House of Commons - Conduct and competition in SME lending

Conduct and competition in SME lending - Treasury Contents

5 Competition in SME lending

A history of competition problems

175. Competition in the banking sector has been perceived as a problem for many years. In March 2000, the Sir Donald Cruickshank examined the competition in the SME banking market as part of his report Competition in UK Banking. He concluded that "competition problems were found in all markets investigated".[322]

176. Over the subsequent decade, a number of studies and follow up reports into banking competition were performed by the UK's competition authorities—the Competition Commission (CC) and Office of Fair Trading (OFT), and later the Competition and Markets Authority (CMA). These are:

· The supply of banking services by clearing banks to small and medium-sized enterprises by the Competition Commission in March 2002[323]

· SME Banking—Review of the undertakings given by banks following the 2002 Competition Commission report by the OFT in August 2007[324]

· Review of barriers to entry, expansion and exit in retail banking by the OFT in November 2010.[325]

177. The most detailed of these reports was the Competition Commission's 2002 market study into competition in SME banking services. At the time, it found competition problems including market concentration, a reluctance among customers to switch provider, practices that restricted and/or distort price competition, pricing transparency, and barriers to entry and expansion.[326] The further reviews conducted in 2007 and 2010 found that elements of problems identified in 2002, for example low switching activity and low comparability of products, had persisted.[327]

178. Competition in banking has also been investigated by Parliament and by the Independent Commission on Banking (ICB). In 2011, the ICB expressed concern about the state of competition in retail banking. Its final report said:

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179. In June 2013, the Parliamentary Commission on Banking Standards (PCBS) also concluded that competition problems in banking persisted. However, it also recognised that action was being taken to try to improve banking competition:

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The PCBS acknowledged that these developments "could have a significant impact on competition in this market", but it considered that delay should "not be allowed to serve as an argument for indefinite inaction."[330] As a result, the PCBS recommended that the CMA "immediately commence a market study of the retail and SME banking sector" to be completed on a timetable "consistent with making a market investigation reference, should it so decide, before the end of 2015".[331]

Box 2: Ongoing measures to improve competition

There have been a number of recent measures by industry, business groups and the Government intended to improve competition in SME finance. These have included:

Divestments from Lloyds Banking Group and the Royal Bank of Scotland Group to create two additional banks. These divestments, the result of EU state aid rules, have created TSB and are in the process of creating Williams and Glyn.

Changes to the authorisations and prudential regulation regime for new banks. These were introduced by the FSA in March 2013, and included a simplified bank authorisations process and temporary reductions in capital requirements for new entrants.[332]

The establishment of the Payment Systems Regulator (PSR) which will become fully operational in April 2015. The PSR's objectives will be to promote competition, innovation and the interests of end-users through overseeing designated UK domestic payment systems.[333]

The introduction of a seven-day Current Account Switch Service (CASS), which is available to smaller SMEs. Benefits for small businesses include automatic switching of direct debits, and a payments redirection service for money accidentally sent to the old account.[334] The Government announced at the 2014 Autumn Statement that coverage of the service would be expanded to "99% of all SMEs" and that the redirection service would be extended to 36 months.[335]

Measures to increase the availability of SME creditworthiness information to help newer or smaller providers to make more effective lending decisions.[336] The Small Business, Enterprise and Employment Bill is intended to legislate for this scheme.[337]

A programme called Business Banking Insight that regularly collects survey data on business customers' experiences of banks. The survey is conducted once every six months, and published online. The program is run by HM Treasury in conjunction with some major banks and business groups.[338]

A programme to refer SMEs that have been rejected for loans to challenger banks and alternative finance providers who are looking to offer finance. The Small Business, Enterprise and Employment Bill is intended to legislate for this scheme.[339]

The current state of competition

180. In response to the PCBS, the OFT brought forward its planned market study into small business banking. This study, Banking services to small and medium enterprises, was published in July 2014 by the OFT's successor the CMA, in conjunction with the FCA.

181. In its 2014 market study, the CMA and FCA acknowledged that, as the PCBS had highlighted, a number of developments had the potential to help alleviate competition concerns in SME banking.[340] However, while these developments were considered "valuable in addressing some of the historical concerns" in competition, the CMA and FCA said that "fundamental competition concerns" remained.[341] In particular, the CMA and FCA said that take up of seven-day switching had been "low", with only 7,300 SMEs switching out of a population of 3.5 million business current account (BCA) holders.[342] The study also concluded that the divestment of Lloyds and RBS would only have "limited" impact on competition.[343] The market study was, however, positive about changes to bank authorisations, predicting that the changes would be "likely to reduce some barriers to entry and expansion."[344] It was also positive about the Government's scheme to increase the availability of SME creditworthiness information, saying that "action currently being taken by the Government provides an effective mechanism substantially to address any of the concerns in these areas if implemented in full."[345]

182. Overall, the CMA and FCA concluded that the UK SME banking sector still did not exhibit many of the characteristics of a "well-functioning" and competitive sector. The report found four significant characteristics in the UK market that it considered consistent with markets where "competition is prevented, restricted or distorted":[346]

· Markets were concentrated, with concentration levels persisting over an extended period of time;

· Barriers to entry and expansion, although reduced, continued to be present and significant in the markets;

· There were low rates of switching, negotiation and shopping around (in spite of the availability of easier switching), with evidence of a belief among SMEs that "all banks are the same"; and

· Transparency and comparability were limited.[347]

183. Alex Chisholm, Chief Executive of the Competition and Markets Authority, told the Committee that competition had worsened since the crisis. He said that the "the market context is different today from where it was five years ago", and that the financial crisis had undone much of the progress in improving competition achieved in the early and mid 2000s:[348]

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The Committee also received evidence which suggested that competition had worsened. The Association of Chartered Certified Accountants said that "the financing landscape has become less competitive for most UK SMEs over the last two years, following a surge in competition in the early days of the recovery".[350]

184. The market study concluded that many of the problems identified in 2014 were not new, noting that "many of the concerns identified in previous reviews remained".[351] These included:

· The provision of BCAs and business loans was concentrated among the largest four banks, with those providers maintaining relatively stable market shares; indeed, the sector was now as concentrated as it was in 1999;

· New entry had been limited and there were still high barriers to entry and expansion for newer and smaller banks;

· SME customers believed there to be little differentiation between providers;

· SMEs had difficulty comparing offers across providers and demonstrated low levels of shopping around; and

· The banks with lower customer satisfaction levels had high market shares and were not losing significant market share—while those with the highest customer satisfaction were not able to expand.[352]

185. As a result of its findings, the CMA decided to make a provisional market investigation reference, subject to consultation and a final decision on the matter.[353] On 6 November 2014, the CMA confirmed that it would undertake an "in-depth market investigation into the personal current account and SME retail banking sectors".[354]

186. Witnesses to the Committee agreed with assertions from the CMA and FCA that competition in banking remained weak. Mr Lane of Kingston Smith and Dr Tomlinson, Entrepreneur in Residence at the Department for Business, Innovation and Skills, believed that competition in SME banking was limited.[355] Mr Hollis, owner of Hollis & Co, agreed, telling the Committee that he did not see "any meaningful competition between the four large banks at all".[356] He also said that competition amongst banks for business was stronger for large firms than it was for small firms:

357

The Treasury also acknowledged there was a problem. The Economic Secretary to the Treasury said that "in the area of SME lending […] there are improvements but there is a long way to go".[358]

HOW HAVE NEW ENTRANTS AFFECTED CONCENTRATION?

187. The SME banking market has seen some changes arising from challenger banks. Metro Bank represents an entirely new entrant into the UK's banking market, whilst banks such as Aldermore, Shawbrook and Handelsbanken have expanded their operations significantly since the financial crisis. From its first branch in 2010, Metro Bank opened its 33^ndbranch in February 2015.[359] Handelsbanken announced its 175^th UK branch in June 2014,[360] and told the Committee that while it had operated in the UK since 1982, it was only in the "last couple of years the expansion has really picked up".[361]

188. In terms of debt financing, a number of innovate alternative finance providers have also emerged. For example, peer-to-peer and crowdfunding platforms such as Platform Black, Funding Circle and Zopa all provide loans to UK SMEs. The Liberium AltFi Index—a survey of alternative lending industry performance—found that the peer-to-business lending it surveyed had seen an annual growth rate of approximately 200 per cent between January 2014 and January 2015.[362]

189. One potential measure of competition is market concentration, which measures the market shares of players in a market. Mr Woolard told the Committee that the FCA used concentration an indicator of competition in a sector:

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Chart 3: Market shares in the provision of BCAs to SMEs by volume of accounts/main banking relationships, England and Wales

Source: Competition and Markets Authority, Banking services to small and medium-sized enterprises, 18 July 2014, p 46

190. Despite the presence of new entrants and new types of providers, evidence still shows little change in the level of concentration in the UK SME banking market since 2002. In its market study, the CMA and FCA found that, in England and Wales, the "UK's four largest banks have accounted for at least 85 per cent of SMEs' main banking relationships for the past 14 years".[364] For Scotland, it found that the "largest three banks (RBS, Lloyds and Clydesdale) have accounted for over 80 per cent of the main banking relationships of SMEs since 1999".[365] In Northern Ireland, it found that two large and two mid-sized market participants cumulatively accounted for 90 per cent of the market for liquidity management services.[366] Similarly, for business loans, it found that the 2013 market shares of the top three or four providers in England and Scotland both had a 90 per cent share of the market—unchanged from the Competition Commission's review in 2002.[367] The Economic Secretary to the Treasury said:

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Indeed, the CMA and FCA found that the high Herfindahl index—a measure of competition in a market—for business current accounts across the UK as a whole was relatively unchanged over time:

Chart 4: Concentration in BCA supply in Great Britain as measured by the HHI

Source: Competition and Markets Authority, Banking services to small and medium-sized enterprises, 18 July 2014, p 46

191. The CMA report notes that some progress had been made in new entry into the banking sector, but concludes that the effect on the overall market has so far been limited:

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192. Alternative lenders also appear to have made only a limited impact on the overall shape of the SME finance market. Alternative lender penetration in debt markets overall appears to be low. The October 2013 Trends in Lending by the Bank of England said:

The vast majority of gross flows of external finance raised by UK businesses in recent years were from bank lending and capital market issuance, based on available data. The largest flow of external finance raised was bank lending to large businesses. The flow of new asset finance (leasing and hire purchase) was smaller in comparison, though was slightly higher in 2014 H1 compared to 2013 H1. Some of this lending is likely to be to small and medium-sized enterprises (SMEs).

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193. Alternative lenders, in particular peer-to-peer finance and crowdfunding, are discussed in more detail in section six of this report.

Why have competition problems persisted?

BARRIERS TO ENTRY

194. Regulatory barriers to entry have, in the past, been identified as being detrimental to competition in the UK SME banking market. The Parliamentary Commission on Banking Standards concluded that "for a very long time, the regulatory authorities in the UK have displayed an instinctive resistance to new entrants" and that the new bank authorisation process had "long stifled entry to the banking market".[371]

195. There are some signs that progress has been made in reducing these barriers to entry. In March 2013, the FSA announced two key changes to the authorisation of new banking firms.[372] Mr Woolard of the FCA told the Committee:

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196. However, other barriers to entry also exist. The SME banking market study lists these barriers under two categories:

· Inputs to develop an SME banking business. These included the need for IT systems, access to payments systems, access to customer credit information, the need for a distribution network and SME behaviours; and

· The behaviour of incumbent banks. These include waivers and deeds of priority, bundling of products, price discrimination and restrictions on banking services.

197. The market study found that some of these barriers were being gradually lifted, for example access to IT systems.[374] However, the CMA said:

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Some of these barriers are discussed in detail in the sections below.

NEW ENTRANTS, BRANCH NETWORKS AND "CRITICAL SCALE"

198. A problem of scale was mentioned by some as a barrier to establishing stronger competition in the sector.[376] A number of challenger banks have entered and expanded in the banking market, and other new entrant banks appear to be in the process of authorisation. But some have argued that there is a minimum scale before new entrants can effectively challenge incumbent banks. Mr Chisholm of the CMA said:

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In particular, the market study stated that, "whilst the usage of local branches by SMEs has diminished in recent years", a branch network "continues to be particularly important to enable a bank to both acquire and service a wide range of customers".[378]

199. In 2011, the Independent Commission on Banking also concluded that minimum scale was needed to create an effective challenger bank.[379] It said that smaller banks on average grew at a slower rate than larger ones:

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200. Dan Moore, Project Director of the SME Banking Market Study at the Competition and Markets Authority, added that existing concentration worsened the problem. Challenger banks need scale to compete effectively with large incumbents, but achieving scale was difficult because it required competitiveness:

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LIMITED SWITCHING BEHAVIOUR FROM SMES

201. The SME banking market study identified "low rates of switching, negotiation and shopping around" as both a symptom and cause of poor competition. In particular, the CMA found that shopping activity—when a business queries many banks searching for the best deal—was low amongst SMEs.[382] The study said that "the majority of SMEs (71%) approached only one provider on the last occasion they sought finance" and that "SMEs tended to spend very little time shopping around, with research showing that almost 60% of SMEs that shop around spend less than an hour considering their financing options".[383]

202. The problem of limited switching behaviour was highlighted by the persistence of high market shares for those with the lowest satisfaction score. Mr Chisholm told the Committee that the SME banking sector had "low levels of satisfaction by comparison with some other sectors,"[384] and that despite low satisfaction, SME customers did not switch providers. Mr Moore said that there was a "generalised pattern where those who have the highest satisfaction levels do not seem to be making that much progress".[385] He said:

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203. Overall, the market study said that this lack of switching arose from three key factors:

· strong belief that there is limited differentiation between the offers available at different banks;

· limited negotiation between SMEs and banks; and

· the relatively high complexity of business current account and loan pricing.[387]

PRODUCT COMPARABILITY AND SMES' PERCEPTIONS OF BANKS

204. Some evidence to the Committee suggested that the perception amongst SMEs was that there was very little difference between the offerings of major banks. Mr Moore of the CMA said:

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In its written submission, the manufacturers' organisation EEF noted that its companies "point to a lack of differentiation between the major retail banks".[389] Peter Hollis, owner of accountancy firm Hollis and Co, said that "I do not see any meaningful competition between the four large banks at all".[390]

205. SMEs perceived no difference between major banks, but some differences may indeed exist. Professor Russell Griggs, Independent External Reviewer of the Banking Taskforce Appeals Process, said:

391

Mr Moore agreed, and said that the CMA had found "some differences between service levels and, in some cases, some significant differences between service levels and, in some cases, prices".[392]

206. Asked why many SMEs could not perceive differences between providers, Mr Moore suggested that limited information on banks' products and performance might be a source of the problem:

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This lack of information may be reinforced by an overall lack of financial acumen on the part of SMEs, particularly small firms. The SME Finance Monitor found that the "proportion of SMEs with a financially qualified person looking after their finances has remained relatively stable, and was 28% in Q2 2014".[394] Some evidence also suggests that few SMEs take external advice. For example, the SME Finance Monitor said that the proportion of SMEs seeking advice before they applied for an overdraft was 9 per cent for overdrafts of under £25,000, rising to 18 per cent for overdrafts above £100,000.[395] The Association of Chartered Certified Accountants recommended that "encouraging and helping businesses build up their in-house finance capabilities early on could help steer them away from disengagement".[396]

CONCENTRATION AND LINKAGES BETWEEN MARKETS

207. The CMA and FCA market study identifies links between:

· personal current accounts (PCAs) and BCAs; and

· BCAs and business loans.

On the link between PCAs and BCAs, the market study states that "there is a strong propensity for start-ups to choose a BCA provider based on their choice of PCA provider".[397] The market study states:

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The CMA concludes that "a major bank is likely to be able to count on obtaining a significant volume of business from its PCA customers, limiting, in turn, its incentives to compete as vigorously as it would otherwise do".[399]

208. On the link between BCAs and business loans, data published by the CMA suggests that close to 90 per cent of SMEs have sourced business loans from their main bank.[400] The CMA said:

We observe that the banks which have high, and relatively stable, market shares in the supply of BCAs in each of the relevant geographic markets similarly have high shares in the supply of business loans.

[…]

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209. In written evidence to the Committee, Lloyds Banking Group said that owing to the constant flow of new business creation and destruction, a natural "churn" existed in Business Current Account (BCA) markets:

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While the CMA and FCA acknowledged that natural SME BCA customer turnover occurred, they believed it only had a limited positive effect on competition due to the links between PCAs, BCAs and business loans:

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MUTUAL REINFORCEMENT OF COMPETITION PROBLEMS

210. The CMA and FCA concluded in their market study that individual factors inhibiting competition were "closely interrelated and mutually reinforce one another, resulting in competition being more limited than it would otherwise be".[404] The CMA's market study explained:

405

211. The CMA identified concentration in particular as a problem that reinforced and amplified other competition problems. The market study said that "concentration is often not a competition concern in itself" but that "it is more likely to be a concern where there are barriers to entry and SME inertia".[406] Mr Chisholm of the CMA said:

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212. Inadequate competition in banking is a long-standing problem. Many of the problems identified by the Parliamentary Commission on Banking Standards, the Independent Commission on Banking and the 2002 Competition Commission market investigation persist. The UK SME banking sector remains dominated by four major banking groups, who among them have a market share in England and Wales of 85 per cent. The largest firms have the lowest satisfaction scores.

213. Challenger banks and the growth in alternative lending have scope to increase competition. However, gross peer-to-peer lending to businesses in H1 2014 was £300m, only about 1% of the £24.8 billion lent by banks to SMEs over the same period, and the CMA found that the SME banking market share of banks outside the top 5 in England and Wales was less than 5%. Challenger banks and alternative lenders are therefore not yet at a scale sufficient to challenge incumbents. There is currently little evidence to suggest that new entrants in the SME finance market and existing measures to improve competition will deliver the transformation in competition that the industry needs. This lends weight to the importance of the CMA's market investigation into SME banking.

Policies to improve competition

MULTIPLE CREDIT SEARCHES

214. The Committee received evidence about the role of credit score calculation methodology on competition. In particular, evidence to the Committee suggested that multiple credit searches by an SME could harm its credit score. In its written evidence to the Committee, HSBC explained:

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215. Multiple credit searches may indicate heightened credit risk, but they may also merely indicate that an SME customer is shopping around. Rebecca McNeil, Head of Business Banking at Barclays, noted that multiple searches could mean "a customer is having to go to a lot of places to seek that finance because they are being turned down elsewhere".[409] However, as the ACCA noted, "while such behaviour often correlates with financial stress, it also correlates with 'shopping around' for a good deal".[410] HSBC added:

411

216. Evidence suggested that the existing treatment of credit searches creates a disincentive for SMEs to shop around for credit, reducing competitive forces in the SME market. HSBC wrote that this was "a potential barrier to switching, as customers may be deterred from shopping around for the best offer if they are concerned about the negative impact on their credit score"[412]. The ACCA notes that "the banks' collective advice to customers is to avoid asking for more than a simple quote when shopping around, in order to avoid impacting their credit score".[413] Evidence from the Forum of Private Business notes that, when searching for credit, businesses needed to "access the right type of finance from the right provider first time"[414]. The negative repercussions of failed searches can also affect businesses who already had offers of credit. The FPB wrote:

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217. At present, there does exist a facility within credit agencies that can differentiate between "quotations" and "applications" for credit. This is potentially a method for businesses to shop around without damaging their credit score. However, not all lenders provide such quotations. For example, Lloyds Banking Group said that its small SME services do not include providing "bespoke quotations".[416]

218. HSBC has suggested that the existing disincentive could be "resolved by lenders agreeing to re-engineer their scorecards to remove or reduce such negative impact."[417] However, Ms McNeil noted that it would be difficult to "separate out whether someone is shopping around or being turned down consistently".[418]

219. The presence of multiple credit searches in a business's credit history can damage their credit score. Multiple credit searches may indicate that a customer's applications for credit have been repeatedly declined, and therefore suggest to a lender that they are a higher risk. But they may simply be evidence that the customer is shopping around. Borrowers are sometimes deterred by the banks themselves from comparing providers by the negative impact that making applications to multiple banks could have on their credit score. As part of its market investigation, the CMA should, in consultation with the industry and the Information Commissioner's Office, examine how this disincentive can be addressed.

PRICE COMPARISON

220. The Committee received evidence which suggested that price comparison tools could contribute to improved competition in SME banking. However, the availability of price comparison tools appears to be limited. HSBC wrote in its written evidence that "there are currently limited online tools that particularly smaller SME customers can use to compare BCAs and loans offered by different banks".[419] Lloyds also agreed, stating that "price comparison is not readily available from published tariffs".[420]

221. Increasing the availability of price comparison tools may help to encourage competition. HSBC wrote that SME customers "may find it difficult to compare different banks' BCA propositions due to the diverse tariff models and the lack of a standardised way of presenting these offerings across the industry".HSBC wrote:

SME customers are likely to need to carry out a manual search of providers' websites in order to select the most appropriate BCA or loan product. This is likely to have a dissuasive effect on shopping around.

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222. Mr Chisholm agreed with HSBCs position, noting that "electronic tools like price comparison websites can assist" in improving comparability.[422] However, he also warned that effort would be needed from SMEs to engage with such tools. He said:

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Mr Chisholm also noted some of the difficulties with generating comparisons for business banking services:

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223. Dr Andrea Coscelli, Executive Director of Markets and Mergers at the Competition and Markets Authority, added that price comparison was not the only factor in SMEs decision making, and that qualitative features were also important:

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224. Mr Chisholm also noted that stronger competition itself could lead to greater transparency that would complement the effectiveness of price comparison websites:

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225. Price comparison tools are prevalent in retail banking and insurance markets, but less so in business banking. This may be due to the relative complexity of products in the SME banking market. It may also be a symptom of a lack of competitive pressure in the industry. As part of its market investigation, the CMA should examine, in consultation with the industry, why the provision of price comparison tools for SME banking has so far been limited, and the scope for increasing it.

ACCOUNT SWITCHING FOR SMES

226. A faster Current Account Switch Service (CASS) was launched in September 2013. The service offers a seven day switching service to retail customers, as well as some smaller businesses—those with fewer than ten employees and a turnover or balance sheet of less than €2 million. Alongside the transfer of balances, the service also offers the automatic transfer of payment arrangements both into and out of the account.[427]

227. Use of the CASS by SMEs appears to have been relatively limited since its introduction. The CMA and FCA wrote in their SME Banking market study:

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228. Mr Chisholm noted that more could be done to increase awareness of the CASS amongst SMEs:

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229. The CMA and FCA also found that SMEs were concerned about the risks of switching accounts. They found—from a study dating from before the introduction of the CASS—that "many SMEs consider the process of switching BCA provider to be costly or risky or both".[430] Concerns included the need to contact customers to update their payments to the new bank, the risk that errors would be made when transferring payments, and a risk of payments delayed or missed altogether.[431] Evidence from the Federation of Small Businesses suggests that the CASS may not be working as it should be for SMEs. The FSB wrote to the Committee that it was "concerned that small firms are still experiencing significant difficulties in switching accounts", and that "in some cases, this has taken longer than expected with much of the leg work being undertaken by the businesses rather than the bank".[432]

230. At the 2014 Autumn Statement, the Treasury announced changes to the existing CASS to improve availability for SME customers:

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231. The Current Account Switch Service has been geared primarily towards retail customers, not businesses. Changes announced by the Government at the 2014 Autumn Statement to improve the CASS for SMEs are therefore welcome. As part of its market investigation, the CMA should examine how the scheme could further benefit SMEs, and what steps can be taken to improve SME awareness of the scheme.

A STRUCTURAL REMEDY?

232. As part of a market investigation, the Competition and Markets Authority has the power to enact two kinds of remedies to address competition problems it has identified. Describing its powers, the Competition and Market's Authority's predecessor, the Competition Commission, said:

The CC has significant powers to remedy problems it identifies. When considering remedies, the CC is required to "achieve as comprehensive a solution as is reasonable and practicable" to address the adverse effect (section 134(6) Enterprise Act). The CC may also have regard to any relevant customer benefits (section 134(7) Enterprise Act). When deciding on what is an appropriate remedy, the CC will consider the effectiveness of different remedies and their associated costs and will have regard to the principle of proportionality.

The CC's remedies fall into two basic categories: structural remedies and behavioural remedies. Structural remedies typically involve the divestment of assets—for example, in the Airports market investigation the CC has required the divestment of Gatwick, Stansted and either Glasgow or Edinburgh airports in order to remedy the adverse effects on competition identified.

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Indeed, the Competition Commission has previously noted the advantages of structural remedies over behavioural remedies:

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233. In 2002, as part of its market investigation The supply of banking services by clearing banks to small and medium-sized enterprises, the Competition Commission proposed a number of behavioural remedies designed to "assist entry or otherwise serve SMEs' interests and promote competition" in the SME banking sector.[436] These took the form of commitments by the eight major clearing banks at the time to improve areas such as pricing transparency, ease of switching and credit data availability.[437]

234. However, at the time, the Competition Commission believed that these remedies would not solve completely the competition problems it had identified:

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235. As a result of the perceived ineffectiveness of its behavioural solutions, the Competition Commission also examined structural remedies. Three options were examined—the divestment of physical branches, divestment of SME businesses without property and divestment of SME businesses, with physical assets. The report concluded that there would be "formidable, and potentially insuperable, obstacles to structural remedies"[439], noting in particular that forcing the divestment of a business would not "be a proportionate remedy for the SME-related problems the CC has identified".[440] The report also emphasised that personal as well as business customers would be affected by a business divestment and that such customers lay outside of the scope of the investigation.[441] At the time, structural remedies were not implemented.

236. Following the financial crisis and state support for some UK banks, both Lloyds Banking Group and RBS have conducted major branch divestments in order to comply with EU state aid rules. These projects—Verde at Lloyds and Rainbow at RBS—have created the challenger bank TSB from Verde, and will create Williams and Glyn from Rainbow. However, the Independent Commission on Banking warned that Verde was of insufficient scale to create an effective challenger bank:

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237. The Financial Times has reported the Chancellor as saying that he made a "mistake" in not radically restructuring the state-controlled Royal Bank of Scotland in 2010. It went on to report that he had said that for several years he had gone along with RBS's insistence that the investment bank was going to be a viable business with operations all over the world.[443]

238. Measures taken so far by the competition authorities and the Government have not resulted in a transformational improvement in the competitive environment. The CMA has concluded that concentration in banking is part of the problem. It must now also decide whether reducing concentration would help to address it. This has been examined more than once before. In 2002, the Competition Commission concluded that the forced break-up of large banking groups would not be "proportionate". The Parliamentary Commission on Banking Standards examined the possible benefits to banking from breaking up RBS into a 'good' and 'bad' bank. It stopped short of recommending an immediate breakup of the bank, but recommended that the Government commission a detailed analysis of the case for such a split. This study concluded against such a split. But the question of concentration will not go away. The Chancellor is now reported as having said that he made a mistake in not radically restructuring RBS in 2010. The Committee recommends that the CMA's market investigation should include a detailed examination of whether the conclusions of both the Competition Commission and the Parliamentary Commission on Banking Standards remain relevant, and whether structural reforms may remain essential to secure a reduction in concentration in the market.

THE FCA'S COMPETITION OBJECTIVE

239. In its final report, the Parliamentary Commission on Banking Standards noted that even well-intentioned regulation could, in some circumstances, do harm as well as good. The report concluded:

That regulation is well-intentioned is no guarantee that it is a force for good. Misconceived and poorly-targeted regulation has been a major contributory factor across the full range of banking standards failings. Regulators cannot always be expected to behave as disinterested guardians who will pursue the "right" approach. They are faced with complex challenges to which the appropriate solutions are ambiguous and contested. They have not in the past always risen to those challenges satisfactorily. They need to resist the temptation to retreat into a comfort zone of setting complex rules and measuring compliance. They also need to avoid placing too much reliance on complex models rather than examining actual risk exposures. Regulators were complicit in banks outsourcing responsibility for compliance to them by accepting narrow conformity to rules as evidence of prudent conduct. Such an approach is easily gamed by banks, and is no substitute for judgement by regulators.[444]

240. In particular, the report refers to the existence of an "old regulatory contract"—originally referred to by Sir Donald Cruickshank in his March 2000 report, Competition in UK Banking: A Report to the Chancellor of the Exchequer.[445] Sir Donald's report said:

446

The Commission noted comments from John Kay, Professor of Economics at the London School of Economics, that the "vestiges of the regulatory contract remain".[447] The Commission also noted comments from Professor Kay about "regulatory comfort":

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241. The Financial Services Act 2012 sets out, as an operational objective for the FCA, "promoting effective competition in the interests of consumers".[449] When questioned by the Committee about how deeply embedded the objective was in the culture of the regulator, Mr Woolard said:

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242. The Committee also asked the FCA whether its approach to meeting its competition objective would lead to a change in behaviour across the organisation in general. Mr Woolard replied:

451

243. The Committee also asked the Competition and Markets Authority about the FCA's ability to meet its competition objective. Mr Chisholm said that his impression was that the FCA was taking its competition duties "very seriously",[452] but suggested that competition was not in the FCA's "DNA" and that the FCA was in the process of "learning a new set of skills".[453] Regarding dialogue between the two organisations, he noted:

454

THE FCA AND THE COMPETITION AND MARKETS AUTHORITY (CMA)

244. The FCA was given, as part of its operational objectives, a duty to promote "effective competition in the interests of consumers" in the Financial Services Act 2012.[455] Under the Financial Services (Banking Reform) Act 2013, the FCA is also to become a concurrent competition authority alongside the CMA.[456] Concurrency will come into force on 1 April 2015, and provide the following powers to the FCA:

under the Competition Act 1998 to enforce against and fine for breaches of domestic and EU competition law prohibitions on anticompetitive agreements (for example, cartels) and abuses of a dominant position, and

457

The FCA has said:

458

245. The FCA and CMA's powers differ in a number of places. For example, as the financial services conduct regulator, it has the various rule-making and guidance-giving powers under the Financial Services and Markets Act 2000. Another example is that the CMA has wider competition powers than the FCA, whose powers are limited to financial services.[459] Some of the CMA and FCA powers are complementary. For example, the FCA has the power to request "the CMA to consider whether a feature, or combination of features, of a market in the United Kingdom for financial services may prevent, restrict or distort competition in connection with the supply or acquisition of any financial services […]".[460]

246. The FCA has a duty—set out under section 140G of FSMA—to consider advice provided to it by the CMA under section of 140B FSMA. The FCA must publish a response "stating how it proposes to deal with the advice", including whether it has taken any action and the justification for any action, within 90 days of receiving the advice.[461]

247. The relationship between the FCA and the CMA regarding their competition duties have been set out in a memorandum of understanding between the two organisations. This describes the circumstances each organisation would take responsibility for competition-related activities:

462

248. The FCA and CMA aim to have a "co-ordinated" approach, and, for example, "have agreed to consult each other early on when considering taking action" to address potential overlaps and duplication of work. The memorandum also notes that the CMA has "developed deep expertise in considering competition matters across a variety of sectors", that the FCA has "significant sectoral experience in the financial services sector", and that "organisations will […] provide technical assistance to each other where it may be helpful".[463] But Regulation 8 of The Competition Act 1998 (Concurrency) Regulations 2014 allows the CMA to direct a regulator, such as the FCA, to transfer a competition case to it where the CMA "exercising the Part 1 functions rather than the regulator would further the promotion of competition, within any market or markets in the United Kingdom, for the benefit of consumers".[464] The CMA may not do this once the sector regulator has issued a "Statement of Objections".[465]

249. The FCA will not be alone in having concurrent powers with the Competition and Markets Authority (CMA).[466] The Financial Conduct Authority is part of the UK Competition Network (UKCN), which includes other sector regulators, such as the Civil Aviation Authority and the Office of Gas and Electricity Markets.[467] The Government describes the UKCN as "an alliance of the Competition and Markets Authority (CMA) with all the UK regulators that have a specific role to support and enable competition within their sectors".[468] The mission of the UKCN will be "to promote competition for the benefit of consumers and to prevent anti-competitive behaviour both through facilitating use of competition powers and development of pro-competitive regulatory frameworks, as appropriate."[469]

250. Regulation can be an impediment to effective competition in banking. Regulators appear to have an instinctive resistance to new entrants: in the recent past, prudential requirements had been applied in a way that unnecessarily hindered new entrants, the authorisation process had been difficult for new entrants, and small banks had to reach an agreement with a larger one to have access to the payments system. The FCA now has a statutory objective to promote competition in the interests of consumers. The FCA must continue to transform its regulatory approach in order to fulfil this new objective. It is essential that the FCA's approach to meeting this objective is not siloed within an individual department of the regulator, but instead permeates through the entire culture and approach of the organisation.

The FCA's competition objective is new. The regulator is in the process of learning a new set of skills. The evidence suggests that this is a work in progress. The Committee recommends that the FCA, with oversight from the CMA, produce an annual report on the implementation of its pro-competition activities. In particular, the CMA should be invited to form a judgement on the effectiveness of the FCA's competition regime. The FCA and CMA have concurrent competition objectives. They both remain active in the competition field. The danger is that the CMA retreats, and the FCA does not vigorously fill in the space left. The CMA should report publicly if it believes the FCA is not fulfilling its competition duties.

322 Sir Donald Cruickshank, Competition in UK Banking: A Report to the Chancellor of the Exchequer, March 2000 Back

323 Competition Commission, The supply of banking services by clearing banks to small and medium-sized enterprises, March 2002 Back

324 Office of Fair Trading, SME Banking-Review of the undertakings given by banks following the 2002 Competition Commission report, August 2007 Back

325 Office of Fair Trading, Review of barriers to entry, expansion and exit in retail banking, November 2010 Back

326 Competition Commission, The supply of banking services by clearing banks to small and medium-sized enterprises - Volume 1, March 2002, p.3 Back

327 Office of Fair Trading, SME Banking-Review of the undertakings given by banks following the 2002 Competition Commission report, August 2007, p 6, 8; Office for Fair Trading, Review of barriers to entry, expansion and exit in retail banking, November 2010, p 6 Back

328 Independent Commission on Banking, Final Report, November 2011, p 197 Back

329 Parliamentary Commission on Banking Standards, Changing Banking for Good, First Report of Session 2013-14, HC 175-II, 11 March 2014, p 240, para 403 Back

330 Parliamentary Commission on Banking Standards, Changing Banking for Good, First Report of Session 2013-14, HC, 11 March 2014, 175-II, p 236, para 396; p 240, para 403 Back

331 Parliamentary Commission on Banking Standards, Changing banking for good, First Report of Session 2013-14, 11 March 2014, HC 175-II, 11 March 2014, p 240, para 404 Back

332 Financial Services Authority, A review of requirements for firms entering into or expanding in the banking sector, March 2013 Back

333 Competition and Markets Authority, Banking services to small and medium-sized enterprises, 18 July 2014, p 6 Back