UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 606-xxi

HOUSE OF COMMONS

HOUSE OF LORDS

ORAL EVIDENCE

TAKEN BEFORE THE

PARLIAMENTARY COMMISSION ON BANKING STANDARDS

BANKING STANDARDS

THURSDAY 10 JANUARY 2013

DR DIANE COYLE, JOHN FINGLETON and CLARE SPOTTISWOODE CBE

USE OF THE TRANSCRIPT

Oral Evidence

Taken before the Joint Committee

on Thursday 10 January 2013

Members present:

Mr Andrew Tyrie (Chair)

The Lord Bishop of Durham

Baroness Kramer

Lord Lawson of Blaby

Mr Andrew Love

Mr Pat McFadden

Lord McFall of Alcluith

Lord Turnbull

________________

Examination of Witnesses

Witnesses: Dr Diane Coyle, Enlightenment Economics, John Fingleton, Former Chief Executive, Office of Fair Trading, and Clare Spottiswoode CBE, Former Director General of Ofgas and Member of the Independent Commission on Banking, examined.

Q2321 Chair: Thank you very much for coming in. Sorry to be a moment or two late, but we have had quite a heavy day so far, as you may know, and we have quite a bit to get through today, so with your agreement I would like to get under way. I would like to begin by going to Dr Coyle. What contribution, if any, do you think that imperfect competition-lack of competition-has made to a decline in standards in banking?

Diane Coyle: First of all, thank you very much for inviting me to come and talk to you today. The lack of competition has been very important, I think. If you talk to bankers they will say that it is a very competitive industry-competition is very fierce. What they are thinking about is having to get products into the best-buy tables, and offer very good interest rates, and so forth. That is classic oligopolistic rivalry, where they are competing on a narrow range of products for a small group of customers. That is subsidised by high margins on other products in uncompetitive areas of the business.

I think the language that they use for consumers who shop around to get the best interest rates is quite revealing. They call them rate tarts. That is the industry’s attitude to customers who want to get a good rate of interest. There are a large number of inert customers for personal current accounts and savings products, who do not realise the cost that they are paying for those products, in terms of interest forgone. They are a large source of revenue for the banks, and the scale of those deposits is quite a major barrier to new entry.

In recent years there has been a very understandable focus on regulation as the means of fixing what is wrong with the banking industry and its low standards of customer service, but actually competition is a really powerful force for serving customers. It is less direct, perhaps, but it is more effective, and particularly in a forward-looking way, not just in terms of fixing abuses or poor aspects of service that are already known about. I am thinking about everyday standards: not just mis-selling of PPI products but, for example, under-investment in IT systems that gave rise to the problems that we saw at NatWest a little while ago. It had not mattered, until it broke, to invest in the system.

There is an interesting parallel, I think, with the break-up of the airports monopoly, and the counter-arguments that were put in that case-that it is a complicated business; there are very large economies of scale; if you think there are specific problems you can always tackle those problems by regulation. But the effects of competition have been quite unexpected, and nobody would have predicted that the divestment of Gatwick would have made it so able to deal with an inch of snow, which paralysed Heathrow for days. It is that forward-looking aspect of competition-serving consumers well-that is so important.

Q2322 Chair: That is an extremely interesting answer. Does anybody feel the need to add to it or qualify it in some way? No-can I turn then to John Fingleton. In your final speech as head of the OFT you said, with reference to exactly this issue that, "progress has been too slow and incremental, and fundamental concerns remain about the competitive structure and performance of these markets". Why is it still stuck like that, after so long? After all, it was about a decade ago we had the Cruickshank review, and that comment could pretty much have come straight out of the Cruickshank review itself.

John Fingleton: Again, thank you for inviting me here today. Since Cruickshank there have been improvements in the market. There have been setbacks as well, like the Lloyds HBOS decision. The two fundamental drivers of competition in the market generally are entry and consumer switching. We have seen very little new entry in the banking market generally. There is some attempted new entry at the moment, but the OFT published a report a year and a half or so ago on barriers to entry in the market, and showed, still, very substantial entry barriers.

On switching, in evidence that I gave to the Treasury Committee two years ago, I documented the improvements in the switching experience for customers, but switching bank accounts is still more difficult than it needs to be. The OFT and other organisations have been, in a sense, paring away at such issues. We are, however, talking about many different markets. There is the personal current account market, but the OFT has also looked at cash ISAs and travel money. There is SME banking and the mortgage market. When looking individually at those markets, you can see certain improvements that were made. Similarly, the payment systems task force, which led to the Payments Council, made improvements. We now have faster payments, which took a long time to achieve, and the OFT drove a lot of that process, but it was a poor substitute for what Cruickshank recommended, which was a regulator for payment systems and which was not done at the time. With the benefit of hindsight, more resolute efforts to bring about fundamental change in the behaviour of the industry would have been better from an earlier stage. As a result, we still have somewhere to go both in improving the ability of people to enter the market and improving the customer switching experience across a range of markets.

Q2323 Chair: We began with a brief but powerful description of an oligopoly, which was described in a sentence as being to the detriment of customers, including the standards of behaviour towards banks. Is it realistic to push through reforms, such as have been proposed not least by the OFT but also going back to Cruickshank, that are capable of providing a sharp improvement in standards and leading to a curtailment of the huge rip-offs that customers have experienced over the years?

Clare Spottiswoode: One thing that I fought for in the Independent Commission on Banking was to ensure that we had a proper duty for the new FCA to promote effective competition. That is absolutely essential, because if you get that duty and if the sector regulator has it, they can address directly things such as PPI and barriers to entry, as opposed to what appears to be lots of rule-making, heartache and many years of worry about little bits and pieces. They can do it directly. I think we are going to come to PPI at the end, but it is a really good example of where the FCA could have acted completely differently 10-plus years ago if it had used the competition duties that it already had. It was precisely because I had been watching them not doing so, not dealing with the barriers to entry and not really caring about such issues that I was so keen to get that duty embedded into the new law that created the FCA.

Q2324 Chair: Whether it makes any difference, what is proposed is something that we are going to come on to in a moment, but my question was about standards-one can add culture if one wants. Are banks going to behave better? Can enough competition be introduced into the market to act as a driver of standards to the point that customers feel that they are getting really quite a different and better experience?

Clare Spottiswoode: I absolutely do. Effectively, payments issues include switching, number portability and faster payments, so the Payments Council should have been at the heart of ensuring that those things happened. It appears to me that they get things done only when there is external pressure. One reason why I joined the Payments Council board was to ensure that I could check that the Payments Council actually did stuff that was in the interests of the country. The Payments Council is going to act better going forward, and an awful lot of things to encourage competition can be done if there is that duty and it is taken seriously.

If there is vibrant competition, companies cannot behave badly, because if they behave badly, they will lose customers. By its very definition, if there is good competition, people move their custom if you do not provide a good service with a good product at a good price. If you do not do those things well, you lose your customers. Customers become the heart of your business. Good competition puts customers at the heart of the business. It is not that competition deals with culture directly; it is that if you have a bad culture, you do not succeed. It is an indirect and really strong impact of good competition. The question is whether we can get good competition, and lots can be done that has not been done in the past.

Chair: We are going to come on to that. We are going to try to do it bit by bit to see where each of you lies on a number of points.

Q2325 Baroness Kramer: If we could carry on with this conversation, Ms Spottiswoode. As you have said, the FCA will now have an operational objective to promote effective competition in the interests of customers, but there is often a difference between "can" and "will". What is your perception at the moment of the vision that the FCA has articulated, and what are the indications of how it will employ its new powers?

Clare Spottiswoode: I do not see much sign that it is going to employ those powers at all. There is nobody in a senior position who has the competition label. I think that it has appointed someone to whom competition will report. They had something to do with public policy and research, which obviously has nothing to do with competition. I do not see many signs that the FCA is taking this seriously, which I regret very deeply. The whole way in which the FSA regulates-if you go via the rules and via punishing people, you get people to box-tick. You do not get people to innovate; you do not get the vibrancy of looking forward. You get people to look backwards, and they are scared to innovate. The FSA, through the FCA, is in great danger of going in many ways and in many wrong directions, which is another reason why I pushed that duty so hard. I thought that it would force the FCA to act differently, but there is no sign of its doing so yet.

Q2326 Baroness Kramer: How do we take that on-I think that you have already worked on that within the gas industry-and get a pro-competition function within the FCA?

Clare Spottiswoode: By tackling the FCA and saying, "How are you tackling the competition duty and making sure that it is embedded in everything that you do? When you look at introducing a rule, have you looked at a competition way of creating a better outcome first?" It just does not think that way. It is not the way in which it appears to think. It is not that it is not willing; it is just that it does not have any people there who have ever worked in this area.

Q2327 Baroness Kramer: So it is escalating it up the priority ladder?

Clare Spottiswoode: Yes, and getting people with experience into the organisation.

Diane Coyle: Just to add to that point. Regulators tend to regulate and they do not think about competition as a tool that they can use. Equally-I do not know the documents as well as my colleagues here-I did not see any sign that it would assess the impact of its regulations and interventions on barriers to entry in particular, and I would really like to see an explicit testing of every new requirement on the industry for its effect on competition and barriers to entry, not just individually but cumulatively as well, because it is the cumulative weight of regulation that can matter.

Baroness Kramer: I think that we got some language that that is a co-conspirator here.

Bishop of Durham: There was an amendment in the Lords about that.

Q2328 Baroness Kramer: Yes, which helps somewhat, but we could use more. Do you have any thoughts on getting a pro-competition vision and action, Mr Fingleton?

John Fingleton: I do not disagree in general. The ability of a regulator to use and harness competition and market incentives for the better performance of the market, the good of the economy and its customers is a critical thing. We are all very specialised. When you run a competition agency, you are probably over-confident about the ability of competition to get results in markets, but when you are a regulator, you are probably over-confident about the ability of regulation to solve every problem. What you want in a sector regulator is very strong incentives to use the market and to use competition first to achieve the objectives and to back that up with regulation where needed. It is very important that the FCA sees competition as a positive tool that will achieve all of its other objectives rather than simply as a residual matter at the end of having regulated the market-"Well, do we have enough competition?" It is that fundamental change in attitude from what the FSA has done that is going to be essential if the FCA is to achieve its objective. The way forward document, the one with the funny name that was put out in November, used some of the right language, but I also detected in there a sense in the FCA that there might be a tension between consumer protection and competition. In fact, for the most part, they are complementary. Exploiting those complementarities and seeing them will be important. I think that the competition duty is important, as is getting it inside the culture of the organisation. There is a huge challenge for the leadership of the FCA to create that skill set and that attitude inside an organisation the historical culture of which has been to regulate rather than to think about how you get competition to deliver your objectives.

Clare Spottiswoode: Could I add one thing? When I was the gas regulator I fought very hard to get the duty to promote effective competition into my duties. I definitely treated that as my key primary duty. If you do that, you deal with things in a very different way from a rule-based regulator. Having inherited British Gas as one big monopoly, I knew that I would never win. If I created a series of rules, all that would happen would be that they would work as close to the rules as they could, delegate to me the authority of creating those rules and then play round them. That is exactly what the financial service has done.

You don’t get to the heart of culture unless you embed at board level the thinking that you have to treat customers fairly and make customers the heart of your business because it is in your interests to do so. When I was a regulator I tried to ensure that it was in the interests of the British Gas board to put customers first, and did what I had to do to make it in their own interests to act that way. That is what the regulator should be thinking about within the FCA; not about writing rules but about how to embed at board level the culture that means that the board cares about pushing that culture down through to the bottom of the organisation.

Q2329 Baroness Kramer: And Mr Fingleton, you have obviously been pushing on the competition issue in this industry. How will the relationship of the OFT and the FCA work, now that the FCA has that competition role? Is there a way they can enhance each other rather than substitute?

John Fingleton: Having seen a range of markets and sectors, this is what I think about the arrangement whereby the OFT will become the competition markets authority next year. Making the OFT responsible for competition and applying the competition rules gives you a back-stop; it gives you an organisation that is capable of looking outside the regulatory framework at whether competition is working. That has been incredibly important. If you compare telecoms, water, energy and a whole set of markets where the OFT does not have that ability, with banking and financial services, the OFT has done a huge amount of work on promoting competition and consumer choice in banking and financial services that it has not been able to do in a lot of those other sectors in the economy.

That formulation is the right formulation and the one that seems to work internationally, as having competition horizontally across the economy. That is very different from saying that the FCA should not, in setting its rules and thinking about how to deliver its objectives, make the most use of competition and market incentives to deliver those rules. That formulation is right as it is set out now in the legislation; the FCA has that duty. I think the devil is in the detail, for how this gets implemented. Parliament can write rules to do certain things, but you have to take account of how institutions then develop and the incentives that people building institutions have.

I probably have one concern in this country, which is the inability of Governments to leave institutions alone and hold them to account. There is this constant thing of setting up new institutions and then, before they have really had a chance to show what they can deliver in the long term, reforming them. That creates very perverse incentives for people who want to engage in long-term institution-building and doing the right thing for the long term. It pushes leadership towards short-term objectives. It is incredibly important that the Government-this is across parties-signal institutional stability for the next decade or two in this area, so that people running the agencies can make the right investments in the right internal culture in the regulators and implement this properly. If we end up with leadership of regulators who have short-term objectives, and expect to be judged in the short term, we could repeat some of the failures of regulation that we have had in the past.

Q2330 Baroness Kramer: My last question concerns the thought process for getting everybody aligned in the same direction. To what extent will it be appropriate for the PRA to be given a competition objective, rather than a passive "have regard". Have any of you a comment on that issue?

Clare Spottiswoode: Well, the ICB itself recommended, when we were there, that the PRA worked with the OFT to ensure that they reviewed all the prudential standards to ensure that they were not barriers to entry. That barrier to entry is a competition duty. You don’t want an organisation set up just with prudential standards. You have got make sure that there is some leavening, some regard to other things, to ensure that it is not an industry that stops any innovation and just looks to safety first. I believe there has been introduced-

Baroness Kramer: There is a "have regard", a sort of passive thing.

Clare Spottiswoode: That may or may not be strong enough-I have not really given it enough thought-but it is very important that it is there.

Q2331 Chair: Perhaps you would like to give it some thought and come back to us as a matter of urgency, because the Treasury Select Committee has heard evidence that the "have regard" objective means exactly the opposite to its words-have no regard. That is what happened to the "have regard" requirements of the FSA’s obligations as set out in statute in FSMA.

Clare Spottiswoode: I think it then depends on the institutional culture, because the "have regard to" can be a very powerful tool too.

Q2332 Chair: The point is that the institutional culture will be driven, it is alleged, by the legal framework that is already in place, on the basis of legal advice. That is what Cruickshank told us in evidence as well.

On that point, briefly, John Fingleton, you have obviously thought quite a bit about this issue as well. After a Herculean struggle, the Treasury Select Committee managed to get the competition objective written in, after the Government dragged their feet for a long time. But then the Treasury Committee found itself faced with an overarching objective that trumps the others, thereby, by indication, devaluing the competition objective just introduced into the legislation; this is for the FCA. You will have seen what Tom Cruickshank said about that and what the Treasury Committee in the end reported on that. Do you agree with them?

John Fingleton: Yes.

Chair: I think that is all we need.

John Fingleton: On the PRA, I am of the view that it should have a competition objective. I think there are going to be instances where there is a trade-off between prudential regulation and competition. There is a huge risk, coming back to Diane’s point, about not anticipating the dynamic benefits of competition that come from innovation.

Whether it is a supermarket entering the banking market or a telephone company deciding to provide payment systems, there are potentially huge innovation benefits from people from other markets or other walks of life coming into banking. If the standard they get judged by is a prudential standard that has been set by existing businesses and people who only come and think about those sort of businesses, there is a worry that that gets set in the wrong place.

I think you will want to frame the objective of the Prudential Regulation Authority to say that they should have regard, in setting the prudential rules, to the full costs and benefits of innovation and competition in the market, as well as prudential safety. In my view, if they do not have some competition objective, they will not be able to make that trade-off in the right place.

Diane Coyle: It is particularly important that when judging business models, the only successful business model is not the same as existing incumbent business models, because some of the quite innovative new entry will have entirely different kinds of business model.

Clare Spottiswoode: We talked about the competition duty. I think that the words are being introduced, which were not there when I last saw it, that the FCA must promote competition, but only in so far as it is compatible with consumer protection and other things. That, to me, is a nonsense; I do not understand what that means. It kind of says, "Well, the things that follow are more important than the initial words for promoting competition". I think that that is really confusing. I do not know why they were introduced, but they make no sense to me. I would love those words to be taken out.

Chair: There has been a lot of foot-dragging on this area for some time.

Clare Spottiswoode: I don’t understand why.

Q2333 Mr McFadden: I want to ask you all about bank account portability. Dr Coyle, you wrote in the FT a wee while ago, in writing about the ICB report, that a new account re-direction service would be in place in a couple of years, but this should also include bill account portability. Can you expand on that a little bit and tell us why you think we need to go beyond what is in the ICB report?

Diane Coyle: If you think about why customers do not switch, particularly on current accounts, it is because they take the risk of something that is very disruptive to their lives going wrong for no discernable benefit, because anything that they can switch to at the moment is very similar to the service that they would be leaving. Anything you can do to make that as safe as possible for them, the better. Given that so much of the danger lies around having to redirect direct debits for things that they really care about, such as their telephone service, being able to have it all happen seamlessly with that risk taken away would, I think, make quite a substantial difference to the amount of switching that would happen in the market.

Q2334 Mr McFadden: What do you think about the banks’ objection-I think you have commented on this in the past as well, in terms of your Competition Commission experience-about the cost and complexity of implementing this?

Diane Coyle: Any industry will tell you that it is much too costly and complex to do, and of course you have to think about what the benefits are. I think the benefits of switching and more competition in the industry will be very large indeed.

Q2335 Mr McFadden: Can you give us a parallel, based on your experience, of an industry that said, "We do not want to do this because we think it is too costly and complex," where it subsequently happened and it became the new normal?

Diane Coyle: The telephone industry. Number portability is the obvious example there, and the technological barriers have fallen even further since it happened in the telephone industry. I am sure that there would be complexities and I am equally sure they could be worked through.

Q2336 Mr McFadden: So you are encouraging us to be pretty sceptical about these cost and complexity arguments.

Diane Coyle: Compared with the potential benefits, yes. I am sure that there are technical difficulties and complexities. I am not belittling them in any way, but compared with the potential benefits, I think they are much less important.

Q2337 Mr McFadden: Clare, could you tell us about the discussion of this in the ICB and why you ended up where you did, without going this extra step that we are talking about?

Clare Spottiswoode: We did do quite a lot of investigation and talking to the banks, and it is genuinely very expensive. It is a bit like when you move house you cannot just keep your old postcode, and when you move your landline you cannot keep your landline. A lot of things, such as cheque processing, are done locally; cheques are physically sent to your local branch. There are a lot of processes that are genuinely embedded, and there are a lot of accounting systems where the bank code is embedded geographically. So there are genuine reasons why it is difficult.

On the other side, we promoted the idea of proper account switching where there was a bank guarantee that if anything went wrong, it would be put right, and that this would be in place by September 2013. Subsequently I joined the Payments Council, so I am on the inside of this. We are introducing a new and, I believe, very good account switching service. That is quite a big effort. It is not a simple thing to do, and it will improve a number of the bank systems in getting ready for that.

The other thing we are doing is introducing mobile banking in spring next year. We all have a unique global number in our mobile bank number. We all know it, and we are establishing a centralised system where, if you wish to go into the system, your number will be attached to a bank account. In time to come, it will be attached to a number of bank accounts, your credit card, your PayPal account and all sorts of other things, but to start off it is a one to one. You will be able, first of all, to use account switching and guarantee that all the money coming into your account as well as the money going out of your account-standing orders, direct debits, salary, dividends or whatever-will go to the right place and be put back in the right place if anything goes wrong. Secondly, if you want one-to-one payments, you will be able to make them to a business or to another individual, or to pay for your share of lunch or whatever through your mobile bank, going through an app which will deal with the security. That will become the proxy for your bank account.

In some ways, that is getting pretty close to a portable bank account, but better, because in time to come you will be able to give your unique number and use it not only with your bank account but with your credit card or whatever else, so you choose the method of payment. Then our question is: what else does number portability bring you? I have just agreed yesterday to chair a couple of sessions with people who are interested in this area to make sure that we as the Payments Council look at this area with all those who have got an interest in it and make sure we ask the right questions so we can try to ascertain what customers really want.

Q2338 Mr McFadden: Dr Coyle referred a wee while ago to the problems in NatWest, for example, when the payment system had IT problems last year. It would bring you the power, as a NatWest customer, to say, "I’m fed up with this. I want to open a new account with another bank." It would focus the minds of the NatWest managers at that point to say, "Goodness me, on Monday morning we might be seeing a flood of people changing their accounts." At the moment, that is unlikely to happen. Simply bringing in mobile banking does not give you that incentive either. There is something about the ability to exit easily, which both empowers customers and should focus the minds of managers in terms of their customer service, that the sort of technological advance that you have just outlined does not meet.

Clare Spottiswoode: But account switching will do that. If you decide on Monday morning that you want to move from NatWest because you are fed with them and you want to go wherever else you want to go, you know that within seven days you will have transferred and have a guarantee that all your payments going in and out are coming in and going out, and that you will be compensated if they do not. We at the Payments Council will monitor all that, of course.

We will monitor people’s behaviour and monitor their experience to make sure that they understand their guarantee and that it works. We will also do some Payments Council awareness. We have a multimillion pound budget to make sure that customers are aware that this facility exists, and we will monitor how many and what proportion of the population understands it. If you have the ability to switch your account without fear and you have those guarantees and you subsequently have mobile banking, what more do customers want? We need to find that out.

There is no question in my mind but that we will have account number portability in a few years’ time. It will not be tomorrow. It will take some time, and there will be a lot of investment over the next few years. We at Payments Council are looking at a road map asking, "Where do we want to get to? How are we going to get there? How do we want to direct all this big investment that is going to happen to make sure that it is co-ordinated in these kinds of areas?"

Q2339 Mr McFadden: So your view 18 months on or however long it is since the ICU report is that you stick with where the report was on this. You have not changed your mind about full account portability.

Clare Spottiswoode: It would be very nice to have that. I may be missing stuff. That is one of the reasons to go out for research. It is really important to understand what customers want, what it is that we are missing and make sure that we actually do provide it. It may well be that customers say, "Account switching is not enough. Mobile banking is not enough. We need more than that", in which case we would put it much higher up. Whatever the payments road map will say, that will be going out to consultation and will force that subject way up the agenda.

Q2340 Mr McFadden: John, what is your view on this?

John Fingleton: There is a quite amazing asymmetry here that works against the customer. If the customer happens inadvertently to make a mistake and go overdrawn, they pay the penalty. But if, in the switching process, the bank makes a mistake, the customer still pays the penalty. It does in terms of the delay and the cost to the customer. There is not an explicit payment, but it is a cost to the customer.

In some sense, you would want the switching process to work in the way that, if the switching process did not work smoothly for the customer, the bank had to in some sense give the customer something worth more than the cost and inconvenience to them of the switching process not working. The switching process has improved dramatically over the last three years as a result of various work that the OFT has done with the banks to get it in place. Part of the problem has been addressed. It was much worse three years ago.

It is still the case that we could go further in trying to incentivise banks so that when somebody switches, if the switching process does not work well, it is more costly to the bank than it is to the customer. When you achieve that state of affairs-this is a regulatory thing for the FCA to sort out-at least you think the incentives for the banks are correctly aligned with the incentives for the customer. At the moment, as long as it more costly for the customer if something goes wrong than for the bank, that would not be the case.

The second observation on switching and number portability is when you take the analogy with telephony and you think about the bank account number as being analogous to the number on the SIM card. We do not change the number on our SIM card when we change our telephone account. We change the telephone number that lies above it. We switch the identifier-the telephone number-to a new SIM card with a new provider. To develop and engineer a solution that allows you to change the SIM card numbers could be technically expensive to implement. If you can devise a system of identifiers where you use your mobile telephone number or some other identifier as though the rest of the world knows your bank account, that in principle could do two things.

It could facilitate innovation in payment systems whereby anybody running iPhones or other smartphones can provide add-on services around payments. It might also facilitate a much easier switching, because if I then set up my payments, my income and standing orders from the identifier such as a telephone number and if I then want to change bank accounts, all I have to do is to make one transition. I change who I link my telephone number to, rather than who I link all of the standings orders to. That should be a lower-cost solution for the customer as well as the banks.

The concern I have with that-this goes to the third point-is that at the moment, the process for doing that seems to be either within the Payments Council or left to the FCA. I am not sure that I am happy with a state of affairs where people close to the banks are left to come up with that solution. As a thought experiment, I asked why you do not get somebody like Ofcom to come and sort out faster payments, because it is much more about information technology and communications than it is about money.

In a sense, I worry more about capture by people with installed bases. In any industry, if you have an installed base, the value of innovation to you is far less than to somebody who does not have an installed base already making a revenue. I am worried that although we are moving a bit in the right direction on some of this stuff-I very much applaud the work Clare is bringing to the Payments Council, because it is sorely needed-we are not being radical enough in pushing that forward.

Mr McFadden: I am conscious of the Chairman’s beady eye, Clare. He wants to move on.

Clare Spottiswoode: It is even better than what you said, John, about mobile banking. If account switching is combined with mobile banking, if you change your bank account, as part of the account switching service, they will automatically change the mobile number to attach it to the new bank. Obviously, the customer will have to sign up to a new app for the new bank and go through their security systems, but we will make it as easy as possible. We will also check with customers that the guarantees are working. If there is any resistance from customers because they are not getting enough compensation, I hope we will pick that up.

Also, on the Payments Council being close to the banks, it is absolutely the case that the reason I joined it is because I also perceived that the Payments Council had not been very effective in the past. I am one of the four independent directors. I genuinely believe that we can make and are making an enormous difference. I would still like some external push on the Payments Council to give us more power to do the right thing. I would like, for example, to borrow the competition duty from the FCA to make sure that we absolutely have the power to get the right things done. I think the institutional structures are getting there, but they are not there yet. They need a bit more.

Mr McFadden: I am going to leave it there, with the obvious conclusion that this is one end of the telescope. The other end is who you switch to. If there are only three or four people to switch to, it is a very imperfect thing.

Chair: We are coming to a number of these issues.

Q2341 Baroness Kramer: This is a very quick question while we have Ms Spottiswoode sitting there, because it is time-sensitive. At the moment, if you switch banks, the cost is about £1, split between the bank you leave and the bank you are going to. As of September, we understand, it will be £50, and all will be paid by the receiving bank. I can see the interests of the current establishment in that particular set-up, but I think there are some very serious competition issues around that one. I therefore push it on to your shoulders as a member of the Payments Council. Somebody is making money out of this.

Clare Spottiswoode: It is free to the customer, but yes, there are costs.

Baroness Kramer: It is free to the customer, but the problem is that we want new banks and new entrants.

Q2342 Chair: What does that mean?

Clare Spottiswoode: It means the customer will not pay anything.

Q2343Chair: But they pay. They always pay.

Clare Spottiswoode: Yes, they pay eventually, one way or another.

Chair: There is no such thing as anything free.

Q2344 Lord Turnbull: On free in-credit banking, can I add one last point on switching? Do overdrafts go with it? How do you handle them?

Clare Spottiswoode: The receiving bank has to accept that there is an overdraft coming across and accept it, obviously, as part of that transfer. But yes, it will go across.

Lord Turnbull: There is no charge for personal advice in the Banking Commission.

Q2345Chair: And they cannot say, "You may have tolerated this person’s bad behaviour with their overdraft, but I am not going to"?

Clare Spottiswoode: They can say, "I’m not taking you on as a customer," as any bank can, but once a bank has agreed to take you on-

Q2346 Lord Turnbull: So you would have to negotiate that they would accept your overdraft?

Clare Spottiswoode: Yes.

Q2347 Lord Turnbull: Various eminent authorities have queried free in-credit banking. One is someone called Andrew Bailey, one is Lord Turner and there is also a man called Fingleton. Is it one of those solutions that every economist in the land will agree is nonsense, particularly when combined with a very low interest rate world? The endowment effect will effectively be zero. It will then cause two effects, and we need to look at both of them. The first is withdrawal of quality of service. You cannot find someone to do something out of the ordinary, like deal with a probate case. The second is aggressive selling. I assume all three of you share that diagnosis-that there are some adverse consequences of this to which we, as customers, and the political system are all addicted.

Diane Coyle: Yes.

Q2348 Lord Turnbull: The question then is how you resolve this. It seems that the first mover is going to make themselves unpopular. I remember Barclays bank wanted to introduce charges for ATMs and got beaten up and withdrew. Are politicians ever going to give a lead? How do you sell this to the public, when you are saying, "Get rid of this thing: it looks nice to start with but the new situation will be better for you"? Can a narrative be constructed that will be convincing?

John Fingleton: The OFT’s approach to attempting to deal with this problem was to tackle unauthorised overdrafts and other things-that was where the money was being made-and to try to tackle forgone interest, in some sense, by saying that if you limit the banks’ ability to make revenues in less transparent, hidden charges on customers, you are going to force them to compete on explicit, up-front charges, and you will drive it in that way. Unfortunately, we lost that case at the Supreme Court. Overdraft charges have come down and interest rate margins have narrowed in the intervening period, so the numbers that we had on how much the banks were making from various non-transparent charges will have changed in the past few years, but certainly our view at OFT was that explicit, transparent pricing should be on the things where the banks make all their money; forgone interest and overdraft charges were the least transparent and least visible to the customer-put aside quite enormous distributional effects as well, which they had across different income categories. Our preferred solution would have been to try to stem all of the alternative sources of revenue and channel competition into up-front charges.

We succeeded in doing that reasonably well in airlines. For example, six years ago almost all air fares had come down to headline air fares-£5 here, £5 there. OFT then came along and said, "No, you have to include all the compulsory charges." The airlines then came back and started to disaggregate things, so they said seat selection wasn’t a core part of the service and, in the case of some airlines, they designated one quite narrow-I have to be careful, because they don’t like me saying this-payment mechanism as the default and said, "Any other payment mechanism is an option, and we’ll charge for that."

Mr McFadden: I think we know who you’re talking about.

John Fingleton: I am not going to name particular airlines. More than one airline did this. There is an element of cat and mouse when you are bringing enforcement cases, and OFT eventually made recommendations to the Treasury to regulate payment cards and so forth. But I think that the airline industry, although not a perfect example, has moved a long way towards being much more transparent. That has made it much easier for customers to compare prices on one flight with prices from another one when they go online to look. We estimated that the up-front benefits were about £120 million a year from customers being able to choose from increased competition in the market: in other words, prices fell by about £120 million a year overall because of customers being able to search more.

We were trying the same the same strategy with banking. It is obviously more complex in banking, but I would still say that the FCA should be looking at trying to make sure that banks-and this is the same issue as with PPI-are making money on what they put up front in their charges, and not, as with PPI, default charges and forgone interest, making money in secret through the back door. That is, if you like, the pro-market solution that will force banks to start charging. I agree with you that it is not going to be easy for the first one that does it.

Q2349 Lord Turnbull: If the FCA does various customer surveys, how are they are going to find a consensus for this? People want to have free bank accounts. One charge is very visible-every time you make a transaction-and the other is invisible. You don’t need, for example, an overdraft charge. It may be something periodic. Finding a bit of consensus for these more sensible price measures still seems difficult.

John Fingleton: It is, but they have just done that with independent financial advisers. You had a similar thing with a lack of transparency in charges. Yes, there is a bit of a fuss about the fact that customers are paying up front, but we need to be responsible about saying to people, "You are getting a service. You need to pay for that service." That is why I have been quite happy at the Treasury Select Committee and in other places to associate myself with remarks by Adair Turner and others about this. It is important, if the banks are going to make this adjustment, that we do not have regulators, those in positions of authority or politicians being critical of that move; there needs to be a broad leadership consensus around that.

Q2350 Lord Turnbull: This looks to me like one of those classic cases where if the Government decide to put their weight behind something, the Opposition-whichever party it is-will always choose to do the opposite. Someone has to demonstrate that this is a way of suppressing other abuses and making it clear what those abuses are. Otherwise, it will always be in someone’s interest-whether it is banks or the Opposition of the day-to say, "Let’s stick with free banking."

Clare Spottiswoode: There is one other thing. These bank accounts cost money-I think it is around £70 or £80 a year for the typical bank account-and it is important people understand they are getting value for which they are not being charged. In addition to the interest forgone, which the FCA has not agreed to put on yet, we should also have things like how many times you have used the ATM and how many times you have visited a bank branch. There are lots of costs people can see. People are getting these things for free, but those things cost the bank something. If you at least had that as a counterbalance to the things the customers were paying for and do not really understand they are paying for, it would help people understand that these things are not free-well, nothing is free.

Q2351 Lord Turnbull: In the RDR, it was possible to demonstrate what the abuse was-the incentive to churn. While things may look more expensive in the short run, people would actually get a better outcome.

On mis-selling-John may want to say something about this-I want to try one proposition, which came out of yesterday’s discussion. When I talked to your colleague Peter Davis, he had a figure that said that the return in a particular year in excess of the cost of capital was £1.2 billion. He said that that was not the consumer detriment, because a large part of it-he put it at about £1 billion-was used to subsidise the credit, so the detriment to the consumer was probably more like £200 million. Am I right in thinking that the banks have made an absolutely calamitous commercial judgment and are now being forced to repay part of the gross amount? They cannot go to the customer and say, "I’ll give you back what I overcharged you on the PPI insurance, but will you give me back the subsidy?" This £15 billon that they are going to end up giving back is vastly in excess of the detriment that they caused. Had they been less obstinate, they would not have got themselves into that mess.

John Fingleton: I think you are quite right. The same would have applied if the Supreme Court had ruled for the Office of Fair Trading in the unauthorised overdrafts litigation. Given the way the law works, it would not have gone back and worked out the difference between the unfair charge on the customer and what a fair charge would have been. Instead, it would have gone back and said, "This was unfair. The counter-factual is zero, and you get it all back." That vista of handing out many billions of pounds to customers who had had overdraft charges against them was an important factor. It was not obvious that the compensation scenario was more fair, because, in some sense, you were retrospectively overcompensating people who had gone overdrawn, and, ultimately, other customers would pay those costs. The just solution would be to have gone back and just calculated the differential, but that is not what the law does.

Q2352 Baroness Kramer: If one were to look at the issue of free in-credit banking, would a first step be to get quarterly, or on annual statements, a kind of mini P&L, with interest forgone, collective fees that you have paid, and the cost of operating your current account? Is that something that is entirely doable and rapidly doable?

Clare Spottiswoode: Not only is it entirely doable, but I have seen banks’ pro formas where they are prepared to do that, and they want the FSA to encourage some experimentation. If you are a bank and you have 1 million-plus customers, you can segregate them. You can send out something that looks like this to 10% of your customer base, then to another 10% you can send out something that looks like that. Then you can properly tell which of these the customers understand, and what they like and dislike. Then you can say, "This would work. This would get the information across to people." I think that we should be doing that.

Q2353 Baroness Kramer: And also spur competition.

Clare Spottiswoode: Absolutely, yes.

Diane Coyle: Obviously, it is something that only regulators can do, because as you say, politicians cannot do it, and the banks are not going to be the first to go ahead and do it. It has to be a regulatory push.

Q2354 Lord Lawson of Blaby: My perspective is that my good friend Lord Turnbull is making heavy weather of this by getting the wrong end of the stick completely, and that you are mistaken to go along with him. The most absurd formulation of this was Adair Turner’s, who said that these poor banks were obliged to go into mis-selling because they were not making any money on their current accounts. What complete nonsense. The banks will, quite clearly, try to get away with mis-selling, given the current banking culture, if they think that they can get away with it, whether current accounts are charge-free in credit, or not free in credit. What you need to do, if I may put it to you, is focus on the abuses, along with the other authorities. I know that you are not the PRA or the conduct authority and so on, but what the regulatory authorities, within their own billings, need to be focused on is stopping the abuses, mis-selling and avoidance of transparency, where there is a lack of it. If you have done that, then you have satisfied society and the customers, and you do not need to worry, whether free in-credit banking continues or not. When you look at supermarkets, do you say-

Chair: You must get to a question soon, Nigel.

Lord Lawson of Blaby: I have asked it. Is it not absolutely absurd to go to the wrong end and say that we have got to stop free in-credit banking? I know the banks, and that is not going to stop the abuses. Not at all. If, on the other hand, you stop the abuses, then free in-credit banking is no longer a problem.

John Fingleton: I think you are completely agreeing with what I said.

Q2355 Lord Lawson of Blaby: Good. So we can focus on the abuses, not on free in-credit banking.

Clare Spottiswoode: I think this is really simple. If you have got a duty to promote effective competition, one of the things that that does is say, as a litmus test, what does good competition look like? If you have got undue discrimination-that is what you are talking about, because the abuses are discrimination-that competition regulator, in my case as a sector regulator, can go to stop that abuse right at its start. You could have gone and intervened on free in-credit banking at its start, so that it never became established; you could have gone in and dealt with PPI at the start, before it got going, because you have got an abuse that is going on that you can deal with under that duty.

Lord Lawson of Blaby: I am sorry, this is-

Chair: Nigel, are you sure that you want a rejoinder on this, bearing in mind that you want to come in on a later subject?

Q2356 Lord Lawson of Blaby: I do not mind not coming in on the later subject. The point at the bottom is that this is basically a question of whether, if people behave properly, they should be given freedom. Do you want to prohibit supermarkets from having loss-leaders?

Clare Spottiswoode: No.

Q2357 Lord Lawson of Blaby: Right. So if the banks want to have a loss-leader, why do you want to prohibit them?

Clare Spottiswoode: What you do is concentrate on the bits where they are overcharging. They are overcharging on current accounts and on PPI for some customers, so that is where you concentrate.

Lord Lawson of Blaby: That is my point. We are in agreement.

Clare Spottiswoode: If they want to lose money on the others, that is fine.

Q2358 Chair: That is why it is less than clear who got the wrong end of the stick, Nigel. I won’t put it more bluntly than that, unless John wants to say something.

John Fingleton: I wanted to give a different example-an old and quite simple one: printers and printer toner. It is well established that consumers focus on the up-front cost of anything, so printers are very cheap and printer toners are very expensive. The solution to that is not necessarily to try to regulate the price of printer toner, but to try to break the hold the printer manufacturers have over the exclusivity on the toner. If you can get a more competitive market in the toner, you will get the prices in the up-front market to adjust, so you try to go with the grain of the market. I use this as an example because in certain circumstances what you want the FCA to do is think like that about solving the problem, rather than necessarily thinking that we need to regulate the price of the toner in order to get the right price up front. You are on a hiding to nothing when you do that. When you start to do that you have regulatory costs but also you won’t get it right. Then you end up having to regulate the up-front price and you end up in a mess.

Chair: That is exactly what the Treasury Select Committee, on the basis of advice not only from the OFT but from numerous others, has been proposing, but which has not yet been fully understood.

Q2359 The Lord Bishop of Durham: There is a hideous familiarity in all this. It sounds just like many sermons I have heard and probably preached, which are basically saying, it would be nice if everything was nicer. Basically you have said that competition would help a lot but you have also said that the FCA is not going to bring in competition and that the way it is structured it will be very difficult, because of the small number of banks, to get more competition. That sets up huge barriers to new entry. It is really about entry that I want to ask a few questions.

Since it is going to be so difficult to break the logjam that makes it possible for people to come in, why don’t you simply break up one of the big banks that are more or less zombie banks anyway and create seven or eight major, new banks that provide the competition, break the logjam and enable more competition to happen?

Clare Spottiswoode: In my regulatory experience, I was looking after a monopoly and we introduced competition, and I was much more interested in getting dynamic competition and making sure that the barriers to entry were reduced. We did get very vibrant competition in the early days-it is a bit too much of a cartel these days-and that was by ensuring that we defined very carefully where the natural monopoly bits were, where there competitive bits were and then making sure that we looked really hard at all the barriers to entry. I don’t think anyone has done that for the financial services sector.

Q2360 The Lord Bishop of Durham: But are they going to? Under the Financial Services Act, don’t we have a recipe for regulatory comfort, where they sit there with what they’ve got and they don’t want do more?

Clare Spottiswoode: The one thing we’ve got to do is make sure that there is a proper, really strong duty for it to promote competition and not one that is so watered down as to be pretty irrelevant. Unless we have that then they will sit comfortably by and do nothing.

Q2361 The Lord Bishop of Durham: And if we can’t change that, what is the alternative?

Clare Spottiswoode: The problem is that if there isn’t that force for competition we will get more and more supervision, more and more rules, and more and more ossification of the system. There won’t be the dynamic impact of encouraging competition, of the regulator being forced to encourage competition, whatever their current culture is. I just think that some time it will just get so ossified that there will be a political revolution and we will have something better put in place. But it is going to take us 10 years to get there.

Q2362 The Lord Bishop of Durham: So grit our teeth and wait?

Clare Spottiswoode: No. Make sure there is a proper competition duty and then there are super-complaint possibilities. The OFT and the new CMA can investigate the FCA and make sure they are using competition in everything they do. It will potentially require external force-you, I mean people in Parliament, can clearly put force through the Treasury Committee. I think they will need constant scrutiny until they start to use that duty with some force.

Q2363 The Lord Bishop of Durham: Okay, supposing that does change and the ossification ends at some point and we get to the point where there are lower barriers to entry. One of the major problems is that there are large parts of the economy, particularly the more marginal areas economically, as in my diocese, where people don’t want to come in. Nobody will want to come in-none of the big banks or even new providers. They want to go to areas where people are doing lots of interesting things and they can make lots of money. What is your view about new entry into ways that increase access to finance in areas of social deprivation?

Diane Coyle: I think there is actually some hope for quite radical new entry into the market from a competitor set that isn’t in banking at the moment. There are some very small-scale examples of peer-to-peer lending and crowd source funding. There is the possibility of mobile banking by mobile companies that have experience of running payment transaction schemes in developing countries. One of the key issues is to make sure that the prudential system, the regulations, do not prevent entry by those very different kinds of providers.

Q2364 The Lord Bishop of Durham: And do you think they do at the moment, Dr Coyle?

Diane Coyle: I think it is possible. We don’t quite know how it is going to work out in practice. It depends on how these institutions put into practice their various duties. It is not obvious to me that they are thinking outside an existing competitor set. What people describe as challenger banks are still banks with quite conventional business models.

Q2365 The Lord Bishop of Durham: Precisely. Do you have any view about the credit union movement in this context?

Diane Coyle: It is proving very difficult to increase in scale, and I do not really understand what the barriers to growth have been. The technology seems to me to offer more hope, because what it does is get over the information asymmetries in some quite interesting ways. One of the downfalls of the oligopolistic system we have is that banks have withdrawn from local communities. They do not know who their customers are. Decisions have been centralised. So with small business lending, for example, banks have no idea what kind of company they are lending to. Using the technology to improve access to information for financial service providers might prove a useful route. This is really small scale, so we do not know. This might not happen, but I think it is a possibility, and one that regulators should not foreclose in any way.

Q2366 The Lord Bishop of Durham: Dr Fingleton, the FSA is shortly to unveil changes to the authorisation process, and requirements to make it easier for firms to enter the UK banking market. What would be the bullet point headline points that you would like to see them introduce to reduce barriers to entry into retail banking?

John Fingleton: Taking up Diane’s point, I think it is about being open to new and different business models, and getting people into the market quickly, and giving them a clear pathway to get there. I think if you have a company that is already a strong player in something like the supermarket sector, they are not a particularly strong prudential risk in relation to the banking market. They may become a risk if they grow a bit. If you look at Tesco’s entry into petrol retailing, it had a dramatic effect on shaking up competition among the existing players, and I just worry that the FCA may underestimate those benefits, relative to some of their potential costs. I also think it is important that the FCA stays with a risk-based approach to doing this, because there is a danger that anything new looks risky, and therefore we should not do it. We need new things at the moment.

Let me give a different example, just touching on your question about break-up, because I think it is a difficult question as to what the ideal structure should be. Through the noughties, I think there was a lot of free money around, and if you look at SME lending in this country, I think the people working in banks at a local level, generally speaking, lost the skill set around judging the creditworthiness of individual businesses. As there was a lot of free money around, the skill set became slightly more the sort of car salesman skill set of "How can I flog credit swaps or other products, or the business equivalent of PPI, to these people?" because the core product was not making a lot of money.

As a result, we now have a real difficulty in the banks, and if the chief executive of a bank really wants to get business lending going, and pulls the lever, they do not have the ability to discriminate finely between those businesses that need extra money and those that do not. You hear all this cry about the need for extra lending in the economy; we also need to deleverage as an economy. We are too debt-addicted as an economy. What we need is discriminating bankers who are capable of distinguishing between the innovative, efficient growing businesses and the others.

Breaking up the banks is not going to solve that problem. It is a problem of talent and getting the right talent into the banks. I think it is going to be a slow process to get our banks lending, but we should be thinking about how to make sure that the right incentives are there. If you look at some of the entrant banks like Aldermore and Handelsbanken, they refuse, in some cases, a lot of the Government programmes, because they do not want to expand rapidly. They want to build this talent pool in a systematic way that is aligned with their business model, to be able to make good lending decisions on the ground. In that sense, some of the new entrants offer great hope. We should not be trying to force them to expand too rapidly, but I think moving towards that transition is important.

I am very unclear what the right answer is on structural break-up. Part of me says, "Wait and see what happens, but push in this direction." I think there are only two mechanisms by which you get structural break-up-the breaking up of a bank as you described it. One is if the Government were to nationalise one of the existing banks that it owns a lot of and then sold it off in component parts. The other is to have a reference to the Competition Commission. On the first, I am very unclear-I do not fully understand the costs of nationalising, for example, RBS, and breaking it up. I think that is a very difficult calculus to make. I think if we found ourselves in the situation we are in now in five years’ time, we would look back and regret not having done it, but that is always easy to say. It has now been four years, when people did not think we would have four years like this.

The alternative way of doing it is to have a reference to the Competition Commission. In a sense, that is a more rigorous process-à la airports-and a longer process. The view I took at the OFT on this, which is consistent with the Independent Commission on Banking’s view-I think it is still the OFT’s position-is that we should encourage the banks to make substantial change and the FCA to get up and running with its competition work, but if within a few years we have not seen that delivering positive change, a reference to the Competition Commission would be proportionate and justified.

That may need to happen anyway to deal with a problem, which may not be what you were referring to. In Scotland, for example, two banks rather rule the roost. You may end up getting a very strong entry process through the market working, better entries, and better switching in the south-east of England and other parts of the country, but extend it to quite a tight duopoly north of the border and in other parts of the UK, and you might want a Competition Commission inquiry just to look at that issue, if not at the whole market at that stage. In that sense, the Competition Commission may be asked to look at this in the next decade.

Q2367 The Lord Bishop of Durham: There is one other question, which I might ask you to answer in writing-we are quite short of time-when you have had a chance to reflect on it. It is whether there is evidence of the FSA’s approach discriminating against new providers. You have publicly stated that "It is important that regulators do not unduly constrain competition". Is there evidence that that is happening? We would like to hear your thoughts on that in due course.

John Fingleton: I do not know whether I am in a position to provide evidence. I am no longer running the Office of Fair Trading.

The Lord Bishop of Durham: I realise that.

John Fingleton: As a private individual, I may not be best placed to get you that evidence, but I think the OFT will be giving evidence here, and it may be a suitable question to ask the OFT.

Clare Spottiswoode: Should I add a little bit on the payments issues that are associated with this?

Q2368 Chair: Before you do that, have you anything further to add on the structural separation issue-that is, on the issue of putative break-up?

Clare Spottiswoode: No. At the ICB, we looked at this. We thought seriously about doing a full-scale competition review ourselves, and just decided that it was much more appropriate to send it to the Competition Commission at a time to come, and that we should concentrate on other things, because that would have been a huge task. We never seriously looked at structural break-up; we just thought it should happen via a proper, full-scale Competition Commission inquiry at some point.

Q2369 Chair: I know you want to talk about the payments issues, but I want to bring this area of discussion to an end. Dr Fingleton has put on the table-I have heard him say it before-that there should be some kind of threat hanging over the banks.

Clare Spottiswoode: Yes, I agree with that.

Q2370 Chair: I am going to come on to you in a moment, Dr Coyle, if you do not get a look in now. That will be in a second or two, but first let us hear about the payments issues that you have been eager to get in on.

Clare Spottiswoode: There are two areas that the Payments Council is actively looking at. First, the ATM network is very fragile, and it is quite easy for people to remove free ATM use. One of the things the Payments Council worked on-well before I got there-is that you get more money if you put it into some areas rather than others, so there is a bigger interchange fee. That is really important for ensuring the spread. That is something we are keeping our eye on to make sure that there is a proper geographical spread, including to the most needy areas, because they are the ones it is likely to be withdrawn from first.

The other area is challenger banks. It is undoubtedly the case that it is really expensive and difficult to access our payments systems at the moment. If you are a challenger bank, there is a huge up-front cost of getting your IT systems in place and an additional huge cost of getting your own access to the schemes. Most challenger banks go via another competitor, which is a terrible way. If you put the core of your business into a competitor’s hands, it is not a good way. You do not get the best service and you get put on the old systems, so when your faster payments service breaks down 25 times in one year and the host bank’s never breaks down, you have to explain it to your customers and take on the responsibility for that, although it is not your fault. We, at the Payments Council, are doing quite a lot of work, and are beginning to work with challenger banks to try to say, first, "How we can make life easier today?" In the longer term we are potentially looking at producing a challenger bank entry point to make it easier for them to get into the business, but we cannot do that today.

Q2371 Chair: An additional barrier to the challenger bank is the cost of funding, driven by regulation.

Clare Spottiswoode: Yes, absolutely.

Chair: Are you also looking at that?

Clare Spottiswoode: Some of that is not in our remit, but we are looking at it in so far as it is part of the Payments Council’s remit.

Q2372 Chair: Before I bring in Andy Love, Dr Coyle can have an opportunity to comment on anything she has heard so far.

Diane Coyle: I was just going to agree wholeheartedly with the need for holding a Competition Commission reference in reserve within a few years’ time.

Q2373 Mr Love: First of all, I am a little worried about the drift of the Commission’s discussion on free banking, but I was very pleased to hear what Nigel had to say. There is quite a lot of opinion among the Commission that is rather sceptical of recommending anything in relation to free in-credit banking. That is for the sake of clarity.

I have a question for Dr Fingleton, and indeed anyone else who cares to comment. I take your point about a full Competition Commission inquiry into banking being a sword to hold over their heads, but are you fully confident that that would deliver the increased competition that we are looking for? There has been some scepticism about whether the Competition Commission has the ability to do something in areas such as supermarkets. You were carrying out the role in recent years, so is there a need for the Competition Commission to have strengthened powers to ensure that, if it does decide to carry out an inquiry, it will be able to implement real change, bringing greater competition into the marketplace?

John Fingleton: I think the powers are there. The break-up of the British Airports Authority was where those powers were used, and if we had not seen the powers used there, the answer to your question might be more ambiguous. We have not seen a situation where the Competition Commission has looked at an oligopoly situation with a view to a break-up, but that was not the question asked in reference to the supermarkets, either. There was no question about breaking up supermarkets; it was a very different question about how supermarkets treat suppliers, and so on. I am reasonably confident that the legal powers that the Competition Commission has, and that the successor body, the Competition and Markets Authority, will have, are absolutely adequate for looking at that question.

Q2374 Lord McFall of Alcluith: On the ATM interchange fee, Clare, we made a great effort a number of years ago to get unanimity between the banks and the consumer groups to have free ATM machines-there are 600 in low-income areas. The Royal Bank of Scotland has changed the interchange fee, which was the key to the whole thing. I, along with others, can see that crumbling. What can you do to assist us?

Clare Spottiswoode: That is something we are very concerned about, because it can crumble very easily. We do not have powers, as far as I am aware, to stop that. If banks decide they wish to stop doing it, I do not think we have powers, other than public pressure, to stop them. The fragility of the ATM system is something we are very concerned about, and I do not know the answers yet.

Lord McFall of Alcluith: Okay. But it is a live issue.

Clare Spottiswoode: Yes, it is a very live issue.

Q2375 Lord McFall of Alcluith: Dr Fingleton, you said that the payments system installed under the control of banks could impede competition. Andy Haldane, when he was before us a few weeks ago, was talking about a utility framework in which people plug in on that. Given that banks have all this information, and given the point you make about new challengers having to get IT platforms and having to engage-I have experience of that myself-it is almost impossible to get in there. Is there a case for seeing the payments system as a utility? Would that help to assist competition?

John Fingleton: I would prefer to go in the other direction, which is to think about the payment system as an area where you can allow innovation and think about how you can free up new players, because payments are ultimately not about moving cash around or holding cash deposits but about moving or transmitting information from one person to another. I think all the big innovations in payments are going to come through information technology.

Q2376 Lord McFall of Alcluith: New challengers have to spend many, many millions of pounds even to be considered, so there is an impediment there straight away. Do you agree, Dr Coyle?

Diane Coyle: That is certainly one of the key barriers to entry. On cash in and cash out, I agree with John that one might look for some innovation. To take the mobile example again, there are no ATMs to speak of in Kenya but there is a cash-in and cash-out system through the airtime resellers and the ability to use the credit on your mobile phone to get that out. That might not work here, but thinking about it in more innovative terms-through IT or mobile companies-would be appropriate.

Q2377 Lord McFall of Alcluith: On PPI, you and I have had many meetings on it, and you have been before the Committee. The timeline depresses me. We had complaints in the 1990s and it will be April 2013 by the time that we will even think that this is sorted out-18 years from when we first had the complaints.

In the OFT at the time, you had the authority to grant licences to banks or other firms for consumer credit. These complaints were aired as early as the 1990s. Indeed, we on the Treasury Committee referred the issue to you in 2005, and I asked Callum McCarthy and John Tiner to look at it urgently in November 2005; we have the transcript of that. Given that, why was removing the credit licence of a firm that was mis-selling PFI not considered? We could have saved ourselves not only the 18 years of bother but possibly the £40 billion of payments paid out at the end of the day.

John Fingleton: The credit licence is not like the rest of the financial services regulatory system. It is simply a fitness test-"Is this person a fit person to hold a licence?" And the issues that came up with PPI probably would not have gone to the issue of the fitness of the person. It would also have been the case that if you had done that, and withdrawn their licence, you would have withdrawn all their ability to offer all credit to people.

The Consumer Credit Act 2006 changed that. It came into effect in 2007 and it should add slightly more flexibility about taking away or removing licences. However, at the time that the complaint from Citizens Advice came to the OFT, which was in 2005, that remedy would not have been available.

In any case, PPI raised more fundamental issues than just credit issues; they were about mis-selling, competition and other issues. The mis-selling issues were properly within the remit of the Financial Services Authority and were dealt with by it. The competition system, through the Competition Commission, dealt with the competition issue. It was slower than it should have been, but it was one of the first market investigation references under the new Competition Act. Subsequent work by the OFT and by the Competition Commission has been much, much faster. So, if you take issues like travel money and cash-

Q2378 Lord McFall of Alcluith: But John, what do we need to do? I accept that there is a weariness about this issue, with the timelines. We were put into a soporific daze yesterday when the Competition Commission guy came along.

I have a constituent who had been in prison. He went into his local Halifax with a toy gun, held it up and he got 10 years in prison. I visited him quite regularly in prison and I said, "Look, it was the wrong side of the counter you were on, because if you were on the other side of the counter you would have appeared before the Treasury Select Committee and not been in Barlinnie for 10 years." [Laughter.]

That is the type of thing I am talking about-there are two worlds here, John. It has taken 18 years to get this done. Surely we must have some way to get things speeded up-hopefully.

Clare Spottiswoode: When I was a regulator-I finished in the autumn of 1998-I saw this stuff coming with PPI. I read-at the time it was not FSMA, but later on I read in FSMA-that there were competition duties that the FSA could have used.

I have never understood and I still do not understand-maybe John understands-why the FSA did not use those powers, because there was clear discrimination going on. People were being sold a product from which they had zero benefit. That is discrimination and if you have a situation like that, the regulator-using those competition duties-can say to the bank, "You must explain to me why you are not discriminating." You put the burden of proof on the other foot.

I did not understand why it was not sorted out at the end of the ’90s, and it became a big problem in the early 2000s. That was partly because the cost of loans became too low, so there was discrimination there in one direction. The way in which the banks thought that they could sort it out was by overcharging for PPI, so they thought that they were making money, losing money, but that is a really unhealthy market. And different people had benefited out of that, and it was just like free in-credit banking-the same issues. I have just never understood why the FSA did not use the powers that it had; it just never used them.

Q2379 Lord McFall of Alcluith: John, to what extent are the problems with PPI caused by the particular terms of the PPI contracts, as distinct from any sales practices or competition issues? I remember one case we brought up in 2005 about a secured loan. It was Barclaycard granting a couple a loan of £91,500 over 25 years, with the couple being advised to buy a PPI policy with a single premium of £22,500. That was added to the loan, so that it was a total loan of £114,000. The PPI policy lasted only five years but they had to pay for 25 years, and at the end of the day the cost of the policy exceeded the maximum benefits payable under those two elements. Surely that is a rock ’n’ roll case of mis-selling.

John Fingleton: The question is, how does that get dealt with? That type of mis-selling is properly dealt with by the FSA.

Lord McFall of Alcluith: Improperly dealt with.

John Fingleton: I can speak better to what the OFT did in this area. In areas where we thought there was mis-selling that was covered by the OFT, you have to remember that the banks will not suddenly say, "Oh, we agree with you. This is a breach of this or that law."

We went to court on unauthorised overdrafts and we managed in two and half years to go from starting a High Court case against the eight banks to getting a Supreme Court judgment. That was the fastest I know of going through the High Court, Court of Appeal and House of Lords, on a very substantial issue. However, the banks in 2005 and 2006 did not accept that any of this was wrong.

There is the matter of the OFT’s consumer powers. We have talked about the credit powers. Withdrawing a licence is a very draconian thing. For two years at least, if not three, the OFT wrote to the Department of Trade and Industry and the Department for Business, Innovation and Skills, as it became, asking for the power in law to withdraw a credit licence, and got nowhere on it. Thankfully, that power has now gone into the legislation.

We would have somebody come in and get a credit licence, who had lied about not having a criminal record, only to find it took a year or more of legal process to remove that licence, because they had already acquired "a right". We had no ability to take away that licence. There is a whole lot of difficulty in being an enforcement agency in these areas.

As a consumer authority, our only ability is to go to the High Court and get an injunction against them. That was always going to go to the Supreme Court on any of these issues if we had gone that way. So I think we at the OFT have done more in this area because there have been gaps elsewhere. I do share your concern that a lot of this is taking far too long.

Q2380 Lord McFall of Alcluith: We have seen the banks using fines with FSA as a cost of doing business. There is no doubt about it. We had good evidence yesterday on the mis-selling panel that we are going to take forward. Given this 18-year time scale, how can we shorten that? Do, for example, the unfair terms regulations give sufficient powers to protect consumers in relation to complex financial products? If not, the Commission is looking for some way forward so that the interest of the financial services industry and the interest of society and consumers coincide. They don’t at the moment and that is where there is a lot of frustration and lack of trust and confidence in the system. What can be done to protect consumer interest in a shorter period of time than what we see just now, which is totally unacceptable?

John Fingleton: I would go back to Lord Turnbull’s earlier observation that if the cost to the banks subsequently of having been caught out on this is far greater than the benefit that arrived for it, that is creating quite a strong incentive not to do this again. Although it creates a different injustice, I would probably say that in cases of mis-selling, having a punishment that is far greater than the benefit of the banks from that mis-selling is a really important part of the deterrence mechanism. Just as we don’t sit somebody from the Government in the passenger seat beside everybody driving a car, checking their speed and how they are driving, we can’t have somebody from the Government sitting beside every bank. We are at risk of pushing it in that direction. We have to have very strong sanctions when these things go wrong. I think the process that we are going through now is that process of the banking system as a whole waking up to the fact that the sanctions are going to be greater than the benefits they get from the bad behaviour.

Lord McFall of Alcluith: Sadly, John, you give me no hope.

John Fingleton: Well, I am an optimist.

Chair: Thank you, all three of you, for giving splendid evidence, which was very interesting for all of us. It is well travelled territory but none the worse for having another go round. If you have further points you want to put in writing, please do; we are very receptive.