Competition and choice in the banking sector
Written evidence submitted by RBS Group Plc
Executive Summary
• RBS Group believes that competition is good for markets and that a competitive market is the best way to raise standards and deliver excellent services for consumers.
• We are committed to increasing transparency across our product range to make it easier for customers to understand what they are purchasing and how they are charged. A number of initiatives agreed with the OFT are already underway in this regard.
• The UK banking sector, in line with other capital intensive industries, has consolidated in recent years as shareholders have required a sustainable return on their investment. In future, any barriers must remain low if the market is to encourage new entrants.
• Our focus as a business will remain on competing in the market to serve our customers in our chosen businesses to the best of our ability.
Introduction
1. We welcome the opportunity to contribute to this Inquiry. Many of the issues to be covered by the Committee are also being considered by the Office of Fair Trading and by the Independent Commission on Banking. Furthermore, many of these issues have been considered in depth by OFT and Competition Commission market studies and inquiries, and we do not propose to go into detail about their findings in this submission.
2. We believe that competition is good for markets. RBS welcomes competition because we firmly believe that a competitive market is the best way to raise standards and deliver excellent services for consumers. Whilst we believe that banking in the UK is very competitive, the industry must do more on the issue of cultural change: reconnection with customers and communities; restoration of management excellence; reform of pay structures that have become hard to defend. The financial services industry is integral to our economic system and as such, its weakening comes at considerable peril to society’s broader wealth creation and stability. But our more intangible licence to operate from society is at present rather battered. Our integral role requires that we restore it.
3. In this response we propose to address the terms of reference set out in the Press Notice of 13th July in turn.
Assess the impact of the financial crisis on competition and choice in both retail and wholesale markets
4. The financial crisis has had a significant impact on the banking sector. The crisis accumulated a varied list of casualties, from Northern Rock and Bradford and Bingley to Icelandic and Irish banks. Failures encompassed big banks and small, specialised and universal, investment and retail. The illiquidity of securitisation markets also weakened the ability of banks to compete.
5. The number of players may have decreased since the period before the financial crisis, and therefore arguably competition, but it is important to draw a distinction between effective competition and that which is based on business models which carry significant risks to financial stability. The latter is based on the cheap wholesale funding, leverage, mis-pricing of risk and unsustainable lending practices. There is a broad consensus in the industry and beyond that the industry should not return to these practices. We believe that post crisis there remains an adequate level of competition and choice in the banking sector.
6. Increased regulatory requirements for capital and liquidity have increased costs for all banks. The cost of wholesale and deposit funding have increased significantly, pushing up costs of lending for customers over the base rate. The availability of funding is a further constraint. As many banks seek to attract more deposits, the price we have to pay increases. The ability of banks to drive competition further will be impacted by these constraints on their balance sheets. These increased costs, applying across the industry, should not be mistaken for increased pricing power.
7. As the Committee will be aware, the UK market is a very mature one across both wholesale and retail banking with intense competition across all product ranges. One product area which has been particularly impacted by the financial crisis is that for deposits. Given the withdrawal during the financial crisis of a number of sources of wholesale funding, many banks have increased their focus on securing relatively stable retail and commercial deposits, and this trend has been encouraged by regulators’ liquidity requirements. This has sharply increased competition particularly for fixed term deposits, with both new and existing providers offering attractive rates of interest to attract these deposits; this is clear evidence of competition benefiting the consumer.
Assess the impact of widespread consolidation among banks and mutuals
8. The UK banking industry, in common with those existing in many other major economies, has grown more concentrated over recent years, in line with the concentration of other capital intensive industries. Larger, more diversified companies have the ability to achieve greater synergies and create economies of scale. This enables banks to provide services at lower cost to the consumer whilst also delivering a sustainable return to investors. However, the market share of the four largest banks is now lower than it was in the 1970s and 1980s, and with the expansion of Santander it is now more accurate to speak of the "big five" than of the "big four" banks. Moreover, there has been a significant deconsolidation of financial services relationships, leaving current account providers less likely to provide their customers with additional products such as mortgages, credit cards or loans.
9. As with other consolidated industries, the UK retail and wholesale banking markets remain competitive, as major players compete effectively with one another and new entrants with lower customer bases and smaller back books can compete and grow. Nevertheless, the players in the market must be able to make an adequate return on equity over the cycle in order to cover the cost of capital and satisfy the cost of investment to shareholders. Recent regulatory reforms have made banking more capital intensive, which will only be sustainable if investors are content to bare this and are adequately compensated. This is especially important for the ultimate beneficiaries who include pension funds and the taxpayer.
10. The conditions imposed on RBS and Lloyds Banking Group by the European Commission in connection with state aid will also impact the market place subject to certain conditions including regulatory approval. RBS will divest the Royal Bank of Scotland branch-based business in England and Wales, the NatWest branch network in Scotland, its Direct SME customer base and certain mid-corporate customers across the UK to Santander. This will result in the divestment of 318 branches and supporting infrastructure and services. The business will include approximately 1.8 million retail customers, 230,000 SME customers, 1,150 corporate customers and £20 billion of assets. This represents approximately 2% of the UK retail banking market and 5% of the UK SME and mid-corporate markets respectively and will increase Santander’s share of both these markets.
11. By 2013 Lloyds Banking Group will have divested more than 600 branches and part of Northern Rock is likely to be privatised. There are financial services providers who are poised to enter the PCA market, including Tesco Bank, Virgin Money and the Post Office, as well as new banking brands such as Metro Bank which opened the doors of its first branch on 29 July 2010. These changes in the UK retail banking sector illustrate the dynamic nature of the UK retail banking sector.
Examine the key barriers to entry inhibiting increased competition – including regulation
12. There is significant evidence of new entrants to the market, planned or active (e.g. Tesco Bank, Virgin Money and Metro Bank).
13. The financial crisis has in fact created opportunities for potential new entrants. The reputation of several incumbent banks has been damaged by the financial crisis (to the advantage of new or newer entrants). Furthermore, recent advances in technology have resulted in an increase in the number of channels through which customers can access banking services. The internet and telephone banking have made access more convenient for customers and reduced the level of reliance on a physical branch network for the savings market.
14. On regulation specifically, the fact that banking is a capital intensive industry and that proposed regulatory reforms are increasing the capital requirements further is likely to reduce prospective returns. This may be a dis-incentive for some market entrants, however these are challenges which impact on all market players, not just new entrants.
15. The cost of compliance with regulation is increasing in the financial services industry as the financial crisis has prompted a significant increase in the pace and volume of regulatory change and this increase seems likely to continue for some time. If regulators and Government are to avoid creating a very significant, unnecessary burden on the industry going forward, it is important that regulatory changes are proportionate and well-considered, that sufficient time is given for implementation and that supervision of firms is also proportionate and consistent.
16. Previous reports have looked at the issue of payments systems (for example, the Northern Ireland PCA banking report and OFT 2003 Market Study into payment systems) and have identified no significant concerns. The direct access and governance criteria for UK payment systems have been subject to extensive regulatory scrutiny in recent years. We believe they are fair, open and objective and are the minimum necessary to encourage competition without compromising the systems’ safety. There is active competition between settlement members to provide indirect access. The low barriers associated with access to payment systems are borne out by the fact that new entrants such as Tesco Bank, are coming to the market via agency arrangements.
17. Access to financial risk information for the provision of personal banking services is a not a barrier to entry or expansion (either for personal and SME banking) and this has not been impacted by the financial crisis. This issue was considered by the Competition Commission in the Northern Ireland PCA banking report, which concluded that access to information regarding customer risk was not particularly complex or expensive.
18. There are many different business models and ways to compete in the personal banking sector. For example a new entrant can enter the market and build up a customer base, even on a relatively small scale (see the business model which Metro Bank is adopting in relation to PCAs). Many economies of scale (e.g. in payments processing) are accessible at relatively small sizes through arrangements with specialised processing companies.
19. It is also possible to enter the market for a product on a larger scale by leveraging a strong position or well-known brand from other financial services products or indeed other industries. Examples of this include former building societies such as Nationwide entering the PCA market or Virgin Money and Tesco Bank extending a well-known brand from personal loans, credit cards and insurance to PCAs. Tesco Bank and Virgin are also prime examples of how a brand can be leveraged from another industry into financial services.
20. Customers are increasingly accessing their banking services in new ways. Improvements in technology, such as internet banking, have changed the nature of the market and reduced the direct usage of branches. Therefore, an extensive branch network is not a prerequisite for expansion in personal or SME banking. Whilst access to physical premises is considered an attractive feature by some customers, there are other viable ways to expand a customer base, such as through investing in direct channels. Firms such as Virgin Money and ING Direct have successfully used this strategy to achieve a viable and competitive scale in the savings market. For some products another option is to utilise third party intermediaries as a distribution channel to expand.
21. Some firms have looked to focus on certain characteristics or customer segments to build up their customer base. For example, Triodos Bank has highlighted an "ethical" approach to banking that has enabled it to build up a targeted customer base. Finally, the State Aid remedies imposed by the European Commission provide opportunities for smaller banks to expand their customer base.
Examine whether competition is inhibited by difficulties faced by customers in accessing information about products
22. It is straightforward for customers to compare different products across the personal banking sector, through the use of comparison websites and to switch between competing providers. As the comparison websites become more sophisticated, they allow for ever more meaningful comparisons between products.
23. There are already a number of legislative and industry led initiatives in place to provide customers with product details prior to entering into a contract for the product, e.g. key facts documents and summary boxes. These measures provide customers with the information they need in order to make an informed decision, and highlight the costs involved in taking out the product including the level of interest rate and the charges.
24. Further enhancements to make prices even more transparent are in train with current account interest rates due to be printed on customer statements by end 2011 followed by Cash ISA interest rates by Spring 2012.
25. Particular concerns have in the past been raised regarding the ease with which customers can compare current accounts. This concern has been addressed by the industry working with the OFT to agree some representative customer scenarios that consumers can use to assess which current account product best meets their needs. It is important to recognise, however, that customers may choose between providers on the basis of a number of different factors not limited to price, such as service quality.
26. Despite the current high level of transparency, RBS is committed to further increasing transparency across our product range to make it even easier for customers to understand what they are purchasing and how they are charged. In our recently launched Customer Charter (see http://www.natwest.com/global/customercharter.ashx) we pledged to help customers to make the right choices by providing a clear product range with simply explained features and charges. All of our branch literature will be simplified and rewritten in line with customer feedback. We’re also introducing a new Customer Service Review programme to make it easier for our customers to choose the right product for them.
Explore the Government and competition authorities' strategy to increase competition in banking, including the likelihood that new entrants will successfully enter the market
27. As the Committee is aware, both the OFT and the Independent Banking Commission are reviewing the level of competition in the UK banking market. We look forward to working with these bodies as well as the TSC as they explore these issues. For our part, RBS is complying with the decision of the European Commission to divest the RBS branch-based business in England and Wales and the NatWest branch network in Scotland, its Direct SME customer base and certain midcorporate customers.
28. It is difficult to predict the likely success of new entrants. RBS believes that the industry is competitive and the unprecedented disruption in the market will present new opportunities for new entrants (such as Metro Bank) as well as for existing players to increase market share (such as Santander) or to move into offering new products (Tesco Bank and Virgin Money). Barriers to entry must remain low if the market is to encourage new entrants.
Consider the relationship between competition and financial stability;
29. The relationship between competition and financial stability is complex. In the years before the crisis, competition was facilitated by a plentiful supply of inexpensive wholesale funding which gave rise to financial instability.
30. More broadly, one would expect a competitive financial system - one which facilitates the exit of weaker financial players and the entry of new firms – to demonstrate greater long-run durability, by encouraging stronger and more innovative participants. But whilst the system as a whole may thus demonstrate greater stability, it is an environment which by definition is likely also to exhibit greater instability at the individual firm level. This might prove disconcerting from a consumer perspective, if the rate of change is high, and threatens short-term instability given the potential for contagion effects within financial services (and banking in particular).
31. There is thus a balance to be struck in the level of competition one might ideally wish to see in a financial system. Levels of exits need to be managed such that adverse impacts on confidence and consumer interests are kept to an acceptable level. Regulation both reduces the probability of failure and its impacts; it also raises costs and thus the overall supply of and demand for financial services. Regulation therefore has an impact on competition and growth, and needs to be calibrated accordingly.
Consider the impact of free banking on effective competition
32. There is a widespread perception amongst the UK public that core banking services such as current accounts and credit cards should be provided for free. This is in contrast to the position across the Continent where monthly fees for current accounts are more common.
33. Consumer Focus’ report "Free or Fee: Are ‘free’ products good for consumers?" describes the drivers that led to ‘free’ services as well as some of the consequences. It was intense competition in the market following the introduction by Midland Bank of "free-if-in-credit" in 1984 that led all other banks to swiftly follow suit (Midland gained approximately 450,000 customers in the year following the introduction of this pricing structure while NatWest lost 60,000 current account customers and estimated that it had lost a further 100,000 potential customers with no previous bank account to competitors that had adopted this pricing model). Competitive pressures also mean that it would be commercially difficult for a bank, as a first mover, to start charging for hitherto free services.
34. There are, however, significant costs incurred in providing these core banking services including the cost of operating the physical branch network, staffing and support services and the technology platform including the ATM network.
Look at the role of foreign-based operators and whether they are likely to return to the UK.
35. In August, the Bank of England Quarterly inflation report found that the withdrawal of foreign lenders from the United Kingdom has played a key role in the weakness of corporate lending. However, contacts of the Bank’s Agents reported that a number of foreign banks had recently entered, or re-entered, the UK market. Since the end of 2009 we have seen foreign lenders increasing their share of syndicated lending. Lenders such as Handelsbanken have expanded their presence in the SME market and we have previously noted the purchase of RBS’s assets by Santander.
September 2010
|
