Competition and choice in the banking sector

Written evidence submitted by Metro Bank

Competition is the key to customer choice and Metro Bank is the first of new competitors who will challenge the present oligopoly.

British banking has developed into a commoditised market in which there is very little service differentiation and players compete solely on product and price. This has led to a degradation of service and mass customer dissatisfaction.

Metro Bank is the first new entrant in Britain in over 100 years. It is a ‘community bank’ model focusing on gathering deposits, without wholesale funding, and lending within the UK. Our basic proposition is a retail service model where our customers become fans and where the human being is the "deliverer of profit", as commented by TSC member John Thurso, "not a generator of cost". There are many examples outside of banking, i.e. Apple, where a better value proposition creates successful and sustainable business models.

We believe that new competitors with differentiated business models would improve the economic and banking climate in Britain. As in every market, there are barriers to entry and we have noted some we think apply in the UK:

1. A lack of entrepreneurship in the banking field as all the banks have consolidated into a few very large commodity providers.

2. Financial Services Authority ("FSA") approval is required for new entrants and, indeed, should be required. This process needs to be thorough but responsive and we understand that the FSA is streamlining the process.

3. The application of modern integrated information technology is central to the implementation of a service-based bank and the lack of external providers such as Fiserv and Fidelity, is a serious barrier to new entrants. The formation of new entrants would encourage the development of this important support segment.

4. New banks rely on customers exercising their freedom of choice to switch banks. The account switching process in Britain is complicated and needs to be streamlined and improved.

We would make the following suggestions to improve competition:

1. Account mobility: Members of your Committee suggested a standardized account mobility program similar to the mobile phone account mobility program. After discussing this with our management team we believe that this can be done and is a practical solution to providing customers more freedom of choice. We urge that this option be explored.

2. Deposit Insurance: The deposit insurance scheme is not well understood in Britain. It does not have the same degree of customer confidence as the Federal Deposit Insurance Corporation ("FDIC") in America. The FDIC requires its banks to display words to the effect: "All deposits are insured by the FDIC." On inquiry, the UK deposit insurance scheme, the Financial Compensation Scheme ("FSCS"), does not require such advertising and in fact, the FSCS advises we are not allowed to make such a deposit insurance statement. A change in this area would encourage competition.

3. Small and Medium Enterprises ("SME"): This segment is the most under-served portion of the British banking society. I call to your attention the Enterprise Finance Guarantee scheme which provides limited loan guarantees to the SME segment. While worthy, this scheme is underfunded and severely restricted and we urge the government to consider an expansion of this scheme including: a) allowing new banks to enter as lenders; b) increasing the size of the loans subject to guarantee; and c) removing the barriers to taking residential homes as collateral for loans. As you may know the Small Business Administration ("SBA") lending guarantee program in America has been extremely successful. I have enclosed a brief paper, which discusses the two schemes.

1. Planning: The development of new retail sites is essential to new bank competition. While the existing banks are located in the premier retail areas, the existing planning permissions exclude banks from A1 locations, thus providing a location advantage to existing banks. Allowing banks (which currently require A2 consent) to use A1 locations would level the playing field.

As to compensation, we believe that the granting of stock options encourages individual performance, focuses the team on the total performance of the bank while aligning staff and shareholder interests.

ANNEX

PURPOSE

· Comparison between US Small Business Administration (SBA) 7(a) Loan Scheme and UK Enterprise Finance Guarantee (EFG) Scheme and recommendation of action to take forward.

· The SBA is a multi faceted independent agency of the U.S. Government, created to aid, counsel, assist and protect the interests of small business concerns, to preserve free competitive enterprise and to maintain and strengthen the overall economy of our nation. Details of the 7(a) Loan scheme are attached in Appendix 2

· The EFG Scheme is managed by Capital for Enterprise Limited a wholly owned subsidiary of the UK Government managed by the Department for Business Innovation and Skills. Details of the EFG scheme are contained in Appendix 3

BACKGROUND

· The EFG Scheme is a relatively new scheme introduced in January 2009 to replace the previous Small Firms Loan Guarantee Scheme.

· Metro Bank PLC have made approaches to Capital for Enterprise Ltd, to participate in the EFG Scheme, but been advised that it was closed to new entrants in July 2009. Further approaches have been made and our request is currently under consideration.

· The Scheme is offered by 44 lending institutions in the UK, but has not been extensively publicised by the government/member lenders.

· The current funding pot (£500m) has been fully allocated to existing member lenders through to 31st March 2011 (the extension date for the scheme revised in December 2009 pre budget report). At present there is no level of commitment beyond then.

· By comparison a wide range of material is available on the US SBA 7 (a) Scheme, it is long established and the SBA is looking to expand the Scheme by increasing the maximum loan which may be part guaranteed to $5m.

· Whilst there are a number of similarities between the two schemes, the opportunity exists to bring the two schemes closer together in terms of content to help support small businesses.

COMPARISON

The table below and additional attachments (Appendices 1 and 2) provide details of both schemes and a comparison.

The principal similarities between the two schemes are:

· Both are designed to encourage lenders to support small businesses where the request for funding meets Bank criteria with the exception of the level of security available.

· Both delegate the assessment process fully to the lenders who are members of the scheme.

· Both have seen significant volumes of business:

o SBA 7a Scheme in 2009 guaranteed $9.2bn to 44,222 small businesses resulting in over 450,000 jobs being created/retained.

o Of the EFG Scheme budget allocation of £1.3bn for 2009/10 (ending 31st March 2010) a total of £1.304bn to 11,648 small businesses has either been drawn or is in course, of which £931.1m to 9,127 businesses has been drawn to date. (No information provided on jobs created/retained). A new fund allocation of £500m has been made for the year to 31.3.2011.

The main difference is one of approach by the lenders /governments to the two schemes:

· The SBA 7a scheme:

o Actively pushed by the participating lenders, has been running for a number of years and the government are looking to expand (proposal to increase loan maximum from $2m to $5m being considered).

o Focuses on and readily provides information on successes such as jobs created.

o Apart from the guarantee fees, the lenders are not allowed to charge additional arrangement fees.

o The scheme is generally more flexible - longer terms, more flexibility around security, other guarantee schemes available with specific target markets.

· The EFG scheme:

o Established in 2009 to replace the previous Small Firms Loan Guarantee Scheme, and funding is only approved by the government so far for a year at a time. The forthcoming election may well have an impact on the approach going forward.

o Whilst the numbers are still significant, the scheme managers advise that the attitude of lenders varies, but certainly you have to look harder to find information on the scheme from the major lenders. Experience from working within some of these institutions is that the scheme is not pushed forward.

o There is a restriction on other security taken to exclude the personal residence of guarantors/business owners.

o There is no certainty beyond the 31st March 2011, and the outcome of the forthcoming election in May is likely to impact, although it is likely that whatever the outcome, the new Government will want to be seen to be supporting Small Businesses.

CONCLUSION

Whilst the EFG Scheme is more closely aligned than it’s predecessor to the SBA 7(a) Scheme, an opportunity exists to help shape how the government and lenders approach providing support to small businesses going forward, and to bring it closer into line with the US scheme.

Metro Bank PLC are ideally placed because of their US experience to have an input into both shaping and pushing this going forward, and with the current scheme presently only extended through to March 2011, we believe now would be an ideal time to start this process.

APPENDIX 1

EFG Scheme

· Product

o Lending Bank/other lending institution provides debt, Government provides partial guarantee to lender

· Eligibility/Criteria

o Qualifying UK Businesses up to £25m p.a. turnover.

o Most sectors – principal exclusions are Coal, Real Estate and Insurance.

· Purpose

o The guarantee will cover the following types of lending:

§ New term loans (with terms of between three and ten years).

§ Refinancing the existing term loans, where the loan is at risk due to deteriorating value of security or where for cashflow reasons the borrower is struggling to meet existing loan repayments .

§ Conversion of an existing overdraft into a term loan to meet working capital requirements.

§ Guarantee on invoice finance facilities to support an agreed additional advance on a SME's debtor book. This will supplement the invoice finance facility already in place.

§ Guarantee on new or increased overdraft borrowing for the SMEs experiencing short term cashflow difficulties.

o The guarantee will fund:

§ working capital.

§ investment by businesses seeking to grow or develop.

· Maximum Loan/ Guarantee

o Loan amounts from £1,000 to £1m.

o EFG Scheme will guarantee 75% on all loans.

· Maximum Term

o Up to 10 years.

· Collateral/Security

o 1st charge on assets funded. If less than 100% cover (on discounted basis) the lender will look to the guarantors personal assets, but cannot take a charge over guarantors principal residence.

· Remuneration

o Interest rates

§ Subject to negotiation between borrower and lender.

o Fees

§ 2% per annum guarantee fee based on the balance of the guarantee

§ Loan arrangement fee is subject to negotiation between borrower and lender

· Supplier/Lender

o 44 UK Banks/lending institutions.

APPENDIX 2

SBA 7(a) Scheme

· Product

o Lending Bank/other lending institution provides debt, SBA/Government provides partial guarantee to lender.

· Eligibility/Criteria

o Designed to be as broad as possible:

§ Operate as a for-profit company.

§ Do business (or propose to) in the United States or its possessions.

§ Must meet SBA definitions of Small Business. A range of sector specific criteria:

· 500 employees for most manufacturing and mining industries.

· 100 employees for all wholesale trade industries.

· $6 million for most retail and service industries.

· $28.5 million for most general & heavy construction industries.

· $12 million for all special trade contractors.

· $0.75 million for most agricultural industries.

§ Be an eligible type of business. While the vast majority of businesses are eligible for financial assistance from the SBA, some are not (including Real Estate Investment, Banking/Finance/Insurance, Gambling/Speculation, anything illegal)

§ Plan to use proceeds for an approved purpose. Loan proceeds may be used to establish a new business or to assist in the operation, acquisition or expansion of an existing business.

§ Have reasonable owner equity to invest.

§ Use alternative financial resources, including personal assets, before seeking financial assistance. SBA does not extend financial assistance to businesses when the financial strength of the individual owners or the company itself is sufficient to provide all or part of the financing. Both business and personal financial resources are reviewed as part of the eligibility criteria. If these resources are found to be excessive, the business will be required to use those resources in lieu of part or all of the requested loan proceeds.

§ Ability to repay the loan on time from the projected operating cash flow of the business.

§ Good character. SBA obtains a "Statement of Personal History" from the principals of each applicant firm to determine if they have historically shown the willingness and ability to pay their debts and whether they have abided by the laws of their community.

§ Management expertise and commitment necessary for success.

§ Feasible business plan.

· Purpose

o Loan proceeds may be used to establish a new business or to assist in the operation, acquisition or expansion of an existing business. Eligible use of proceeds include (non-exclusive):

§ To purchase land or buildings, to cover new construction as well as expansion or conversion of existing facilities.

§ To acquire equipment, machinery, furniture, fixtures, supplies, or materials.

§ For long-term working capital, including the payment of accounts payable and/or for the purchase of inventory.

§ To refinance existing business indebtedness that is not already structured with reasonable terms and conditions.

§ For short-term working capital needs, including seasonal financing, contract performance, construction financing, export production, and for financing against existing inventory and receivables under special conditions.

§ To purchase an existing business.

o Ineligible Purposes

§ To refinance existing debt where the lender is in a position to sustain a loss and SBA would take over that loss through refinancing.

§ To effect a partial change in business ownership or a change that would not benefit the business.

§ To permit the reimbursement of funds owed to any owner, including any equity injection or injection of capital for the businesses’ continuance until the loan supported by the SBA is disbursed.

§ To repay delinquent state or federal withholding taxes or other funds that should be held in trust or escrow.

· Maximum Loan/ Guarantee

o Maximum Loan $2m.

o SBA can guarantee as much as 85 percent on loans of up to $150,000 and 75 percent on loans of more than $150,000.

o Other guarantees ranging from 50% to 90% of the loan balance are reserved for sub-programs targeting specific borrowers (veterans or underserved markets: rural areas or areas of, high unemployment or poverty) or loan purposes (export finance).

o There is currently a proposal under consideration to increase the loan size from $2 million to $5 million.

· Maximum Term

o 25 years for purchase, construction or refinance of Real Estate.

o 15 years for business acquisition, equipment and fixture purchase.

o 10 years for working capital.

o If for more than one purpose, the term is blended.

· Collateral/Security

o 1st charge on assets funded. If less than 100% cover (on discounted basis) the lender will look to the guarantors personal assets (guarantees from all owners of 20%+ of the business).

· Remuneration

o Interest rates

§ Variable rate loans (linked to base or LIBOR) subject to negotiation between borrower and lender.

§ Fixed rate loans subject to maximum margin (over base rate) between 2.25% and 4.75% depending on loan size and unexpired terms.

o Fees

§ 2-3.75% guarantee fee dependent on amount of loan.

§ 0.55% annual fee (calculated on the outstanding balance of the guaranteed portion of the loan).

§ No lender arrangement fee.

· Supplier/Lender

o Most US Banks and other lending institutions.

January 2011