestments that have already happened as a result of the state aid control, and we make sure there are no unnecessary regulatory barriers to entry in the market. Then the question is: given those market dynamics, is that going to be sufficient to create a dynamic market structure, in which large market shares that are held by banks only because they are large, not because they are more efficient, get eroded away over time, and in which consumers switch to new entrants? That is one view of the world.

Another view of the world is that you need to have quite deep restructuring; you need more banks, and so on. What I would say about that is: if you don’t tackle the inertia issue and the switching issue, having 10 banks where consumers can’t switch doesn’t obviously mean it will be more competitive than having five banks where consumers can switch and where you don’t have ease of entry.

Q769 Chair: So we need both, but what is your view on the 10-bank point?

John Fingleton: I think that it could be very costly to restructure the banking sector before we try the route of dealing with the consumer switching and barriers to entry first, so I think that that could be a very costly option.

Q770 Chair: So you have no view on how the Government should divest itself of its holdings? For example, do you think, as has been put to us by witnesses, that there should be a public interest test to secure competition?

John Fingleton: I think when the Government sells its assets in this sector it should consider the trade-off between how it increases competition and maximising revenue. So, for example, selling an existing shareholding in a bank to one of the existing competing banks would probably look beyond the pale. As to whether it should separately divest assets, certainly we would be arguing that competition should be top of the Government’s mind in that, because the cost to the economy, long term, would be very high. However-

Q771 Chair: Sorry, that competition should trump revenue? Is that what you said?

John Fingleton: Yes, I would argue that generally as a proposition. If I think about, for example, the privatisation of the airports as a single monopoly, that would be very high-cost, long term, for the economy, and so I think that the costs of lost competition when you privatise a monopoly are very high. So, as a general principle, I think that Governments can get that wrong, and there is ample evidence that the UK, although it did very well on privatisation in leading internationally, one of the lessons was: we privatised a lot of monopolies and then had to do various restructurings afterwards. Restructuring at the time you privatise is probably the best thing to do and that promotes competition.

What we have here is a different situation. We have two big differences. The Government doesn’t own all the banks outright and is not privatising a monopoly, and therefore the issue is more subtle. So I think that the difficulty is not whether the Government should prioritise competition in that regard but whether those divestments would really make a big difference, relative to the cost of doing them. That answer might be different in Scotland from in the rest of the UK, for example. So it’s a difficult equation. I think the Independent Banking Commission is certainly considering that question. We have talked to them about that as well, and I said-as I’m saying to you-that it’s an evidence-based question, and we’ll continue to be involved in it. But it’s not obvious to me that I can say, here and now, "There should be divestments; that would be a good thing," because there would be costs and benefits, and they need to be carefully considered.

Q772 Chair: Just to be clear, the Vickers Commission is looking specifically at the regional distribution of banking retail competition in the context of the divestment commitment that the Government has made.

John Fingleton: It is looking at the entire retail banking market. I have no doubt, because we hear it-and I’m sure you hear it as well-that there are regional differences in the competitive effects, and it is very obvious, from our decision in Lloyds-HBOS, that the Scottish market was more affected by the Lloyds-HBOS decision than the UK as a whole.

Q773 Jesse Norman: Mr Fingleton, in competitive markets there are certain things we naturally look out for: multiple players, low charges, high levels of customer satisfaction, profits competed away between the players. How would you compare the banking sector with other competitive areas of the UK economy? I am happy for either of you-

John Fingleton: I’ll start off. If Clive wants to jump in, he is very capable of doing so. It is clearly much less competitive than a lot of the sectors we look at. In huge sectors of the economy-retailing, distribution, airline transport, and so on-we see high levels of competition, innovation, costs coming down and no real difficulty in firms earning a profit for their shareholders and managing to pass on low prices to customers, being very innovative in the process and driving up productivity growth in the economy. That picture does not characterise the banking sector. It is concentrated. We see many concentrated markets where there is very good performance in terms of competition. Concentration is not itself the source of the problem. It’s a question of how the dynamics of the market work.

There are clearly barriers to entry in banking. We did a report in the autumn on barriers to entry in banking. Clive can say a little bit more about it. But, for example, one of the things that comes out very clearly is that the branch network is quite a big barrier to entry. We also got the FSA to agree to look at some of its rules on licensing new banks-of course, they hadn’t had a lot of applications for new banks for a while, but there have been a number recently-on making sure that there is nothing in the FSA rulebook that is unnecessarily preventing entry into the market. So market entry is more difficult than in other markets, and the branch network is a critical thing there, but that’s not different from certain other retail-type markets.

But I think the big issue is the inertia, and the inability of customers to see what they pay, and to make price comparisons. We have done a lot on the switching process. The switching process bit has become easier, and I can say a little bit more about that as well, but switching is more difficult here. This market is never going to be as easy to switch as when you’re booking your holiday with a flight, because you can switch flight operator, but it should not be as difficult to switch as it is made to be. Historically, too much of the risk has been borne by the customer in the switching process, and we’ve been very much trying to push the banks so that banks bear the risk in the switching process, so we create the right incentives. Do you want to say a bit more about the switches?

Clive Maxwell: Yes. I want to start by saying that retail banking itself encompasses a variety of products and subsectors. So we see the current account market and the small business market as the ones that are most concentrated and suffer from the highest levels of inertia. By contrast, the mortgage market has rather high levels of switching, even if at the moment it is relatively concentrated. For other types of credit-unsecured credit and credit cards-there is a much wider range of suppliers, and much lower levels of inertia out there. So you have different patterns within the retail banking spectrum there.

When we looked at barriers to entry, we looked at them across those different bits of the marketplace and those different subsectors. We looked at the regulatory requirements to which John has referred and found that, of course, regulation does present a barrier to entry to new firms. That is inescapable if you think that to do these activities you need to be licensed in some way and authorised in some way. I think the FSA has made some improvements but time will tell whether some of those entry requirements can be done even better.

The most significant issues that we found, especially in the personal current account market, were around consumer inertia, to which John has referred; it was worries about switching and things historically.

Jesse Norman: We’ve had lots of testimony on that, yes.

Clive Maxwell: The other issue that came through in some cases was the need to be able to grow a business quickly, for example to be able to recoup IT spend, which is a large fixed-sum cost.

Q774 Jesse Norman: Okay, but the point that Mr Fingleton made, which is that the banking industry is characterised by low levels of innovation and poor passing on of profits to customers, low productivity growth, high inertia, high barriers to entry-is that your picture as well?

Clive Maxwell: Yes.

Q775 Jesse Norman: That is helpful. Thank you. Can I ask about whether competition can ever function effectively if you have banks that are too big to fail? Why don’t you kick off with that, Mr Maxwell? There is no need for a long answer; just a "yes" or "no" would be quicker.

Clive Maxwell: I think it makes competition much more difficult. If you look at competition, the impact of competition is felt first within a firm, and it forces its management to think differently; second, you have rivalry between the firms that exist in the marketplace; and, third, you have a potential for bigger dynamic change from new entrants coming into the market with disruptive technologies. I think if you have an absence of exit from a market it makes the second and third types of competition much less likely to occur.

Q776 Jesse Norman: Have you noticed a change in the competition levels as a result of the consolidation recently?

John Fingleton: We haven’t, because we don’t regulate the market. We haven’t gone and looked at measuring competition in the market since the Lloyds-HBOS change.

Q777 Jesse Norman: You didn’t track it when you were looking, for example, at your report last year?

John Fingleton: No, we haven’t. Clearly we’re aware-as I think everybody is-that in both the mortgage market and the SME lending market, because of the contraction of credit, there has been a sharp reduction in supply in that market and that has all the appearances of less competition. If you’re out there as a business or as a mortgage customer trying to get a switch, or get a different deal in the market, supply is much tighter. That may be a temporary phenomenon. I don’t think it’s a feature of a sort of long-term competition problem if it’s a cost shock to the market. But we haven’t been tracking, for example, the impact on personal current accounts of the Lloyds-HBOS decision.

Q778 Jesse Norman: Just turning to the wholesale market, which we haven’t talked about much in other testimony, have you looked at, or are you planning to look at, wholesale market banking charges-for example, the cost of raising equity capital in the UK markets, which on some estimates has doubled over the last 15 years?

Clive Maxwell: We have a market study under way at the moment looking at the equity underwriting market, which is due to report in the next couple of weeks.

Jesse Norman: Okay, that’s very interesting. Thank you very much.

Chair: Andrea wanted to chip in.

Q779 Andrea Leadsom: Thank you. Yes, very specifically, it is on this question that regulation perhaps trumps competition. This is a very highly regulated market that isn’t regulated by you, yet your remit is to look at issues of competition, whereas in the past-and probably into the future-the FSA’s remit has only been to have regard to it, and there has not been any specific focus on competition. So, my question is this: do you think that there is a structural problem with enforcing competition in the banking sector that needs to be addressed through the regulatory changes that are coming up, which would give the regulator a more proactive focus on ensuring competition?

John Fingleton: I think this goes to the heart of the relationship between consumer policy and competition policy, because a lot of traditional competition policy is acting against cartels, breaking up monopolies, and so forth, and then in many of those markets the consumer switching drives the competitive process going forward. The problem here is quite a different one. It is the lack of the ability of the consumer to switch that stops competition from working. So we have taken the view that it is a consumer policy-a consumer-side intervention-used to drive and stimulate competition. So, in actual fact, the biggest part of what I’m saying the CPMA should be doing is it should be getting the demand side of the market working well in order to get the supply side to work well.

Going back to Mr Norman’s question, you get this virtuous circle: if consumers can switch, the companies that have the best deal in the market win the demand, and that incentivises productivity growth and efficiency, which furthers rewards consumers who do the switching. The problem here is that you have to ask yourself the question: where in that chain is the big block happening? In our view, the big block is happening because the consumers are really unable to switch.

Chair: A very quick rejoinder from Andrea.

Q780 Andrea Leadsom: I can absolutely concur with you in terms of retail banking, but in terms of banking overall, on this whole issue of "too big to fail", not enough competition, wholesale markets, and so on, is there the need for the new regulatory environment to have a proactive regard for competition?

John Fingleton: Yes.

Q781 Mr Ru ff ley: Good morning, Mr Fingleton. For completeness, could you summarise the initiatives that the OFT have undertaken to increase transparency and also let us know how far the banks have responded to those initiatives-what the state of play is on implementation by the banks?

Clive Maxwell: Yes. I think I can cover it under three headings: transparency, switching and control. Firstly, around transparency, the banks have committed to being clearer about the charges that they’re applying to individual customers, and to setting them out much more clearly on their statements. That is already starting to happen. They’ve committed to state people’s average balances, for the reasons that we set out earlier. That is happening in some cases already; it is beginning in other cases over the course of the next year or so.

The second area is switching, where we’ve seen significant improvements in the switching process being driven by Bacs, which is the central organiser of the payment system around this. The number of complaints around switching has fallen from something like 30%, 32%, I think, of customers down to less than 10% of customers who have switched current accounts. We’ve seen some improvements there.

On the control side, we have been keen to make sure that, through greater transparency, not only do customers understand what the charges are but they feel more in control of the circumstances where those charges are levied. A number of banks have introduced accounts that allow customers to turn on or off their unauthorised overdraft facility. The banks are working with us to put in place some common arrangements for how they describe those sorts of facilities to customers and the arrangements around those, and also to make sure that we have arrangements for dealing with customers who find themselves in financial difficulty as a result of those sorts of overdraft charges. That is going to be included in some lending guidance that I think the OFT will be putting out in March this year.

So we’re seeing a series of things going on. I have to say each of those steps has required an awful lot of engagement and work, and it takes place in very small, incremental stages.

Q782 Mr Ru ff ley: Could you remind us of the sanctions that you have at your disposal where some banks are being rather laggard in following these initiatives?

Clive Maxwell: In nearly all of those areas we’ve talked about now, those have been voluntary agreements reached with banks, so we have no sanctions directly around those.

Q783 Mr Ru ff ley: Would you like sanctions?

John Fingleton: Even if we bring a consumer case, there are no fines at the moment under consumer law. There is a pilot piece of legislation coming in later this year giving us civil sanctions for breaches of consumer law, and we very much welcome that. So we will have those sanctions for a breach of consumer law, but the Supreme Court has said that the way in which the banks priced and structured their products was not in breach of consumer law. So, as Clive said, anything we have done has been basically by trying to persuade the banks that this is the right thing to do, rather than having any legal power or sanction.

Q784 Mr Ru ff ley: It will be a civil sanction, in other words?

John Fingleton: Yes, but that requires there to be a breach of the law, and we don’t necessarily have that nexus here.

Q785 Mr Ru ff ley: My final question is for you, Mr Fingleton. Sir Don Cruickshank has said this: "Would we allow Google to manage the internet? No, never. So why do we allow banks acting in concert almost absolute control over the money transmission systems, over which all financial transactions take place?" When we asked him to flesh out his thoughts on this, he said: "give the CPMA both the competition objective up front, and also give it powers to license money transmission systems-a licensing regime, in other words. It would be a class licence. It wouldn’t need to be specific to the different systems, and in the legislation I would give the CPMA objectives on using their powers under that licence, and they would have sanctions, a bit like Ofcom has." I wondered what you thought of that advice that Sir Don Cruickshank gave to this Committee, because I find it quite attractive.

Clive Maxwell: I think there are some interesting things there. The importance of the payment system is a key issue here. To operate as a bank you need to have some sort of access to that. Banks can either do that directly, or through other banks-agent banks. Our barriers to entry work didn’t find that lack of access was in itself a big inhibitory problem for people wanting to set up banks. They found they could find those sort of secondary relationships-agency relationships-except in a very few cases where they said they had some issues about pricing and things like that, but it really did not come through as a major problem. The other recent development has been the development of the Payment Services Directive, which is a piece of European law that has been-

Q786 Chair: Sorry to interrupt. Just on that first point, is there something you can send us on that particular point?

Clive Maxwell: Yes, of course, very happy to do so. I would just add another more recent development there that has happened over the last couple of years, which is the introduction of the Payment Services Directive and its implementation in the UK through the relevant regulations. It has given the OFT a particular role in looking at entry conditions for people wanting to come into some of those payments markets. The payments industry, and the banking sector, cannot set conditions that are disproportionate for people to come and join up to their networks. Those sorts of things could be looked at by the OFT, and they’re also considered by the Payments Council. So there are some other mechanisms there, but the centrality of the payments system to banking is very important.

Q787 Mr Ru ff ley: Just a final question: are you going to be making any representations to the Chancellor in relation to this?

John Fingleton: We will engage with the Treasury as negotiations go through. We will say things that are exactly the same as those we have been saying in this Committee. In terms of Don Cruickshank’s view that the CPMA should have a competition objective, I completely agree with that, and I think that could also cover the rules on the payment system. So some of what we do there could be taken on by the CPMA.

Q788 Mr Umunna: Can I just follow up on the market concentration and competition issue that you have been questioned about earlier? You said generally in answering that there is a trade-off to be struck between competition and revenue, and that generally competition should trump revenue. I think it’s fair to say, on the evidence we took last week from Bob Diamond of Barclays, and also very much in my view the evidence we took from Eric Daniels of Lloyds, we listened with some incredulity to their claims that with the increased consolidation there wasn’t a reduction in competition. One of the arguments that was cited by them, in favour of consolidation in the larger banks, was that the economies of scale would ultimately benefit consumers, in terms of lower prices. Do you agree with them?

John Fingleton: I am sceptical, and I’ll explain why. When we consider a merger, like Lloyds-HBOS, it would be normal for the parties in a merger like that to argue there are some efficiencies or economies-of-scale arguments. Because the banks sort of knew the answer to the question, they didn’t really engage with us on efficiencies, so they didn’t put forward the evidence on efficiencies. So, first of all, we didn’t see the evidence on efficiencies. In terms of how we look at that evidence generally in a merger situation, if the market is not particularly competitive, or is not likely to be competitive after the merger, we would be very sceptical that the incentives are there to exploit those efficiencies; that is number one. Number two, even if they are there to exploit the efficiencies, the incentives won’t be there to pass them on to the customer. So, generally speaking, I think we have a sceptical approach to efficiencies in mergers. Having said that, we have allowed through a number of mergers in the last few years where there were good efficiency arguments made by the parties. We encourage people to make efficiency arguments; we don’t want to be a body that ignores that.

There’s a separate part to your question, I’m inferring, about minimum efficient scale. I have seen no evidence that suggests that you need a 33% or a 30% market share to achieve minimum scale. There may be evidence suggesting that below 5% or 10% of the market, it may be difficult to have the sort of scale to deal with the IT investment we’ve seen. But if you go back a few years you will remember that HBOS itself was a challenger bank in the market; it didn’t have a 25% market share, and it was doing rather well at competing with the other banks. So none of the evidence I’ve seen suggests that the minimum efficient scale is at 25% or 30% of the market. There might be some efficiencies about being able to spread your IT investment over such a wide market share, but it’s not clear that it’s of such a magnitude or that they would be passed on to the consumers.

Q789 Mr Umunna: Just going back to the first part of my question, then, I presume you would therefore agree with what Vernon Hill of Metro Bank said to us. He said the larger a retail bank is, once they get past a certain point, the poorer they serve the consumer. Would you agree with that?

John Fingleton: No. It is a very sweeping assertion, and I know some other markets where there are very large firms that serve the customer extremely well. What I would say is that in many other markets a very large firm can become complacent and lose its market share over time. So you see two different approaches: you see firms who are very good at constantly innovating, being responsive to the consumer, and keeping their leading market position, and in other markets we see companies where their leading market position gets eroded over time.

Q790 Mr Umunna: Do you think our five big boys have become complacent because of their size?

John Fingleton: "Become" is the verb I would focus in on. I’m not sure that this has ever been a market that has been incredibly customer-focused in that sense of thinking what do we need to do-

Mr Umunna: Hence all the fines we’ve been seeing over the last few years.

John Fingleton: Yes. Clearly there are pockets of the market where you see very high levels of competition. A few years ago, you saw very intense competition to win mortgage business; certain types of saving products might be driven by a very high level of rivalry. The banks do compete with each other, in the sense that the free-if-in-credit banking market is itself a sign of a certain type of competition, but it is channelled in ways that are maybe not particularly what the consumer wants.

Q791 Mr Umunna: I’m glad you brought up Lloyds-HBOS, because I was going to ask you a few questions about that. You obviously had some concerns about that merger at the time that it went through. My impression very much at the time was that there was a general consensus towards it, because people thought it was something that should be done in the interests of financial stability for the system as a whole. Do the concerns that you had then still remain valid now? Do you think they still remain valid now?

John Fingleton: There is no reason to think that the issues we identified then don’t remain valid but for the divestments that have come about, or will have come about, as a result of the application of the State Aid rules by the European Commission; that is point one. Point two is that once a merger has gone through and been consummated, if the answer to the question, "Would the merger have been a bad idea in the first place?" is a clear "yes", it doesn’t obviously mean that undoing the merger later is the right thing to do, because there could be very big costs associated with doing that.

Q792 Mr Umunna: Is there any evidence that it has been detrimental to competition since that merger took place?

John Fingleton: We haven’t tracked that. If we do an ex post analysis of what has happened in a merger, typically we would wait three to five years to see how the market has settled down. This market is anything but settled down. We would have great difficulty in separating out contraction of supply issues, divestment issues and other issues, and in working out what the marginal impact of the Lloyds-HBOS merger is on competition. At the time, we were pretty damn convinced this merger was going to reduce competition. We have a balance of probabilities test; we have to take a cautious approach. The Competition Commission has the ability to clear mergers in a different way than we do. The tests are slightly different for the Competition Commission, if it had gone there. But as to our assessment then, nothing that I’ve seen in the market since has made me think that some of the concerns we had would not become problems in the market over time.

Q793 Mr Umunna: We have taken evidence from Lord Myners, and he wrote a piece in the Financial Times on 13 December last year, which was well reported, in which he argued that proper consideration should be given to splitting up one or both of Lloyds Banking Group and RBS in the interests of increasing competition. Do you agree with him-yes or no?

John Fingleton: I agree that consideration should be given to it, but I don’t know what the right answer to that question is. That is a very difficult question. The Independent Banking Commission will, I think, be the first port of call on that, and we would then look at what the Independent Banking Commission has said. It is not clear what instruments the Government has to implement something like that. The Government can’t easily undo mergers. The competition regime can look at those issues. We can refer the market to the Competition Commission, for example.

Q794 Mr Umunna: That is quite significant: you think consideration should be given to splitting them up in the interests of competition, which isn’t the same, of course, as saying that we should actually do that.

John Fingleton: Yes. But I do think it is an important question where you’ve had a merger that has gone through. I will unpack that. I think there are two considerations there: one is the impact in the banking market; the other is the signal it sends more broadly-the incentive it creates for others to lobby for political protection from anti-competitive mergers. I think that people feel that getting an anti-competitive merger through by political clearance can create incentives for lobbying and rent-seeking, long term, and I think if people feel that is not a lifelong guarantee for a business, that it’s an important consideration as well. So that is another factor to be weighed in the balance. So it’s not just the impact within the banking market but the broader signal it sends about merger policy. But I’m not opining on what I think should be done; I am saying that it is an important question and in some sense it shouldn’t go unanswered.

Q795 Mr Umunna: I would have been quite astounded if you had pre-empted the findings of the Independent Banking Commission in that regard.

The other thing that Lord Myners mentioned in the piece that he wrote was what should be done with Northern Rock. This week, UKFI issued invitations to tender to corporate finance advisers to advise on strategic options for privatising Northern Rock. One of the things that Lord Myners has argued, for which I have great sympathy, is re-mutualising Northern Rock, again in the interests of competition and increasing diversity in the financial services sector. Where do you sit on that issue?

John Fingleton: On the question of what type of business model would be best, I probably don’t have a strong view. Lord Myners will have a different perspective on this, having been a Minister in the Treasury.

Mr Umunna: Of course, but I’m asking what you think about that.

John Fingleton: I don’t have a strong view. I think I would say that-

Q796 Mr Umunna: Do you think it would help with competition?

John Fingleton: I think what would help competition is for Northern Rock, or the privatisation of Northern Rock, to not add to existing concentration in the market. That would be my strongest point.

Q797 Mr Umunna: Do you think the privatisation of Northern Rock would add to concentration in the market?

John Fingleton: I think if it was sold to the wrong person, it could increase concentration in the market, and that could be a concern, but I wouldn’t want to opine on that formally because there are circumstances under which that issue might come before us formally for review.

Mr Umunna: Quite. Thank you very much.

Q798 Michael Fallon: Going back to the Lloyds-HBOS merger, do you think the Government was wrong to overrule your advice?

John Fingleton: I think at the time, in September 2008, when the original decision was made, the decision was perhaps understandable. I think in October, when the systemic issue had been dealt with by the recapitalisation of the banks, the assessment of whether the Lloyds-HBOS takeover then made sense became a different one. I think the problem was that at that stage, it had become quite a big juggernaut that was too difficult to stop.

Q799 Michael Fallon: Do you think they were wrong to ignore your advice and let it go through without insisting on some divestment, which the European Commission later did insist on?

John Fingleton: Obviously, we would have preferred if they had used the reference to the Competition Commission and gone down that path at that stage, yes.

Q800 Michael Fallon: So that was a mistake?

John Fingleton: Yes, I think so.

Q801 Michael Fallon: Why does it take you three to five years, as I think you said earlier to Mr Umunna, to look again at the competitive position of such a large group? Is this not something you monitor annually?

John Fingleton: First of all, the Lloyds-HBOS merger is fully legal and it is not our job to go and try to override what Parliament and Government have decided to do. So, one can express a view on it, but we work within the existing law. The Lloyds-HBOS merger is a fully legal merger; I don’t want any doubt about that. What we would want to do before we intervene in the market is establish that there is a case for intervention. I think there is quite a lot happening in the market at the moment, when you take the work we’re doing on switching, the divestments that are happening, and the Independent Commission on Banking; I think it would be foolish of us to try and engage in further, duplicative activity. So, for example, we are doing the equity underwriting work, which is not duplicative, and we have done the barriers to entry work, which is intended to complement and provide a better evidence base for the work of the Independent Banking Commission. While all of that is going on, we wouldn’t propose to open any significant examination of the market. After the Independent Banking Commission has reported, after the Government has responded to that report, we will want to look at that and then take a view on whether any further action is required.

Q802 Michael Fallon: So simply the existence of those two other inquiries means you won’t revisit your original concerns?

John Fingleton: When companies merge-and going back to the earlier question about the efficiencies-it takes quite a bit of time for things to bed down, and we would not be able to measure the effect of the merger. We did a prospective analysis. We tried to anticipate what the effects of the merger would be.

Q803 Michael Fallon: Sure, but it’s two years ago now.

John Fingleton: But the full effect of the merger will not have been felt yet. On the implementation of that, market dynamics are very slow. We do ex post evaluation of mergers, and it is at least three years, if not five years, before you see what has happened. Separating that out and identifying the marginal effect of the Lloyds-HBOS merger from other things would, I think, be very challenging. Quite apart from that, I think it would be inappropriate simply to go after the merged bank now because you didn’t like a decision that was made. That might appear vindictive. I do think we should look at the banking market as a whole and ask what is wrong with the banking market as a whole, and come at it from that point of view. I think that would be the fair way to deal with it. The efficient way to do it is to do that when everything else has settled down, and then you can look properly at where you have got to.

Q804 Michael Fallon: That is helpful. It has been proposed that an alternative to breaking it up is to introduce a cap limiting its market share in certain products. How do you weigh the comparative costs of restructuring against the benefits of competition?

John Fingleton: I think a cap on market share would be a rather crude instrument to try and achieve that. We’re trying to encourage dynamic competition in the market. If Lloyds manages to win customers over by better offerings, I wouldn’t want to prevent the consumers benefiting from that.

Q805 Michael Fallon: You spoke earlier about the costs of having to break up a bank, and so on, which also get passed through to the consumers. How do you weigh the balance of those two arguments? Even though a cap might be crude, it might be cheaper.

John Fingleton: A cap could create quite a big incentive not to be very efficient. I would weigh the cost of that incentive for the bank not to be efficient-so they would lumber along not feeling they had much incentive to do good-against the costs of the divestments. The problem with divestments is that it is always going to be what it is that you cut out, because simply divesting small bits of the business may not be enough of a leg-up for entrant banks. I think that is part of the cost and the challenge there.

Q806 Michael Fallon: Just one final question, if I may. On new entry, we haven’t really had a second tier of banks. It all seems incredibly slow. Apart from the switching you have referred to, are there other changes that could make the whole thing more competitive and just make it faster for new banks to enter?

John Fingleton: I would say that even in other, highly competitive, markets we see, the entry process and the process by which firms grow is slow. If you think about airline liberalisation, the first liberalisation measures happened in ’87 at a European level, and they happened from ’87 through to ’97. The low-cost airlines business model really only took off in the last decade as a serious phenomenon; even in that market, with very high levels of switching and very high levels of customer transparency, the incumbents retained market share for quite a long time. But what we have seen there is that the incumbents brought down their prices and became much more efficient over time.

On the process of entry, going back to the point Clive made about the within-firm and between-firm effects, what you really want the competitive process to do is not to wipe out the incumbents but to force them to be more efficient. Very often, a market entrant-a challenger-with 5% to 10% of the market can have a dramatically big effect on the others, simply because of the threat that they are going to grow. If the incumbent banks respond to that, the process will look slower, but you get a lot of the delivery of the effect on the ground.

I think what we saw with the market study, and what we probably regretted about Lloyds-HBOS, was that HBOS was a challenger bank. It did things slightly differently; it had a different strategy; it was a little more disruptive in the market. Competition authorities like challenger entrants. We like entrants who come in and try to do things a bit differently and try to upset the existing business model, because they cause more potential for change in the market, and we like to see change in the market. So I think at the moment we’re at quite a sensitive period in trying to work out which of the new entrants’ business models might succeed, and what we see in the market is there is a diversity of different business models being used in the market. That diversity is quite healthy. At the moment we would foster that-anything we can do to help it. The reason why we did the piece on barriers to entry before Christmas, and so on, was to make sure that the regulatory system and other things weren’t interfering with it.

Clive Maxwell: I have just one small thing to add to that, to do with thinking about where new banks come from. They can be set up from nowhere, or they can be other types of businesses that choose to get into banking. So I think thinking about the different parts of the retail banking market is quite important. We would certainly be concerned if, for example, some of the regulatory hurdles to getting into some of those markets that are very closely related to retail banking, like some of the types of corporate lending, were raised. If the entry barriers to those were raised, it might make it more difficult for firms to take the first step up, and then to be able to get into the more core retail banking markets later.

Q807 Mr Love: I want to ask you some questions about current accounts. We have found it incredibly difficult to get clear answers from some of our witnesses so far. Are current accounts profitable for banks on a stand-alone basis?

John Fingleton: The banks don’t attribute their cost by product line.

Mr Love: We found that out.

John Fingleton: Consequently, it is not possible for us to make that assessment. I should say, when we did the market study, what we did do was outline where the revenues came from, and what we found was that I think 70% or 80% of the revenue from the current account market came from foregone interest and from default charges. What we were not able to do, and we don’t have investigative powers in our market studies, was to-

Q808 Mr Love: Are those the latest figures you have from your 2008 study?

John Fingleton: Yes. We have not updated those figures, no.

Q809 Mr Love: Let me ask you a slightly different question. Free-in-credit banking: who gains and who loses from the free-in-credit banking model, and do you believe that cross-subsidy exists in that model?

John Fingleton: There is truly a cross-subsidy, because people who don’t pay anything over the year for their current account clearly have cost something to the supplier. Therefore, there is logically a cross-subsidy. The people who benefit in that model are the people who have average balances that don’t go into overdraft and who manage their accounts very well. People with average balances of less than the £1,000 a year are far more likely to go into overdraft. As that number comes down, you get numbers that go into overdraft, say, six times a year. If you go into overdraft six times a year, the chances are you are paying way above the average cost of a bank account. So there is an important distributional aspect of this. Some of the people at the lower end of the income distribution are cross-subsiding people perhaps in the middle. Perhaps some people at the higher end of the distribution with high average balances, on the foregone interest, are also cross-subsiding some of the people in the middle.

In terms of customers whom the market serves well-this is a phenomenon we see in the credit market as well-those on lower incomes face less competition for their business. If you have a poor credit record, generally speaking, you’re going to find it more difficult to switch; you are not going to have people competing for your service. Possibly those in Scotland, as a result of the merger, also face less competition for their business. So there are pockets of consumers, either geographically or in terms of average balances in their account, who may face less competition in the market, and there may be other customers who might find quite a lot of competition in the market if they go out and search around.

Q810 Mr Love: Let me ask you: we suspect consumers out there think free-in-credit sounds great, but there is a complete lack of transparency. How important is it to improve transparency so that the consumer understands better? And how about this cross-subsidy element that you have talked about-is that something you’re concerned about?

John Fingleton: The cross-subsidy is not in itself something that would concern us. If you think about airline pricing, people who book late cross-subsidise people who book early, and that happens in quite a competitive market. So we don’t necessarily think that cross-subsidies are inconsistent with the competitive market situation. I think what concerns us is the inability of people to know what they pay for their bank account and, as a result of that, the inability to make any meaningful comparison between them. There are clearly very big distributional consequences from changing that model, because if you move away from free-if-in-credit banking there will be winners and losers. In any process like that, the losers usually cry a lot harder than the winners cheer; it’s much more visible to them. In this case, I suspect that would be particularly true.

So we have very much adopted the approach of trying to make sure that where the banks make their money-on the foregone interest and on the overdraft charges-that that is far more transparent than it has been. Clive has outlined the measures we have done in that regard. We could go further. We have gone probably as far as we can go. We’re doing what we do now with voluntary persuasion by the banks. I think it does require tougher powers to get that bedded in properly.

Q811 Mr Love: That is leading me up to the very obvious question. You mentioned the Supreme Court decision, and the disappointment that you weren’t able to look at the fairness aspect of this. If these conditions were amended to allow you to do that, what powers do you think that would then give you to deal with some of these issues?

John Fingleton: I think the way we would prefer to go with that is to make this specific for this sector, because some of the issues we see here are very different from the issues we see in other sectors. So dealing with it through the specific regulation and the CPMA might be a better way of dealing with it than trying to change all consumer law. I think the risk of changing all consumer law to address the Supreme Court decision would be that it would create a lot of uncertainty for other businesses and other sectors of the economy about where intervention might occur. Having said that, we will publish a market study in February on consumer law and our approach to consumer contracts generally-issues like small print and so on. That is very much with a view to us bringing other cases that clarify the law in this area, and trying to get back to some of the issues that came up in the Supreme Court case.

I wouldn’t give up on the fairness law to be able to deal with similar issues in other cases. I think it is really important that we don’t just look at one case and think, "Well, that’s it: the law is useless." I think it is always important to bring other cases. This case had a number of very unusual features, and we would like to bring other cases back before the Court of Appeal and the House of Lords in due course, having thought through what they have said in this case and framing it correctly. So I think our view is that, broadly speaking, current consumer law is fit for purpose. We don’t think that should be upset, but we think that in the banking sector there are very specific issues that the CPMA should deal with.

Q812 Mr Love: But you wouldn’t want to ban cross-subsidy in any shape or form through fairness provisions?

John Fingleton: No. We are very much driven by trying to get the market to sort this out and trying to encourage the banks to be the ones who lead in that process. It will be more efficient if it happens in that way.

Q813 Mr Love: We have asked quite a lot of witnesses from the banking industry about the free-in-credit banking model, and whether or not that is a barrier to competition. There has been quite a move in recent years towards packaged accounts, but generally speaking, the free-in-credit model has survived and thrived. Is it a barrier to competition and how would you foresee an alternative model emerging?

John Fingleton: It is part of the barrier to switching at the moment, because it is part of the transparency. For a long time I have said that very often it’s not free; people are paying. So in some sense there is an element of it not being what it says on the tin. I think that is not helpful for competition or for switching. I wouldn’t favour saying that you should regulate to have fixed fees for banking. That would seem to be heavy-handed. Instead, I think it’s paring away at hidden charges, so that you are forcing the banks to put more and more of it up front. What might emerge in the market then is a situation where there are more products with up-front fees. You might still have some free-if-in-credit banking, but cross-subsidised in a more transparent way that enables better switching between consumers. That type of diversity in the consumer offering might be better than trying to impose a standardised approach. I think what it requires is that you really pare away at the untransparent hidden charges that are in the system. As long as they are there, and they are allowed to cross-subsidise the up-front fees, you are always going to have that problem.

Q814 Mr Love: Finally, let me ask you, philosophically in a sense, will that be enough? Will transparency-exposure, if I can put it as crudely as that-be enough to get the banks to change the model, or do you need some rather heavy-handed regulation that you are reluctant to go down the road of?

John Fingleton: We’ve never tried it, but we see that it works in other markets, so I think it is worth trying. I think Adair Turner, when he was here, may have used the term "nudging the market in the right direction", and I think what we need is a CPMA that has the regulatory power to nudge the market faster and harder than we’ve been able to do, but to continue that, what I would call, "nudging approach," so that you do let the dynamic in the market lead it forward. Regulators would not be well placed to control the IT investments and the systems that banks develop, and to anticipate all the possible ways in which banks may try to get around regulation, game the system, and so on. I think if you can work with the grain of the industry, work with competitive incentives and try to get them to work better, that’s a better way to go. So I’m not advocating heavy-handed regulation-that the CPMA should regulate every price in the market and, in some sense, try to impose a market solution-but in giving it a competition objective, and making sure it has the tools to nudge the transparency issues in the right direction, that it is really forcing the market to sort this issue out. If we go down the road of thinking the regulator sets prices in the market, we would probably have a very inefficient sector, and it might be worse than it is now.

Q815 Andrea Leadsom: You said earlier that you do believe the CPMA should have a competition objective, a specific one. How would that work in conjunction with the proposed merger of the OFT and the Competition Commission? Do you think that they would work together? How could you see that working to improve competition in the banking sector?

John Fingleton: I don’t think the merger of the Competition Commission and the OFT would have any impact on giving the competition objective to the FSA. At the moment, the way the system works is that we have a duty to look at the rules the FSA sets and give the FSA an opinion on competition. We’ve done that a lot, for example, with clearing houses, stock exchanges and so on, and it has given us a good evidence base on the issues in the industry. It would affect that relationship, and some of that would then be done internally by the CPMA. It would not take away from us the ability still to offer an opinion on a voluntary basis if we thought there was a problem. We retain that ability in any sector that we look at. Normally, we do that by working closely with the regulators. We do this in communications, energy, water, transport, and so on; we work with the regulator informally on a lot of these issues, and they come to us for advice and we give them advice, as we do with Government Ministers who are thinking about regulating things. So I think that the merger of the OFT and the Competition Commission is not specifically relevant to that question. It just raises a broader question.

If I could mention payment protection insurance as an example, payment protection insurance is an issue that was dealt with by the OFT, the Financial Services Authority and the Competition Commission, and there is certainly an argument that the competition part of that, which the OFT and the Competition Commission dealt with, could have been dealt with faster and better and with greater consistency for everybody if there had been two organisations rather than three organisations. That is not to say that the co-operation between the three organisations was not handled well, but it is always more difficult to manage a relationship among three bodies than among two bodies. As we and the Competition Commission apply broadly the same competition tool in that case, that type of benefit could arise from a merger.

Q816 Andrea Leadsom: Moving specifically to the question of switching, you will be aware of the various conversations we have had here on the idea of account portability. Sir Don Cruickshank was particularly in favour of consumers being able-but obviously not compelled-to move their bank account with them, to dramatically change overnight the prospects for switching between banks. The first question is: would you support that as an idea? The second question is: if there were such a move to do that, who would you see enforcing that? Is that something that the OFT would give direction on or is that something that, in the future, you would see the CPMA giving direction on?

John Fingleton: In answer to your second question first, it would be very much something that would be done at a sector-specific level by the regulator, as Ofcom does in number portability, for example. If one compares number portability with telephones and number portability with bank accounts, there is an important difference. It is critically important with telephone numbers that everybody else knows your telephone number. Therefore, changing your telephone number is very costly: you have to change your business cards; you have to tell everybody; you risk losing contact with people you haven’t seen for a while, and so on, when you change your telephone number. With your bank account, you can function your bank account without everybody you know knowing your bank account number, so the benefits of that and the costs associated with switching are slightly different.

If the switching process makes sure that those people who need to know your bank account number change-that is, those people who have standing orders and other relationships with you-then I think it deals with a large part of the issue. So the benefits of having number portability here are probably lower than with telephone numbers. On the other side, the cost of number portability needs to be brought into the equation. So I think there is a careful cost-benefit analysis of whether it is worth the systems costs that would be there. I don’t know the answer to that question. My intuitive hunch would be that it could be very costly and not worth while doing it in the short term. But if you said, "From 2020 or from 2025 that is what we expect", you might give the banks the time to make sure that the upgrades to IT systems that happen over the next 10 years move in that direction; so you set it as a longer term objective. That would be a much less costly way of achieving it. So I think with some of these things, we have become very aware that well-intentioned, industry-wide moves, when everybody has different IT systems, can be very costly to implement in the short term.

So, certainly intuitively-and again I’m caveating this; it is my own personal intuitive stance-I am attracted to it as a long-term vision for the market. There are some other things there that I think one should think about in that regard, but in the next year or two it wouldn’t be my top priority.

Q817 Andrea Leadsom: Can I just push back on that a bit? We had Jayne-Anne Gadhia, Chief Executive of Virgin Money, here this week. She was very much saying that in her experience-obviously, they are a business trying to win account customers-one of the biggest objections is this whole concern that consumers have that "If I change my bank, then my direct debits will be lost; my TV bill won’t be paid," or whatever it is. Indeed that does prove to be the case, and there is a period-some of the chief executives of the big four said it is between two and six weeks-to transfer all of that information.

So while I take your point about telephone numbers-you want people to know it, whereas for bank accounts, you don’t-on the other hand, if you have a complicated life, as people do these days, there is that concern that things won’t get transferred in a timely fashion. Surely that is a big contributor to the reason why people don’t switch banks and that in itself has huge implications for bank customer service, their willingness to improve and to be innovative, and so on. Certainly, Jayne-Anne Gadhia felt that it was a key to improving competition in the retail sector.

John Fingleton: If, when things go wrong in the switching process, the banks are liable-there is a certain irony in the fact that if I don’t manage my personal or current account balance well, the bank can impose a very large charge on me, but if the bank doesn’t manage my switching process, I can’t impose a very large charge on the bank-and if you said that when things went wrong, the bank had to compensate the customer for things going wrong, that might be a far more effective way of dealing with the switching issue. As Clive has said, the complaints about switching have come down from over 30%, I think, to about 10%.

Clive Maxwell: 32% in 2007 down to 8% in 2010. That is the perception of it.

John Fingleton: The perception of it is not to be ignored. I agree with you. I don’t think I disagree with the vision you have for the consumer perception that things should go well. I am arguing that, on the cost side, it could be very costly to implement it quickly. But I think longer term it is very compelling.

Q818 Mark Garnier: In your report-and I am looking specifically at the FSA, at the regulatory process here-you said that a small number of respondents indicated that the uncertainty, length of time and cost of the application process had proved insurmountable, and decided not to apply for a banking licence. This was something that I picked up and have been sticking needles into to try and extract more information about it. Certainly, when we interviewed Hector Sants and Adair Turner about it, he came back and said, "No, no, this is not the case; it only takes six to nine months."

I followed the same line of questioning up with people like Virgin Money and Vernon Hill at Metro Bank, and their experience has been very much that the FSA is very good and the whole process has been very easy, although Vernon Hill did say it took 18 months to get their banking licence, which obviously is different from what Hector Sants has said. But I am particularly interested to find out more about those people who have had problems because, of course, we don’t get the people who have failed to get a banking licence in front of us. I’m just wondering if you could expand on that and say what the problems are that you have seen for people who have failed to get a banking licence, or been put off getting a banking licence?

Clive Maxwell: Yes. When we talked to people about their experiences in doing this, one message we got through was that, in fact, things probably had improved over the recent months. As John said, the FSA has had a period where they had very few banking licence applications, and they have changed some of their systems and the way in which they deal with things. The message we were getting from businesses was that it is very often the uncertainty that they find most difficult; that there is a certain circularity-the chicken and egg situation here. For example, something that a firm will need to be able to demonstrate to the FSA is that they have finance in place and funding arrangements in place. Needless to say, in some cases the providers of that funding will only sign up to the necessary documentation when they know that the licensing has reached a particular point in the process. That is the sort of thing the FSA has been looking at-how to create milestones through the process to give people a better understanding of where they are, so they can be talking to their backers and to other businesses about where things have got to, and to give them a key member of staff who will follow that process through.

The thing I find very difficult to know, where firms have not been given a licence, is whether that is because they have decided to withdraw because of the quality of the licensing process, which is the FSA’s responsibility, or whether it is because they didn’t like the sorts of conditions that the FSA were requiring of them, and they couldn’t meet those requirements.

Q819 Mark Garnier: Yes, which is a very good point, and there is the so-called Catch 22 problem, which is where, as you say, you have to have evidence of funding in place, and this is a big leap of faith into the unknown, to a certain extent, by the investor.

Clive Maxwell: It is.

Q820 Mark Garnier: Of course, the other problem is the IT systems, which seem to be bespoke. Do you think that is a big problem? Of course, you have to have your IT systems in place in order to test them to get your licence.

Clive Maxwell: Yes. The IT raises some similar sorts of issues that have required significant types of investment. That investment is very typically sunk, so not only is it a lump of funding, but if the business doesn’t take off, very often you will have to write off those costs. So people are very wary about making those financial commitments to IT. Being able to prove the stability and solidity of the IT systems is one of the important steps that people have to show to the FSA, so again that is an important part on that critical path of becoming a bank.

Q821 Mark Garnier: And the fact that there aren’t any off-the-shelf systems is also a problem?

Clive Maxwell: No, that is true. I think increasingly there are more things that look like off-the-shelf products. I think the people we spoke to tended to say, yes, you buy the off-the-shelf system, but then in fact you need to spend quite a lot of money making it specific to your business. So there are a range of options there. It is quite possible that different ways of thinking about computer systems and being able to rent some of that computing power, or buy it incrementally as the size of your businesses changes, will offer different sorts of business models to people wanting to get into banking in the future. I think some of those sorts of developments are starting to happen.

Q822 Mark Garnier: Are you talking to the FSA about how they can improve their regulatory process? If so, what sort of recommendations are you making?

Clive Maxwell: What we said in that particular report is: we talked very closely with the FSA about their experience over recent years, and we listened to the improvements that they said they had put in place. Those improvements seem to us to be in the right direction, as to what they should be doing. I think time will tell whether they go far enough, in terms of being able to provide the certainty to people as they are going through the process.

Q823 Mark Garnier: Finally, on Basel III, again, you need quite a lot of capital, and increasingly more capital under Basel III. This sort of fundraising thing is obviously a key barrier to entry, particularly when you are trying to build a business from scratch, ab initio, as new businesses would be doing. Do you think there is any way that we can tackle this problem, and do you think there should be slightly different capital requirements at the earlier stages, while a business gets going?

Clive Maxwell: You clearly want banks to hold a certain amount of capital. I think the expectations of those levels need to be higher than they have been previously. We are also seeing, though, ideas about the fact that capital requirements should reflect some of the different sorts of risks that different institutions pose. For example, it may be that larger, more systemically important firms will have to hold proportionately more capital, not less capital. So you might see a differentiation on the basis of size across different types of banks. That might have the same sorts of effects in the real world as what you are suggesting. I think we will have to wait and see how that happens.

I think customer trust and confidence in an institution, especially a new one, is very important. As part of our survey results, we asked customers about switching, interest and things. That is clearly an important consideration for them. I suspect that feeling that a new bank was less well-regulated, had less capital and lower funding requirements might make them more worried about that sort of bank than they ought to be.

Q824 Mark Garnier: Do you think Basel III is an advantage, or a disadvantage or disincentive, to people coming into the market? On the one hand, you have the greater capital requirements, but on the other hand you have a safer system, so therefore you may feel more inclined to come into it.

Clive Maxwell: I don’t think we would be able to take a view. It is a big set of changes to the capital requirements across the economy. A lot of the implementation issues are still being worked through. I think the sort of flexibility I talked about may well end up being quite important.

Chair: A quick question from Michael Fallon.

Q825 Michael Fallon: I just want to come back to Mr Fingleton on this concept of challenger banks. How can we be reassured that the new regulator will understand the need to look at business models in that sense?

John Fingleton: I think that the new regulator will want to be able to tell a story about competition in this market a few years out-to say that the regulator has made a difference. I think it is going to be very important for the CPMA to be seen to have brought about change in this market.

Q826 Michael Fallon: How do they do that if we’re moving to more of a judgment-based regulatory environment? How can they bring about change?

John Fingleton: I think by addressing the transparency and switching issue, and the CPMA will have regulatory powers to do that. I should mention as well that our credit powers will move to the CPMA. The Government is consulting on that at the moment, but that is the expectation of the outcome of that process-that credit regulation will be done by the CPMA as well. That will also give the CPMA the power to regulate the credit side of the market, as well as the deposit side. I would say that if the CPMA has an objective to promote competition, and has the ability to deal with the switching issues, the new entrants in the market are much more likely to be challengers in some sense, because they will be bringing some fresh, new ideas or some approach that they have from existing markets they are in, bringing that into the market and having a different approach to customer service.

Q827 Michael Fallon: They will need a competition policy division, won’t they? As well as an objective, they will need people to do the kind of analysis-

John Fingleton: They will need that skill within the organisation. I wouldn’t go so far as to work out how they should structure it internally, but they will need-

Q828 Michael Fallon: They will need some of your people, to be blunt about it.

John Fingleton: They will need to analyse the competitive effects of rules that they make. I don’t necessarily think that means a vast number of people. It is as much about attitude and approach to the type of questions you ask.

Clive Maxwell: Can I give a particular example, at a very micro-level, of the sorts of difference it might make? There are questions such as whether to put interest rates on the statements for savings products. You can look at that from a narrow consumer protection point of view, in the sense of saying, "Now, the consumer needs the right information. You need to protect them, look after them and make sure they have that information," or you can look at it from a competition perspective as well, and you can say, "Well, in thinking about the benefits that putting those interest rates on the statements"-for example, cash ISAs are a market we have looked at-"not only do you get those benefits of consumer protection but, by having that information, you will help drive competition in the market through the market." So it is about the way in which the body could think about regulation.

Q829 John Thurso: Can I apologise to the witnesses for being absent for much of what has been said? I was unavoidably in the Chamber. Can I ask a very quick question regarding consumer credit, which is due to go to the CPMA? Are there any dangers you foresee in that, or any particular things that need to be looked out for?

John Fingleton: As with any change like this, there are going to be risks that need to be managed. At the moment, we enforce consumer law and consumer credit law in tandem. So there is a risk associated with separating those out. There is also a risk in that the majority of the businesses that we regulate are small businesses. I think 40% of the licence-holders are sole traders. They are generally people involved in some type of retail or other service business where, because of the cost, it makes sense to break it down into payments, and they need a credit licence to do that. We have just under 100,000 licensees in the consumer credit regime, so you’re putting a lot of the retail sector under a financial regulation when really it is retail, and not financial, regulation.

It has never been easy, because, of course, then we end up with the large institutions as well on the credit side. But it doesn’t make sense to have the large institutions just in the CPMA and the small ones in ours, so we think it is just important to manage the risk. One of the things I think could happen is that we might expect the fees to rise. We are, I think-touch wood-not the highest-cost regulator in the world. Even the industry itself sometimes says to us we should raise more fees and do more activity. We stepped up our activity a lot in that market in the last two years, really trying to clean up the market. But I think one can expect that the fees would rise a lot. So there is an issue about the impact of that on sole traders and small businesses who hold credit licences, and that needs to be thought through. I don’t think the intention is to rush the move, and I think there is plenty of time to think through those risks.

Q830 John Thurso: One of the reasons I ask-it is a small example-was the work you did last year on the debt management industry. You have a large chunk of it that has no fees to the consumer because it is paid for by the people that they deal with, which I think is largely regarded as a pretty effective way of doing it. But there is a growth industry of people who charge the consumer a fee, where quite a number, as you have highlighted in your September report, give a very poor service. Is there a concern that those kinds of important bits of work might fall through the cracks?

John Fingleton: No. I think we would expect that all of that work would continue regardless of the switch. We gave warnings to 129 firms in September. We are going to follow that up, and we would expect that follow-up to continue seamlessly through. We’ve also taken a lot of action on home credit in the last year, which we’ve seen as a particular issue, and we’ve done a lot to try and create minimum standards in the sector and done a lot on guidance in the sector as well. So I would expect all of that to continue through.

Q831 Chair: Thank you very much for coming to give evidence. There is one issue that you haven’t covered, with respect to barriers to entry on the switching side, and that is fraud, which has often been put to us as a concern. People are reluctant to switch because they think it might increase the risk of fraud. Rather than explore that now, I wonder whether you could come back to us with what information you have been able to glean on it. At various times we have tried to obtain a bit of information orally from witnesses. We haven’t done very well on it, but it has certainly been raised with me outside formal sessions.

Today you are announcing, are you not, your conclusions on the case for anti-competitive practices in RBS? You mentioned it earlier in your evidence. Is there anything you want to say on that before we conclude?

John Fingleton: No. I think it is a formality of a decision that is already properly known. There is no particular news in that. It is just the writing-up of the decision whereby RBS agreed to pay a fine of £28.6 million last year in respect of a breach of competition law. We are very pleased that we dealt with that case expeditiously, and that resulted in everyone being sent an important deterrence message, a compliance message, not just in the banking sector but across the economies.

Q832 Chair: And that suggests that there are some anti-competitive practices around.

John Fingleton: We have done a huge amount of work on compliance, and one of the things we have seen in a number of cases is that one of the things companies need to worry about is when individual employees move from one business to another; you really need to focus on compliance then, because very often what we see is that the companies don’t want to have this type of investigation and a fine. What we’re trying to do is to help them understand how to avoid it. That is the best answer we can get, in terms of the economy.

So we are seeing some risk factors, and there is always a risk factor when employees move from one bank to another operation. But I think you come together to meet common standards in the industry. We have produced some compliance guidance for business last year, in the light of this and other cases, highlighting a risk-based approach where-and in the banking sector you have a lot of this-people do need legitimately to come together from competing businesses to discuss shared standards, but where they need to be absolutely crystal clear about where the red lines are that they must not cross. So where we see those red lines crossed, I think we will take a strong view on enforcement, because we need to make sure that banks take their compliance responsibly in that area, as with other firms in the economy.

Chair: Thank you very much for coming to give evidence. It has been extremely clear-outstanding; very direct answers, and very valuable for us in the conduct of this inquiry. Thank you both.