Competition and choice in the banking sector

Written evidence submitted by the Yorkshire Building Society

Executive Summary

· Building societies make a crucial contribution to the competition, diversity and strength of the UK’s retail financial services sector. Yorkshire Building Society (YBS), as a mutual, is able to offer competitive rates on savings and mortgages because it does not have to maximise returns to shareholders. YBS believes that, provided they are able to compete on fair and level terms, building societies can further enhance the level of competition in the financial services market..

· YBS believes that, in investigating competition and choice in the banking sector, the Treasury Committee may wish to scrutinise (a) the distortions that injecting public funding into plcs has created in the market, and (b) how current and proposed regulation of financial services is a significant and growing barrier to fostering competition, choice and innovation in the sector.

· YBS has welcomed the Government’s stated intention to "foster diversity in financial services, promote mutuals and create a more competitive banking industry1" and is encouraged by the Chancellor’s recent statement that "building societies and mutuals have an important role to play in the future". YBS looks forward to seeing how this stated intention to promote mutuals is translated into action.

· One of the biggest priorities for YBS is to ensure that current and future regulatory requirements appropriately reflect the mutual model. A number of new and proposed regulatory requirements have been created or implemented. These new and proposed regulations have tended to favour large legacy institutions, with additional prudential regulation typically representing a disproportionate cost to small firms. In addition, we believe that little account has been taken of organisational entity in terms of regulating the financial services industry.

· YBS therefore believes that the Government should commit to alter the terms and approach of regulatory and supervisory authorities, including the FSA and its successor bodies. This would include appropriate and proportionate treatment of mutuals in respect of capital and liquidity requirements, and other key regulatory issues such as the funding model for the Financial Services Compensation Scheme. In particular, the financial mutual sector needs access to a mutual capital instrument.

1 Introduction

1.1 Yorkshire Building Society (YBS) welcomes the opportunity to contribute to the Committee's important and timely inquiry into competition and choice in the banking sector. YBS, which also incorporates the Chelsea and Barnsley building societies, is the second largest building society in the UK, with a strong belief in, and commitment to, the mutual ethos. With total assets of £30 billion, the Society holds £23 billion in residential mortgages and £23 billion in members’ savings from 2.8 million members, and employs approximately 3,000 staff in a network of 178 branches and 77 agencies located across the UK.

1.2 The Yorkshire's geographical reach creates a business that is big enough to compete, yet small enough to care. Its commitment to the communities it serves is reflected in its retention of branches in areas where many other lenders have withdrawn. Over the last few years YBS has experienced a growing high street presence, at a time when many others have been reducing theirs. Our approach to mergers (see also paragraph 2.5 and 3.1) is predicated on the creation of a strong organisational centre balanced by the retention of local names, brands, character and presence in and understanding of the local communities from which we derive our strength and sense of identity and purpose.

1.3 YBS views its approach to financial stability and strength as being a direct consequence of its mutuality and the governance arrangements this entails. Strong capital and liquidity positions ensure the Society and its constituent brands are well funded. Although not untouched by the financial crisis, YBS’s financial resilience enabled it to emerge from this period of instability in much better shape than many quoted banks, without having recourse to taxpayer support. Moreover, the mutual sector as a whole, through consolidation, has largely protected the sector’s own strength and, in turn, enhanced the stability, vigour and diversity of the wider UK retail financial services market and supported its recovery.

1.4 YBS continues to work hard to maximise opportunities for its members to contribute to the effective running of the Society and in order to develop and sustain over time a robust mutual governance model. This accountability structure is a key differentiator between the mutual model and that of the plc. Member forums, a members panel and member 'question time' meetings also play their part, as part of a coherent and self-iterating programme of member engagement, in ensuring that the Society's leadership team remain continuously accountable (with votes on key issues, for example, remuneration), take decisions for the longer-term, and act with the interest of members at heart. The long-term, sustainable approach to lending that YBS has maintained in the past decade and more has allowed the Society to retain a strong financial position during and after the financial crisis.

1.5 This submission seeks to address important issues in relation to competition and choice in the banking sector, including:

· The distortions that injecting public funding into plcs has created in the market for competitors which do not have the benefit of the implicit guarantee that State support entails.

· Throughout the period of financial crisis and following it, building societies retained a higher level of consumer confidence than plcs. This is reflected in regularly measured levels of customer satisfaction2.

· How current and proposed regulation of financial services is a significant and growing barrier to competition to the sector. How regulation disadvantages building societies by failing to take into account comparative organisational structures on issues such as capital and liquidity requirements.

· Specific proposals on how to ensure the future stability and growth of the mutual sector in a way which creates a level playing field with the banking sector, something which YBS does not believe currently exists.

2 The impact of the financial crisis on competition and choice

2.1 An immediate consequence of the financial crisis of 2008 was, for mutuals and quoted banks alike, a substantial tightening in credit available to consumers. YBS, in common with other building societies, was less badly affected than the retail banks – most notably the nationalised and part nationalised banks – and has been able to continue to offer a wide and well balanced range of competitively priced products which continue to top "best buy" product league tables3.

2.2 But, whereas the retail banks benefited handsomely from taxpayer support (variously including the Bank Recapitalisation Programme, the Asset Protection Scheme (APS) and the Credit Guarantee Scheme), these initiatives, although ostensibly accessible on fair and level terms by the building society sector, were largely unavailable to most mutuals to draw down upon.

2.3 YBS was in a position to utilise the Credit Guarantee Scheme (CGS), which was for it a potentially suitable vehicle. Although in principle the scheme was the perfect vehicle to strengthen depositors' and broader market confidence in the mutual sector, in practice, it was much less accessible to the mutual sector than to banks, when the need arose, because many building societies were too small to issue debt securities which this initiative sought to underwrite with State support.

2.4 Although YBS did not require the type of support that other, more short-term, shareholder-focused financial entities did, counter-intuitively, those retail deposit taking institutions that took State aid came to be seen by many as enjoying a special status as "too big to fail" which enhanced the perception of their attractiveness in the eyes of actual and prospective depositors. Consumer inertia to switching means this remains a legacy of the period of instability. YBS believes that this situation could be exacerbated as the Special Liquidity Scheme is withdrawn.

2.5 Nonetheless, the building society sector in general, and YBS in particular, has played its part in reinforcing the stability of the mutual sector, and the continuance of a diverse and more robust financial services sector, through a process of defensive consolidations: YBS merged with the business of the Barnsley Building Society in December 2008 and merged with the Chelsea Building Society in April 2010. It is important to note that this strengthening of the building society sector was achieved at nil cost to the taxpayer.

2.6 So far as consumers were concerned, the market in mortgages saw a reduction of products from 27,105 in April 2007 to just 2,516 products in January 2010, according to Money Supermarket. Today, although lending criteria remain strict, that figure has risen to 2,990, and among the best mortgage products are to be sourced from the building society sector.

3 The impact of widespread consolidation among banks and mutuals

3.1 In the course of the past two years, YBS has merged with other building societies (see paragraph 2.5 above). The circumstances and rationale for each transaction were different, but both building societies share YBS’s commitment to mutuality and the values which go with this.

3.2 The financial services market has changed fundamentally in recent years, and scale is increasingly important for the efficient operation of building societies and access to funding markets. However, while remaining big enough to compete, YBS is small enough to care about its customers and the communities it serves. In addition, YBS strongly believes that its retention of the three separate brands of 'Yorkshire', 'Barnsley' and 'Chelsea', with their own high street presence and product sets, competing with each other and other providers in the sector, sustains strong competition, while helping to ensure the longer-term strength of the mutual sector in the utility retail financial services.

3.3 In YBS’s view, the system protects and in fact entrenches incumbency; militates against dynamic competition in the marketplace; and, most crucially, denies consumers real choice; and, structurally and behaviourally, obviates the switching between brands and products that, in a truly competitive banking sector, this would predicate.

3.4 New regulation to support financial stability, as well as enhanced capital and liquidity requirements, have collectively had the perverse effect of further entrenching the position of the large quoted banks, a number of which are supported by substantial taxpayer support. This has further protected their positions and, in inverse proportions, enhanced the disparity between the competitive positioning of banks and mutuals to high street consumers. As the BSA has noted, in 2009, the Lloyds Banking Group had a 24% share of new mortgage lending and 28% of the increase in deposits; Santander took about an 18% share of new lending and 23% of the increase in retails deposits.

3.5 Existing regulators can easily give the impression that they find it easiest to deal with large deposit-taking institutions, based on a plc model. This has the effect of further legitimising the plc model in preference to the mutual one, in spite of the fact that, as we explain elsewhere in this memorandum, and as the coalition Government has made clear, mutuality has a key role to play in delivering choice, competition, value, innovation and, therefore, enhanced financial stability. Mutuals, which stick to utility banking, have played their part in ensuring the continuance of diversity and vigour in the mutual sector. YBS has, through its merger with the Barnsley and Chelsea, strengthened all these businesses, as well as provided reassurance to their depositors, members and staff.

3.6 It is worth remembering none of the building societies which went down the path of demutualisation have succeeded in remaining independent entities.

4 The key barriers to entry inhibiting increased competition - including regulation

4.1 Building societies make a crucial contribution to the competition and diversity of the retail financial services market. YBS is, as a mutual, able to offer competitive rates on savings and mortgages as it does not pay dividends to shareholders. YBS believes that, provided they are given a level playing field, building societies can further enhance the level of competition in the sector, in the interests of consumers.

4.2 YBS believes that regulation is a significant and growing barrier to competition in the sector. A number of new and proposed regulatory requirements (such as capital and liquidity requirements, the Mortgage Market Review, changes to the Financial Services Compensation Scheme) have been created or implemented. While the intention to further stabilise the system is welcome, there needs to be greater recognition and understanding of the cumulative effects of all these regulatory changes on market competition.

4.3 These new and proposed regulations have tended to favour large incumbent organisations, protecting them from competition, with additional prudential regulation typically representing a greater proportionate cost to small firms. In addition, we believe that little account has been taken of organisational structure in term of regulating the financial services industry.

5 Explore the Government and competition authorities’ strategy to increase competition in banking, including the likelihood that new entrants will successfully enter the market

5.1 YBS has welcomed the Government’s stated intention in the Coalition Agreement to "bring forward detailed proposals to foster diversity in financial services, promote mutuals and create a more competitive banking industry"4. YBS has also been encouraged by a recent statement from the Chancellor that "building societies and mutuals have an important role to play in the future" and the Government wants to "strengthen them and support those who want to create mutuals."5 YBS looks forward to seeing how this stated intention to promote mutuals is translated into action, and believes that the mutual sector could benefit from and support new entry.

5.2 But YBS believes that more emphasis should be placed on strengthening existing financial mutuals to ensure that they compete vigorously, sustainably and effectively with plcs. That provides the shortest route to enhancing the competitive dynamic in the retail financial services market. That means providing mutuals with a non-publicly funded vehicle that enables them to draw down upon fresh capital, recognising that their organisational structure inhibits their ability to inject capital from the markets in the same way as quoted banks. In YBS’s view, the only credible way to achieve this highly desirable public policy outcome is to provide mutuals with a capital instrument to capacity build within the existing mutual sector and, in this way, drive choice and competition in the interests of consumers, rather than shareholders (see also paragraph 5.5 below).

5.3 One of the biggest priorities for YBS is to ensure that current and future regulatory requirements appropriately reflect the mutual model. We believe, for example, that the Financial Services Authority (FSA) has not, to date, taken organisational structure into account when regulating the financial services industry and has failed to cater adequately for building societies both in its regulation of the UK market and in its European and international negotiations. We believe that the mutual sector should be treated as a sector in its own right and not be treated in the same way as plcs.

5.4 YBS therefore believes that the Government should commit to alter the terms and approach of regulatory and supervisory authorities, including the FSA and its successor bodies. YBS proposes the following:

· An appropriate treatment of mutuals with regards to the Capital Requirements Directive in order to ensure a capital instrument consistent with mutuality. The definition of core capital needs to be consistent with mutual ownership if it is not to disadvantage mutual firms.

· A review of the current funding model for the Financial Services Compensation Scheme (FSCS), where allocation does not reflect risk and the burden falls disproportionately on building societies. New arrangements are needed that more accurately reflect the relative risks faced by banks and building societies. In particular, the way in which building society regulation has developed over time has created an anomalous position in which the FSCS – and, therefore, the depositor protection threshold of £50,000 – applies to the consolidated group of businesses within a mutual, whereas for a plc with banking licences per brand, the consumer protection is multiplied by the number of banking licences it possesses. This could sustain an existing behavioural incentive for understandably risk-averse depositors to see banks rather than mutuals as the best home for their savings.

· The European Commission has proposed that deposit protection cover should increase to EUR 100,000 per individual from 31 December 2010. At this time coverage will also be limited to each deposit taker and the temporary arrangement for dual cover for merged building societies will end. As building society legislation makes it far more difficult for the operating of subsidiaries, this potentially places building societies at a disadvantage to plcs, which do not operate under such restrictions and can therefore continue to benefit from dual protection. We fully accept that if dual protection received a dual levy that would be appropriate and fair.

5.5 These changes can be implemented without cost to the taxpayer.

6 Conclusion

6.1 YBS has been pleased to offer these thoughts to the Committee which it trusts the Committee will find helpful. YBS would be delighted to have the opportunity to expand on its views and ideas, in oral evidence, if the Committee would find this useful.

September 2010