CORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 710-i

HOUSE OF COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE THE

PARLIAMENTARY COMMISSION ON BANKING STANDARDS

(SUB-COMMITTEE F)

PANEL ON RETAIL COMPETITION

TUESDAY 13 NOVEMBER 2012

CRAIG DONALDSON and JAYNE-ANNE GADHIA

BENNY HIGGINS and PHILLIP MONKS

USE OF THE TRANSCRIPT

Oral Evidence

Taken before the Parliamentary Commission on Banking Standards

Sub-Committee F-Panel on Retail Competition

on Tuesday 13 November 2012

Members present:

Baroness Kramer (Chair)

Mark Garnier

Mr Andrew Love

Lord McFall of Alcluith

Examination of Witnesses

Witnesses: Craig Donaldson, Chief Executive, Metro Bank and Jayne-Anne Gadhia, Chief Executive, Virgin Money, gave evidence.

Q1 Chair: We very much appreciate your coming here today and being willing to start about five minutes early. We thought that, rather than leave you sitting out there to gaze at the scenery, it would be very useful to pick your brains even more thoroughly. We hope to finish this sitting pretty much at 3 o’clock, if that is okay.

We are part of the Parliamentary Commission on Banking Standards and this is the panel on retail competition. As I say, we are very pleased that you are here today, because we are very concerned that the evidence we get should reflect not just the four or five major banks in the United Kingdom, but also the challenger banks that are playing a role in diversifying and providing competition in the system, so, again, we very much appreciate your coming here today. The way in which this will work is that we will address questions to you in turn. If there are areas at the end that we have not covered that are important, we will be delighted to receive a note on any of those areas, or to find other ways to continue the conversation. If I could begin in a more general sense, the theme of this panel is competition. One of our underlying concerns has been prudential regulation as a barrier to entry. We have heard from challenger banks that capital and liquidity requirements often place entrants at a financial disadvantage relative to the established banks. May I just ask you what your experience has been in this area? Perhaps I could start with Ms Gadhia and then ask Mr Donaldson.

Jayne-Anne Gadhia: Thank you for inviting me. As far as competition is concerned, I should start by saying that it is absolutely essential that there is the right amount of capital and liquidity, both in the system and in every bank that participates in it. We have seen what happens when that is not the case. Anything I say should not be taken to imply that I do not think that we should be achieving appropriate and very solid standards of capitalisation and liquidity.

Looking at it from my perspective, where I think that banking can become anti-competitive is not so much that there should be less of a capital requirement for the new entrants and the smaller banks but that there should be a level playing field with the bigger providers. As we have seen over time, as a new provider coming into the marketplace, it is important for us to hold capital against a three to five-year plan. That plan of course anticipates accelerated growth if we are going to be successful. One finds that you are holding capital on day one for a bank that could be so much bigger in three to five years’ time, and that can be quite an expensive thing to do for a bank. A way of levelling the growth trajectory for a new bank is potentially important. Equally, an established bank is able to look at its capital requirements based on the experience of its risk-weighted assets, its lending book, in a way that a new provider cannot-it simply does not have that same experience. Sometimes the internal models that banks use, while sensible in terms of displaying their own experience in the behaviour of their products, can sometimes get to a place where the bigger banks hold disproportionately less capital than the smaller banks. I believe that it is important that any internal models are properly validated to ensure that there is a level playing field for capital and that there is sufficient capital to support the very big balance sheets that the banks have.

Let me briefly move on to liquidity. For me, at this point in time, Virgin Money has been in banking for three years as a small starter- we acquired Northern Rock at the beginning of this year. We definitely find that capital is the bigger inhibitor to competition and, growth than liquidity. At the moment, given the scale of our operation, our brand and the liquidity market, we find that it has not been an issue for us to raise retail deposit funding or indeed wholesale funding, so we do have sufficient liquidity to be able to lend out as assets. The constraint for us is the capitalisation that we require to lend out those assets in comparison with the bigger providers.

Q2 Chair: So, as I understand it, you are essentially saying that for new entrants at the moment, the playing field is not level. I ask the question because the Governor of the Bank of England has talked about the importance of looking at these issues to ensure that there is a level playing field. Have you seen any change over recent months in the way in which the regime is looking at this or is this relatively unchanged from the same experience that you would have had a couple of years ago?

Jayne-Anne Gadhia: I think that the regime, to me, from our business’ perspective is largely unchanged. I do not think that that is inappropriate. But to give you an example, when we acquired Northern Rock in January this year, our tier 1 ratios were in excess of 20%. We would always set a tier 1 ratio of around 15%. Some of the bigger banks operate on tier 1 capital ratios that are significantly less than that. I think it is just appropriate to question whether or not those ratios for the bigger banks are wholly adequate, given the scale of the operations that they undertake. So it is not so much that things have changed, I think it is that we should of course be capitalising banks appropriately. I think "appropriate" should mean as significantly for the big banks as for the small banks.

Q3 Chair: I wonder whether, Mr Donaldson, you have some thoughts to add.

Craig Donaldson: We got our licence two and a half years ago-remember, we are a greenfield site, covering retail and commercial, so we set ourselves up from scratch. The business plan we put together had a significant capital requirement in there because it seemed proportionate and appropriate that, as a start-up bank, we had that. To me it is about how over time the capital requirement should reduce, as the risk of running an organisation reduces with longevity, and it is about the proportionality that is applied by a prudential approach that needs to be seen over time. If I look at the numbers Jayne-Anne was talking about, I cannot say what ours are-we are not allowed to-but I can tell you that I am significantly higher than 20%. We are running at least three times higher than most of the major high street banks. That carries significant cost, which could be seen to be significantly anti-competitive if you are trying to be out there doing things. But to me it is not about the capital you require when you start, it is about how that capital reduces over time as you evidence continued risk management and continued sustainability in the model.

The other thing that I would say then is of course on liquidity-actually, I will go back to the application of the different models. Again, we have built that in. As a greenfield site, we knew that we would have to apply the standard formula and that we would go to the complex formula once we were able to. We are still working to that plan, but there is definitely need for a proportionate approach. I agree with Jayne-Anne that the capital held by others possibly should increase, but certainly what we are looking at should not be where it is either. On liquidity, we have seen significant reductions in what we have to hold-definitely proportionate, definitely being reviewed appropriately-and we are holding now, still, significantly higher than you would see on the high street, but I believe it is proportionate to what we are doing. I have not seen that on capital.

Q4 Chair: On the capital side, do you think it would make a difference if the PRA had a competition objective?

Craig Donaldson: I do not think that the word "competition" would do it, no. A competitive objective, yes, but a competition objective, no. You can have competition without being competitive. I think high street banks have proven that. What you need is a competitive environment, not more competition doing the same things.

Q5 Chair: Would you agree with that, Ms Gadhia?

Jayne-Anne Gadhia: Given the issues in banking and the need to hold sufficient capital, personally I do not think that the PRA should have a competition agenda. I think that that is much more appropriate for the conduct authorities. However, I think that the PRA should be mindful of looking at a level playing field.

Q6 Chair: Thank you. If I could just go on to the money transmission system-again an issue that has been raised with us-Sir Donald Cruickshank repeatedly stressed that the need to strip the large incumbent banks of their control of the money transition system. Would you agree with Sir Donald that this is a priority if we are to increase competition in this market?

Jayne-Anne Gadhia: I think that Sir Donald also suggested that it should be a regulator that is responsible for the payment systems in the UK, and I thoroughly endorse that. Now, whether that should be a separate regulator or, again, a regulator that reports to the conduct authorities is for me a moot point. I would be happy for it to report into the conduct authorities, but I think that an independent regulator with an objective, again, to level the playing field so that all banks can participate fairly and evenly in the payment system is important. At the moment, as we only have very few banks with direct access to those systems, banks such as mine-probably Craig’s too, I am sure-need to access those systems through a large bank, through what is called an agency banking arrangement. Those arrangements can work very well-mine works very well-but I do not think that I can imagine many industries where people would be prepared to put the lifeblood of their own operation in the hands of a major competitor. The way in which the payments industry is structured at the moment means that that is the only way in which we can access those systems.

Craig Donaldson: I totally agree with what Jayne-Anne has said. The other thing is that if you are trying to differentiate yourself-indeed, to differentiate yourself on something like service-and you have to bank through the big banks, you are dragged down to the lowest common denominator.

If you look at the banking industry across the world, different models are applied, where you would have payments as a utility that banks link into. Therefore, everybody was starting from a level playing field and could then differentiate themselves, based on the proposition they wanted to offer customers, rather than having to rely on the proposition that the big banks wanted to offer customers. If we genuinely want competition, we need to create the level playing field, almost like a utility play, rather than forcing challenger banks to go to the lowest common denominator.

Q7 Chair: That is interesting. We have had a number of people talk around those issues. Andy Haldane almost went on a step farther-again, using the word "utility" that you used-and talked about a money transition mechanism that was sort of centrally managed by an independent body, and proposed that all banking transactions should actually take place on a single common platform for the banks. Does that have any appeal to you? Do you have any thoughts around the Haldane idea?

Jayne-Anne Gadhia: Yes, for me, intellectually, I completely support that idea. I think that getting to a place where there is a central system that gives all banking competitors access to a clear platform-meaning that every banking customer can be confident that there is not going to be any upheaval in their lives as a result of changing their bank account-or where banks can access a single payment system through a single mechanism is very appealing. I think it would really help competition. It is the practicalities and the cost, of course, that need much more discussion.

Craig Donaldson: Intellectually, I fully support that, but it is a massive undertaking-massive. With seven-day switching from next September-we have to deliver that; we have to focus on it; we have to manage perceptions; we have to make sure it delivers what it should-and with, say, a utility offering around payments, which we were just discussing, you could deliver the vast majority of the benefits at a fraction of the time and cost.

We need to be careful that the intellectual does not take us so far that we forget about the operational requirement to do something now. We must make sure that the things we need, such as seven-day switching-and I would stand by the utility offering payments to create that level playing field for new entrants-would go a significant portion of the way, at a fraction of the cost and a fraction of the time.

Q8 Mark Garnier: I am interested in coming back to you on your answer about the competiveness or the competition mandate for the PRA. The FCA-of course, this is half of the authorisation process-does have a competition mandate. I am very interested to know why both of you seem to be less than enthusiastic about a competition mandate than the PRA is. It is an angle that I was not expecting.

Jayne-Anne Gadhia: From my point of view, as I say, I think it is important that none of us, as smaller players in the banking market, argues that there should be less capital in the system. The system needs to be stable. There needs to be a lot of trust in the system. People need to know that they are customers of a very sound bank. As things currently stand, I think that the capitalisation of my business is what gives me absolute confidence that this a very sound bank going forwards, and that that is where my customers can be confident, too.

I am not sure that competing on capital per se is going to change the market. For me, the issue is absolutely about making sure that service is much more relevant in financial services, and about where we can compete on both service and price to give customers a good deal.

Q9 Mark Garnier: I absolutely take your point. Competing in terms of a sort of regulatory race to the bottom is not the ideal thing.

Where I want to go with this questioning is the authorisation process as a whole, which is something I have a particular interest in. What seems to have been the case is that when you actually come down to an individual who is on the authorisation panel of the FSA, somebody will have to take that decision to sign off a new entrant bank. If you are not careful, the default position could be financial stability, and therefore not to risk the system by having a new-entry bank. This is something that we obviously want to be very careful not to let happen.

That comes on to my next run of questions. Craig Donaldson, your Metro Bank is fairly unique, in that it has the first ab initio banking licence granted for, as I keep saying, the past 100 years, but somebody corrected me and said that it is since 1837.

Craig Donaldson: The last one I could find was 1879, but don’t quote me. That is an internet play.

Q10 Mark Garnier: But it is an important point. I believe it took 18 months for you to get it. How did you find the application process?

Craig Donaldson: Exceptionally challenging, but I didn’t think inappropriate. That is my point-it should be challenging. Going through our systems, going through our policies and procedures, going through the due diligence on the management team and on the board takes time. Dare I say it, I felt somewhat sorry for the FSA, because this was the time just after everything had changed, and it would be fair to say that the world was in constant flux. We would be asked a question one week, and the question would slightly change as more information came out about what had happened, so I found it extremely challenging, but not inappropriate. If you are looking for more competition and the removal of barriers, I think that is the key rather than the regulator. The removal of barriers to enable people to get it faster and being able to fulfil the requirements of the FSA faster is the need.

Q11 Mark Garnier: Yes, and I think this is the key point. What specifically did you find about the FSA approval process that proved to be a hindrance? Within that answer-perhaps everybody could have a think about it-I would be interested to know how much the cost attributable to the regulatory application was.

Craig Donaldson: If you think about it, we are the de novo bank, so when we started we genuinely had a blank piece of paper. We had to link up everything and build everything from first principles. If you think about it too much it hurts your head. But we did it by working through what the core things customers want in banking are, how you fulfil them and how you bring the regulator and everybody with you so it is safe and secure.

When we started joining the payment schemes-whether it be Faster Payments, clearing, BACS, CHAPS, Swift, Link, MasterCard or Visa-they all have different schemes requiring different things and you have to join all of those things before you can get your licence. But you cannot get your licence until you have proven that you have joined them, so you have a bit of a Catch-22 situation. It took several months, but we came up with a way round it.

Q12 Mark Garnier: It took you seven months?

Craig Donaldson: Several months. It took about three months to get around that and get the right auditing in place. But I wouldn’t have faced any of that, and I would have saved, I reckon, about £1.5 million to £2 million in build, if I had a utility to join. I had to join those schemes individually; I had to go to different banks to join the schemes. If there was one payment utility, they could say to the regulator, "This organisation is fit and proper; they have linked up to us; we are happy that they have done the appropriate testing." But instead, I had to go to this scheme and do it, this scheme and do it, this scheme and do it, and I couldn’t even join some schemes. That is when I had to go to a bank and say, "Please, Mr Bank, will you let me join?"

Q13 Mark Garnier: Can I ask you a question about your software? We have had one or two comments, I think it was from Andy Haldane, who mentioned that the legacy software in the existing banks is basically creaking at the seams and held together with Sellotape and string. You would have had to have created a brand new software system. Was there an off the shelf framework that you could buy, or did you literally have to create it from scratch?

Craig Donaldson: No, we went to a global banking offering that is in-I will get the number wrong, forgive me-tens of countries and has about 1,000 customers across the world. We went to them because there was not a proprietary system for the UK that covered our tax and our regulatory regimes, etc. So we took a core banking system and then developed the tax regime and the regulatory reporting regime. We took the top 10 issues that customers complain about to their banks, and we asked how we avoid them by building it into our system. We print cards at the store, and we have all of the things that a customer holds with us in a single client view. So we built it from scratch using a core engine called Temenos-it is a Swiss company-which we found to be very good.

Q14 Mark Garnier: You are creating an incredibly strong argument for a utility banking system, irrespective of what the cost is.

Craig Donaldson: I believe that if you genuinely want de novo entrants, if you genuinely want the ability for banks to differentiate, you need to move to that model. It is a model that is well versed in America, where they had de novo banks and they have the ability for de novo banks to launch at pace with the appropriate capital. If you think about it, what you are doing with the utility offering is de-risking a bank’s launch. You are saying here is a proof-and-payments approach that is linked into this technology, so the capital requirements you need against it are reduced as well.

Q15 Mark Garnier: Jayne-Anne, you went a slightly different route. You had a banking licence transferred across and then you bought-

Jayne-Anne Gadhia: Northern Rock.

Q16 Mark Garnier: So you have inherited some legacy. Can you talk about your application process for a change of beneficial owner of the banking licence and how you found it in terms of getting started?

Jayne-Anne Gadhia: We seem to be echoing each other quite a lot today. From my point of view, we decided to acquire a banking licence. We bought a small bank called Church House Trust before we acquired Northern Rock. That was a deliberate decision because we knew that the FSA had a defined time period whereby they had to agree a change of control for a bank rather than a de novo process. We knew that, if we had started a de novo process, it was open-ended and the open-ended nature of the process that Craig is talking about could be anti-competitive because you simply don’t know, we didn’t know, how much it would cost and how long it would take.

So, for us, acquiring a small bank gave us certainty of time scale although, of course, there was a risk that the answer would be, "No, you can’t acquire that bank". Having made that decision, however, the change of control process that we went through with the FSA, I would agree was entirely appropriate, entirely within a sensible time frame and entirely within the costs that we had anticipated. It proved to be a very good step for us. I wouldn’t expect it to be any different for anybody else coming into the market.

From a systems point of view, again, without a shadow of doubt, getting to a place where my business is owned nearly 50% by American shareholders, and they constantly say to me in America, "We could buy a bank in a box, and we could set up this entity that has access to full banking capability and then compete on service and price." Why do we in the UK have to wait for systems to be ready before we can actually compete?- that is why I would agree completely with the utility side of things.

I agree that it is a huge task, and I agree that it is a very expensive task. But, Mr Garnier, you said that Andy Haldane talked about old banking systems in the UK. Without a doubt, the very large banks must need to invest significantly in their banking infrastructure for a new generation. We would really lose an opportunity if, as part of that reinvestment, we didn’t think about a common platform in this sort of way.

Q17 Mark Garnier: So in fact there is a double reason to do it rather than a reason not to.

Jayne-Anne Gadhia: I think so, yes.

Craig Donaldson: May I just bring it to life a little bit? We are a trading bank and we’ve got 120,000 customers, retail and commercial. We are members of Faster Payments through our agency bank, though I have to say that I think they have done a very job for us because they have genuinely tried to help us and work with us. But their Faster Payments mechanism has had 27 outages this year. Faster Payments has not had 27 outages, but the one that I get from them has had 27 outages. That impacts on my customers. I have to apologise to my customers. I have to put it right for them. But Faster Payments has not been down. They are saying, "Well, it’s you". I say, "Of course, it is", because they are my customers. It is my job to look after them. But actually, it is because I haven’t joined the utility offering. I have had to go through somebody else, a second-hand system.

Q18 Mark Garnier: Who do you use?

Craig Donaldson: I think that that is a separate entity for me to discuss, to be fair.

Q19 Mark Garnier: I couldn’t let you go without asking.

Craig Donaldson: I just want to be balanced in this because they have been very good to us as well. Remember, I have to have a relationship with these people.

Q20 Mark Garnier: Indeed, you have to have a relationship with the regulator as well. You have both been very complimentary about the FSA and, without any hesitation, about their numerous charms and their hard work. If I were to have a conversation with you in private like this, would it be any different?

Jayne-Anne Gadhia: No, mine would be exactly the same. Genuinely, one of the benefits of being a new entrant is that there is obviously no legacy to protect. I can anticipate that there have been a number of the bigger banks with lots of legacy issues where there have been very difficult conversations with the regulator. I feel in a slightly privileged position to be able to have seen the crisis from afar, but not be part of it and, therefore, understand where the regulator is coming from on a lot of issues. I don’t think that their interventions are inappropriate, and I absolutely understand what they are trying to do to get the balance of capital and liquidity right. I do think that balancing competition and financial stability is a difficult trade-off. No, I feel that we have an open, transparent and positive relationship with the regulator, which is not just something that is said in public.

Craig Donaldson: I would echo 90%. When we set off and we were going through the journey, it was a fairly challenging journey. But that is right. This is people’s money and we have to look after it. We have to be confident that it is going to be looked after properly. The issue for me is how, over time, proportionality is applied as long-term sustainability as things are working. When you are de novo and you launch, then people could go, "Is it going to work?" Well, we have proven, yes, it is. We will have 16 stores by the end of this year. We will have over 130,000 customers. It is working. Therefore it is about where you get these high capital and liquidity requirements on day one: how do they come down over time to enable a business?

I believe the FSA is going through a challenge on that at the moment. It will be interesting, as we go through that-if we were talking in six months or a year-to see how they deal with that, because you cannot keep de novos at two or three times what the large organisations are at and expect it to be a competitively level playing field. You can in early days, but over time that needs to be used for the growth of the organisation, and that is where I think it will become interesting, as Virgin grow and as Metro Bank grow, about the capital requirements and how they move towards the big banks and how the big banks move towards us.

Q21 Mark Garnier: The FSA is in the midst of reviewing its authorisation process and going through an internal review on this. Have you both engaged in that process of consultation?

Jayne-Anne Gadhia: I am sorry. Say that again.

Q22 Mark Garnier: The FSA is reviewing its internal process of new bank authorisation. Have you both been involved with that process?

Jayne-Anne Gadhia: No, I have not.

Craig Donaldson: Yes.

Q23 Mark Garnier: And you have found they have been in listening mode.

Craig Donaldson: We have had several hours of good discussion.

Q24 Mark Garnier: Full and frank.

Craig Donaldson: We have that sort of relationship with the supervisor. Our supervisor, David, is a really good guy. You can have proper discussions with them, and that is what you want. You want to be able to have a discussion with your supervisor, because it needs to be balanced on both sides.

Q25 Mark Garnier: Jayne-Anne Gadhia, will you be engaging with them in this process?

Jayne-Anne Gadhia: If invited to do so, yes. At the moment, we have not participated in that, because we have not been invited to participate, as opposed to not stepping in.

Q26 Mark Garnier: I am sure they will now.

Jayne-Anne Gadhia: We would be delighted to do so.

Craig Donaldson: May I come back on a question you asked that I did not get a chance to feed back on? You asked about the conduct authority and competition and I make my point again. If competition is just more of the same, we do not need it. What we need is competition that is competitive and offers a different proposition.

There is a danger, if you look at what is coming out-cash management to the SME markets, cash current accounts to the retail market. The competition needs to offer the core banking requirements, not just offer internet savings and mortgages through this channel or another. There is a real danger that we get more competition, but we do not get a competitive landscape. Genuinely, that needs to be taken into effect by the conduct board.

Q27 Mark Garnier: I want to turn to your distinct business models, because you both offer a different thing. You have gone for a current account model with branches in London, based very much on excellence of service. Of course, Virgin are also going for excellent of service as well. But it is a slightly different thing. You are buying in legacy systems and trying to build on that. Can you talk about your two different models and how you think each of them has an advantage over the other? Why don’t you start, Craig?

Craig Donaldson: What a great question.

Jayne-Anne Gadhia: I’m glad you are starting.

Craig Donaldson: Cheers.

Mark Garnier: It’s all right. I’ll come back to you, so you can have the final word.

Craig Donaldson: We are clear that our business model is about service and convenience. We offer high street stores on the best corners in the towns where we are. We want to grow by 2020 to have over 200 stores, servicing over 1 million customers. That is about being there, where they want us, and giving great service and convenience through the internet, mobile banking and through whatever the channels are. But that does include the high street.

If you are a small business man or a small business lady or a commercial business, you need cash management and need to be able to manage your business, and cash flow is king. We believe, therefore, that you need to be able to offer something on the high street to fulfil the SME market.

The SME market is the most under-served-something like 90% of all SMEs are banked by five banks. You cannot tell me that is competitive. Therefore our model is simple. It is about surprising and delighting customers through service and convenience. We do not offer the best rates-you can get better on the internet-but we offer the best value through the whole package. We are open seven days a week, 362 days a year. We are open from 8 am to 8 pm Monday to Friday, 8 am to 6 pm on a Saturday, and 11 am to 5 pm on a Sunday. Our telephony is 24/7, and when you phone up you get straight through to somebody, because that is what our customers tell us that they want. We listen, because we want to fulfil what they want so that they come to us, and they are coming to us. That is our business model. Very simply, it is about serving customers and keeping them happy and then keeping them for longer.

Jayne-Anne Gadhia: So the reason we adopted a different model to building from scratch, as Metro did, is that the Virgin brand is quite a big, established brand in the UK, and we believed that it would attract a significant number of people to the banking proposition provided that we could adhere to some of the key Virgin values that are around great value, good price, good service, relationship with the business, and being able to compete against the more established providers in a fair and transparent way. Since we acquired Northern Rock in January, we have opened more than 1 million accounts, so I think that that demonstrates that the platform needed to be significant and broad enough to achieve that.

Q28 Mark Garnier: These are not personal current accounts though, are they?

Jayne-Anne Gadhia: Not at this point in time. When we acquired Northern Rock, we acquired an in-branch only capability to offer current accounts. We have some 120,000 of those. Our intention is to build out from there and offer more online and broader capability than that. At the moment, we are selling credit cards, savings, mortgage products, insurance, and investment products. It is across that range that those 1 million new accounts have been opened. From our perspective, my chairman would say that-it is a genuine ambition for us-it is easy to build a big bank, but it is not so easy to build a good bank. Our intention over time is to build a competitive good bank with customer relationships at its heart, and that would be so much easier from our perspective if we were able to participate in this utility platform that we have both been talking about, because it means that we can focus on really delivering excellence to customers, rather than what so many banks have to focus on at the moment, which is building the systems to deliver that excellence later.

Craig Donaldson: May I build on something that Jayne-Anne said? She mentioned competition and building the bank. Removing the utility platform would undoubtedly be hugely advantageous to de novos entering the market, but also to challengers such as us. There are other things that can be done to support challenger banks over and above that which are being done now. For Metro Bank, when I go for planning and try to be on the high street, I get turned down, because I am A2 use not A1. A bank is classed as A2. I want to be on the high street. I want to do 80 hours a week. I want to be open 362 days a year, but because I am not a retail shop I get turned down. I think that that has already cost me something approaching £1 million.

Q29 Mark Garnier: This is a planning thing, is it not?

Craig Donaldson: A planning thing, but my point to you is that you are talking about competition. The big banks are there. They are on the corners on the high street. They might not look after them, but they are on them. I need to be on them to build the proposition that I offer, but I get turned down. I could be a significantly bigger bank today if planning had supported me. I would employ several hundred more people and be in several more communities, lending into them, if the anti-competitive nature of planning was removed. It genuinely seems crazy to me that we are turning down jobs and lending into high streets. That is one point.

The second point is that the Government have huge amounts of deposits-local authorities-and it is not put with any of the challenger banks. I would love to hear from the other incumbents around here. You allow wholesale funding. You create wholesale funding mechanisms, which take away the focus from customers. My commitment to you is that if you want to do £1 billion more lending into communities and if I won £1.5 billion from you as a customer-local authorities and all the different Departments-I will do over £1 billion in lending. Done. Net lending. Done. You do not need to create more problems for the British taxpayer. You do not need to give the banks more wholesale lending. I will do it, and I can do that if you help me with the planning and you allow me to bid appropriately to win customers with taxpayers’ money.

Q30 Chair: We are going into a funding for lending discussion.

Craig Donaldson: Well, funding for lending is a wholesale offering.

Q31 Chair: Can I just say that it would be very good, off piste, if we could get some more on those examples of how utility platforms are working in the States and bank in the box and so on.

Q32 Mr Love: We are constantly accused of expanding our remit, Mr Donaldson. You have just expanded it-

Craig Donaldson: I apologise. I could not miss an opportunity.

Q33 Mr Love: That may be an opportunity we’ll take up. You never know. I want to come to another aspect of effective competition. When he came before us, Don Cruickshank was very clear. He said it really has nothing to do with concentration. He said, "It’s the dynamic of the market and the ease with which customers can move from one supplier to another which is key." To what extent would you both agree with that?

Jayne-Anne Gadhia: I would probably look at it the other way round and say the fact that customers find it so difficult to move their personal current accounts between suppliers means that the nature of banking in the UK is less competitive than any of us would like. To be honest, the incumbents would say that they have moved on enormously over the last few years in enabling people to switch. I think that there is some truth in that, and I guess seven-day switching will help us even further with that. But there remains in the customer’s mindset the perception that if I move my current account from bank A to bank B, I will be the one who is left to pick up any problems that happen as a result of my mortgage not transferring or-the thing that always comes through-my cable television not working when I have done it. Being able to give customers absolute certainty that when they move their current account, they will not have that sort of dislocation in their lives, because none of us needs that, will enable us all to give much better service and much better pricing. As a consequence, the market will be more flexible and there will be more movement between banks, and I think everybody will get a better deal as a consequence.

Q34 Mr Love: Before I come on to the seven-day move, let me just ask you, Mr Donaldson. Inherent in the first answer we have just received was the idea that it is the difficulties of switching that are the problem and not that everyone is content or at least accepts that there is really no difference between banks. Would you accept that? More importantly, from your experience, what evidence do you have to say that that is the core reason?

Craig Donaldson: I do not have evidence to say that. My view is that it is not difficult to switch. We employ people who do switching for customers. I believe it is the perception-to use Jayne-Anne’s words-that it is difficult to switch that is the issue. What I really hope happens in September with seven-day switching is that we ensure that everybody delivers the perception that switching is easy within seven days. If we do not and the perception is damaged, then you are back to where you are now. I think it is easy to switch. We make it easy for customers, because that is our job, because I want to win customers, but there is a perception in the marketplace-I cannot imagine how that was created-that it is hard to switch. September is our opportunity to put that right.

I think a lot more people would have switched by now if there had been credible alternatives on the high street. If you were switching, did you want to switch from the big bank on that corner to the big bank on that corner when you knew they did exactly the same things? They have the same opening hours-the same, the same, the same. As we get more competitive with more competition, we will see more switching by default, because people will choose to leave somebody, whereas I believe up until people like us came along, it was very much almost a protest vote.

Q35 Mr Love: You spoke rather warmly, I thought, about seven-day switching and the possibilities. What gives you the confidence that this is going to make a tangible difference to people’s attitudes or perceptions?

Craig Donaldson: I think because we have to make it happen. We were talking with the Payments Council and I said the same to them. It is key that we enforce the key performance indicators on this and that somebody has teeth. As soon as the perception is allowed to be damaged, we have thrown away the opportunity that the seven-day switching presents. It is all about the perception. SMEs are the most under-served. If the consumer and the SMEs perceive the switching as difficult, who cares about seven days? It will be damaged, and we must make sure that that does not happen. That is why somebody-a regulator or a certain body-needs teeth to ensure that the KPIs are managed tightly across the industry.

Q36 Mr Love: There is already an ingrained perception that we need to shift-

Craig Donaldson: Absolutely.

Q37 Mr Love: There have been a lot of people before the various bodies of this Commission, and we have heard a lot of evidence suggesting that seven days really is not big enough. Ms Gadhia, you were much more sceptical about the seven-day turnaround and suggested full account portability. Why are you so sceptical about seven days, and why would full account portability meet your scepticism and move perceptions?

Jayne-Anne Gadhia: I think that seven-day switching is, undoubtedly, a good step in the right direction, so I am not dismissing it as something that will not improve things. The reason I think that it will improve things is that the big banks have got to do it, and holding the incumbent’s feet to the fire to make sure that switching is both easier and perceived to be easier is good. That said, it does not get us to a place where there is a truly competitive environment. If I can give you an example, I used to work at RBS until about seven years ago, and at the time I was working in an area that was selling PPI. I spoke to a senior person at RBS about the need to withdraw PPI at that time from our - from RBS’s- marketing, and the reply I got was, "Yes, it is clear that that should be withdrawn but we can’t be the first people to do it because we would be the ones who lose profit first." The industry around PPI knew that a problem was coming up, but nobody was prepared to be the first mover to resolve it because they felt that their share price and profitability would be damaged first.

As a consequence, what that says to me is that the industry needs to be able to move in a way where everybody goes at the same time, and seven-day switching helps that. I do not think that that is enough. In order to enable not just honesty and comparability among the incumbents, we need to move to full account portability so that a broader range of banks can participate on a level playing field, as we have discussed, and enable true competition to be brought into the sphere of banking, rather than what appears to be frankly-I am not sure I should use the word, but it is-a cartel. It is very difficult to break in until we get to a place where access to those systems enables us all to compete in the same way.

Q38 Mr Love: Mr Donaldson, how long should we give the seven-day procedure before it is decided that we need something more radical? I will come on to the expense aspect of it, because you will have heard what the big banks have to say.

Craig Donaldson: I have. I think you need to give it proper time, actually. It is about forcing investment in the perception change, because it will take investment in management. You will know very quickly if it hasn’t worked.

Q39 Mr Love: I understand, and that is what the banks are saying to us. How would you respond to the argument that we, while accepting the seven-day procedure, should set a longer time scale for the introduction of full account portability?

Craig Donaldson: I certainly would do the work on full account portability. I certainly would set the road map out; you need to build a road map that delivers improvements along the way, not just a big bang. I do not think that we in the UK can afford to wait for the big bang because it will be some time out and there are paths that can be laid that will enable us to get the benefits along the way. Seven-day switching is one-the utility that we discussed-and you would have to have the utility to fulfil the full portability, so if you were to get people together and to lay out a proper road map, you could have stage gates along the way delivering real benefits to the British economy and the British people. Then you could get to portability by delivery, not by long-term thinking, and that is what I think this needs; it needs constant delivery and constant improvement rather than a 10-year plan with a big bang delivery.

The other thing I would say is that we need to manage the perceptions around this, because portability is a bigger question than seven-day switching, which I believe, if managed properly, can deliver significant benefits-if managed properly. It is beholden on the banking industry to manage it properly, and I hope that the regulator will take a very strong view of that.

Q40 Mr Love: We do not have any evidence in relation to why people don’t switch, and we do not have any studies that have projected how many people would switch if we had seven-day switching. The banks are telling us that it is extremely expensive to move to full account portability. How do we argue our case?

Jayne-Anne Gadhia: I believe, as I said earlier, that the banks will have to invest hundreds of millions of pounds in their own systems. We heard recently that RBS is reportedly investing £80 million this year alone in its own systems. I know that the other-

Q41 Mr Love: But they went badly wrong.

Jayne-Anne Gadhia: In order to ensure that their own systems are robust, I am sure that the other big banks are investing tens of millions a year as well in those systems. Of course those systems need to be fit for purpose as they are operated day to day, but I would have thought that some of the investment for a more common system of banking could be made by diverting some of the investment in the old systems into the new over a period of time. We are not just talking about full account portability or a common platform or about just the new providers benefiting; the big banks will benefit for the future as well, because we will have genuine competition. I do not want to compete in a way that is unfair to the big banks; we should give customers the best deal and all participate on the same platform.

Q42 Mr Love: Mr Donaldson, is there a role for cost-benefit analysis here? At the end of the day, when you ask banks to invest, clearly they want a rationale for that. Just saying nobody switches only starts an argument about why, how many would switch and whether it is an enormous cost for small benefit.

Craig Donaldson: I cannot remember who I heard say this-if it is somebody around the table, I apologise-but there is almost a cost case of whether they can afford not to do it, given what is going on and the infrastructure that they have now. Ultimately, it is going to run out of road. That is why I come back to what I said. We need a road map that is properly worked through, with deliverables along the way, so we can work out what we get, at what cost and in what time. If we could see something like that, it would enable us to make informed decisions that we could plan on.

We need to be careful that in running to do something, we do not create unintended consequences that have knock-ons for challenger banks because they do not know what to link into, how to build or whether they are looking X years out. I have been talking to banks that are building their systems now and looking to launch, and they are saying, "Crikey, we were 90% down the line, and now we’ve got to change to fulfil seven-day switching. We’ve just been told we’ve got to fulfil that if we’re going to get our banking licence." We need to be careful that the road map is clear, worked through with the right cost-to-income benefits and planned properly. Otherwise, it will have unintended consequences. That would be my concern.

Q43 Mr Love: What should we include in that road map? We have a seven-day redirection service which is already on its way. We have full account portability. We have a utility that can control the transmission service. We have a platform that will allow new banks to hook into the system without having to go through one of the big boys. Should we be laying out a scheme for all of those? You both mentioned earlier the horrendous costs of a platform. This is a very long-term project. Is that necessary, or should we limit ourselves to the utility aspect, which could be brought in much quicker?

Craig Donaldson: For me, if you get the right vision and the right road map, the things that we have talked about will come much quicker. That would allow you to make informed decisions as you move down about whether you have achieved what you wish to achieve. If you do not achieve what you wish to achieve, it allows you to go to the next level.

Jayne-Anne Gadhia: I think painting an exciting and positive vision of what banking could be like in the UK in the future would be a really positive part of that. I think about some of the changes that people such as yourselves have enabled to be introduced over the course of the last few years. We are trying to break down banks that are too big to fail. We are helping people to understand what depositor protection really is. We are helping people see their bank accounts with more transparency. On top of that, we are enabling people to move without fear of system failure to the best product and the best service. That would give us a uniquely mobile banking customer proposition that can only be good for the country and for the customer.

Craig Donaldson: Banks could then differentiate themselves on their propositions and not on the propositions of the people they bank through.

Q44 Mr Love: To pick up on the transparency point, that is the other aspect of it. How do we tell? How does the customer express their choice without knowing exactly the cost of the choices that they want to make? We were supposed to be getting a statement of interest forgone, but that does not seem to have happened. Could both of you say what needs to happen in terms of transparency to give customers real choice?

Jayne-Anne Gadhia: I really believe that we have to publish interest forgone and work out how to explain that in a sensible, user-friendly way that everybody can understand. I say that because I was talking in my own business two or three months ago to a large group of people about the fact that there is no such thing as free banking. A lady dropped me a note afterwards saying, "I keep hearing you say that, Jayne-Anne, but I think I have free banking. Why haven’t I?" I said to her, "Have a look at how much money you have had in your current account over the past few years and tell me how much you would have earned if that was on deposit." And she said, "Blimey, I think I have been ripped off." If we can find a way to make that real for everyone, I think it will help transparency.

Craig Donaldson: I have to come back on that point, because I am concerned that, in our drive-we have to have transparency, I agree-we have to understand the value. If somebody has forgone interest, you might apply a simple number to that if it was an internet-based purely blah blah blah service or if it was another service. We need to look at value in the broader sense, because what you value will be different from what I value, which will be different from what someone else values. It is about creating freedom of choice for the customer so they can decide where they want to be for the reasons they want. That is what we lack at the moment: not more numbers that people do not understand, but customer choice competition that creates an environment where you have to work harder to win customers and keep them. Rather than trying to explain "This would have cost you x, and here are four pages trying to explain what that really means," it is simplicity that has to go with transparency.

Chair: Thank you. If you could drop us a note on the idea of road maps, it would be much appreciated because that will be extremely useful as we start to move forward.

Q45 Lord McFall of Alcluith: I have a number of questions, and I would like to get them done in 10 minutes if possible.

I am very much taken by the issue of competitiveness and competition. Will you both paint me a picture of how you would like to see the banking market in the UK? Would it be a host of small firms? Would it be regional banking that you support? Would it be along the lines of the mittelstand in Germany? How do you see that? You are challenging the big five, which represent 455% of the country’s GDP. Is that the type of banking structure that we want?

Jayne-Anne Gadhia: I think I would be much closer to the US model. If we get to a place where we don’t have banks that are too big to fail, where we can protect depositors and where people who run banks realise that they do have responsibility and accountability for the success or otherwise of their institution and don’t expect to be bailed out ever again by the taxpayer, then I do believe that we should be creating a banking market that is much richer and with many more competitors. Since the crisis, I think we are down to 80%, or something, of the original starting number of banks have vanished. That cannot be right for competition.

Craig Donaldson: I will add no more.

Q46 Lord McFall of Alcluith: So along the lines of "let 1,000 banks bloom"?

Jayne-Anne Gadhia: Certainly many tens.

Craig Donaldson: I think what you need is competition.

Q47 Lord McFall of Alcluith: That aspect is important for us. The UK retail market has been described as effectively a mature, low-growth market. Is that the case? That view would indicate to people that it is not really worth while coming into the retail market, so what are you bothering about? Can you get underneath that veil for me?

Craig Donaldson: To use Jayne-Anne’s word, if it is a "cartel" or "oligopoly," or whatever we want to talk about, and it is positioned by them as being that, I would say that it is low growth. But if you have competition and organisations that enter markets and segments to create a different proposition, I would say we are high growth. We are a high-growth opportunity. We have created 600 jobs in the past two years from nothing; we have won more than 100,000 customers and we are going to grow another four stores, so there will be another third this year, and I will double my size by the end of next year. That does not feel low growth to me.

Jayne-Anne Gadhia: Virgin Group would say that if we feel there is a market that we can come into where we can give the customer a better deal, we would like to be in it. I think there is no better market at the moment where you can see how to give customers a better deal.

Q48 Lord McFall of Alcluith: Good. Sir David Walker told our Commission previously that poor standards in some parts of the retail market are linked to the prevalence of so-called free in-credit banking. Do you concur with that?

Craig Donaldson: No.

Jayne-Anne Gadhia: I think that free in-credit banking, the way that it is described, can actually be seen as a lot that is bad with banking: it is not transparent, it is not clear, it confuses customers and it can be mis-sold. For all those reasons, it is something that we should think about very carefully.

Craig Donaldson: Can I come back? It is really interesting where we have owned our stores. We create cards in store, so if you lose your card on a Saturday, you can pop in on a Sunday morning and we will print you out a new one straight away-done. A lot of banks said that wasn’t necessary and wasn’t needed, so it is interesting that one of the large banks is now piloting around some of our stores to do it for existing customers. It is also interesting that another one of the banks, which said said that we didn’t need to open for longer hours, is now opening on bank holidays around our stores. It is also interesting how they said people did not want a bank outside 9 to 5-that people just wanted to do it on the internet-but now they have just extended their opening hours round our stores. Competition drives the focus on to the customer.

Q49 Lord McFall of Alcluith: Craig, you talked about the SME market being the most under-served. Given that it is the most politically sensitive, because the debate for years has been how do you get lending to business, what initiatives would you have to open up this market and get that lending?

Craig Donaldson: I think, as I have said, that it is understanding what the SMEs want. What they tell us they want is the high street presence, continuity of relationship and somebody who will get to know their business. You will create that by having banks on the high street, with a utility offering behind them, so they can focus on the customer and not on building the bank.

Q50 Lord McFall of Alcluith: The key barriers to entry and growth are?

Craig Donaldson: The same ones. The same ones around the utility offering. I think for the SME it is all about the cash management. We all know cash flow is king, as they say. For the SME, it is about creating cash management to help people run their businesses.

Jayne-Anne Gadhia: From our perspective, in entering the SME market we would think about following a similar model to the acquisition of Northern Rock. We know there is significant demand from SMEs to bank with Virgin. We would look to do that initially through acquisition and then by enhancing the service and price that SMEs would achieve.

Q51 Lord McFall of Alcluith: Access to credit-scoring information-is that a barrier in the SME market?

Jayne-Anne Gadhia: No.

Craig Donaldson: I do not believe so. One sort of barrier is winning the customers over-breaking the perceptions that are there and being in their communities and talking to them. It is just shoe leather, I am afraid; with SMEs it is good, old-fashioned getting to know them.

Lord McFall of Alcluith: Good. Admirably precise.

Q52 Chair: I thank you. We really appreciate how you have been very concise on the last questions. Can I ask you one closing question? We are a Commission on banking standards. Sir Donald Cruickshank has suggested, as have others, that competition is an absolutely key element if banking standards are to change to the sort of benchmarks that we would all probably think appropriate. Would that be your view? Can you see an impact of competition on standards and culture, and customer service?

Craig Donaldson: Yes, I would absolutely support the idea that competition drives standards. I go back to what I said earlier about people who were waiting two weeks to get their cards delivered. We start doing it instantly in store for new customers and existing customers, and suddenly we are seeing some of the larger banks, who said that it could not be done and that customers didn’t want it, starting to do it. Why would that be? You need competition to deliver what customers want and to drive others to have to come with you.

Jayne-Anne Gadhia: I think that, in everything we have talked about, for me it is important, as long as competition is to be the best, not the biggest. Historically there has been competition to be the biggest and to outdo the few others. Having many more banks, and competing to be the best, must be the right outcome for customers.

Craig Donaldson: Just thinking of segments, it is really interesting in banking how we have the few banks who try to be all things to all people. There is room for segmentation. We offer great service and convenience, and the best value, we believe, but we don’t offer the very best pricing on deposits. If you want the very best pricing on deposits, you can go to other people. It is about allowing customers the freedom of choice: creating choice for customers so that they can get what they want is the key to this in my view. I do not expect to win everybody, just those who value real service and convenience, because that is what we offer. And that is fine.

Q53 Chair: Ms Gadhia, earlier you gave an example where banks that anticipated that PPI was turning into a problem dared not leave the market because they would look less profitable than their competitors, so they would not take the leap first. Are there some downsides to competition, and are there particular things we should guard against as we look at a more competitive environment?

Jayne-Anne Gadhia: I think that, if the cartel is broken, there are many fewer downsides to competition, simply because there will be more variability and more life in the particular market. Where there are very few players and they can see what each other is doing, they do not want to move away from being part of the pack, and I think that is very dangerous. I’d go for breadth of market.

Craig Donaldson: I agree.

Chair: We thank you very much indeed. If you have further thoughts on these or other issues, we would very much appreciate it if you would drop us a note. You have given us a great deal of food for thought. Thank you.

Examination of Witnesses

Witnesses: Benny Higgins, Chief Executive, Tesco Bank, and Phillip Monks, Chief Executive, Aldermore, gave evidence.

Q54 Chair: Thank you for coming. As you know, we are a sub-set of the Parliamentary Commission on Banking Standards-the panel on retail competition. May I say how much we all appreciate the fact that you have come, and are willing to give us your time and the benefit of your thoughts and advice this afternoon? We felt it was very important that this discussion about banking standards, but also particularly about competition, should hear from the challenger banks, not just the dominant four or five. We have already had one meeting with some of your colleague challenger banks, if I can put it that way. It has been very interesting how different the perspective can be when looking at it from a much more diverse base. So thank you very much indeed.

The way in which we will do this is that we will pass the questions between ourselves and our goal is to end at 4 o’clock. On prudential regulation as a barrier to entry-you have had different experiences in this area-could I put this question to Mr Monks? We have heard from some of the challenger banks that capital liquidity requirements often place entrants at a financial disadvantage, relative to the established banks. Could you give us your experience and thoughts about that?

Phillip Monks: Yes, certainly. It is entirely appropriate that the banks are capitalised appropriately. There undoubtedly is not a level playing field in the UK, and there does not seem to be any directional move towards a level playing field in the UK. I have to say that of the two forms of capital in banking, the first is your capital adequacy ratio, and I have no complaints about our capital adequacy ratio. We have been through two or three ARROW visits from the FSA and our capital ratios are not far off those of the big banks. The FSA when it goes for an ARROW visit looks at governance, systems of controls, management competence and resolution in the event of failure. Clearly, the FSA is comfortable that, as far as Aldermore is concerned, we stand very well in that respect.

There is, however, the standardised approach to capital risk weightings as opposed to an internal ratings basis, the IRB approach. That is where we would find that, in general, we probably need to apply twice as much capital as the main incumbent banks. So, regardless of our capital adequacy ratio, we would need to apply twice as much capital. So if you take residential mortgages, the standardised weighting is 35%, and many of the large encumbered banks would be on an IRB approach with anything from 5% to 10%1. I would say the average is probably around 17.5%.

Our recommendation to the FSA has been: first, to follow up on the Independent Banking Commission and make data on homogeneous pools of assets like residential mortgages more freely available; secondly, to allow credit reference agency data, such as Experian, to complement the data that we have; or thirdly, to recognise that we are on a path towards IRB and to put us on a glide path, to use the regulator’s own phrase, from a standardised approach to an IRB approach-a hybrid approach.

We are certainly not unrealistic about wanting to move straight to an IRB approach with perhaps only half the number of years of behavioural data that the bigger banks have. But there are ways to supplement that. To put it mildly, or to put it in context, if I had an IRB approach, which was 17.5%, it means I can lend twice as much on my capital ratios. This is something that, when I speak to Treasury Ministers, they are very keen for me to do, but there seems to be a discontinuity between what the Treasury Ministers say and the ambition to try re-stimulate the economy, and currently what we see at the FSA.

Q55 Chair: Picking up on a similar comment made in the earlier hearing, are you essentially saying that perhaps it wasn’t a problem on day one, but that, as you grow and begin to establish a track record, you are not seeing the kind of change in the approach to your capital base that reflects that expansion, growth and experience that you are building?

Phillip Monks: Not entirely, no. Our capital adequacy ratios have fallen very nicely as we have grown in experience and as the FSA has grown in confidence in us. The fact of the matter is that the IRB approach needs seven years of data. So we would have to wait seven years to be able to apply in our own right if we were not able to supplement it. Sir John Vickers recommended in the Independent Banking Commission report that external data sources be used to supplement that to increase competition.

Q56 Chair: Do you have any comments, Mr Higgins?

Benny Higgins: Yes. The significance here is between standard and advanced. That really applies principally to the mortgage business. Where you have a skew to mortgage business, the advanced would be likely to lead to a lower capital requirement. With our mix of business in Tesco Bank, it has not been significant, so I would not claim that it has in any way held us back in terms of developing the business.

Q57 Chair: Mr Monks, would it make a difference, in your opinion, if the prudential regulator had a competition objective? Is there a lack of focus around the issue that you are raising that might be changed by that?

Phillip Monks: If the question you are asking is, "Should the PRA be stimulating competition?" or, "Should the PRA not stifle competition?", I think it would be the latter. It should act to ensure that there is a more level playing field. In a commercial environment, I think I would find it difficult to see the PRA be specifically targeting or incentivised to increase competition. I do not think that that is the role of the regulator.

Q58 Chair: That is very helpful.

If I could move on to the money transmission system, and again if I could start with you, Mr Monks, Sir Donald Cruickshank has repeatedly stressed the need to strip the large incumbent banks of their control of the money transmission system. Would you agree that that is a priority, if we are to increase competition in the retail market?

Phillip Monks: First, Aldermore does not directly use the money transmission system. It does not have a current account for either its personal customers or its SME customers. It has ambitions for some form of payments mechanism for SMEs; we think that that is absolutely critical. I think that when we commit more directly to an inter-bank agency agreement, we will be at the mercy of the large four or five banks that are behind that.

My own view is that you have two avenues in which you can proceed. The first is to regulate the money transmission system within the existing banking industry and therefore ensure that, as and when the bank’s price-for me-enters that system, it does so under a regulatory umbrella.

The second is that there has been a lot of comment about creating a utility or lifting out the money transmission business. I think very few people-I would include myself-understand how complex that is. The tentacles of the money transmission business in the large banks extend a long way. If we were going to go down that route and create a form of Railtrack, BT or Post Office equivalent in the banking industry-I would thoroughly recommend that-we should do it with our eyes open. It is a long and incredibly complicated project. It probably needs a working group of experts to scope it.

Q59 Chair: Could I ask your views on that, Mr Higgins?

Benny Higgins: Certainly. We look at all these issues from the vantage point of the customer. If we look at this particular question, I think you will quickly reach the conclusion that it is not a priority. We have an agency relationship in place today, which we have had for some time. It serves customers’ needs. It is not without its failings, and we deal with them as we go, but when we are looking at how well the banking sector serves retail customers, this would not be a priority-there are much higher priorities.

Phillip Monks: It cannot be right that new challenger banks that I know of coming into the market are put on a contract for six months’ notice for their banking infrastructure. It means that, if something happened, one of the main banks would pull that contract and give that challenger bank only six months’ notice. That is the degree of anti-competitiveness that exists in the system. My view is that a greater regulation of those terms and conditions in the existing industry would be a short-term way to ensure that challenger banks have a more level playing field.

Q60 Chair: We had comments in an earlier meeting that were very much in favour of going in the utility direction-pretty much as you have described, Mr Monks. We had a discussion of a potential road map to get there, as a mechanism for facilitating steps along the way and opening up the environment to more competition. Is that an approach that would have some merit, from your perspective?

Phillip Monks: Yes, it would. That is why I think it is important to get a panel of experts to really look at what the constituent parts of that utility might look like and in what order they would be tackled. There is a lot of talk about switchability at the moment. To my mind, that is less important than creating an environment where you can have more competition, because all that is going to happen is people are going to talk about switching between the existing banks in the marketplace. It tends to be a commoditised market when you are talking about personal current accounts.

Q61 Chair: Andy Haldane, who gave us evidence, went beyond that and talked about all banking transactions being undertaken on a single platform that banks, including the new ones, could access-taking this almost to the ultimate degree. Over the long term, can you see advantages or disadvantages in that? I am thinking of technological advantages and competitive advantages.

Phillip Monks: I can see significant advantages in terms of commonality of systems, interfacing systems, and therefore reduced cost for challenger banks; the need not to have to negotiate complicated contracts with the incumbent banks; and the degree of stability that would come from a common platform. So yes, long term it is a desirable outcome, but we must go into it with our eyes open, because the banking infrastructure, as I say, has tentacles a long way in to the banks themselves, and lifting that out sounds like a nice idea but it is not compartmentalised within the banks.

Chair: Do you have any particular comments on that, Mr Higgins?

Benny Higgins: Yes. I go back to my earlier point. I think that the effort required would be disproportionate to the benefit. For me, the issue is that we need a transparent market, a market where it is easy to switch and where there isn’t the distortion of so-called free banking. There are many higher priorities that would mean the customers were better served. As an organisation that has an agency agreement today, I do not list that as one of my priorities. It is getting in the way of serving more customers in more ways.

Chair: What I will do, because I think we are rather interested in this area, is ask both of you if you would not mind sending us a note on your thoughts about the kind of direction and the scope and priorities. It would be really helpful to have that, and I think you will find that there will be other questions later that will follow up around many of these issues. I will hand over to John McFall.

Q62 Lord McFall of Alcluith: My apologies. I will be leaving just after the questions. I have another Committee in the House of Lords.

On the UK retail market, Mr Higgins, we have been told through a number of submissions that it is effectively an immature, low-growth market, unattractive to new entrants. What do you think?

Benny Higgins: We find it a very attractive market, where we feel as though we can serve Tesco customers in more ways than we ever have before. If you take the past four years, for example, we have gone from doing one in 12 credit card transactions in the UK to one in eight, so we have seen a growth in the ways in which we can serve Tesco customers. We have seen our ATM transactions rise by 27% over the same period. We have seen our savings balances grow by 68%. We think that, if you have the right culture, the right products, the right prices and the right way of talking to customers and serving them, there is ample opportunity to serve more of them every day.

Q63 Lord McFall of Alcluith: We have been told about new entrants in the credit card market, the personal loan market and savings accounts, but it would seem that there could be a problem in terms of new entrants for the current account market. Is that the case?

Benny Higgins: Yes. If one looks at the current account market, there is the question: why do people not switch? Many people are actually happy with the bank that they are banking with. We should not rule that out. Also, there are those who think that all banks are the same. Certainly, there is a perception, and a reality, that switching is difficult. Those are the things that stack up against people switching, in many cases.

I think that the notion of free banking is a distortion, because if you go back to 2008, I think it was the OFT that showed that £8.3 billion of income was generated by the banks on current accounts, of which roughly half was credit interest and about a quarter was insufficient fund fees. Banking in the UK is not free. The cost disproportionately lands with a minority of people, but the notion that it is free and the fact that people keep talking about it being free is, I think, another area that gets in the way of people switching.

Q64 Lord McFall of Alcluith: So it is a good spin, which you need to demolish.

Benny Higgins: Indeed. Economists often talk about the asymmetry of information in markets, and that is very much the case in banking in many aspects, where the provider knows a lot more about the product that the customer.

Q65 Lord McFall of Alcluith: I am told that the IT legacy systems in major banks is a big issue. Given your experience over many years, is that the case? Do you have any ideas about how we would accommodate updating IT legacy systems with initiatives that we could propose to the Parliamentary Commission?

Benny Higgins: I think we have to look at the market and ask where is the customer detriment, what is the cause of it and what can be done about it. The switching service that is due to come in next year, if it delivers what it is supposed to, should be a major step forward. It should make switching much more reliable and much more consistent. However, we need to ensure that there is a high level of awareness among retail customers, because even if it works if there is not enough awareness of it that would be an issue.

What is interesting in the Netherlands, for example, where a similar switching service was put in place, is that it now has a very high satisfaction rate; it is something like an 85% rating by customers who switch. However, the level of switching has not changed, so the fact that switching becomes easier does not necessarily mean that there will be a lot more switching. At the end of the day, the notion that it is free is quite a distorting factor, when it clearly isn’t free.

Q66Lord McFall of Alcluith: Mr Monks, regarding the issue of the SME market-I know that you have been very much involved in that, and to a successful extent-four banks control approximately 80% of the SME market. Why is the SME market so concentrated in comparison with other parts of the retail market?

Phillip Monks: It is the very same reason that the vast majority of banking is concentrated in four or five banks-there has been no competition and no alternative. However, what we are finding, as our balance sheet has grown from nothing to £2.3 billion in the last three years, is that SMEs are searching out a bank that has some very key principles when it is working with them. One, it provides expertise, where the main banks have deskilled their offering to SMEs in favour of a more sales-type culture. We have an industry-segmented model, so that we put ourselves in the shoes of that industry; we understand it intimately. Therefore, we speak the customer’s language and that is something that gives us an insight from a credit point of view and an industry-wide point of view, but it also provides that real expertise; not a credit-scored expertise, but a human intervention expertise.

We also have a completely straightforward attitude to our customers and our products. We don’t have bonus accounts on deposits, so we don’t seek to deceive our customers. But equally we then apply technology very effectively, so that SMEs, for example, can open a deposit account with us online in under 15 minutes. If I can do it in nine minutes, then most people can do it in less than 15 minutes. So it is a mixture of technology, expertise, speed of offering and-above all-reliability, and unfortunately the incumbent banks in the UK at the moment aren’t seen as reliable.

Q67 Lord McFall of Alcluith: You were a challenger that overcame the barriers to entry. Tell us how you did that.

Phillip Monks: This is the second bank that I have established. I established a bank before this, for Arab bank-a Jordanian-quoted bank-in Europe. In between my doing that and starting Aldermore, the FSA’s permissions department had pretty much closed, thrown away the key and they weren’t actually looking for it, I don’t think. So it became clear to us very early on that it would have been easier to buy a small bank, which was in the space that we wanted to develop. We didn’t buy a banking licence; we bought a bank that had asset finance and property development, which were the types of products that we wanted to offer and expand.

We went through that process-that change of control process-in the statutory three months. We had a management team. We had a credible business plan that was appropriately stressed. It was challenging, and it should be challenging. I have always said that it is refreshingly difficult to get a banking licence, and that is not because I’ve got one and a lot of people are trying to get one. I think there is a big prudential responsibility on the chief executive of a bank, but I have to say that our process was very straightforward with the FSA.

Q68 Lord McFall of Alcluith: Is there a lethargy with the big banks in relation to SMEs in this country? We have seen the perennial debate going on-in this Government but in the previous Government as well-and as a Sub-Committee we went to Birmingham to speak to small employers, and the negative tones coming back from them were considerable.

Phillip Monks: I think there is huge negativity and a lack of trust for the banks. There isn’t a day that goes by when there isn’t another banking scandal, which adds to that unfortunately. Aldermore set out from day one-I have two daughters who have grown up now, but I can remember when they were younger that we sort of looked at them, we looked at other kids and thought, "We’re not going to make that mistake." And that’s how we have set out to grow our bank. We have set out to grow a bank that we can be proud of and that our customers can be proud of, and that is reliable, expert, dynamic and very straightforward.

People look at the main banks now and they say, "Where is the skill base? If I want to talk to a relationship manager, does he have the skills in dealing with smaller and medium-sized businesses?" And if you go into a branch of one of the big banks, as like as not you’ll be told, "I’ll make an appointment for you", or if you go in to buy a mortgage you’ll be told, "I’ll make an appointment for you." So the bank manager on the street is not really a point of expertise for an SME, whereas we have always taken the view that even though we have 14 regional offices the great joy in banking, and certainly throughout my career in banking, was going and visiting customers to see the passion that they had for their business. If they have queries they can phone us or in due course Skype us and we can have face-to-face time over a laptop. For me, there is a complete breakdown in trust in the SME community. It is very difficult for SMEs to switch for any number of reasons, not least of which is that the collateral that a lot of the main banks have is over multiple facilities. Therefore, if somebody wants to leave one facility and come to me the banks will not release that collateral.

Q69 Lord McFall of Alcluith: Do you want to add anything, Mr Higgins, before I ask the final question?

Benny Higgins: Yes. I would say on our part that there are many things that dictate how well customers are served by a bank or any business, for that matter. I think that the culture of the business transcends all other aspects of it. Certainly, we have set out to have a culture that is about serving customers, about rewarding loyalty, not punishing loyalty, about being transparent, about offering good prices because that is an important part of good value. We are very proud of the culture that we are creating, and I think that is the most enduring powerful thing that a bank can do.

Q70 Lord McFall of Alcluith: Both of you agree that the culture of the business is key. It takes a long time to develop a good culture.

Phillip Monks: Aldermore now has 500 people and three years ago there were 30. People have joined Aldermore from all sorts of organisations. It is very important, and it has been very important for me as the CEO, to create an Aldermore way of doing things. When people come in there is an absolutely rigorous induction process that talks about the values, where we want to take the bank, how we want to deal with customers, the straightforwardness and the efficiency of our systems. People buy into that. They buy into the journey and the pride that come with that. Frankly, that culture starts with us.

Benny Higgins: Could I add something? There is not an organisation or a bank in the country or the world that does not talk a good game. Everybody talks about looking after customers, everybody talks about the customer being at the centre of what they do. Culture is really determined by the accumulation of real decisions you make, and also what you tolerate, what you applaud and what you reward as a business. That is what determines the culture. Let me give examples. As soon as we were under our own full control, having moved away from the RBS dependency, we stopped having incentives in our call centres and stopped having sales targets.

When the funding for lending scheme became available, as you may have read recently in the newspapers, we passed on that advantage quickly to customers who are taking mortgages from us. In our behaviour towards our savers we have made sure that if you stay with us you get looked after. We do not try to take advantage of you if you look the wrong way for five minutes. Those decisions determine culture; it is not talking about it, because everybody talks a good game.

Q71 Lord McFall of Alcluith: This is maybe my last point for you. What is your vision for banking for the future? You are walking down different communities. How do you want to see banking in years to come? We have the concentration of half a dozen banks at the moment-with 450% of GDP. How do you see what a bank will be like in 20 years’ time?

Phillip Monks: We always concentrate on the big four or five banks in this country. We forget the huge number of foreign banks that have left these shores as well. There has been a complete demise of banking, particularly for SMEs in this country. There are umpteen reports, not least Tim Breedon’s report for Dr Cable, that show that there is a vast dearth of finance available to SMEs. Tim Breedon reckons it is anything from about £90 billion to £190 billion2.

There is ample room for more competition to come in. The need for the big banks to de-leverage means that you will get quite quickly to probably nine to 12 medium-sized banks in the UK. I would like to see the further growth of what we used to have in terms of specialist finance houses that have had to run off because they can’t get the wholesale funding from the big banks that they used to be able to get. There is room for a number of medium-sized banks. I think that is inevitable but I would like to see lots more regional finance houses and challenger banks.

Benny Higgins: The most important thing is that public trust in banking has to be regained. That is going to take time. Interestingly enough, I think competition is a necessary condition for customers to be looked after but it is not a sufficient condition. You can have very competitive markets where customers are not served well. It is very important that banks regain trust. It is about looking after customers. It is about taking actions that are consistent with what was often rhetoric. What we are setting out to do is to create a culture and a business where we genuinely look after customers’ needs, and where we genuinely reward them for their loyalty, not punish them.

Lord McFall of Alcluith: Thank you very much.

Q72 Chair: Thank you. Mr Monks, I do not want to lose the collateral point that you mentioned. Would it be possible to send us a quick note on that? It has come up before and it would be very helpful to make sure that we do not lose it.

Phillip Monks: Certainly.

Q73 Mark Garnier: To continue on one point that you made to Lord McFall, you talked about how you did not want to make the mistakes that other banks had made. You also talked about the way you set the culture at Aldermore. In five years I think you had gone from 30 members of staff to 300 members of staff, and you have been very careful indeed about setting the right culture. Joining those two things together, what can you see in the big banks in terms of what is wrong with their culture?

My question is coming from some of the other investigations where we see that there are a number of things going on, one of which is cross-contamination from the investment side of the banking to the high street side, in terms of the wrong culture. The other thing is that to a certain extent you have been merging together lots of different types of culture-these things have morphed together like mercury-and you have had some clashes of culture. What would you highlight as the big problems that the big banks have got, which you would clearly want to avoid?

Phillip Monks: I think they are organisationally fragmented, which we are not. We are one bank, one credit committee and one culture. If I look at some of my previous employers, they were multiple banks with multiple cultures that are instilled in those businesses-those divisions-by the leaders of those businesses.

What I have seen over the past years, as I have said earlier, is the de-skilling of a number of banks. I can remember back in the late ’80s that this whole idea of sales leadership and sales management became the mantra, and with that sales targets as well. If I look at some of my ex-colleagues and some of the big banks now at a branch level, there is no continuity or thought about what those sales targets are. It is definitely a "pile it high" philosophy that does not necessarily service the customer’s needs. The use of credit scoring removes the human element from the relationship with the customer.

The whole area of sales incentives has overcome the need to look after your customer, satisfy the customer needs, and have the intelligence and the expertise to understand what those customer needs are as opposed to pushing products at them. In what we do, that expertise and that industry knowledge allow us to have that conversation with the customer in their language and understand their competitive environment and how they compare to other people in their industry. None of that is really available to SMEs, at least; it is more available to the large corporates and the big banks. Certainly, at the small and medium size, that expertise is not there.

Q74 Mark Garnier: Benny Higgins, you are attaching a bank on to a huge corporate culture. How are you finding that?

Benny Higgins: In a sense, what I am trying to do is to put what Tesco as a retailer has done for its customers into banking and insurance. The one thing that characterises financial services, perhaps more than any other, and one which is in conflict with what almost any other business would do in the retail environment, is the notion that you punish loyalty; you treat loyal customers as inert customers. There are £1.2 trillion of deposits-savings-in the UK. If that money were put on to the average of the top 10 rates available with the same characteristics, it would transfer £10 billion from the pockets of banks to the pockets of customers. It is anathema to a business like Tesco that you do not treat your most loyal customers the best you can. That is one important thing.

Then there is the architecture of a business. I very much believe that it is ineluctably corrosive to have sales targets and incentives aimed at front-line staff. I think you get the wrong outcomes. That is not because people are behaving badly, but because it creates a pressure. People will say that it is possible to have good incentives and healthy targets but I think it is very difficult to execute that at the level of front-line staff, which is why we have chosen not to have that. As I said earlier, cultures are determined not by what you talk about but by what you do. That is the most important thing.

Q75 Mark Garnier: One thing that has been very striking about you and both the two panellists before us is that of the four panellists who have come, only one has got current accounts as part of the offering. Why do you not have current accounts, Benny Higgins?

Benny Higgins: We are due to launch current accounts at the end of next year. When we assumed full control of Tesco bank-it had previously been a joint venture with the Royal Bank of Scotland-we had about 6 million customer accounts, across a range of products, and we had to build the bank and the insurance company from the bottom up, from scratch. That is something that we have been doing over the last four years, and we completed the migration to stand entirely on our own two feet, in terms of having no dependency on the Royal Bank, as it was, in May. The process of initiating the project to deliver current accounts was started in the summer, and we will deliver it at the end of next year. It takes time, because we have to build something that is scaled. We have the aspiration to serve many of Tesco’s customers with a very good current account that meets their needs, so we are firmly focused on doing that.

Q76 Mark Garnier: Phillip Monks, it has always struck me that the key thing that most consumers will look for is a current account, and everything else cascades from that, but you seem to have been quite successful without having a current account.

Phillip Monks: We are not really in the personal sector market. We are a simple bank, and we set it up to be very simple. We take retail deposits and we lend those on to UK homeowners and UK SMEs. You cannot do all the things when you are a small bank starting with a small management team, so you have to pick the markets in which you can be successful and build the infrastructure, perhaps putting a few pieces of the jigsaw together, but with a very clear picture of where you want to take it. My priority, certainly, would be to have some form of money transmission capability for SMEs, but as I sit here now, I have no ambition to have personal current accounts. It seems to be a very commoditised market that needs a big investment. I think we can put that investment better in other areas of the bank.

Q77 Mark Garnier: Fair do’s. Coming back to the regulatory barriers to entry, Martin Wheatley said in a recent speech: "Part of promoting competition is about making sure there are not any unnecessary regulatory barriers to new entrants." Can either of you-or each of you, one after the other-pinpoint any specific, unnecessary regulatory barriers to entry?

Benny Higgins: Frankly, we had a very hand-in-glove relationship with the FSA, as it was, as we went through the process of change of control in 2008. I would not say that there are specific barriers that we would like to see removed. What I would say is that the financial services banking market is not contestable in the sense that it is a market that people can easily enter and easily withdraw from. Therefore, the regulatory burden that goes with being a bank-it is a necessary regulatory burden, because it is important that it is prudent and that the supervisory nature of it is right-means that it is not something that one would go into half-heartedly, because it is a big investment in every sense. The regulatory nature of the business is one aspect that makes it quite a big decision to become a bank. We are delighted to have done so, but it is not something one could take lightly. However, I would not say that there are regulatory barriers that I would like to see removed.

Phillip Monks: I agree, but I think that in looking at challenger banks, the FSA has got itself in a position where it wants to seek to ensure that banks never fail. It has always had the safety of depositors at its heart, which I think is absolutely uppermost-certainly, as the CEO of a bank you feel it very strongly. The amount of capital that you need to have in a new bank at the very outset, to ensure that that bank never fails, is probably prohibitive. The fact of the matter is that capital is put into banks by shareholders and that is risk money. I think the FSA is now coming round to the resolvability of banks and making sure that, should they fail and the shareholders lose their money, the depositors are safe and that the bank is able to resolve itself through an orderly exit, without any market issues or inconvenience to customers. I think that is the right way to look at it, rather than ensuring that banks have so much capital, which then means that the returns are reduced, which means that less capital comes in to the markets, which means that there are fewer challengers. Less competition is not necessarily the right way to look at it.

Q78 Mark Garnier: There is a Catch-22 situation, where bank authorisation seems to require you to be fully capitalised before you get your licence, yet your investors are unlikely to want to capitalise you until they know you have a licence.

Phillip Monks: There is the situation in which you put forward a business plan with appropriate capital, and as you grow-you can only grow if you have more capital. The plan that we put to the FSA about our change of control has changed significantly in terms of the growth that we have been able to achieve. Therefore, we have had to go to existing and new investors and say, "Are you willing to invest more capital, or would you rather that we cut our cloth according to the capital that we have?"

Q79 Mark Garnier: To be clear, not having enough capital is restricting your growth, is that right?

Phillip Monks: It would do, but we have plenty of capital. We have investors turning around to us and saying, "Can we invest more?" We are able to grow at a prudent and safe level. If we were to turn around and say, "Okay, we want to have a £2 billion balance sheet and you have to hold that £2 billion in capital now," that would have been a rather big ask. If you are turning around and saying, "Okay, you get to £500 million then you need to go and get more capital," or you can stick to £500 million and you reduce your origination velocity, then that to me is a very commercial way of looking at it.

Q80 Mark Garnier: What about the IT side of things? We heard in the session earlier that the IT side of things can also be a barrier to entry. There is a sort of off-the-shelf system that you can get, but at the end of the day, it has to be upgraded and fitted. Have you both found that that is a problem?

Benny Higgins: The project that we undertook, which was initiated at the beginning of 2009 and completed in May this year, was very large. It was the most complex project that I have been involved in, and I have had the good or bad fortune to have been involved in many large projects across the banking and insurance world. It is a very serious investment. The IT requirements to run a full service retail bank and/or insurance company are quite significant. That is why I said earlier that it is not a small decision to make that commitment. It is an expensive business to build. We think that it is a good business to build to serve customers very well. But there is no avoiding the complexity and the breadth of building a bank from scratch.

Phillip Monks: We took the view that we did not want to be a full-service bank, and so the most important thing for us was to build scale in a number of niche markets, such as invoice finance, asset finance, commercial mortgages, residential mortgages, savings and the like. Once we had done that and made ourselves profitable, we felt that it was a more sensible time to look at that significant investment. Having looked at it, I am very keen to make that investment on the SME side, but less so on the personal current account side.

Q81 Mark Garnier: In 2010, 26 organisations went forward to try to get a banking licence. Of those, just 11 got one. In 2011, 24 went forward and just seven got a banking licence. Given your experience in getting a bank licence and getting a change of beneficial control, are you surprised by that rather poor success rate?

Phillip Monks: It is a very difficult question to answer. I know what we went through and the rigour and the stress. There was the explanation and transparency that we went through with the FSA and the almost daily contact that we had with them. I am not aware that the barriers are being raised any higher than when we went through it, but, equally, I am not aware of the business plans behind those banks. We had a diversified proposition. I am aware that there have been a number of monoline banks and I can imagine that in this market that is perhaps a more difficult proposition to stress because you are having that diversification. It is very difficult for me to answer that without understanding the plans of those banks.

Q82 Mark Garnier: Perhaps Benny Higgins will have a crack at it.

Benny Higgins: What I would say is that anyone preparing to go through the process should demand of themselves a degree of rigour, a level of resource and a degree of professionalism that is of a high standard. It is a demanding task to get through, and rightly so. It is hard to say what one would expect the failure rate to be, but certainly it should be demanding; it is demanding. It is not something that one could throw together readily. It may well be that those who have failed should reflect on what it is that they did not get right. It is hard to predict what would be a reasonable number, but it sounds entirely plausible that given the reasonable high standards expected there would be a number of groups of people who did not quite make it.

Phillip Monks: Certainly when we went through it initially, there was a tone set at the FSA at about the time we were applying for a licence. As you can imagine, liquidity had completely left the marketplace and there were a number of pools of assets available for sale as banks de-leveraged. There were a number of conversations with applicants that had very much a hedge fund take to them. In other words, they were saying, "Where do we get liquidity? Oh, we’ll have retail depositors. How do we get retail depositors? Oh, we need a banking licence. Can we have a banking licence, because we want to go and buy this sub-prime portfolio of mortgages and make a profit very quickly?" It was not surprising that the answer was no. Having had some of those conversations, the FSA was rightly concerned to ensure that people wanted to establish a real bank, with a real customer focus on prudential growth, appropriate capital and access to liquidity, rather than that more transactional approach.

Benny Higgins: I suspect that pulling together an appropriate group of able, experienced professionals before you have a licence is probably not that straightforward. The market for the most able people, especially in areas such as risk, for example, does not have a very deep talent pool. Even on that one dimension, pulling together the right calibre, quality and experience of people would be a challenge for many.

Q83 Mr Love: May I come back to the issue about the difficulty of entering into the personal current account market? Mr Higgins, in particular, you are about to do that. You have mentioned the number of issues, which I will come back to, about switching and free banking, but I was interested in you mentioning scale. Will you elaborate on what the barriers are? Is this about infrastructure and having a branch network? Can you tell us about the difficulties as you see it for Tesco?

Benny Higgins: I do not actually see barriers into entry into the personal current account market, per se. What we do observe today is that the lack of transparency combined with the perceived and actual difficulty in switching means that probably only 3% of customers switch in a given year. If you compare that with grocery shopping, for example, around 20% of spend by value switches in a 12-month period in that area. There are markets where you see a much greater level of switching. If one is launching into a market where there is a perception and a reality that it will be difficult to switch, that is a barrier to success, rather than a barrier to entry. That is why we welcome the switching service that will come in next year. It is very important that we are committed to making customers aware of it, because that, together with other changes, can make the market much more competitive.

Q84 Mr Love: I want to come back to this switching issue, because it is really quite important. Let me just ask you this: you mentioned your agency agreement with RBS coming to an end-

Benny Higgins: No, sorry, the joint venture with RBS, where RBS delivered the back office for us, is behind us. We separately have an agency agreement on payments with another bank, but that is part of our regular ongoing agency agreement.

Q85 Mr Love: The thought occurred to me that if your agency agreement is with a major high street bank, how would they respond to you suggesting that you wanted to get into personal current accounts and be one of their major competitors? I think that slightly different rules would apply for Tesco, but for any other company is the agency agreement not a barrier to the development of a real challenger?

Benny Higgins: No, I do not believe it is. There are other issues, and it is important that we do not aim off-centre on some of these issues. There are a number of issues that get mentioned, whether it is portability or other issues. I think that there are very specific issues that get in the way of the market being sufficiently competitive, but I do not believe that that is one of them.

Q86 Mr Love: Let me go on. You mentioned several times the seven-day service and your hope that it will increase the level of switching. You also mentioned, in a previous answer, that the experience of the Netherlands rather contradicted that. Although everyone was happy with the service, it did not increase the level of switching. Could you elaborate on that experience and say what the similarities are between the Netherlands and UK personal current account markets? Maybe they did something that we will not do.

Benny Higgins: I think I make a relatively prosaic point by saying that the fact that switching becomes easier does not necessarily mean that more people will switch, but it is absolutely essential for any market to be competitive that switching is not perceived to be difficult and nor is it difficult.

Let us separate the points. First, it is absolutely essential that switching is made easy. Having made it easy, the evidence in the Netherlands says that that alone will not guarantee that there will be lots of switching. The issue then is about transparency, and I think that that gets us back to the free banking concept. Free banking is a myth. It simply is the case that the burden of cost is with the minority of customers, which is not and cannot be right. Therefore, it is very important that there is transparency. It is very important that there is a high-level awareness that switching will be much more reliable, straightforward and easy. We are convinced that, if we put the right proposition to Tesco customers, Tesco customers will take a current account with us and will be aware that switching will not be the thorny process that it has been historically. So it is a very important aspect of making the market more competitive.

Q87 Mr Love: A number of people, including the previous witnesses, have suggested that the seven-day service might end up with a Netherlands result, if I can put it that way, which I think would be a disappointment to challenger banks. They are hoping to trigger a significant increase in switching, of course to their corridors. They suggest that full account portability might be an alternative way, though clearly more expensive, but likely to trigger greater response. How do you respond to that?

Benny Higgins: I think there is an absolute paucity of evidence to support that view. If you ask customers why they do not switch, they will give you a list of reasons, and it would be very unusual for them to say that portability is one of them. Most people would not be able to tell you their bank account number. The process itself is the issue. If the switching service is successful and it brings about the reliability and the awareness of the reliability of switching, I think that portability-I mean, the danger of all research is that, if you say to someone, "Would you like a situation where you can hold on to the same bank account number?", they may well say yes, but that is answering a different question. The focus here should be: let us prioritise what will make this market much more competitive. Making the switching service seamless-so that customers can go into it knowing reliably that they will not have difficulty with direct debits and standing orders-is the issue. I believe that the switching service, if executed well, will achieve that, and I do not think that portability would bring any more. So it is not that it is without merit-

Q88 Mr Love: Are you relaxed about progress so far? Presumably you are monitoring this.

Benny Higgins: We have representation on the working group. As it is set out, this should achieve what it is supposed to achieve and it will be that customers will find it a much more reliable, consistent service than it has been hitherto.

Q89 Mr Love: Mr Monks, do you want to add anything?

Phillip Monks: I think switchability for SMEs is absolutely important, but it comes back to not just the ability to move an account. The thing most SMEs would be nervous about is their direct debits and payment mechanisms and whether those fall foul of the switchability, whether those are transferred. Equally, if an SME moves from an invoice finance facility with one of the major banks, it has to give six months’ notice or pay the bank the profitability that it would otherwise have earned on that six months. Then, as and when it wants to move, the bank is as like as not to say, "Sorry, we won’t release this debenture", or, "If you are going to go there, then actually we want to reduce your overdraft", so there are many ways of tying the customer in, but they are not for the benefit of the customer, and the banks are holding the customer to ransom rather than anything else.

Q90 Mr Love: May I come on to the transparency issue, and in a sense, it links with free in-credit banking? There was talk about interest forgone being included in a statement, in a suitable form so people could understand it. Is that an appropriate response to free in-credit banking, or what other steps do we need to take to address the barrier that that offers to challengers such as yourself?

Benny Higgins: That requires an answer in two parts. If we first tackle the question of forgone interest, I said earlier that, in 2008, the OFT I think reported that more than £4 billion of income was generated by the banks through credit interest. So it is a big number for the industry. In the spirit of full transparency, why would banks not show that?

Some people say, "Well, that’s too complicated." Nothing is too complicated if you try hard enough. Let us just say that you can easily work out what the average balance is in that particular year, and you can easily use a benchmark, whether it is base rate or otherwise, to say that this was the interest forgone. Now, it may not be perfect, but it would give people an indication of what it has cost them in interest forgone, so that would make sense. However, the majority of customers in the UK would see an annual statement that would probably have a run of zeros on their charges, and for the interest forgone it would be a relatively modest number. In some ways, that step alone could reinforce the notion that banking is, if not free, then very cheap in the UK.

Where is the paradox, if you like? The paradox lies in insufficient fund charges, for example, which are borne by a relatively small number of customers. Something like 23% of customers in the UK have at least one charge per annum; 9% of customers have more than six of these charges per annum; and a small number of customers, relatively speaking, experience very large charges. For as long as that is happening, the protection of the notion of cheap or free banking will endure. While I would support forgone interest being something made available to customers, if it was the only step, I am not sure that much would change.

Q91 Mr Love: I will come to you in a minute, Mr Monks, in relation to this.

When we had them before us, the banks said, "We can give you only a global figure on current accounts; we can’t break it down and tell you what is interest and what is the other charges that are made." You are obviously sceptical of that. Do you think that the regulator has a role in insisting that this information is provided?

Benny Higgins: In 2008, the OFT showed that it was £8.3 billion of income in total-£4.1 billion was credit interest, £2.6 billion was insufficient funds-so the number exists. I am not quite sure who said it was not available, but it is.

Q92 Mr Love: Banks individually have said to us that, individually, they are not able to provide these figures.

Benny Higgins: Somebody must have added it up.

Phillip Monks: I suspect that that is more a testimony to their legacy systems, if that is the case. That is obviously not something that we have a problem with. The other way of looking at this is that if you want people to be paid interest, then have a sweep account and enable them, whether from an overdraft or an inwards finance facility, to put any surplus they have into a deposit account, with a base rate or whatever rate of interest is competitive at that time.

Q93 Mr Love: Let me ask both of you a final question. What do we need to do to get rid of free in-credit? An assumption we are making is that, if you are giving transparency, if you provide information in a form that is suitable for the customer, then you should leave it to the customer to decide. Some people will want to stay with what we term free in-credit, but others would want to move for the very reasons you have indicated. Should we be looking for sterner action from the regulator?

Benny Higgins: I think the question really revolves around whether there is an environment where a minority of customers meet the majority of the cost, whether that is a reasonable way for the market to operate. One thing is for sure: if banks were unable to have repeated "insufficient funds" charges on a minority of customers, the environment would change. It is the feasibility of doing that that supports the market the way it is today.

Q94 Mr Love: So you think that the regulator should look carefully at that?

Benny Higgins: It is interesting. I think that, in a market where you have this kind of asymmetry of information, you need to have strong competitive pressures and smart regulation. I think that that brings about the right outcome for customers.

Phillip Monks: I think regulation to deconstruct the tariff structure is absolutely essential, because that allows customers to choose from a menu and to choose between competitors with their different menus. I think that until you get that, you have no way really for the SME or the individual customer-the personal customer-to differentiate between the charges that they are getting or being charged. We have seen that transparency in the airline industry, and it has worked incredibly well in boosting competition, and we have seen it in other utility industries, so it is but a short time before that has to come to the banking industry.

Q95 Chair: Can I ask you one question, Mr Monks? I think it was Douglas Flint of HSBC who said when he was giving evidence to the Commission as a whole that SMEs want a one-stop shop. Your business model is predicated on the fact that SMEs are willing to do business with a variety of different providers who can offer them different strengths, if I understand correctly. Will you make a comment on that? Obviously, it has regulatory implications.

Phillip Monks: I think if you look at the scale and size of SMEs at a very small level-the sole trader, say-they are not confident enough to choose among financial providers, and they can generally get what they want from a single bank. At the top end, the Treasury and some of the larger corporates are actually managing multiple banking relationships. At the mid-corporate level, there is a propensity to choose specialist finance for things like asset finance or invoice finance. Some of the time, those are very much at the periphery divisions of mainstream banks anyway.

To give you an example, a customer goes to one of the mainstream banks and says, "I want a loan for that machine." "Sorry, we don’t do loans for those machines." "Oh." Never is the comment made, "But we have an asset finance division that does exactly that," so they then either go to a broker or go on the website and say, "I want a loan for a forklift truck," and lo and behold, they get directed to Aldermore, and they are perfectly happy with that relationship. The fact that we have grown our business over the period and now lent over £1 billion to SMEs is proof that more and more SMEs, apart from that comment, are so flabbergasted by the behaviour of the banks-so many creditworthy SMEs out there have suffered, to use the Governor’s language, the indiscriminate withdrawal of funding, that there is a complete lack of reliability, or perception of reliability, among the banks. Add that to the de-skilling, and when they come to deal with Aldermore, it is quite a refreshing experience, and a very simple experience. That is what they are looking for.

Q96 Chair: Can I ask you both one final question? We are obviously a Commission whose mandate is to look at banking standards. Do you see competition as a necessary part of improvements in banking standards? If so, do you have any particular thoughts about how that might work through?

Phillip Monks: On banking standards, speaking personally, the standards in Aldermore start with me and with the culture that I set, as we were saying earlier, regardless of whether there is competition. They start with being straightforward with your customer and delivering what you said you were going to deliver. They start with a very simple banking model, because that is what customers actually want. They do not want to be mis-sold. I think it is down to the leadership of the banks.

I think competition can stimulate higher standards, but as we have seen over recent years, excess competition has actually driven sales targets which have led to very poor standards and mis-selling. I think it is down to the leadership of the bank to set the standards in the organisation.

Q97 Chair: Mr Higgins, do you have any comments?

Benny Higgins: Yes. I think professional standards are absolutely an essential building block of how a good business can be built and succeed. It is absolutely essential that we focus on that. For example, we aim at the moment for every one of our front-line colleagues to have a professional qualification related to the work they do. We believe that standards are very important.

In a free market economy, competition is an essential component of the right things happening, but it is not a sufficient condition, as I mentioned earlier. The best and most recent and glaring example is the personal loan market. For many years, it was highly competitive, to the point where APRs were driven to a level where the products were effectively rendered unprofitable, or neutral or zero profit, and all the profit was made on PPI. Competition does not always bring about the right answer. I think competition is a necessary but not a sufficient condition. I think smart regulation is important. At the end of the day, firms need to have the right leadership. They have to have the right culture and the right priorities, and they have to make the right decisions.

Chair: Thank you both very much for coming and spending time with us, and providing us with a great deal of food for thought. If you think later that we did not talk about an issue that is important, we would be most appreciative if you put that in a note and sent it to us. Thank you.