Changing Banking for Good - Parliamentary Commission on Banking Standards Contents

5  Better functioning markets


274. In an editorial to introduce its "capitalism in crisis" series, The Financial Times remarked that "the crisis flows from a lack of capitalism where capitalism was most needed".[597] The Church of England Mission and Public Affairs Council made a similar point to us in evidence, noting "banks have been championing a free market ideology while claiming exemption from its rigours".[598] Banking standards are in crisis partly because markets have not operated effectively to fulfil their role in disciplining participants, rewarding success, penalising failure and responding to consumer needs. Banking standards have been a casualty; all too often the story has been one of unmerited rewards, insufficient penalties for failure and consumer detriment.

275. In calling for better functioning markets we do not reject a role for regulation in banking. Regulation and supervision are required, among other important tasks, to provide a fair and reliable framework for competition to take place and to minimise systemic risk. As set out in the chapters that follow, we do not believe that the market is the means for solving all the problems in banking standards we face. Market discipline is a powerful and efficient force for change. However, the financial crisis demonstrated, particularly in view of the position of banks that proved too big to fail, the need for strong regulation to protect the public interest. Nevertheless, when market remedies can be found, they should be deployed.

A vital utility role


276. In an increasingly cashless society, access to a transactional bank account has become crucially important. Employers and landlords often require an account for payment of wages or rent; utility companies and councils typically offer discounts for payments by direct debit; and consumer goods are often available more cheaply online than in stores. Bank accounts are the overwhelmingly dominant means by which consumers access electronic payment and transaction services. Tony Greenham, Head of Financial Services at the New Economics Foundation (NEF), told us that:

    Retail banking, and specifically the provision of transactional banking services and of responsible affordable credit, is different from any other consumer product and should be explicitly recognised as such. It is a basic utility and the lifeblood of the economy. There is a positive impact for society as a whole if all adults are given access to these services, in all communities and areas of the country.[599]

277. For some sections of society, accessing these services may be challenging, and so banks might be perceived as denying them the opportunity to participate in many every day activities. Yvonne MacDermid, Chief Executive, Money Advice Scotland, said that being able to access a bank account was akin to "allowing people to participate in civic society".[600] Nick Waugh, Social Policy Officer, Citizens Advice, explained that inability to access a bank account may even result in a denial of employment, as without a bank account:

    you are either completely unable to accept a job, because you cannot get wages, or you have to pay money to accept your wages, because you need to pay a cheque-cashing fee.[601]

278. People are unable to access bank accounts for a number of reasons. Bank accounts tend automatically to include an unsecured lending facility in the form of an overdraft, so those with poor credit histories may have difficulty opening this type of account. Banks also require certain proofs of identification before individuals can open a bank account, which some may find difficult to provide. Specific groups may be excluded. For example, of the major UK banks currently only Barclays provides bank accounts to undischarged bankrupts. Some communities may also have difficulty physically accessing banks. Yvonne MacDermid described:

    rural and island communities in Scotland, where people are not getting access to choice at all and in some cases they have to travel many, many miles to get to a bank.[602]

279. The Government and banks have gone some way to addressing the issue of financial exclusion. Following a report to the Treasury by the Social Exclusion Unit in November 1999, highlighting the importance of access to basic account services, the banking industry worked with the Government to introduce a basic bank account founded on a common model which was "specifically designed to address the needs of the financially excluded".[603] However, despite progress over the last decade, witnesses to the Commission suggested that there are signs that progress in both the number and quality of basic bank accounts is slowing. The Treasury Committee reported in August 2012 on the denial of access to third-party cash machines for basic account holders of Lloyds and RBS.[604] Sian Williams, Head of Financial Inclusion at Toynbee Hall, believed that the standards of basic accounts were falling, saying "we know that banks are rolling back from the level of provision in 2009, specifically around quality."[605] It has also been suggested that the process of opening a basic bank account is sometimes difficult for consumers. Sue Edwards told us that:

    we get evidence all the time of people going into a bank to open a basic bank account and being made to feel very small. The discussion might take place in a public area with the bank staff raising their voice: "This person wants a basic bank account!" We sent our researcher around all the banks in the area local to our office to get information about basic bank accounts, and what was really interesting is that only in one bank could you go and get the information about the basic bank account without talking to a member of staff.[606]

In the context of these falling standards, Sir Brian Pomeroy warned of a risk of a "race to the bottom, which means banks withdrawing features precisely to deter customers".[607] Therefore even the most vulnerable in society, who might not experience banks in their day-to-day business dealings or read the business pages of newspapers may view banks as opaque bodies who refuse to help them access the services they offer and that have come to be seen as a necessity by most people.


280. Access to a transactional bank account has become a necessary condition of financial inclusion. While certain products, such as prepaid cards, provide a partial substitute, they cannot carry out direct debits or standing orders, and typically attract fees far in excess of those applied to an ordinary account. The Commission has received no evidence to indicate that technologies are in development in the UK that would provide an alternative to a bank account.

281. The Government's policy on Universal Credit, which could require recipients to have a bank account to receive benefits, has heightened the importance of ensuring the remaining 3 million unbanked individuals in the UK are able to access a basic transactional account should they want one: eight out of ten in this group are in receipt of income-related benefits.[608] Robin Taylor, Head of Banking at The Co-operative Bank, believed that a rise in demand for basic accounts was likely to follow from these changes:

    There is going to be, in our opinion, an awful lot of customers wanting basic bank accounts later in the year and we need to ensure that we have a consistent basis on which they can open accounts and that there are some consistent accounts that they can open and have access to cash, etc. That is vital.[609]

282. Significant progress was made during the 2000s in improving access to basic accounts owing to effective co-operation between banks, Government and the third sector. However, basic account standards have started to fall in recent years: banks, fearful of attracting a disproportionate market share of an unprofitable product, have started withdrawing their features and underselling them in favour of standard current accounts. At a time when access to basic account services is becoming increasingly important, there is evidence of a 'race to the bottom' on standards and access to these products.

283. Following a consultation and a subsequent Recommendation, the European Commission recently proposed a Directive that creates a right for EU citizens to open a payment account with basic features, irrespective of their financial circumstances. The Directive specifies minimum standards that include transactional services, direct debit, a payment card, ATM access and the absence of any overdraft.[610]

284. In establishing a guarantee of access to a basic bank account, a number of considerations must be taken into account:

·  how to ensure that minimum standards for such accounts are adhered to, and updated in the light of technological and economic change;

·  how best to promote such a guarantee to those who are currently unbanked;

·  how to ensure that identification requirements and sales incentives do not militate against customers applying for and being offered basic accounts;

·  how to distribute the burden of providing basic accounts fairly between providers; and

·  how to ensure that the guarantee of a basic account does not adversely affect the size and functioning of the ordinary current account market.

We discuss these issues below.

285. Banks have no apparent profit incentive to improve the standards of basic accounts or enhance their features. Consequently, increasing variability has arisen in banks' basic account offerings, partly through the selective adoption of money management features, and partly through restrictions on access to the ATM network and counter services. Both ATM access and money management features are particularly important for basic account holders, many of whom budget in cash and operate their accounts with low balances, as noted by Sue Edwards, Head of Consumer Policy at Citizens Advice:

    A lot of basic bank account holders budget in cash. They often withdraw all their money and then use it to pay their bills, buy their food and go about their daily lives. [Access to cash] is the key feature really.[611]

It is therefore important that any minimum standards are monitored, reviewed and updated where necessary in light of technological and economic change, so that the floor they are intended to create does not become a ceiling.

286. Minimum standards and a guarantee of an account may be of little practical benefit to the unbanked if they remain unaware of either the existence of basic accounts, or their right to open one. It is important that a guarantee of a basic account is properly promoted, in bank branches, in financial education syllabuses, and by the Government if it decides to require that benefit payments be made into a bank account; that ID requirements are clear and consistent between banks; and that sales incentives do not militate against basic accounts being offered where this is in customers' best interests. In evidence to the Panel, Sue Edwards expressed concern that existing promotion and sales incentives for basic accounts risked stigmatising applicants:

    we get evidence all the time of people going into a bank to open a basic bank account and being made to feel very small [...] only in one bank could you go and get the information about the basic bank account without talking to a member of staff. Generally, you have to talk to a member of staff who is not so interested in giving you any information about a basic bank account; what they want you to have is a packaged account.[612]

287. Based on figures provided to the Commission by the major banks, the large banks already spend approximately £300m per annum providing basic bank accounts. It is important in principle, and for the proper functioning of the market, that the financial burden is spread evenly across the industry. Some banks are already doing more than others: Lloyds and Co-op have market shares well in excess of their share of the standard current account market; and of the major UK banks Barclays are the only provider offering services to undischarged bankrupts. This disparity was noted by Anthony Warrington, Director of Current Accounts at Lloyds, in evidence to the Panel:

    I would say some banks take the responsibility [to provide basic accounts] more seriously than others. I would point to the different market shares and levels of effort that different organisations put into providing basic bank accounts. At Lloyds Banking Group we have a very large market share of this sector. [613]

288. If a "guaranteed" basic account affected other parts of the market by attracting those customers who would otherwise have chosen a more profitable account, the costs could be higher. Banks should thus remain able to differentiate between standard and basic accounts in a way that reflects the needs and characteristics of their customers. This may involve offering features that may make a standard account more attractive than a basic one, but do not discriminate on access to the core utility functions necessary for financial inclusion, such as interest on balances in credit. Underpinned by well specified minimum standards and an approach to sales that reflects customers' best interests, there is no reason why a guarantee should affect the size of the existing market for ordinary current accounts.

289. UK banks already voluntarily spend £300 million per annum providing basic bank accounts to millions of customers who might otherwise be unbanked. Their historic attempts to address the problem of bringing the unbanked into the financial system are to be applauded. However, the Commission notes that the commitment of the banks to basic bank account provision varies markedly across the sector which results in the risk that such provision will be eroded in a so-called 'race to the bottom'. We received evidence that the most recent attempts by the industry to rectify this had stalled. Christine Farnish, Chief Executive, Consumer Focus told us that Consumer Focus had recently "convened an industry/consumer forum to broker agreement on minimum standards for basic bank accounts that all main banks operating in the UK would sign up to", but that agreement had not been reached on a number of key issues.[614] She commented that "We are very disappointed that the banking sector as a whole has not risen to the challenge-and opportunity-of demonstrating its commitment to responsible banking and service to all sections of the public," but added that "Lloyds Banking Group, Barclays and the Coop Bank have agreed to work together on a progressive package of minimum standards for basic bank accounts".

290. The Commission believes that banking the unbanked should be a customer service priority for the banking sector. It should be a right for customers to open a basic bank account irrespective of their financial circumstances. The Commission expects the major banks to come to a voluntary arrangement which sets minimum standards for the provision of basic bank accounts. The failure of the most recent industry talks and the apparent unwillingness of some banks to engage constructively in coming to an agreement is a cause for concern. These standards should include access to the payments system on the same terms as other account holders, money management services and free access to the ATM network. A withdrawal of free access to ATMs would constitute evidence of a race to the bottom. The industry should also commit to a guarantee that an individual satisfying a clearly-defined set of eligibility criteria will not be refused a basic bank account. Such an agreement should outline how minimum standards are to be upheld and updated in the light of technological change; how the right to a basic bank account should be promoted to the public, and particularly the unbanked; and how the obligation to provide basic bank accounts should be distributed between providers. Greater consistency of approach between banks and greater cooperation between them should enable a more cost-effective service to the providers than is possible with the current patchwork of individually designed schemes. In the event that the industry is unable to reach a satisfactory voluntary agreement on minimum standards of basic bank account provision within the next year, the Commission recommends that the Government introduce, in consultation with the industry, a statutory duty to open an account that will deliver a comprehensive service to the unbanked, subject only to exceptions set out in law.

291. It is important to ensure that the money being spent by the banks in this area is being spent in a way which represents best value for money. It may be the case that cooperation between the banks on basic bank account provision could yield cost savings, as could cooperation with other bodies. The industry, working together with other interested parties such as community development finance institutions, credit unions, consumer groups and those representing segments of society who are heavy users of basic bank accounts, need to consider whether such provision could be delivered in alternative ways which ensures high quality cost-effective provision. For example, an alternative approach could be for banks community development finance institutions, credit unions and other providers to work together in city-based or regional partnerships to develop local strategies for ensuring that the right to a basic bank account can be realised by all. The Commission recognises that participation in these partnerships may need to be obligatory, and that evidence of commitment to the development of local and community-based financial platforms should be required for banks to avoid mandatory participation in basic bank accounts.

292. The Government also needs to ensure that the agreement, voluntary or not, is underpinned by a requirement on the FCA to uphold minimum standards. As part of its role in this area, the FCA should have responsibility for collating and publishing data on the market share of providers in the basic bank account market. If the FCA does not currently have sufficient powers to assume this role, it would need to be given them. The provision of statistics is needed on the numbers of unbanked people, together with figures showing each bank's share of the basic account market in relation to its overall current account market share. This data should be periodically produced by the FCA.


293. We also examined whether the mainstream banking sector adequately served the needs of all consumers as well as all communities. The Community Investment Coalition told us that "a significant proportion of our society cannot access the financial services that they need on fair and affordable terms". The consequence, they said, was that "households unable to access appropriate, mainstream financial services [...] often have little recourse but to survive on high cost credit":

    Over four million individuals are borrowing from lenders with very high interest rates (typically 450 per cent-2500 per cent APR), trapping them into a spiral of increasing debt [...] the recent rapid expansion of payday lenders and pawnbrokers, providing credit to households and small businesses, shows that while demand for credit remains strong, access to credit offered on affordable terms remains a problem for many. We believe that this problem is greater in deprived communities.[615]

294. As outlined in Box 7, community finance is "the provision of affordable financial services and other support to businesses, civil society organisations, homeowners and individuals with the aim of delivering economic, social or environmental benefits".[616] A consequence of the lack of development of this sector, we were told, was that it left "large areas [...] of the economy, sections of society and geographical areas underserved".[617]

Box 7: Community Finance

The New Economics Foundation explained the different types of organisations that make up the community finance sector:

·  Cooperative banks, which are owned and controlled by investor members on the basis of one vote per member, rather than by shareholders in proportion to their financial stake, and tend to provide a wide range of financial services.

·  Mutuals, which "are similar to cooperatives, but customers of mutuals automatically become members without having to buy a share". Building Societies are the archetypal UK example.

Credit unions, a type of non-profit financial cooperative that have historically offered a restricted range of financial services—principally savings and loans services—to "members within a community that shares a 'common bond' such as living or working in a particular geographic area, or working for the same organisation".

·  Community Development Finance Institutions (CDFIs), which "lend money to businesses, social enterprises and individuals who struggle to get finance from high street banks and loan companies. They help deprived communities by offering loans and support at an affordable rate to people who cannot access credit elsewhere".[618]

295. The Community Investment Coalition made the case for greater support for the community finance sector. They argued that "the business models that drive mainstream financial institutions are increasingly unable to meet the needs of many small, marginalised and vulnerable communities, and the organisations that serve them".[619] This point was repeated to us by Andrew Robinson, Director at CCLA and Chairman of the Board of Trustees at the Community Development Foundation (CDF), who told us of his experience:

    My first job in the UK was to set up a charity. It was the first of its kind, and all it would do was lend money to not-for-profit organisations in depressed urban areas that couldn't get a loan from a bank. Despite having viable plans they [...] couldn't get through the [banks] credit scoring systems that were there. I think there was also a subtext there of deep disbelief that they could ever pay back, because of the types of people that were involved in the project, and that would be everything from BME women, not-for-profit organisations, micro enterprises and so forth.[620]

In The Financial Times, Will Goodhart, the UK CEO of CFA, argued that stock-picking, rather than engagement, was the investment managers' priority: "Asset managers can choose to engage if they believe it will add value to their clients but their primary concern should not necessarily be with corporate decision making".[621]

296. We received evidence contending that the UK should adopt similar provisions to those in the US Community Reinvestment Act.[622] The Act provided for a number of things, including forcing "the banks to disclose the level of bank lending and service provision within disadvantaged communities".[623] The legislation requires regular examination and grading of a lending institutions' activities in poorer communities and has penalty mechanisms, including barring merger activity, if a lender is neglecting its community by extracting deposits without reinvesting through loans and branch presence.[624]

297. The Government, during the passage of the 2012 Financial Services Bill, promised that the Treasury and the BBA would work together with the large banks to provide similar information on a voluntary basis, but later invoked the threat of legislation if a voluntary disclosure regime was not put in place.[625] The BBA and the large banks are currently working on the details of such a disclosure regime with plans expected to be finalised by the summer of 2013.[626]

298. Many individuals, businesses and geographical areas are poorly served by the mainstream banking sector. Many consumers have consequently opted for high-cost credit from payday lenders, some of whose practices have been a source of considerable concern. There can be a role for community finance organisations in supporting those whom the mainstream banking sector appears uninterested in serving. Given the benefits of a collaborative relationship, the BBA and the banks should be held to their commitment to refer declined loans to CDFIs. The effectiveness of current tax incentives, including Community Investment Tax Relief, intended to encourage investment in CDFIs by banks and other funders, should also be reviewed by the Treasury and, where necessary, re-designed to be more effective.

299. The Commission recommends that banks be required to commit to investigating ways in which they can provide logistical, financial or other forms of assistance to community finance organisations, in order to ensure that the community finance sector becomes strong enough over a period of years to work as a full partner with banks so that issues of unbanked individuals and communities are addressed.

300. Increased disclosure of lending decisions by the banks is crucial to enable policy-makers more accurately to identify markets and geographical areas currently poorly served by the mainstream banking sector. The industry is currently working towards the provision of such information. We welcome this. It will be important to ensure that the level of disclosure is meaningful and provides policy-makers with the information necessary accurately to identify communities and geographical areas poorly served by the mainstream banking sector. The devil will be in the detail of the disclosure regime which is put in place, including, for example, the question of whether such data will be disaggregated by institution and whether it goes beyond lending to small businesses. The Commission therefore supports the Government's proposal to legislate if a satisfactory regime is not put in place by voluntary means.

Competition in retail banking


301. In Chapter 3, we noted that competition is deficient in key parts of the UK retail banking market, including personal current accounts and SME lending. These markets are characterised by oligopoly supported by an implicit guarantee to the major banks, high barriers to entry and limited switching between providers. In this section, we examine possible competition policy measures aimed at increasing banking standards.

302. Parliamentary pressure for the Government to take seriously the issue of increasing competition in the retail banking sector has been a noticeable feature of the current Parliament. The Treasury Committee's 2011 Report Competition and choice in retail banking was extremely critical of the lack of competition in parts of the retail market and expressed concern about increased levels of concentration. It also outlined a set of policy recommendations to boost competition and improve consumer outcomes, including a regulatory regime which did not discourage new entry.[627] Progress by the Government has been too slow. That said, pressure from Parliament combined with the establishment of this Commission—and the decision to make competition a focal point of our inquiry—finally appears to have acted as a catalyst for the Government to take this issue more seriously. Many of the issues we have taken evidence on—for example, reforms to the payments system, and barriers to entry and growth—have resulted in the Government and other relevant bodies putting forward their own proposals.


303. We examined the extent to which low standards and poor consumer outcomes were the consequences of a lack of competition in some parts of the retail market as well as the historic role of regulation versus competition as a mechanism to improve standards and consumer outcomes. Much of the evidence we received suggested that, over the preceding decades, there had been an emphasis on regulation rather than competition which had proved counter-productive.

304. For example, Dr Diane Coyle, Founder of Enlightenment Economics, argued that "competition is a really powerful force for serving customers". In comparison to regulation, she believed that competition was:

    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.[628]

Clare Spottiswoode concurred with the views expressed by Dr Coyle. She told us that "if there is vibrant competition, companies cannot behave badly, because if they behave badly, they will lose customers":

    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 these things well, you lose your customers. Customers become the heart of your 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.[629]

Ms Spottiswoode warned that without "that force for competition we will get more and more supervision, more and more rules and more and more ossification of the system".[630] Andrew Lilico, Director of Europe Economics, said that "competition maintains standards principally via consumer pressure. If a bank does not scrutinise the activities of its staff and those it deals with, in a competitive environment consumers would leave for other banks".[631] Craig Donaldson, Chief Executive of Metro Bank, gave us an example of how he believed competition from his firm had led to higher standards:

    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 did not want it, starting to do it [...] You need competition to deliver what customers want.[632]

305. Clive Maxwell, Chief Executive, Office of Fair Trading, told us that improvements in banking standards would be an indication that markets had become more competitive. He said he was "concerned about some of the cultural changes going on within banks and about their behaviours, approaches and business models, where we are still waiting to see some evidence of change in the way that banks approach markets and their consumers".[633] He went on to tell us that "when competition works well, you get providers and businesses focusing on what really matters to their consumers and to their customers. They try to improve their service levels. They push down prices and pass on those savings to their customers".[634] He contrasted such a state of affairs with the situation in the retail market:

    You can also have competition working less well in markets. If, for example, the customers in that market do not understand the prices that they are paying or if they do not have good ways to understand the service levels and the quality they are seeing, the competition is not necessarily focussed on what the customer wants.[635]

Mr Maxwell concluded by telling us that he was "not yet convinced that banks are sufficiently focused on delivering the sorts of products and services that their customers really want, as opposed to finding ways to charge them for things they do not necessarily want".[636]

306. We concur with the evidence received which has stressed the role that competition can, and should, play to bring about higher standards in the banking sector. The discipline of the market can and should be an important mechanism for raising standards as well as increasing innovation and choice and improving consumer outcomes. Effective market discipline, geared to the needs of consumers, can be a better mechanism for improving standards and preventing consumer detriment than regulation, which risks ever more detailed product prescription. A policy approach which focuses on detailed product regulation alone could inhibit innovation and choice for consumers.


307. In Chapter 3, we noted that the major UK banks are probably too big. Sheer size can prevent effective management or regulation and can make holding individuals to account difficult. The major banks receive an implicit guarantee from the taxpayer as they remain too systemically important to be allowed to fail. They are also so large that, combined, the major banks form an oligopoly in many markets.

308. Adam Posen argued that a "big dumb rule" in the form of "some size limit on share of total deposits or total lending in the economy" was necessary to reduce the size of the largest banks.[637] Paul Tucker, Deputy Governor of the Bank of England, noted that there were international examples of such practices:

    One approach, which has been used elsewhere, is to prevent concentrations via an explicit cap on the market share that banks can accumulate through acquisitions. For example, the United States bans acquisitions that would result in a bank controlling more than 10 per cent of the country's insured deposits. (The rule does not prevent banks from crossing the 10 per cent line organically.) The same broad approach could, in principle, be related to a bank's share of loan markets, or to GDP etc. [638]

Michael Cohrs elaborated on the US example, noting that, while it was intended for use in cases of mergers and acquisitions, "it has been generally applied by the regulators as a rule of thumb".[639]

309. The Chancellor of the Exchequer expressed concern about a rapid introduction of a size limit for banks:

    I think that would have a pretty dramatic impact if you introduced it today. It would cause quite a lot of uncertainty in the banking sector, to put it mildly.[640]

Box 8: A history of oligopoly

The UK has a long history of oligopoly in retail banking. In Anatomy of Britain, Anthony Sampson noted concerns about concentration dating back to the early twentieth century:

    These giants took their present shape, after a succession of swallowings of smaller banks, at the end of the first world war, after which the Treasury became worried, and 'made it known' that they would disapprove of any more amalgamations[641]

Sir Alan Budd told us that "the clearing bank system in the UK, prior to Big Bang, was commonly described as a 'cosy cartel'" and that "mergers were permitted because the authorities believed that the surviving banks would not take undue advantage of their market position". This was due to "an implicit gentleman's agreement […] between the banks themselves and between the banks and the Bank of England".[642]

Sir Donald Cruickshank's 2000 report, Competition in UK Banking: A Report to the Chancellor of the Exchequer, expressed grave concern about concentration in pivotal markets:

    The Review considers further action is necessary, in particular to prevent anti-competitive mergers. The Review found the structure of several banking markets, most notably the supply of banking services to SMEs and the supply of current accounts to personal customers, to be highly concentrated.[643]

As the Independent Commission on Banking noted, the market is now "considerably more concentrated" than it was at the time of the Cruickshank Review.[644] UK retail banking is now arguably more concentrated than ever.[645]

310. Adam Posen explained some practical concerns with establishing a rapid increase in competition:

    people are not going to go to Joe's bank the day it is set up. You need a branch network and you need a computer infrastructure and you need some competence and some confidence from people.[646]

Virgin Money argued that "the creation of new banks through combinations of branches of the large banks would be operationally and culturally challenging, and it would probably take some time before such new banks could become effective challenger banks".[647] They also expressed concern about the practicalities of rapid divestments to increase competition:

    The view has been put forward that the large banks should be broken up to create new challenger banks. Although we think that this would in theory be good for competition, we are not sure that this is practical, given the difficulties experienced by RBS in separating the branches which it had agreed to sell to Santander, and by Lloyds in finding a buyer for its divestment.[648]

311. Since that submission was made, the scheduled divestments of branch networks by both RBS and Lloyds have been aborted. The collapse of the sale of RBS branches to Santander UK in October 2012 was attributed to delays in finalising the deal and incompatibility between the two banks' IT systems, [649] which Santander argued would not result in a "seamless journey for customers".[650] The Co-operative Banking Group explanation of their decision to withdraw from its proposed purchase of Project Verde branches from Lloyds in April 2013 illustrated the challenges currently posed by the wider economic climate:

    against the backdrop of the current economic environment, the worsened outlook for economic growth and the increasing regulatory requirements on the financial services sector in general, the Verde transaction would not currently deliver a suitable return for our members within a reasonable timeframe and with an acceptable level of risk.[651]

312. The fact that the largest banks have gained their dominant positions in retail banking markets, in part through their receipt of a 'too important to fail' subsidy and bail-outs, is a very unhealthy situation for effective competition. These increases in concentration are bad for competition and bad for stability.


313. As discussed in Chapter 3, barriers to entry in the retail banking market remain a fundamental obstacle to effective competition. Given the importance of brands in banking,[652] the decline in trust in major banks in the light of both the financial crisis and conduct failures might be expected to offer an opportunity to new entrants. RBS made this point in evidence to the Treasury Committee:

    The financial crisis has in fact created opportunities for potential new entrants. The reputation of several incumbent banks has been damaged by the financial crisis (to the advantage of new or newer entrants).[653]

314. There has been some evidence of new entrant activity. Metro Bank has entered the retail market,[654] while Virgin Money and Tesco Bank also have a retail presence and are poised to offer personal current accounts.[655] In April 2013 the Post Office announced its intention to enter the personal current account market. Subsequently, it has launched three different types of account: a "free in credit" standard account, a packaged account and a control account. The Post Office describes the control account as "a simple, straightforward account that protects you from unexpected, expensive bank charges and from accidentally going overdrawn for just £5 per month". The three accounts, which are provided by Bank of Ireland UK, are currently available in 29 branches in East Anglia. The Post Office plans a full roll-out across its network in 2014. Some new firms, such as Aldermore and Handelsbanken, have entered the SME market.[656] However, challengers to the major firms are currently relatively niche offerings. John Fingleton told us that there has been "very little new entry in the banking market generally".[657]

315. Nationwide has previously argued that retail banking in the UK is a relatively mature industry and therefore unattractive to new entrants.[658] Anthony Thomson, co-founder of Metro Bank, disagreed, stating that the lack of new entrants is not attributable to a lack of desire on their part:

    why, since the launch of Metro Bank in 2010, have there been no new lenders? It is not a lack of enthusiasm. In the past 12 months, I have spoken to several potential entrants. One of the leading consulting groups told me it had received 20 approaches in the past 18 months from individuals, local enterprise partnerships, local businesspeople and others. As one leading consultant told me, it falls into the "just too difficult category". Why?[659]

Mr Thompson stated that there were three particular challenges facing new bank entrants: capital requirements, the authorisation process, and access to the payments system. We consider each below.

Prudential requirements and risk-weightings

316. Representatives of the challenger banks argued that new and smaller market participants were disproportionately affected by prudential regulation, creating a regulatory barrier to entry and expansion. Anthony Thomson wrote that "the amount that entrants must hold is not commensurate with the risks that they generate, either in terms of depositors or the banking system".[660] Craig Donaldson contrasted Metro Bank's capital requirements with those of those of the large banks, saying they were "at least three times higher". This, he argued, imposed a "significant cost, which could be seen to be significantly anti-competitive".[661]

317. Jayne-Anne Gadhia expressed concern that challenger banks were required to hold capital commensurate with their planned size in several years' time:

    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.[662]

This, Anthony Thomson suggested, was more of a problem for a rapidly growing bank than the capital ratio itself.[663]

318. Virgin Money submitted that large banks are given an "unfair advantage" by being permitted to calculate risk-weighted assets (RWAs) using an advanced internal ratings-based (IRB) approach rather than the standardised approach on offer to smaller banks and new entrants.[664]
Box 9: Prudential requirements for small/new banks

An issue raised frequently by new/small banks through the course of our inquiry was that prudential requirements for new/small banks created an unlevel playing field between such banks and their larger and longer-established competitors. The ICB has previously highlighted that small and new banks might be disproportionately affected by prudential regulation and face higher capital requirements than large banks:

·  they might be penalised for less experienced management or lack of a track record;

·  they might be required to hold extra capital to compensate for concentration in a particular market or geographical region;

·  or the risk weights on their assets might be higher due to using a standardised rather than advanced approach to risk-weighting.

With respect to the third factor, under the Capital Requirements Directive, levels of capital required for different types of risk are calculated using either a standardised or internal ratings based (IRB) approach.

Small and new banks typically use the standardised approach to risk-weighting, which as both the ICB and OFT have previously noted, can produce higher risk-weightings than the advanced methods used by large banks. This can place small and new banks at a competitive disadvantage as they will face more onerous capital requirements.

Small and new banks use a standardised approach because they often do not have the history of back data nor the experience of managing their assets required for the transition to the advanced approaches. Nor do they tend to have the scale to justify the investment required to move to an advanced approach.

319. In a 2012 report, the Basel Committee on Banking Supervision noted that "the potential for very large differences between standardised and internal models based capital requirements for a given portfolio is a major level playing field concern".[665] Phillip Monk, Chief Executive of Aldermore, gave the example that his bank was required to hold twice the capital for a given portfolio of residential mortgages as the average large, incumbent bank.[666] Furthermore, the validity of the internal risk models used by large banks have been seriously questioned. This only exacerbates the distortion between large and small and new players. We discuss this issue in greater detail in Chapter 9.

320. In March 2013, the FSA published a review of regulatory barriers to entry and expansion in banking. The report states that the PRA will require start-up banks to hold proportionately less capital than major incumbents, a reversal of the situation that often occurred in the past, when the FSA was unduly concerned by the potential failure of non-systemic market entrants. Similarly, automatic new bank liquidity requirement premiums will no longer be enforced.[667] Under the new regime, capital requirements for rapidly growing new banks will also rise gradually, meaning that they will not be required to operate on the same basis as incumbent firms for three to five years.[668]

321. The FSA review acknowledged that "the requirements to achieve IRB status are considerable for a small bank and that this may cause competitive distortions relative to banks undertaking similar business under the IRB approach".[669] It states that this problem will be tackled through taking steps to "reverse the existing under-estimation of risk in the IRB approach" and adopting a more flexible approach to setting capital planning buffers for new banks that are small, non-systemic and relatively easy to resolve. [670] The review commits the PRA to providing support to new entrants who wish to move to the IRB approach.[671] The PRA should also review existing arrangements for banks such as Clydesdale, whose CEO told us not being able to use IRB meant they carried significantly higher cost of funds, which impacted their ability to compete in Scotland, where they have traditionally been the third player.

322. Jayne-Anne Gadhia argued that it was important to consider the appropriateness of capital ratios for large banks as well as for new entrants.[672] Lord Turner explained that the combination of the removal of capital and liquidity add-ons for new entrants, combined with global and domestic surcharges for systemic institutions, would result in a "significant shift" in their relative competitive positions:[673]

    in the past, we have had pretty much the same capital and liquidity rules for new entrant banks as for existing player banks—indeed, we have tended to have capital or liquidity add-ons for new entrant banks, so they have been disadvantaged—but we are shifting to a process in which a new entrant bank will be able to run on the minimum legal requirement under CRD IV, which is a 4.5 per cent capital ratio, whereas RBS, Lloyds bank and HSBC will effectively have to be up at about 9.5 per cent or 10 per cent, once you allow for the 4.5 per cent plus the 2.5 per cent conservation buffer and the global SIFI surcharge or equivalent under the Vickers rule.

However, Lord Turner did caution that "these changes will not in themselves transform competitive intensity in UK banking".[674]

323. The prudential reforms outlined in the FSA's review of barriers to entry are to be welcomed as a long overdue correction of the bias against market entrants, who are, at least initially, unlikely to be of systemic importance. Although the concerns of challenger banks in this area appear to have largely been addressed, the practical application of the regulatory authorities' laudable statements needs to be monitored closely.

The bank authorisation process

324. The FSA review of barriers to entry also contained proposals to streamline the bank authorisation process. The previous system was criticised in evidence to us as time consuming and costly. For example, Burnley Savings and Loans told us:

    The authorisation process should be more encouraging. At present, it takes too long, costs too much and it requires would-be banks to make huge investments in staff and IT before they have any idea if they are likely to be allowed to open.[675]

Martin Wheatley expanded on that last point, explaining the "Catch-22" situation that faced potential new entrants:

    When we spoke to new entrant banks, one of the interesting things that they said was: "In order to set up, we need backers and capital. We need to employ the right people and to have systems, but we face this Catch-22 situation where, until we are authorised, we cannot get the capital or the people or the systems, and you are telling us that you cannot authorise us until you have those things in place."[676]

325. Further concerns were expressed about the authorisation process. Andrea Leadsom MP told us that, in private, "potential bankers say that they do not find the FSA at all helpful to them".[677] Her point appears to be shared more widely amongst Parliamentarians. In a backbench business debate on the retail banking sector, secured by Ms Leadsom herself, a large number of participants spoke about the importance of encouraging new entry and ensuring the bank authorisation process did not act to discourage such entry.[678] The OFT stressed that the authorisation process should not unduly disadvantage unusual business models:

    Competition from outside the traditional banking model may also create challenges for the process of granting authorisation. It is important that regulators do not unduly constrain competition by taking the business model of incumbent and traditional banks as the starting point for the design of new rules in way that could disadvantage new technologies and innovative providers.[679]

John Fingleton made this point more succinctly, saying "there is a danger that anything new looks risky, and therefore we should not do it. We need new things at the moment".[680] The role of alternative modes of provision in improving banking standards is considered later in this chapter.

326. The FSA review outlined several changes to the authorisation process. These included:

·  a six-month fast-track authorisation process;

·  an alternative, staged process, enabling entrant firms to gain authorisation before being required to mobilise capital, personnel or IT infrastructure;

·  additional support from regulators; and

·  reduced demands for information.[681]

327. In its final publication, the FSA reformed an authorisation process that has long stifled entry to the banking market. This reform was welcome, but long overdue. The Commission supports both the specific proposals and the broader approach set out in the review for encouraging new entry. However, for a very long time, the regulatory authorities in the UK have displayed an instinctive resistance to new entrants. This conservatism must end. The regulators' approach to authorising and approving new entrants, particularly those with distinct models, will require close monitoring by the Government and by Parliament, and the regulator should report to Parliament on progress in two years time.

Access to payment systems

328. The August 2011 Treasury Committee Report on The future of cheques concluded that "The Payments Council is an industry-dominated body with no effective public accountability" and recommended that it be brought "formally within the system of financial regulation".[682] In Setting the strategy for UK payments, the Government consulted on three options for improving the way payments strategy in the UK was made. These were:

i.  to build on the present approach to UK payments strategy by making a series of changes to the governance of and operation of the Payments Council;

ii.  to introduce a new public body, the Payments Strategy Board, to set strategy across the UK payments industry; and

iii.  to create a new statutory regulator for the payments industry, similar to those used in other regulated sectors such as gas and electricity, as recommended as "Paycom" in the 2000 Cruickshank Report. [683]

The second was the Government's preferred option.[684] The consultation paper was dismissive of the statutory regulator option, stating that it would involve "a major increase in the overall regulatory burden" and did not consider it in detail.[685]

329. In February 2013, the Chancellor of the Exchequer made a speech in which he announced a more radical approach:

    At the moment, a new player in the industry has to go to one of the existing big banks to use the payment system.

    Asking your rival to provide you with the essential services you need at a reasonable price is not a recipe for success.

    [...] There are no incentives on the big banks to deliver new and better services for users - like saving the cheque or creating new services like mobile payments.

    [...] The system isn't working for customers, so we will change it.

    I can announce today that the Government will bring forward detailed proposals to open up the payment systems.[686]

330. The Government's revised proposals were subsequently set out in Opening up UK payments. This consultation proposed "bringing payments systems under economic regulation" with the establishment of "a new competition-focused, utility-style regulator for retail payments systems",[687] the underdeveloped third option in the original consultation. The Government explained that "a number of developments" had occurred which had led it to change its mind, including increasing concern "about the difficulties faced by both new entrants and existing small challengers in the UK banking market".[688]

331. This policy, Sir Donald Cruickshank told us, was "close to [his] original recommendation, which is that someone with competition powers should be given the job of licensing and regulating the underlying networks. So that is back on the table, but we have lost a decade".[689] The principle of creating a payments regulator was also supported by Anthony Thompson who said that there was a simple solution to the problem of access to the payments system—"to introduce a payments regulator, to ensure that new entrants are not at best disadvantaged and at worst priced out of the market".[690]

332. The consultation document sets out the competition problems that the Government is seeking to address:

    a number of large banks dominate the industry at every level. These banks dominate the decision-making process of the Payments Council; own the payment schemes; operate as direct users offering services to consumers; and operate as agents for smaller financial institutions who do not want, or cannot obtain, direct access to the schemes. Because of their involvement at each level of operation, there is considerable opportunity for these banks to manipulate their involvement in the process for their own benefit.[691]

333. The proposed new arrangements leave ownership of payments systems in the hands of overlapping groups of banks with the large banks predominant. The Government justified this by the potential innovation and efficiency benefits of competition between different payments systems with slightly different ownership arrangements. The consultation document concedes that the "nature of the market may mean that there is limited scope for these systems to compete with each other".[692] It also acknowledges the "clear potential for owners of the payment systems to use their position to stifle innovation and competition"[693] through the creation of barriers to entry.

334. We welcome the Government's Damascene conversion to bring payments systems under economic regulation and establish a new competition-focused, utility-style regulator for retail payments systems, along the lines originally proposed by Sir Donald Cruickshank in his 2000 review of competition in UK banking. The current arrangements, whereby a smaller bank can only gain access to the payments system via an agency agreement with one of the large banks with which it is competing, distort the operation of the market. Such agency agreements place small banks at a disadvantage, because the large banks remain in a strong position to dictate the terms on which indirect access to the payments system can be secured by smaller banks, even if there is currently no evidence of them doing so. The Government's proposed reforms will, however, continue to leave ownership of the payments system largely in the hands of the large incumbent banks. Continued ownership of the payments system by the large banks could undermine the proposed reforms, in view of the scope such ownership gives them to create or maintain barriers to entry. The Commission therefore recommends that the merits of requiring the large banks to relinquish ownership of the payments system be examined and that the Government report to Parliament on its conclusions before the end of 2013.

335. Craig Donaldson raised another barrier to entry and growth for small/new banks, which he believed acted to create an unlevel playing field between institutions. He told us that Government and local authorities had "huge amounts of deposits", but which were not placed with "any of the challenger banks".[694]

336. The Department for Communities and Local Government (DCLG) provides guidelines to local authorities on where to place their investments. The current guidance specifies that for short-term sterling deposits (specified investments), local authority funds should be deposited either with government bodies or other bodies with high credit ratings. They are also required to strongly consider the security, liquidity and yield of investments, with the former two taking priority. As the Local Government Association has explained:

    The heart of a council's investment strategy is the decision about which institutions an authority will deposit money with. Authorities should only deposit funds with financial institutions that are of a sufficient financial strength to be included on a "counterparty list"

    Counterparty lists are informed by an independent assessment of the financial stability of the institutions, the normal source of which is the rating given by one or more of the three main rating agencies. The agencies all give short and long-term ratings for financial institutions. Some give further information - for example about countries. The investment strategy sets out the minimum acceptable rating that an institution must achieve to be included on the counterparty list. The LGA has carried out research, this shows that whilst there are minor variations between individual counterparty lists - the general principle of placing deposits with highly rated institutions is a common feature.

337. The key role ascribed to credit ratings in assessing where to place local government deposits can serve to exclude particular institutions from receiving such deposits. As the LGA has noted "not all financial institutions are rated by rating agencies, smaller UK building societies are typically not rated. Some authorities will still include these, recognising the extent of FSA regulation of this sector, but will lend them less money and only for shorter periods (e.g. 180 days)".[695]

338. The Commission agrees strongly that local government deposits should only be held with financial institutions that can demonstrate their robust financial strength. A high credit rating is an important indicator of financial strength. However, it is just one indicator of financial strength. The suggestion of the Department for Communities and Local Government (DCLG) that deposits are placed with institutions with high credit ratings can have an adverse effect on banks without formal ratings. By effectively cutting off from access entrants to this source of funding, new and small banks face an unlevel playing field. The consequence is that, while the Government stresses the importance of encouraging new entry into the retail banking market, the current DCLG guidance acts in a way that puts new entrants at a competitive disadvantage.

339. Deposits held by financial institutions originating from central or local government make up a sizeable proportion of the UK deposit market. Provided that other measures of credit worthiness are in place, it would be a source of concern to the Commission if the guidance or rules in this area prevented such deposits from being held by small banks or other institutions without a formal rating. If so, this would constitute yet another example of an unlevel playing field between the large incumbent banks and small or new banks in the retail market which needs to be addressed. As a result, the Commission recommends that the DCLG review its guidance in this area to see whether it penalises new banks and consider the scope for such institutions to demonstrate credit-worthiness as well as liquidity and stability in other ways. A bank's strength should not be measured solely by its credit rating, especially as the financial crisis demonstrated how many banks with strong pre-crisis credit ratings ran into serious difficulties.


340. We examined the role of alternative providers that provide alternative financial services to those offered by banks and traditional investment firms in the market for consumer and small business finance in competing with mainstream retail banks. Many have little or nothing in common with one another except for the fact that they are not mainstream banks.

341. The term "alternative provider" includes organisations, such as credit unions, Community Development Financial Institutions or cooperatives, with a broader set of objectives than profit maximisation and with business models that date back to Victorian times. It also encompasses relatively recent, smaller, non-bank entrants to the retail market, specialising in innovative forms of lending to individuals and businesses. Such firms have emerged and grown significantly over the last five years, driven in large part by technological developments, particularly the growth of the internet. The most visible manifestation of this phenomenon thus far are the peer-to-peer lending (P2P) and peer-to-peer 'crowdfunding movements', which we define in Box 10.

Box 10: modern forms of alternative provision

Peer-to-peer lending comprises consumers or businesses lending to each other directly through an online marketplace as opposed to via a banking counterparty, with the P2P business operating the exchange to bring lenders and borrowers together—a process often referred to as disintermediation. P2P products are available to ordinary retail consumers who actively choose to lend their money in this way. P2P providers may spread a loan across multiple borrowers and similarly often aggregate lots of lenders to produce a loan for a particular borrower.

Some P2P lenders specialise in loans to individuals consumers—for example Ratesetter, others such as Funding Circle focus on lending to small or micro businesses, while a third group such as Zopa are players, or plan to be, in both markets.

Crowdfunding is also an online marketplace, which also aggregates many investors (often for very small amounts) to provide funds for investment in a particular project, often enabling investments in shares and other instruments. However, crowdfunding can also be used to fund projects with a social or environmental purpose, and can be seen as a form of social impact investing. For example, Buzzbnk is a peer-to-peer lending platform for social enterprises, charities and community enterprise.

The importance of diversity

342. A key theme to emerge from our inquiry was the current lack of diversity in the UK retail banking market and the importance of creating a more diverse market. Many of our witnesses told us that a more diverse market would play a role in improving standards in the wider industry. They also stressed a number of other reasons why greater diversity was important. For example, Tony Greenham told us that we needed to differentiate between "competition and choice", which he told us were "not necessarily the same thing". He argued that "diversity of banking institutions "gives an additional, genuine choice to potential consumers". He lamented the lack of diversity in the UK market:

    That [diversity] does not exist if you simply have a series of very similar banks competing, which is effectively the situation we have had for some while in the UK. We have by international standards a remarkably homogenous banking industry: very concentrated, large national players, very few local banks if any; and they all tend to prioritise chasing the same customers

Mr Greenham explained how diversity in the UK retail market was reduced over time:

    We have lost that sector [mutuals] as a result of various developments, including the demutualisation of the building societies and the gathering-up of all the local trustee savings banks into one national bank that was then taken over by Lloyds. We have lost that diversity. In other countries they have tended to protect these mutual sectors in one way or another.[696]

He went on to expand on how the UK's lack of diversity contrasted sharply with elsewhere:

    There are co-operative banks, which are particularly prevalent in Europe. We have one co-operative bank, but it is national one [...] There are credit unions [...] which, particularly in North America, have significant market shares. There are public savings banks, which are the models we see in Switzerland and Germany but also elsewhere. And you also have, in the US and in this country, the community development finance institutions [...]In addition to these four forms, we of course now have new models [...] of crowd funding and peer-to-peer. We would argue that the more of those you have in your banking system, the healthier it is for consumers and for the economy.[697]

Mr Greenham ended by telling us that "it should be an explicit objective of banking policy in this country to encourage a much greater degree of diversity of provision across all of those potentially different forms of bank".[698] This position was echoed by the Finance Innovation Lab who said that "the Bank of England and the Prudential Regulation Authority should have a statutory duty to achieving greater diversity of providers, along with more new entrants and competition, within and with the existing banking system".[699]

343. Diversity of provision in the retail banking market matters. The Commission sees value not just from more new banks with orthodox business models, but also from alternative providers. Diversity of provision can increase competition and choice for consumers and make the financial system more robust by broadening the range of business models in the market. The UK retail market lacks diversity when compared to other economies, and this has served to reduce both competition and choice to the obvious detriment of consumers. The Commission strongly supports moves to create a more diverse retail market. However, the Commission is not persuaded of the case for adding another 'have regard' duty for the Financial Conduct Authority at this time, beyond the current competition and access provisions. Instead, the regulator should ensure that other forms of provision are not put at a disadvantage. This should be reviewed by the FCA within four years and be the subject of a report to Parliament. The PRA will need to support the FCA in this wherever possible, by avoiding prudential requirements which deter alternative business models emerging or place them at a competitive disadvantage.


344. The Peer to Peer Finance Association, the trade body for the sector and whose members represent 90 per cent of the peer-to-peer lending market, stressed the importance of technology as a catalyst for the growth of such firms and as a force for increased competition in the retail market:

    The widespread availability of digital broadband technology is allowing the cost effective development and distribution of new sorts of financial services products to retail consumers. Peer to Peer Lending (P2P) is a good example of a product that couldn't exist before the arrival of the internet.[700]

Giles Andrews was just one of many who described the internet to us as "the classic disruptive technology" which was a force for increased competition. He asked:

    What does an incumbent do when faced with a disruptive entrant? To compete with a disruptive entrant, they have to discount their pricing significantly across the board. They cannot just compete with the customers who might otherwise go to the disruptive entrant. Often the most sensible thing for them to do is to ignore it, because it might go away. It is classic behaviour [...] typically the incumbents do not respond, because it is uneconomic for them to do so until such a point where they have to respond, by which time they have lost some momentum.[701]

345. We heard that the UK was a market leader in this field. Just one of many organisations to emphasise this was RateSetter, who said that "it should be noted and appreciated that the UK has embraced the innovation of P2P (unlike other advanced economies which have blockages preventing such innovation)".[702]

346. Firms such as Zopa and RateSetter told us that they saw themselves as competing with the mainstream banks, but often across a "narrow product set".[703] Others told us that, in addition to competing with banks, they were also filling gaps in the market, especially in terms of finance for smaller enterprises. For example, the Peer to Peer Association told us that the growth of such firms was a direct challenge to the large banks given that "Peer to Peer Lending now offers a way for consumers with money available to put that money to use in the real economy and get a reasonable return, and for consumers or small businesses who need a fixed term loan to borrow that money and pay it back".[704] This sentiment was echoed by Zopa—which was launched in 2005 as the first peer-to-peer lending business, specialising in loans to consumers—who said that it provided "competition to the banks by offering very competitive lending rates and consumer friendly terms which enabled them to compete "directly with the banks in a narrow product set".[705] This theme, that peer-to-peer lenders were more efficient than traditional lenders, was one that surfaced time and time again. For example, RateSetter argued that:

    By offering rates which are amongst the best value in the personal loan market (as seen on all the 'price comparison' sites), we have kept the market open and competitive at a time when established lenders have reduced their exposure (to focus on more core lending such as corporate and mortgages). Had P2P not kept a competitive offering in personal loans, their availability and cost would be significantly worse for consumers.[706]

RateSetter described itself as having "reduced" "the gap between what savers can earn and what borrowers can pay", but acknowledged "P2P companies are still middlemen, just like a bank ultimately is: they [P2P] are just 'thinner' middlemen".[707]

347. Crowdbnk stressed how their internet-driven business model allowed them to:

    Introduce much lower cost, and more transparent, retail financial services than traditional service providers. Relying solely on internet and mobile technology enables new entrants to market their services, process transactions and enable secure consumer access to transaction data for a fraction of the cost of traditional firms with legacy IT systems and physical branches.[708]

Funding Circle told us that they were "faster and more efficient than a bank loan. On average it takes 12 days for a business to gain finance through Funding Circle, compared to 15-20 weeks with a bank".[709] Another advantage cited by such firms was a greater focus on customer service. For example, Giles Andrews told us that his firm combined the use of technology with what he described as a "much more human side to what we do". Mr Andrews told us that this was particularly relevant to the SME sector:

    Because banks are unable to make human decisions to lend, when humans make the best decisions on lending to SMEs. someone goes to kick tyres or count parts in a warehouse. We have re-introduced quite a lot of that, which is very economical for us to do at scale. It involves a simple phone call, where we can establish, we think better than any algorithm can, the likelihood of the person repaying.[710]

348. Funding Circle described themselves as enabling retail investors and savers to "lend directly to businesses", thereby "side-stepping the banks". They argued that they were "helping to fill the void created by the retrenchment of traditional providers to lend to small businesses".[711] This point was also stressed by Crowdbnk who told us that they were helping to "fill a significant funding gap currently ignored by the major retail banks and traditional investment firms. We conservatively estimate that there are approximately 25,000 viable small businesses that fail in the UK every year because of a lack of growth funding and the unwillingness of banks and existing investment firms to provide financing".[712]

349. Abundance, a crowdfunding platform, that is an online retail investment platform which allows people to invest directly in UK renewable energy projects, infrastructure and businesses, also told us that they "compete directly with UK banks both in terms of the provision of finance to UK businesses and infrastructure and in the provision of investment products for retail investors". However, they also saw themselves as "reaching the parts of the economy which universal banks cannot reach or no longer feel it is economic within their legacy business models to reach", and thereby acted to "fill the funding gap" which were "particularly acute for community scale independent producers". Abundance also stressed the benefits to consumers from an investor perspective of the growth of organisations such as their own which enabled retail investors to tap into a far wider range of asset classes:

    The advantages to retail investors of gaining access to these projects are significant. Until the launch of Abundance in April 2012, it was only possible to access the returns from renewable energy assets via schemes targeted and incentivised for so called high net worth investors with minimum of £10k or more to invest.[713]

350. Peer-to-peer and crowdfunding platforms have the potential to improve the UK retail banking market as both a source of competition to mainstream banks as well as an alternative to them. Furthermore, it could bring important consumer benefits by increasing the range of asset classes to which consumers have access. This access should not be restricted to high net worth individuals but, subject to consumer protections, should be available to all. The emergence of such firms could increase competition and choice for lenders, borrowers, consumers and investors.


351. We examined the barriers facing new alternative providers trying to enter or grow in the market. The Financial Innovation Lab listed four barriers to a more diverse retail market: "regulatory barriers to new entrants, unfair market advantages of incumbent banks, lack of consumer awareness and trust of alternatives to existing banks, and poor engagement between regulators and financial innovators with new business models".[714] Some of these barriers—for example, the process of regulatory approval, rules around capital and liquidity, the "entrenched advantages of incumbent large banks", "the implicit state subsidy they receive"—were common to all new entrants, but others were specific to alternative providers.

352. One issue, frequently raised in written evidence from alternative providers, was regulation. The regulation of peer-to-peer lenders and crowdfunding platforms is at a nascent stage, with some parts of the sector already subject to regulation while others are in the process of being brought into the regulatory orbit. Peer-to-peer lenders, for example, "are currently unregulated other by the OFT for the consumer credit part of their business"[715], although the Treasury recently announced that peer-to-peer lenders would be brought into the regulatory framework. This move was welcomed by the industry.

353. The Peer to Peer Finance Association told us that the industry welcomed the "recent announcement by the Treasury that peer-to-peer lending will in future be formally regulated".[716] This sentiment was echoed by RateSetter who told us that being regulated was important "because it would boost consumer confidence in the product, while reducing the risk of consumer detriment should a less professional or even rogue player enter the market".[717] Funding Circle concurred, stating that "formal regulation will help to raise awareness and provide additional levels of credibility for the wider peer-to-peer lending industry".[718] RateSetter outlined yet another benefit to coming into the regulatory fold boosting "the confidence of intermediaries such as independent financial advisors who see the value in P2P but are reluctant to advise their customers to consider it purely on the basis that it is unregulated".[719]

354. However, industry participants cautioned that regulation must be "appropriate and proportionate".[720] The Peer to Peer Finance Association said that they were:

    Concerned to ensure, however, that the new regime established by the FCA is truly proportionate and risk based. A risk averse backward looking regulator who did not fully sign up to the dynamic market benefits of promoting competition could construct a regime that was so cumbersome and costly that innovative new businesses would be stymied [...]

    Unless the right regulatory balance is struck, regulation could prevent UK consumers from benefitting from the simple, good deal products available now.[721]

They argued that a different form of regulation was more suitable because such firms were "neither 'bank', in that they do not take deposits, arrange payments and take counterparty risk in the way a bank does, nor are they collective investment schemes or other investment products". Instead, they argued in favour of a regulatory regime which "accepts that full transparency and clarity of the deal to consumers is consumers' best protection".[722]

355. A related issue raised by alternative providers was the perceived lack of regulatory understanding of unorthodox business models, combined with a tendency for regulators to focus on the big banks at the expense of smaller players. We received a number of submissions which stressed the lack of understanding of their business model amongst regulators as a significant barrier to starting up. The Finance Innovation Lab summarised the problem as follows:

    Existing financial service regulation is set up to handle business models from the status quo. By definition, any innovations will be harder for regulators to address [...]

    The sheer size of big banks has inevitably led to policymakers and regulators focussing their limited resources on those players, thus squeezing out the time to engage with innovation. This creates a vicious circle where the expertise of regulators is concentrated over time onto certain types of bank and financial risks, making it even harder for new entrants to be heard or understood.[723]

356. Alternative providers such as peer-to-peer lenders are soon to come under FCA regulation, as could crowdfunding platforms. The industry has asked for such regulation and believes that it will increase confidence and trust in their products and services. The FCA has little expertise in this area and the FSA's track record towards unorthodox business models was a cause for concern. Regulation of alternative providers must be appropriate and proportionate and must not create regulatory barriers to entry or growth. The industry recognises that regulation can be of benefit to it, arguing for consumer protection based on transparency. This is a lower threshold than many other parts of the industry and should be accompanied by a clear statement of the risks to consumers and their responsibilities.

357. We also took evidence on other issues which needed to be addressed in order to create a more level playing field between the incumbent banks and alternative providers. The issue of tax arose frequently. For example, the Financial Innovation Lab told us that "the way the tax system treats products from mainstream banks compared to new innovations places a distortion on the savings market".[724] RateSetter explained that this was because, while "banks are able to attract funds from many tax-advantaged sources such as SIPPs and ISAs", this was not the case with respect to peer-to-peer:

    While it appears legally possible to include P2P in SIPPs, some SIPP providers seem reluctant to make the necessary updates to their systems. It is not possible to include P2P in an ISA which sets P2P at a significant disadvantage to banks. The ability for consumers to place their P2P funds in an ISA would make a massive difference (and is something our customers ask for every day).[725]

This point was also stressed by Abundance, who argued "for the extension of ISA rules to create a more level playing field for so called alternative finance companies".[726]

358. Giles Andrews also explained that lenders through the P2P platforms were disadvantaged compared to banks because they were taxed on the advertised rate of interest rather than the return received. If P2P lenders were given the same tax advantages as banks then lenders would be able to move further along the risk spectrum to offer services to a broader range of clients. More specifically, Mr Andrews explained that:

    If Zopa lends currently in a very prime world, where there are very low credit losses, our lenders have to pay tax on the interest they have received gross. If a lender lends money at 7%, suffers a 0.5% credit loss and makes a net 6.5%, he pays tax on 7% and then suffers his credit loss afterwards, and the fact that he suffered a credit loss after tax does not really matter.

    If you then move that into a world of more inclusive lending—economically, we simply cannot do that, because of this tax incentive—and lend money at 15%, with an expected credit loss of 8%, the lender would pay tax on the gross amount of 15%. A reasonably high proportion of our lenders are higher-rate taxpayers, so they would pay tax at 6%. They would then suffer predicted credit losses of 7% or 8%, and they would be left with nothing. The tax incentive, which is in statute—we are talking to the Treasury, as you might imagine, about trying to amend it—is very clear: because these are private individuals earning interest, they have to pay tax on the gross amount they are not allowed to offset. In terms of reasonable expenses to offset against that, a credit loss is a pretty reasonable expense to offset against an income stream.

Mr Andrews added that, until this was "changed", "a business like ours will never be able to undertake inclusive lending in disadvantaged areas. We have a huge amount of interest in doing so from our lenders, but it makes no sense for them to do so".

359. The Commission recommends that the Treasury examine the tax arrangements and incentives in place for peer-to-peer lenders and crowdfunding firms compared with their competitors. A level playing field between mainstream banks and investment firms and alternative providers is required.

Enabling customer choice


360. Freedom of switching between providers is an important indicator of the effectiveness of a market. John Fingleton told us that switching was one of the "two fundamental drivers of competition", alongside market entry.[727] Sir Donald Cruickshank explained why switching was important to achieving high banking standards:

    the person who is managing a division of a bank […] has got to worry on a Friday night that he might have lost a significant number of his customers by Monday because of something he did on Thursday night, such as if nobody could transfer money or get paid […] He or she has got to believe that there is a significant risk that, if that happens, a significant number of his or her customers will have gone by Monday morning.[728]

361. Switching rates are currently very low. The OFT cited estimates that 3 per cent of personal current account holders switched their main account in 2012.[729] Martin Wheatley explained the two main explanations for low switching rates:

    there is still a risk. People have all heard horror stories of how payments have not been made or critical payments have been dropped, so they have concerns about how safe it is. More importantly, it is not clear that there is another offering that is significantly better than your current bank.[730]

Craig Donaldson said that "it is not difficult to switch […] it is the perception […] that it is difficult to switch that is the issue".[731]

362. A new seven-day switching service (sometimes referred to as a redirection service) is to be introduced in September 2013. It is the result of the Payments Council taking forward a recommendation by the ICB.[732] The service should reduce the amount of time it takes to switch an account from an average 18 days at present to seven working days. It includes various measures to reduce disruption for customers in switching.[733]

363. Various more radical alternatives to the seven-day switching service were suggested to us in evidence. These options tend to fit on a scale of reduced switching times and increased central storing of information. This scale encompasses the overlapping concepts of full account portability and a common utility platform. These are considered below.


364. A common utility platform is a single shared core banking infrastructure, which all banks could use. VocaLink identified information that might be held by a common utility platform:

    A central database of standardised customer credentials that meet "Know Your Customer" (KYC) requirements, with a 'portable' identifier. This would also deliver a standardised level of KYC across the industry;

    A central database of payment mandates for each account, to allow customers to move banks easily and also allow payments to continue flowing in the event of a bank failure.

    A central database of end-of-day balances for each account, to further facilitate customers moving banks, to aid resolution of a failed bank and to facilitate payments under the Financial Services Compensation Scheme.[734]

Andy Haldane explained the potential competition benefits of holding such information in a common utility platform:

    I am personally attracted to the notion of customer account details being stored in some central utility-type function. That information is effectively a public good and should be stored as a public good. Banks generally would then compete to plug and play into that central utility. That will lower barriers to entry. The difficulty of current account switch is currently a barrier. It would make the process of searching across deposit account offerings that much easier.[735]

Andrea Leadsom MP wrote that the reduction in barriers to entry resulting from a platform would "be a boost to challenger banks and take away the unfair advantage enjoyed by long-established clearers".[736]

365. A number of witnesses, including Bank of England officials, stressed the financial stability and resolution benefits which could result from adopting a common utility platform. These benefits would crucially not accrue with 7-day switching or account portability. For example, Sir Mervyn King explained the financial stability benefits of a platform, particularly in terms of the resolution of failed banks:

    One of the key elements of resolution, even in simple cases, is how you handle the transfer of retail depositors from the bank that gone into resolution possibly into a new bank between Friday night and Monday morning. A mechanism in which that was simple and straightforward would help. So I am in favour of the principle.[737]

Mr Haldane said that the creation of a common utility platform would "safeguard the safety, security and resilience of the payments mechanism".[738] Other potential benefits cited included that it would provide impetus to update antiquated bank IT systems,[739] and that it would reduce opportunities for fraud.[740] Mr Haldane told us such a platform was "well within the compass of technology".[741] There was agreement, amongst both advocates and opponents of a common platform, including VocaLink,[742] Lloyds Banking Group,[743] Tusmor[744] and Intellect[745] that a common platform was technically feasible.

366. We heard several criticisms of a potential common utility platform. António Horta-Osório's noted "the increasing systemic risk" if banks were to share IT platforms, warning of reduced incentives to innovate to compete on technology and that it would be "highly costly and will take a long time to implement".[746] Andy Haldane acknowledged potential overreliance on a single geographical site and the civil liberties implications of centrally holding customer information.[747] Lloyds Banking Group argued that a common utility platform would be desirable if UK banking was being started from "a blank piece of paper". However, they argued, the UK has well established payments systems and "to deliver a utility infrastructure now would be akin to flattening the whole of London to rebuild it as a more efficient grid-based Manhattan style city".[748] David Yates, the CEO of VocaLink, explained the technical difficulties in moving to a common platform:

    It is an enormous technical work-out and it would be quite invasive to the banks' own operations to do even the first step on that journey. It is not to say it should not be done but it would be a big work-out because you would effectively be changing a core of data sets that drive all payments in and out of the bank network. It would need an immense amount of co-ordination and would take quite a long time. I guess the question then becomes: what is the opportunity cost of doing that versus doing some other pieces of innovation within the market?[749]

Lloyds Banking Group drew attention to the danger that, by the time the platform was created and current accounts had been migrated to it, "infrastructure would also be at risk of being obsolete".[750]


367. The phrase "account portability" is sometimes used interchangeably with the "common utility platform".[751] It is also used to describe two broad and related alternatives to the redirection service that are less radical than the creation of a platform:

·  account number portability in which a customer's sort code and account number would not change when the customer changed banks, thereby avoiding the need to change any payment or credit instructions; and

·  account portability through the creation of an "alias database" and assigning unique and permanent identifier to each account, which would facilitate rapid switching without the need to retain the same account number and sort code.

368. Andrea Leadsom MP argued that a system based on a unique identifier was not, unlike full account number portability, "eye-wateringly expensive",[752] and would achieve very similar goals in a "minimalist way".[753] She also explained that it would overcome a crucial practical objection to account number portability, in that you could continue to make international remittances, which rely on sort codes being unique to individual banks.[754] Several witnesses, including the Chancellor of the Exchequer[755] and John Fingleton,[756] argued that retaining a particular account number was not as important to consumers as, say, retaining a phone number. Benny Higgins, CEO of Tesco Bank, added "most people would not be able to tell you their bank account number".[757]

369. Currently, when a consumer or small business switches their account the costs of making administrative changes are imposed on a large number of other parts of the economy. Employers have to change their payroll details, small and large businesses have to change regular payments and government departments and local councils have to change details for the payment of benefits. The costs of these changes will not be removed by the seven working day switching service. By removing the need for these administrative changes, account portability also has important administrative savings for consumers, small and large businesses and Government.

370. Jayne-Anne Gadhia told us that the deficit of competition in retail banking was such that seven-day switching was insufficient and it was necessary "to move to full account portability so that a broader range of banks can participate on a level playing field".[758] Andrea Leadsom MP suggested that "seven-day switching be part of the journey towards full-account portability":

    It should be supported to provide a quick-fix to some of the problems. And the government should announce now the intention to introduce full account portability with a long lead time, to tie in with the timetable for the retail ring fence.[759]

371. Lloyds Banking Group expressed concern that the mechanism for linking old and new account details following a switch would concentrate risk in payments systems:

    Considering there are around 300 million separate accounts in the UK, and over 120 million transactions daily through these accounts, the new routing table would have a vital but risky role to play.[760]

Lloyds also argued that the technology and infrastructure required to achieve account portability on a unique identifier basis would be "incredibly complex" and tantamount to a utility platform.[761] Ben Wilson, Associate Director, Financial Services Programmes, Intellect, said that "that it is probably the case that a central utility would provide the best means of account portability".[762]


372. The ICB looked at the case for 7-day switching versus account portability. They did not dismiss the case for account portability, but instead acknowledged that "there may be a case for account number portability in due course, but the redirection service would be a cost-effective first step":

    If it does not achieve its aims, there could be a strong case, depending on cost, for full account number portability to be introduced (potentially through use of an alias database.[763]

The ICB said that once implemented "the FCA should assess whether it is delivering enough of an increase in willingness to switch to lead to effective competitive tension". If not, then "the incremental costs and benefits of account number portability should be considered".[764] Sir John Vickers explained to us the rationale behind the ICB's decision:

    We did consider the case for moving to full account number portability. However, we thought that the costs of that, even though we didn't believe all the numbers put to us, were likely to be substantially greater, and it was not clear—without seeing how the redirection service goes—what the incremental benefit of portability would be. So it seems to me that a perfectly sensible approach is to get the redirection service in place; there are other related things about payment systems reform in general. Let us see how that redirection service goes and then come back to number portability.[765]

Sir John said that he thought there was a "good chance" that seven-day switching "will change behaviour and consumer confidence around the switching process".[766]

373. Proponents of the seven-day switching service argue that it will successfully address many of the key reasons why consumers decide not to switch. Adrian Kamellard from the Payments Council said that new seven-day service would address concerns that switching is difficult:

    What makes the difference, and is the critical thing, is that everything is characterised as being simple and hassle-free. The key thing for the customer is that once you have told your new bank that you want to change, you need to be able to sit back and do nothing more.[767]

António Horta-Osório told us that the redirection service would remove "uncertainty and risks" in the switching process.[768] Benny Higgins also supported seven-day switching, arguing that, if well executed, it would achieve the benefits of account portability:

    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.[769]

    Mike Dailly of the Financial Services Consumer Panel was similarly enthusiastic:

    It is going to be much, much better than what we have at the moment. It will cure all the problems we know that put people off in the first place—direct debits going wonky. All that sort of stuff is going to get fixed, and we see this as being really good.

Tusmor, while supportive of 7-day switching, questioned why the 7-day time period could not be reduced further: "we believe the new 7-day switching process could happen much faster than seven days. Indeed it could and should be an overnight process".[770]

374. Several witnesses confirmed the experience of the Netherlands, where a system very similar to the 7-day switching service had been introduced and was working well. Disappointingly, so far, there has been little movement in switching rates, which remained very low.

375. Clive Maxwell said that, properly publicised, the seven-day service "could make a big difference":

    Having a formal commitment around seven days and making sure that the rate of errors and so on drops markedly will be very important. Publicising the way it operates will be important.[771]

Both Clare Spottiswoode and Adrian Kamellard told us that a substantial public information and promotion campaign was planned. [772]


376. We also examined the issue of the switching fee under the 7-day switching service and, in particular, who would pay the fee. The cost of introducing the Central Account Switching Service (CASS) is currently estimated at around £750m. The majority of this cost will fall on individual institutions, but approximately £100m will be incurred at the centre. Of this £100m of central costs, around four-fifths is to be recouped via a per switch transaction fee which would be contributed by participating users of the service. This fee could be structured in a variety of ways, for example:

·  the bank acquiring a customer pays the entire switch fee;

·  the bank losing the customer pays the entire fee; or

·  the per switch fee is shared between the two institutions.

377. The Payments Council told us that "originally" their Board "had endorsed the working principle that this cost should be recovered through a per switch charge paid by the institution acquiring the customer during the initial period of live operation". However, they went on to tell us that:

    As the development and implementation of the service progressed, that working principle has been challenged and is now under review. To ensure a fair and considered approach is taken in this, we have commissioned and independent consultancy to make recommendations regarding the most appropriate model or models for the recovery of these costs. The independent review is looking at two aspects: what costs should constitute a per switch fee and who should pay it.

The review is due to conclude in June 2013.

378. The Payments Council's original decision to endorse an acquirer pays model had caused some concern about whether it would disadvantage new and smaller banks hoping to win market share. In December 2012, Benny Higgins, CEO of Tesco bank, wrote to us stating that:

    If executed in a fair and accessible way the Central Account Switching Service will enable new entrants and existing current account providers to compete for customers on a more level playing field. This will enhance the market and allow customers to vote with their feet and encourage all providers to offer competitive and innovative products.[773]

He wanted to see a switching fee adopted which was "affordable, appropriate and shared by both the old and new bank regardless of whether a customer's switch is full or partial".[774] However, Mr Higgins went on to express concern that the Payments Council's apparent preference, at the time he wrote to us, for adopting an acquirer pays model for the new switching service "may deter new entrants from entering the market, lead them to opt out of CASS due to the high cost or pass this cost on to customers to ensure they can offer the service".[775]

379. The ICB which initially proposed a new switching service had been clear that such a service "should be introduced in a way that does not impose disproportionate costs on new entrants and banks that access the payments system through agency agreements". It went on to state that "in particular, small banks/building societies and small business direct debit originators should not be penalised by this move to improve the switching system". The OFT, in their review of the personal current account market, also stressed this point":

    the OFT would have concerns over fees from this service being borne wholly by the new bank unless a very clear justification for this approach can be provided that takes into account the impact of this approach on competition in the market and barriers to entry

380. The ICB, the OFT and others have been clear that the new switching service and the per-switch fee should not impose disproportionate costs on new entrants or small banks. The Commission concurs and finds it difficult to envisage any circumstance in which it would be appropriate for the per-switch fee to be borne wholly by either the new bank acquiring the customer or by the bank losing the customer.


381. An important concern articulated by several witnesses was that the proposals for radical reform of the switching process are intuitively appealing but have not been fully developed. Professor Robin Bloomfield said "what you have before you are a number of vague visions and some speculation about common platforms".[776] António Horta-Osório guarded against the "conceptual attractiveness" of a common platform clouding its practical problems[777], a view echoed by Craig Donaldson:

    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.[778]

Andy Haldane conceded that "the precise model needs to be articulated" and that "those should all be evaluated properly".[779] Sir John Vickers told us:

    I can see its appeal in the abstract, but being practical and realistic about it, and thinking of time scales, no one can know at this point whether that is the right kind of solution or the cost-benefit analysis of getting there, particularly before we know how redirection works out.[780]

382. Several witnesses guarded against taking industry warnings of huge costs at face value. Referring to account portability, Diane Coyle said:

    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.[781]

Clive Maxwell, when asked about the costs and complexity of account portability, told us that he had "not seen [...] a serious piece of analysis that sets out those costs". He said that the OFT had "pressed the Payments Council to do that most recently and I would like to see the numbers setting out those costs and benefits".[782] Sir Donald Cruickshank argued that a regulator ought to estimate the costs of the various switching options:

    If it concluded at the end of three or four years that there was indeed no case for number portability, that the costs outweighed the benefits, so be it. There would be amendments to the present regime, and on we would go with something different. […] However, if we do not make that investment, we will never know, because the banks have the monopoly of the information here.[783]

383. In its 2011 Report, Competition and Choice in Retail Banking, the Treasury Committee recommended that "an independent technical study should be done into how account portability could operate".[784] This study has yet to be commissioned, still less completed. Andy Haldane called for "a full, objective, arm's-length quantitative evaluation of the costs and benefits of the [common utility platform] proposal, which is something that, so far, we have singularly not had".[785] The Governor of the Bank of England argued against putting the regulator in charge of such a study, but instead advocated giving it to "a group of people who [...] understand how to operate systems of this kind and get them to do an appraisal".[786]

384. The Commission welcomes the introduction of the seven-day switching service. It should improve the switching process for consumers and increase the level of competition in the current account market. We consider it vital that the launch of service be fully publicised and that any practical problems that emerge be addressed with urgency. We regret the fact that neither the Government nor the Payments Council have established benchmarks to measure the impact of the new service.

385. A common utility platform is an intellectually appealing idea and has the potential to introduce much greater competition into the market than a seven-day switching service. The benefits of a common utility platform include improving competition through significantly faster switching times and reducing the risk that consumers will encounter administrative problems as a result of switching their bank account provider. Financial stability benefits, supporting the FPC's objectives, that could result from the implementation of a common utility platform include raising the general levels of transparency in the money system, improving bank resolvability in the case of bank failure and encouraging banks to make much needed investment into their patchy and outdated in-house IT systems. However, the idea is insufficiently developed to be recommended by the Commission. It is impossible to make a judgement about its merits or about related proposals for account portability without a much clearer idea about the cost, benefits and the technical feasibility of each. It is also extremely disappointing that no independent technical study of account portability has been conducted, despite a request by the Treasury Committee over two years ago. The vagueness of the proposals put to the Commission is disappointing.

386. We were concerned that the largest banks object very strongly to bank account portability. While there is some evidence that individual banks may have done some work on the costs of account portability, this does not appear to have been accompanied by a comprehensive consideration of all the benefits of portability. This gives the impression that their objections are instinctive and, arguably, that they are opposed to any reform that could encourage competition. The lack of an independent regulator, a matter being considered by the Government, may help to explain why no real progress has been made on this matter.

387. The Commission recommends that the Government immediately initiate an independent study of the technical feasibility, costs and benefits of the full range of options for reform in this area. Such a study must be conducted by an independent body rather than one linked to the industry. To this end, the Commission recommends that the Treasury establish an independent panel of experts to consult widely and report on portability. The panel should not have current industry representatives amongst its membership. Membership of the panel should be drawn from banking IT specialists, retail banking competition experts, economists, representatives of retail consumers and small businesses and resolution specialists. It should report within 6 months of its establishment on switching and within 12 months on other issues. The panel, as part of its work, should examine the implications of the central storage of consumer data, implicit in the common utility platform proposal. It should also examine the scope for reducing downwards from seven days the time it will take to switch under the new switching service.

A market investigation reference

388. The main driver of consolidation and increased concentration within the sector in the aftermath of the financial crisis has been a significant increase in mergers as well as the exit from the UK market of some overseas operators. In a recent speech, the Chancellor of the Exchequer said:

    One of the prices we're paying for the financial crisis is that our banking sector is now dominated by a few big banks.

    It verges on an oligopoly.

    75 per cent of all personal current accounts are in the hands of just four companies.[787]

389. Of these mergers, the largest by far was the merger of Lloyds TSB and HBOS. The combined entity Lloyds Banking Group is now the market leader, often by a considerable margin, in most segments of the retail market. Indeed, the OFT's 2010 Review of barriers to entry, expansion and exit in retail banking found that the combined group had the largest market share in the personal current account market, the mortgage market, the savings market—where its market share was twice as large as that of its nearest rival, Santander—and the unsecured personal loan market.[788] The OFT in its October 2008 report to the then Secretary of State on the merger expressed some concern about the potential impact on competition. It concluded that:

·  there is a realistic prospect that the anticipated merger will result in a substantial lessening of competition in relation to personal current accounts (PCAs), banking services for small and medium-sized enterprises (SMEs) and mortgages;

·  the OFT's concerns on PCAs and mortgages are at the national (Great Britain) level, while its concerns on SME banking services are focused on Scotland. In addition, the OFT cannot exclude competition concerns arising at the local level in relation to PCAs and SME banking services;

·  no further competition concerns are considered to arise in relation to the other identified overlaps between the parties in retail banking (savings, wealth management, personal loans, credit cards and pensions), corporate banking (banking services to large corporations, asset finance/fleet car hire) and insurance (PPI, life, general); and

·  in the absence of any offer of remedies from the parties, it would not be appropriate to deal with the competition concerns arising from the merger by way of undertakings in lieu of reference to the Competition Commission.[789]

390. Both Lloyds Banking Group and RBS received Government capital support during the financial crisis. As a condition of this state-aid, both firms were required by the EU to make divestments. LBG's restructuring plan (known colloquially as Project Verde) consisted of the divestment of a retail banking business with at least 600 branches, a 4.6 per cent share of the personal current account market in the UK and up to 19 per cent of the Group's mortgage assets.[790] RBS was to dispose of the Royal Bank of Scotland branch-based business in England and Wales, the NatWest branch network in Scotland, its Direct SME customer base and certain mid-corporate customers across the UK, which would involve the divestment of 318 branches (known colloquially as Rainbow).[791]

391. The ICB in their final report wrote of how the Lloyds Banking Group and RBS state aid divestitures "will reduce concentration to some extent".[792] To date, neither divestment has yet to take place. The proposed RBS divestment to Santander fell through in October 2012. Ms Ana P Botin, Chief Executive of Santander UK, explained the reason for withdrawing from the deal as follows:

    The agreement reached in August 2010 between Santander UK and RBS for Santander UK to acquire the businesses was originally scheduled to complete by end 2011. In August 2011, this was extended to a new target completion date of Q4 2012. However, an independent report commissioned by both parties, estimated completion in Q2-Q3 2014 four years after the original agreement was signed and a delay of almost three years.

    Accordingly, the Board of Santander UK decided on Thursday 11 October that it would not agree to a further extension of the timeline for the deal.[793]

392. The Lloyds divestment (Project Verde) to the Co-operative Group also subsequently collapsed in April 2013. Peter Marks, Group Chief Executive of The Co-operative Group justified the Group's withdrawal on the grounds of the complexity of the Verde transaction and against a "backdrop of the current economic environment, the worsened outlook for economic growth and the increasing regulatory requirements on the financial services sector in general".[794]

393. Lloyds has now signalled that its lead option for the disposal of Verde is via an initial public offering and floating Verde as a standalone entity. If this goes ahead then it could result in the creation of a new challenger bank far smaller than the ICB had envisaged should result from the divestment. The ICB in its final report stated that "the entity resulting from the [Lloyds] divestiture will also need to be large enough to exert a competitive constraint on the large incumbents" and expressed concern that this would not happen unless the divestment resulted in the creation of a new entity with at least a 5 per cent share of the PCA market. A standalone Verde would fall below this threshold with the "significant risk" as the ICB noted "that Verde's market share will fall further as it may suffer customer attrition from the divestiture process" with "a real danger that Verde will fall back into the range of small banks that have not exerted a strong competitive constraint in the past".[795]

394. The ICB considered whether there was a case for the relevant authorities to refer any banking markets to the Competition Commission for independent investigation and possible use of its powers to implement remedies under competition law. It held back from recommending "an immediate market investigation reference of the PCA and/or BCA markets", but argued that "such a reference could well be called for depending how events turn out in the next few years, and specifically whether:

·  A strong and effective challenger resulted from the LBG divestiture;

·  Ease of switching has been transformed by the early establishment of a robust and risk-free redirection service; and

·  A strongly pro-competitive FCA has been established and is demonstrating progress to improve transparency and reduce barriers to entry and expansion for rivals to incumbent banks".[796]

The ICB concluded that "if one or more of these conditions is not achieved by 2015, a market investigation reference should be actively considered if the OFT has not already made one following its proposed review in 2012 of the PCA market".[797] Ms Spottiswoode, a former ICB Commissioner, elaborated on why the ICB had not recommended an immediate referral:

    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.[798]

395. That OFT review of the PCA market has, however, now taken place. The OFT concluded that "significant competition concerns remain in this market" and were extremely critical about how the market was operating. It concluded that:

    longstanding competition concerns remain in the PCA market. Concentration remains high, new entry infrequent, and switching low. While there have been improvements around unarranged overdrafts and transparency of charges, charging structures are still complex and comparisons between products remain challenging. Similarly, despite some reduction in error rates, consumers still lack confidence in the switching process. Together, these problems result in a market in which a lack of dynamism from providers combines with consumer inertia to deliver sub-optimal outcomes for consumers and the economy.[799]

396. Like the ICB, however, the OFT held back from a market investigation reference on the grounds that "developments expected over the next few year could have a significant impact on competition in this market".[800] The Chancellor, when asked about whether there should be an immediate referral, offered a different set of arguments against doing so:

    If there was a referral to the Competition Commission of the banking industry, that is what they would then spend the next two or three years focused on, rather than trying to grow their businesses and expand their lending. You would have to weigh up the benefits of making that referral versus the immediate costs to our recovery. It is not just my view, but the view of the Office of Fair Trading and the view of the John Vickers commission, that that was not therefore a sensible thing to do.[801]

Box 11: The Competition Commission and market investigation references

The Competition Commission (CC) is an independent public body which helps to ensure healthy competition between companies in the UK for the ultimate benefit of consumers and the economy. It conducts in-depth investigations into mergers and markets and also has certain functions with regard to the major regulated industries.

The CC does not initiate inquiries independently. All its activities are undertaken following a reference to it by another authority

·  Mergers are referred for investigation by the Office of Fair Trading (OFT) or, sometimes, the Secretary of State.

·  Market investigations may be referred by the OFT, sector regulators (for markets falling within their sectoral jurisdictions) or the Secretary of State.

·  Reviews of merger/market investigation remedies may be referred by the OFT.

·  Regulatory references and appeals can be made by the sector regulators in gas, electricity, energy, water and sewerage, railways, airports and postal services.

The Enterprise Act enables the OFT (and the sector regulators) to investigate markets and, if they are concerned that there may be competition problems, to refer those markets to the CC for in-depth investigation.

The CC is required by the Enterprise Act to decide whether any feature or combination of features in a market prevents, restricts or distorts competition, thus constituting an adverse effect on competition (AEC). Market investigations enable the CC to undertake a broad, in-depth assessment of the complexities of a market and focus on the functioning of a market as a whole rather than on a single aspect of it or on the conduct of an individual firm within it.

If the CC finds that features of a market are harming competition, it must seek to remedy the harm either by introducing remedies itself or recommending action by others.

In 2012 the Government announced its plans for reform of UK's competition regime. These include creating a new single Competition and Markets Authority (CMA), which will take on the functions of the CC and the OFT's competition functions and consumer enforcement powers. The Enterprise and Regulatory Reform Bill which gives the effect to these reforms, received Royal Assent on 25 April 2013 and the Government aims to have the CMA fully operational by Spring 2014.

Source: Competition Commission

397. We discussed structural approaches to increase competition in the retail market, as well as a possible market investigation reference with the competition authorities and various competition specialists. Clive Maxwell has on a number of occasions mooted the possibility of such a reference. In a speech in 2012 he stated that "if we do not see real change from banks, then a more radical approach needs to be considered. We cannot just continue working with business on incremental change if this does not deliver sufficient results".[802] This so-called Plan B entailed "a market investigation reference to the Competition Commission", which Mr Maxwell said "should be actively considered if the market has not changed by 2015, and if the OFT had not already made an MIR earlier. The CC can take a detailed and fresh look at a market, and has a range of behavioural and structural remedies at its disposal, up to and including requiring the break-up of incumbents, as it did in its airports inquiry".[803] Mr Maxwell argued that:

    if 'plan A' cannot succeed in making the OFT's vision of the banking market a reality, the obvious question is whether the concentrated market structure of UK banking is the problem. And one way to consider this question would be 'plan B'-a reference to the Competition Commission.[804]

398. We asked Mr Maxwell in evidence to elaborate on this Plan B. He told us that such an approach involved "driving structural change in a market through divestments and breaking up entities". However, he cautioned that the Competition Commission had used such an approach "only sparingly" with "the best example [...] the British Airports Authority, where it was felt necessary to break up the market power of an incumbent".[805] Mr Maxwell told us that "if the analysis was that that structural issue was the thing that was getting in the way of this market and that if that was solved, it would make a difference, then that is something that the Competition Commission could do if there was a reference to it".[806]

399. Mr Maxwell outlined the various forms—horizontal or vertical—which structural change could potentially take:

    If the Competition Commission were to go away and look at this and if they had a reference, the sorts of options that would be on the table—if they thought that sort of structural change was the right thing to do—would be both vertical and horizontal. The most obvious option for them to consider would be a horizontal chopping up of the banks—in the same way that the state aid divestments are requiring—which is to take out certain bits of the businesses and put them under different sorts of ownership. You might, therefore, create businesses of a certain size that could be credible competitors in the market. We know that there are significant start-up costs and fixed and sunk costs with establishing a bank. We would overcome some of those barriers to entry by creating those sorts of rivals. That would be one way of doing it.

    It is interesting to look at the pubs example and to ask whether there are forms of vertical separation that could be looked at in this sort of market, or other sorts of arrangements that could be put in place. Andy Haldane made some suggestions about, for example, requiring the existing banks to make available some of their infrastructure for other rivals to use. That would also potentially overcome some of those barriers to entry. As I have said, those will be questions for the Competition Commission to think about if they were to look at this issue. [807]

We also asked John Fingleton, former head of the OFT, about structural solutions and a possible reference to the Competition Commission. Mr Fingleton outlined two possible ways forward: "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." Mr Fingleton told us with respect to such referral:

    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.[808]

400. Mr Wheatley spoke of how the FCA could use its new competition remit in a variety of ways to increase competition in the retail banking market, but also held out the possibility that the FCA could go further:

    If, when we come back to this, we see that those [measures] have not had effect, then we have a broader range of competition powers, which will include references to the Competition and Markets Authority or could include structural changes to the market. Those sorts of things are not taken lightly, and it wouldn't be something we would come to without quite a lot of study, but structural change to the market could be one of the sets of power that we could use.[809]

401. Both the ICB and the OFT have carefully considered the case for making a market investigation reference to the Competition Commission with respect to the UK banks. Their decision not to propose or make such a reference has had nothing to do with progress in increasing competition within the sector thus far. On the contrary, the OFT, in their recent review of the personal current market, were extremely critical of the lack of progress in increasing competition in this part of the retail market. They concluded that concentration remained high, new entry infrequent and switching low, which "resulted in a market in which lack of dynamism from providers combines with customer inertia to deliver sub-optimal outcomes for consumers and the economy". The OFT review took place against the backdrop of a rise in concentration in parts of the retail banking market, following the financial crisis.

402. Both the ICB and the OFT have previously held back from referring the sector to the Competition Commission in the hope that a series of reforms currently in the pipeline—including the new 7-day switching service, the establishment of a pro-competition FCA and the Lloyds and RBS divestments—would increase competition in the market. Both divestments have failed. Regardless of whether these divestments can be put back on track, it looks increasingly unlikely that a significant new challenger bank will soon emerge from them. Additionally, given the delays in the divestments—which now most likely will take until at least 2014 to be completed—it will not be possible to assess whether they have fundamentally altered competition in the sector until 2017 or 2018 at the earliest. This is too long to wait and should not be used as a justification for, yet again, pushing a market investigation reference into the long grass.

403. The Commission has considered the case for an immediate market investigation reference. There is a strong case for doing so. However, there is also a strong case against an immediate referral. A large number of regulatory reforms to the banking sector are already in train, as well as those recommended by this Commission. An immediate Competition Commission referral would further add to the burden of uncertainty on the sector and would divert the banks from their core objective of recovery and lending to the real economy. We are persuaded that arguments for delay have some merit, but should not be allowed to serve as an argument for indefinite inaction. The scale of the problems in the banking sector, combined with their systemic importance, means they will necessarily continue to be subject to regulatory intervention and upheaval for many years to come. A second argument against an immediate referral is that reform measures already in train will significantly increase competition in the sector. We agree that, while the failure to date of the divestments is a disappointment, a series of reforms in the pipeline have potential to have this effect.

404. The Commission recommends that the Competition and Markets Authority immediately commence a market study of the retail and SME banking sector, with a full public consultation on the extent of competition and its impact on consumers. We make this recommendation to ensure that the market study is completed on a timetable consistent with making a market investigation reference, should it so decide, before the end of 2015. We note that, under section 132 of the Enterprise Act 2002, the Secretary of State for Business, Innovation and Skills has the power to make a reference himself, should he not be satisfied with a decision by the OFT not to make a reference, or the time being taken by the OFT to make a decision on a reference.

Tackling the information mismatch


405. In the 1987 film Wall Street, the ultimate shark of the financial markets, Gordon Gekko, said "the most valuable commodity I know of is information". Superior access to information enabled him to "bet on sure things" while the public were "out there throwing darts at a board". This encapsulates the issue of asymmetries of information in banking set out in Chapter 3.

406. Other industries where there is a substantial disparity of understanding between buyer and seller, such as medicine and law, tend to have strong and established professional standards. Banking does not have this type of culture. The extent to which professional standards can be expected to develop in banking and our proposals for the regulated responsibilities of individual bankers towards customers are considered in Chapter 6. In this section, we consider means of bridging the knowledge gap between banks and their customers at the point of sale, both through ensuring customers are better placed to assess the value of banking products and creating incentives for banks to be more transparent about their products.

407. Information asymmetries have played a role in high-profile conduct failures such as interest rate swap and payment protection insurance mis-selling. However, empowering consumers to make better decisions about the merits of banking services is not simply a means of avoiding future scandals. Informed consumers are better placed to exert market discipline on banks more generally and, in doing so, encourage banks to compete on price and service.


408. One possible measure to address the gap in information and understanding between sellers and buyers of banking products would be to impose some form of duty of care upon banks towards their customers. Mike Dailly of the Financial Services Consumer Panel told the Commission that the Panel had advocated "a regulatory objective for the new Financial Conduct Authority to ensure that there is a duty of care. Obviously, that duty, which would be a statutory duty of care, would be made by way of specific rules through the FCA's rulebook."[810] Dominic Lindley of Which? said that "a duty of care is a really important part of any system of profession standards and code of conduct".[811]

409. The question of whether a duty of care should be imposed upon financial services firms arose during the pre-legislative scrutiny of the draft Financial Services Bill. Concerns were raised about provisions in the draft Bill that obliged the FCA to have regard to (amongst other things) "the general principle that consumers should take responsibility for their decisions" in pursuit of its consumer protection objective.[812] The Joint Committee scrutinising the Bill recommended that:

    the consumer responsibility principle be complemented by an amendment to the draft Bill to place a clear responsibility on firms to act honestly, fairly and professionally in the best interests of their customers. The FCA should be empowered to hold firms to account for this and ensure companies address conflicts of interest and the needs that consumers may have for advice and information that is timely, accurate, intelligible to them and appropriately presented.

    Clearly, the actions firms should be expected to take will depend on context and circumstances. For example, the way information is presented to retail consumers is likely to be different from that appropriate for a professional investor.[813]

410. In response, the Government amended the Financial Services Bill both to require the FCA in pursuit of its consumer protection objective to have regard to both the fact that "those providing regulated financial services should be expected to provide a level of care appropriate to the consumer involved or transaction being undertaken" and to "consumers' need for advice and information that is accurate, timely and fit for purpose".[814] These amendments were given effect in section 6 of the Financial Services Act 2012, which amends the Financial Services and Markets Act 2000.[815]

411. The term 'duty of care' has a specific legal meaning in the law of torts, and tests to establish whether a duty of care exists and whether it has been breached are a fundamental tenet of common law. In the context of banks and their customers, it is not clear what a duty of care would look like in practice, and where witnesses discussed this it may not have had this in mind. Clive Briault raised the question of what a duty of care would mean:

    if you express it at that very high level, you then have exactly the same question asked: what does this actually mean for particular firms in particular circumstances? [...] Either the regulator has to produce rules and guidance to amplify its interpretation of that or, if a duty of care is used by consumers to take legal cases, the courts begin to identify what it is that constitutes an interpretation of that duty of care. But it does not get around the very fundamental question that people will still come and ask: whether this practice, in this market, for this product is acceptable.[816]

412. There are limits to the duty owed to customers. Carol Sergeant warned that imposing a duty of care might limit the services banks provide, saying, "yes, people must be treated fairly, but if you make the test too onerous, you are going to find that people will not be providing advice, which is happening at the moment in the financial services industry, and they may not even be providing product".[817] Dr Hahn of CASS Business School suggested that many issues that might be addressed with a duty of care could be addressed through competition, although as the Commission has established, competition in much of UK banking is weak.[818] The Government, in its approach to the Financial Services Act 2012, has also asserted its view that consumers must take responsibility for their own decisions.[819] There is therefore a balance to be struck.

413. For such a responsibility to be imposed in a meaningful way, it must involve judgements by the regulator and banks about whether customers' needs are being met and what level of information was needed by each individual customer. As noted by the Joint Committee:

    the actions firms should be expected to take will depend on context and circumstances. For example, the way information is presented to retail consumers is likely to be different from that appropriate for a professional investor.[820]

The difference is not drawn because retail consumers in some sense deserve better treatment than professional investors, but because of the differences in their likely understanding of the transaction they are entering into. This suggests that it is the customer's understanding of the transaction that is important to make a transaction fair.

414. Christine Farnish noted that there was a risk that imposing a duty of care on banks would lead to banks protecting themselves with excessive process, while avoiding taking any real responsibility for meeting customers' needs. She told the Commission:

    My concern [...] is that too often we see the banks and other financial institutions responding to regulatory initiatives that are designed to protect consumers simply by building in a lot more process and a lot more disclosure, and by giving thicker, more dense information to the consumer, so that the consumer has everything they possibly need and no one can come back to those banks and say that they have not been treating people fairly or exercised their duty of care.[821]

Dominic Lindley of Which? reinforced the fact that a duty of care must not just involve sticking to the letter of detailed rules, saying that "The main purpose of that kind of message is that what governs acceptable behaviour is not just the letter or the detail of the rules, but what is actually in the best interests of your client".[822] This indicates that assessing whether banks are meeting their responsibility does not only involve examining the information given to the customer, but requires a comprehensive assessment of whether the customer has understood the nature and quality of the product they have bought or the service they have paid for.

415. Banks' employees who gave evidence to the Commission varied in their interpretation of a duty of care to customers. A Barclays employee felt that the duty of care was being fulfilled if a customer was satisfied. She told the Commission:

    We survey 18,000 customers a month [... on] the appropriateness of the products and services they were offered. So, every single month we have a litmus test of how we are exercising that duty of care.[823]

A Lloyds employee referred to "outcome testing", which was "independent, post-sale contact with customers", measured against set criteria.[824] This latter interpretation appears to involve a clearer understanding of exercising responsibility towards customers, as a customer may be very satisfied with a product precisely because they do not understand it. We noted in Chapter 2 that purchasers of interest rate hedging products may not have understood until many years after their interaction with their bank that they may incur considerable charges under the terms of the product they had bought.

416. Banks need to demonstrate that they are fulfilling a duty of care to their customers, embedded in their approach to designing products, providing understandable information to consumers and dealing with complaints. A bank has a responsibility to ensure that customers have had a reasonable opportunity to understand a transaction, having regard to their knowledge and personal circumstances. The FCA now has a mandate under its consumer protection objective to enforce this responsibility. Banks should assess whether they are fulfilling it by commissioning periodic independent checks on customers' understanding of the transactions they have entered into and the outcomes achieved. The Commission recommends that the FCA examine periodically whether banks' systems for carrying out their own assessments are adequate.


417. Duties not to take advantage of customers that do not have the capacity to assess the banking services they are offered can be distinguished from the competitive pressures that can be exerted by informed consumers exercising choice between different products and providers. Martin Wheatley told us:

    consumers […] have to be empowered to understand the comparative offerings, so you need a level of transparency about the differences between those offerings, and the differences in terms of cost and quality, such that a consumer can make an informed choice.[825]

Diane Coyle told us that banks are motivated by "having to get products into the best-buy tables".[826]

418. A March 2013 paper by the FSA suggested that in acting in accord with its competition objective, the FCA should be expected to do more than its predecessor to encourage information transparency:

    As part of this new competition mandate, there may be an enhanced role for the FCA to review firms' disclosures to ensure they enable consumers to understand and engage with the market. In doing so, we will seek to learn from wider work undertaken on disclosure.[827]

The FSA paper considered the impact of the publication of complaints data. It expressed some surprise that disclosure of these figures had an impact on the market:

    The FSA has focused on the quality of complaint handling through a number of initiatives in recent years, so establishing a direct causal link between this initiative and the quality of complaint handling is not possible. However, the sentiment from all stakeholders and perhaps unexpectedly, from direct consumer research, suggests that the initiative has helped our objectives and is worth emulating.[828]

419. Natalie Ceeney told us that she hoped that the experience with complaints data would encourage the FCA to promote the publication of other statistics:

    I hope that some of the powers that the FSA and the FCA will have mean that they can act more quickly, particularly on embracing greater transparency. We have found some benefits from publishing complaints data in that the firms that put ethics at the heart of what they do have responded very quickly to some issues. I hope that the FCA will also be able to use transparency to harness public attitude to help change. The tools are there. Whether things happen depends on whether they are used.[829]

420. Banks told us that they already undertake analysis of how well they are delivering for their consumers, particularly through customer satisfaction surveys.[830] Helen Weir, former Principal, Retail Distribution, Lloyds Banking Group, told us that customer satisfaction is not necessarily an effective measure of high banking standards:

    We never believed that customer satisfaction alone was an adequate measure of absence of mis-selling; we recognise that customers could be satisfied even when, potentially, they had been mis-sold to. [831]

Carol Sergeant and Clive Briault told us that mystery shopping exercises banks or regulators undertook to assess PPI products were of limited value because they did not tend to follow the process through to sale.[832]

421. The FSA's March 2013 Transparency paper suggests that the "publication of claims data for insurance products is one idea that we think could help improve the outcome for consumers and change firm behaviour".[833] Tony Boorman, Deputy Chief Executive and Deputy Chief Ombudsman, Financial Ombudsman Service, explained why this might be useful:

    Claims ratios are quite a helpful piece of information for customers. It is part of the evaluation of the product. One of the interesting things that the critical illness part of the insurance industry has done is go through a process of building confidence in customers by explaining the claims ratios that they have, explaining the proportion of cases that are upheld, working with organisations—including ourselves, and also trade associations and customer bodies—to understand why in some cases they are turning claims down, and feeding that information back into the front of their process. It is not just about complaints. Understanding complaints and getting feedback from that is important, but it is about getting a thoughtful understanding about the way in which the product interacts with the customer—what goes well, but also what goes badly.[834]

In attempting to explain why claims ratios had not been published with regards to PPI, Peter Davis, a former deputy Chairman of the Competition Commission, gave an insight into the low regard in which transparency of information was held by the regulators of the time:

    Lord McFall: [...] One of your remedies, according to written evidence, was "an obligation to provide information about claims ratios to any person on request". Why not just require the banks to publish information, as they publish complaints data today?

    Peter Davis: As I recall—I will have to revisit the report—the question around the provision of the claims ratio was around the degree to which that particular piece of information would be used and by whom. What we wanted to make sure could happen was that that information could be accessed by, perhaps, websites or people who were going to turn that information into something that was usable by consumers. Potentially, it would have been available to purchase as a product. The question around where it should be published and by whom, and available to whom, is really one of how that particular piece of information would be used in the context of making decisions, how that would impact and then whether that would add to the effectiveness of the remedies in generating competition.[835]

422. We sought evidence on what the most important areas of banking service provision were for customers, with a view to considering further measures. Ernst & Young told us that they have found there are ten critical areas of consumer interaction with banks. These are: account opening, account closing, account switching, complaints handling, life events such as bereavements and house purchases, lost or stolen cards, first time collections, setting up a payment, change of account details and transparency of fees and charging structures.[836]

423. The Commission welcomes the FCA's interest in pursuing transparency of information as a means of exercising its competition objective. Informed consumers are better placed to exert market discipline on banking standards. The Commission recommends that the FCA consult on a requirement to publish a range of statistical measures to enable consumers to judge the quality of service and price transparency provided by different banks. Such measures should be based on customer outcomes rather than only on customer satisfaction levels. Amendment of section 348 of FSMA is likely to be required to facilitate the publication of appropriate information about the quality of service and price transparency.

Tackling the legacy of RBS


424. The Royal Bank of Scotland (RBS) is one of the UK's largest domestic banks and plays a crucial role in the UK economy. A healthy RBS can make a major contribution to the development of a competitive and vibrant retail banking market. Although the Government has injected £45.5 billion of public funds into RBS in 2008 and 2009 and there have been subsequent efforts to clean up the bank's balance sheet,[837] it remains a wounded institution. It is still 82 per cent owned by the Government, perceived as vulnerable to political interference and weighed down by legacy problems. These factors inhibit its ability to support economic recovery. They are also obstacles to ending State ownership. This section considers whether the current strategy adequately tackles the challenge of restoring RBS to the private sector in a way which can raise standards by contributing to a competitive and vibrant banking system and serving the country's wider economic interests.

425. The story of RBS's failure and the Government's interventions has already been told in detail in existing reports by the Treasury Committee, NAO and FSA.[838] Leaving aside the immediate reasons leading up to the Government interventions, some of the key underlying problems in the business as identified in the FSA's report were poor asset quality arising from aggressive growth, large and uncertain losses in trading activities, and the increased exposure to trading book assets resulting from the acquisition of ABN AMRO on the basis of inadequate due diligence.[839] The failure of RBS contained some common elements with the failure of HBOS which we examined in our Fourth Report, including a brash pursuit of rapid expansion, a failure of internal control and a failure of regulation. RBS also served as the archetype for many of the root causes of the crisis of banking standards and culture that we examined in Chapter 3, most notably incentives to grow which led to the bank becoming unmanageable and the development of an aura of untouchability around those who were leading the bank to the brink of an abyss.

426. The most significant Government interventions for RBS were the equity injections totalling £45.5bn—£20bn in October 2008,[840] and a further £25.5bn of B-shares in February 2009.[841] The average share price at which the Government invested in RBS is equivalent to 502 pence.[842] In contrast, RBS's share price immediately following the publication of its quarterly results on 3 May 2013 was 295 pence—equivalent to an unrealised paper loss of about £18 billion.

427. The Government also provided other forms of support to RBS during and following the crisis. The Asset Protection Scheme involved the Treasury providing partial guarantees on up to £282bn of RBS's assets.[843] RBS withdrew from the scheme in October 2012 without having made a claim and having paid £2.5bn in fees.[844] Under the Credit Guarantee Scheme, the Government guaranteed certain unsecured bank debts in return for a fee, allowing banks to borrow more easily in wholesale markets. The Special Liquidity Scheme ran from April 2008 to January 2012 and allowed banks to swap assets for more liquid Treasury Bills in return for a fee. RBS borrowed and repaid £75bn under the CGS and SLS, with the last repayment in May 2012.[845]

428. As a result of the support received from the Government, RBS was obliged to accept various restrictions and restructuring measures under EU State aid rules. These included the suspension of discretionary payments on debt instruments, shrinkage of its balance sheet and disposals of specified businesses. The required disposals included Direct Line, RBS's insurance subsidiary, and a significant portion of its UK retail and SME business, including over 300 branches. Completion of the disposals was required by the end of 2013.[846] RBS agreed to sell the UK branch business, known as "Rainbow", to Santander UK, but announced that Santander had pulled out of the deal in October 2012.[847]


429. RBS management, led by Stephen Hester, has made good progress in its primary objective of restructuring its balance sheet to improve its financial stability. On all measures of balance sheet strength, the company is ahead of the targets it set itself in 2009. These include overall total asset reduction, wholesale funding reliance, liquidity and capital strength. A particularly large reduction has been achieved in assets in the "non-core" division, which was established in 2009 in order separately to manage assets that RBS intended to dispose of or run off. That division originally held £258bn of assets, many of which were high risk, concentrated, illiquid or linked to proprietary trading.[848] Remaining non-core assets were £57bn at the end of 2012.[849] This balance sheet strengthening has reduced the risks the company poses to the taxpayer. Regulators and politicians alike have recognised the progress made in reducing risk. The Chancellor told us:

    there has been a big reduction in the funded assets on the balance sheet of RBS. It has gone from about £1.5 trillion to about £900 billion. That is a big reduction.[850]

Sir Mervyn King added:

    Stephen Hester has struggled manfully to reduce the size of the balance sheet. That was the remit he was given, and he has done a great deal to achieve that.[851]

430. RBS has also attempted to reposition its business, increasing the proportion represented by UK retail and business banking and particularly concentrating its balance sheet reductions in the overseas and investment banking activities. As Stephen Hester told us, this was a deliberate policy:

    The UK bits of RBS, depending on your measure, are around 70 per cent of the total. Obviously, that is rising, as by far the biggest shrinkage has come from non-UK bits. Retail and commercial banking is getting on for 80 per cent of the total, having been as low as 40 per cent when we took it on.[852]

431. A breakdown of RBS's assets by division as at the end of 2012 is shown in the table below. Despite the considerable restructuring to date, it can be seen that the UK commercial bank—the retail and corporate divisions—still accounts for only 28 per cent of the core bank's balance sheet and 34 per cent of its risk-weighted assets.
(source: RBS Q1 2013 interim statement) Total funded assets[853] (£bn) Proportion of total funded core assets Risk Weighted Assets (£bn) % of total core RWAs Average risk weighting (%)
UK retail117.1 14.244.5 11.538
UK corporate109.9 13.487.0 22.579
Wealth21.7 2.612.5 3.258
International Banking 54.46.6 48.912.6 90
Ulster Bank30.6 3.736.8 9.5120
US retail & Commercial 76.39.3 58.915.2 77
Total retail and commercial 41049.9 288.674.5 70
Markets288 35.088.5 22.931
Other (primarily group treasury) 123.815.1 10.22.6 8
Total Core821.8 100387.3 10047
Non-core52.9 - 54.6 - 103

432. RBS management has also been successful in substantially reducing the level of impairments and restoring the group to profitability on an underlying basis, although net profits remained negative prior to the first quarter of 2013 due to exceptional costs such as PPI redress and LIBOR fines.

433. However, the balance sheet strengthening remains work in progress. On a pro-forma Basel III basis, the group Core Tier 1 ratio would be 8.2 per cent.[854] While this compares favourably with the regulatory 7 per cent requirement, when compared with a 10 per cent minimum recommended by the ICB and expected by markets it implies that a further 20 per cent strengthening of the ratio will ultimately be required. RBS was expected to require further capital to meet the recommendations of the Financial Policy Committee, who announced on 27 March 2013 that UK banks have an aggregate capital shortfall of around £25bn following "a proper valuation of their assets, a realistic assessment of future conduct costs and prudent calculation of risk weights".[855] However, a PRA announcement on 22 May 2013 suggested that RBS now expects to be able to meet any capital shortfall through its existing restructuring plans.[856]

434. RBS is constrained in its ability to increase its capital ratio through issuing new equity because of the Government stake and it has also been limited in its ability to build capital by retaining earnings because of its post-impairment losses since the crisis. Most of the strengthening of RBS's capital ratio has instead come through shrinking the balance sheet. The Governor of the Bank of England told the Commission this has affected RBS's ability to supply credit and that in turn, the pace of UK economic growth has been reined in. Sir Mervyn King said:

    The legacy problems of the balance sheet of RBS have had macro-economic effects. It has clearly been a drag on the supply of lending to the UK real economy.[857]

The Chancellor agreed that RBS had been a problem for the economy, but argued that things have improved:

    the weakness of Royal Bank of Scotland has been one of the major problems for the UK economy emerging from the financial crisis [...] but in the past four or five years, they have gone from great weakness and on the verge of collapse to a stronger position—a healthier capital position.[858]

435. The message from RBS's own performance is mixed. The RBS 2012 annual results showed UK corporate lending down by £11bn during that year, although this was substantially due to the non-core element, as RBS seeks to rid itself of unwanted exposures. Core UK corporate lending was also down £3.7bn.[859] In the first quarter of 2013 RBS reported a modest rise in lending to businesses, totalling £13.2bn in loans in the quarter. It said £7.8bn of this was to small and medium-sized enterprises. RBS contracted its stock of lending under the definitions of the Funding for Lending scheme by 1.9 per cent between 30 June 2012 and 31 March 2013.[860] In contrast, RBS claimed that it had supplied 36 per cent of all new lending to UK SMEs, compared with what it said was its natural market share of 24 per cent based on current accounts.[861] The Chancellor confirmed the picture with regard to support for SMEs:

    When we have had targets for bank lending, RBS has actually done better than some in increasing its lending to small businesses.[862]

436. The extent to which capital and funding issues are constraining lending is disputed. RBS told us that lack of demand was the limiting factor on most of their lending:

    The only sector which has been constrained has been real estate finance which reflects a desire to reduce an over concentration in real estate built up over the last 20 years. All other sectors are comfortably below control limits and therefore the level of lending within these sectors has not been affected. The biggest constraint in lending across our book continues to be lack of demand from customers rather than internally imposed targets by RBS.[863]

RBS also pointed to the fact that lending standards have been appropriately tightened since 2007, meaning that some customers who would once have been given a loan would be refused credit:

    Some customers may find it more difficult to secure a loan compared to a few years ago. This reflects a range of factors including a more responsible approach to lending by RBS ( with a greater focus on the ability of customer to service debt than in the past) and the more challenging economic conditions leading to weaker and more uncertain cashflows (which are used to service debt). [...] For the 10 per cent of customers where an application for borrowing is declined, the main reasons for the decline centre around insufficient cashflows generated from the business. In such circumstances it would be irresponsible for RBS to provide a loan where the customer cannot afford to service and repay the loan.[864]

437. Sir Mervyn King accepted that there was "both a demand and a supply problem" with credit in the UK. However, he drew a distinction between the two by explaining that some big companies had cash reserves and were not seeking credit due to uncertainties which were "not the fault of the banks,". In contrast, access to credit for SMEs was affected by the capital position of banks and their ability to supply credit, because "banks which have bigger legacy balance sheet problems are contracting their lending".[865] Access to bank credit is particularly important for SMEs because they lack the cash reserves of larger firms and cannot access capital markets in the same way. Even where SMEs do have access to credit, we heard evidence that conditions have tightened and become more onerous, for example in the quality of collateral required or the spreads charged.[866]

438. Chris Giles has recently contended that, because "small companies account for less than a 10th of business investment [...] only a very small part of the growth shortfall can be blamed on credit restrictions to small companies".[867] However, even if constrained SME access to credit did only have a limited direct effect on the economy, the legacy of weak bank lending to SMEs over the last 5 years is likely to have had a much broader indirect effect on small business confidence and therefore contributed to the lack of credit demand. Larger firms' willingness to invest may also be influenced by a lack of confidence to which the dysfunctionality of banking over the past five years has contributed. In addition, while uncertainty remains over banks' capital strength, corporate customers' overall confidence may be undermined and they might be more cautious in their expansion plans, not least triggered by concerns that banks could unexpectedly withdraw funding.

439. The Breedon Report on business financing, published in 2012, made the case that, even if current levels of lending could be explained by a lack of demand, there was a risk that, during the next phase of recovery banks might not be in a strong enough position to supply the credit that would be needed to meet the expanding needs of businesses:

    between now and the end of 2016, there is a risk that UK businesses are likely to need more credit than will be available. [...] this finance gap could be in the range £84bn to £191bn - the amount potentially required to meet comfortably the working capital and growth needs of the UK non-financial business sector.

    [...] analysis of the impact of domestic and international regulation suggests that the ability and willingness of banks to lend to businesses will be constrained in future. Capital adequacy rules have tightened considerably including higher capital ratios and new specific rules on risk weightings on SME loans and overdrafts. The impact of these rules is likely to fall disproportionately on smaller businesses which tend to be riskier and have higher risk weightings attached.[868]

440. Sir Mervyn King argued that it was only when all the major banks had rebuilt their balance sheets that the sector as a whole would be in a position to supply credit normally. He commented:

    The legacy problems on the balance sheets of some of our banks have been largely responsible for their wish to contract lending to the UK real economy. The banks with the largest amounts of capital have actually increased their lending; Barclays, HSBC and Nationwide have lent more to the UK real economy. RBS and Lloyds, unsurprisingly given their balance sheet legacy problems, have been contracting lending. All of that is completely natural and understandable. Only dealing with those legacy balance sheet problems as soon as possible will get you into a different position.[869]

441. The Chancellor agreed that weaknesses in UK banks have had a wider economic impact, saying "our banking industry is a larger proportion of our GDP, so weakness in the banking industry spills over even more than in the US".[870]

442. Given that RBS is one of the UK's biggest SME lenders, responsible for 36 per cent of new lending,[871] its continued position as one of the more weakly capitalised banks creates concern about its ability to provide adequate credit as the economy picks up. It could be argued that other large banks in the UK are in a stronger position than RBS and therefore have the capacity to pick up any shortfall in its lending; both Barclays and HSBC have grown their UK corporate loan books in 2012.[872] However, regardless of overall capacity, it may not be easy for many existing customers of RBS to switch to alternative providers, due to some of the barriers to competition discussed earlier in this chapter. For example, in Scotland in particular, RBS and Lloyds Banking Group together have 70 per cent of the market share for SME business,[873] so any dysfunction in RBS is likely to have a pronounced impact.


443. The Government's continued ownership of major banks is widely held to have had a negative effect on confidence in banking, and on confidence in the UK economy. When the Chancellor announced his intention to sell Northern Rock in June 2011, he set out the case for privatisation in these terms, which apply equally to RBS:

    its chaotic collapse did great damage to Britain's international reputation. Its return now to the private sector would help to rebuild that reputation. It would be a sign of confidence and could increase competition in high street banking. We could start to get at least some of our money back.[874]

444. Government ownership of banks creates a risk of interference or the perception of interference which can undermine their autonomy and commercial decision-taking, limit willingness to lend and depress the long-term value of the firm. RBS has already been under public ownership for over four years. Sir Mervyn King referred to the experience with State ownership of banks in other countries:

    The lessons both of the failure of Japan to do this and for their banking system to be hobbled for a long time because they were not decisive enough in dealing with it, in contrast to the Scandinavian experience in the early 1990s when they took banks into public ownership for a short time to restructure and recapitalise and put them back into the private sector, show very clearly that it is not a good idea to have banks in the public sector for very long.[875]

445. Sir Mervyn King thought that "the whole idea of having a bank that is 82 per cent owned by the taxpayer, run at arm's length from the Government, is nonsense. It cannot make any sense". [876] Vince Cable has commented that he had argued for full nationalisation at the time of the RBS collapse for this reason:

    But that was not what happened and we are now living with the consequences. In many respects, this Government inherited from its predecessor the worst of all worlds—responsibility without control.[877]

The Chancellor admitted that, while the Government had "kept the UKFI model—that is, this is managed at arm's length", it had nevertheless exerted influence over RBS: "as the major shareholder, through UKFI acting independently on our behalf, we have insisted that, actually, they do change their business model".[878]

446. Robin Budenberg, the Chairman of UKFI has defended to Parliament the value his organisation adds:

    I certainly think that market participants see the role that UKFI plays as very helpful. One of our roles is to make sure that disagreements do not arise between Government and the banks, and that applies to all banks, but it is particularly the case where the banks have Government shareholdings. One of the things we do is explain both to the banks and to the Government what the position of the other is, to make sure those disagreements are less likely to arise. That is in the commercial best interests of the banks. I think market participants see that and feel we comfortable that we do play that role, recognising that if at any stage the banks are asked to do something that is fundamentally not in their commercial best interests, then it is our role, supported by our board, to make sure that the banks know that we are going to stand up for them and prevent that from happening.[879]

447. However, in evidence to Parliament Mr Budenberg set out in some detail the extent to which the Chancellor has directly engaged in discussions about RBS remuneration. For example in relation to Stephen Hester's bonus, he said that the Government was "very clear" in the guidance they gave UKFI that "they wanted to make sure that this decision was made in the context of the climate on remuneration, and they wanted to make sure that it was substantially lower than the figure that was announced for Stephen Hester last year [2010]".[880]

448. Furthermore, Sir Phillip Hampton, Chairman of RBS, has previously warned about the dangers as well as the consequences of political interference in RBS:

    It is the Board's view that running the business on commercial grounds is the best way to make the bank safer and more valuable for everyone who depends upon it. I do not believe there is a workable alternative if our aim is to provide the opportunity for the UK government to sell its shares in the public markets in a reasonable timescale.[881]

449. Robin Budenberg, Chairman of UKFI, told the Treasury Committee that political interference in the running of RBS:

    certainly has the potential to affect the share price. [...] there are inevitably situations—we discussed one of them last time around Stephen Hester's bonus—where public concern about banks that have Government shareholdings in them makes it difficult in terms of the commercial operation of the banks.[882]

Concerns about the consequences of political interference in the running of the partly State-owned banks, particularly RBS, have also been expressed by market participants. For example, bank analyst Manus Costello told the Treasury Committee in May 2012 that "there clearly have been some signs that commercial strategy is being influenced by public pressure, the CEO's compensation being an obvious one during the course of this year".[883]

450. The Royal Bank of Scotland Group is one of the UK's largest domestic banks and plays a crucial role in the UK economy, particularly in relation to small and medium enterprises. The current state of RBS and its continued ownership by the Government create serious problems for the UK economy, despite the commendable work of Stephen Hester and his team in cleaning up its balance sheet since 2008. RBS's capital position remains weak, impairing its ability to provide the levels of lending or competition needed for the restoration of vitality to the banking sector and for the UK's full economic recovery. RBS continues to be weighed down by uncertainty over legacy bad assets and by having the Government as its main shareholder. Such problems for one of the UK's largest banks weaken confidence and trust in banks and bank lending. They also undermine wider economic confidence and investment activity even for firms not facing immediate credit constraints.

451. UKFI was established by the previous Government to manage the Government's shareholdings in the State-owned and partly State-owned banks, but also crucially to ensure that Government was not involved in the day-to-day running of these institutions, thereby ensuring that they would be run on commercial lines, thus facilitating an early return to the private sector. These were sensible aims, but they have not been fulfilled. Instead, the Government has interfered in the running of the two partly State-owned banks, particularly RBS. On occasions it has done so directly, on others it appears to have acted indirectly, using UKFI as its proxy. The current arrangements are clearly not acceptable. Whatever the degree of interference, UKFI will increasingly be perceived as a fig leaf to disguise the reality of direct Government control. The current arrangements therefore cannot continue. It could be argued that bolstering UKFI's independence from the Government is the way forward. It may be possible to bolster UKFI's independence, but this would be extremely unlikely to end political interference in the State-owned banks. In the present economic and political climate, governments will continue to be tempted to influence or intervene in the banks. The Commission has concluded that UKFI should be wound-up and its resources absorbed back into the Treasury.


452. RBS's strategy for restoring its balance sheet and exiting public ownership has changed little over the last four years, although the Chancellor argued that the Government has insisted that they "change their business model and they do shrink their investment bank much more than they had previously wanted to do".[884] The strategy involves managing the run-off of the remaining non-core assets and gradually shrinking the investment banking operations, with the aim of making the bank more attractive to investors, restoring payment of dividends, lifting the share price and getting to a point where the Government's shareholding could start to be sold off. Stephen Hester argued that the restructuring process he had overseen was nearing completion, and that RBS should soon be ready for a return to the private sector:

    I hope the process that we have undertaken of very radical reform is close to practical completion. In other words, as we move into 2014 and soon thereafter, I hope that this company's restructuring period is, if not fully behind it, largely behind it, and that we are able to start thinking about dividends again and indeed that the privatisation can happen thereafter.[885]

Shortly after giving evidence to the Commission, RBS published results containing more detail on its restructuring plans, including a partial flotation of their US banking business Citizens in around two years, and a further reduction in the scale and scope of RBS's markets activity.[886] The message that the bank would be ready for return to the private sector in 2014 was reinforced by Sir Philip Hampton at the time of the publication of the 2013 first quarter results.[887]

453. However, giving evidence after the RBS announcement on its 2012 results, Sir Mervyn King raised doubts about whether the proposed steps were bold enough:

    It is four and a half years on and there is no immediate sign of it going back to the private sector. That means that we have not been sufficiently decisive in either recapitalising the bank or restructuring it. I sense, from comments of the Prime Minister and the Chancellor, that they feel too that they are rather frustrated in their attempts to get this bank back into playing a role as a healthy UK bank, lending to retail and commercial clients. I think that will need a more decisive approach to the restructuring and recapitalisation of the bank.[888]


454. There are several reasons to share Sir Mervyn King's doubt about whether RBS will be in a position within the next year or two that will mark the end of restructuring and allow the Government to start selling its stake. Potential obstacles considered further below include:

·  The uncertain value that is still attached to many assets;

·  Concerns over the shape, coherence and underlying profitability of different parts of the business;

·  The limited prospect of a dividend;

·  The Government's approach to the price of sale.

455. The uncertain valuation attached to many of RBS's legacy assets makes it an unattractive and risky investment. These include not just those already placed in the non-core division but potentially other risky assets as well, such as loans made by Ulster Bank and some other corporate and commercial real estate loans. For example, even though these assets are already heavily marked down on RBS's balance sheet, one recent analyst report suggested that RBS's commercial real estate and Irish lending might be under-provided to the tune of £8.6bn.[889] However, such assets are difficult to value with certainty because their performance might be both heavily dependent on wider economic conditions and on the specific details of loans, which are not publicly available. RBS's existing strategy reduces the quantity of these assets over time, but they are likely to remain an impediment to selling down the Government stake except at a significant discount.

456. In addition to the difficulty of valuing such assets, Sir Mervyn King expressed a concern about the coherence of the bank in its current shape, saying "RBS has a portfolio of different activities which do not sit well enough together to make the market willing to bid for it".[890] The retention of a sizeable portion of the investment bank is particularly questionable, given the increased pressures on such operations from the current environment and new regulations, and the fact that RBS is not one of the market leaders in this space. RBS's Q1 2013 results showed a sharp fall in the profitability of the markets division—down 66 per cent on the same quarter a year earlier. Although RBS is approaching the shape which management intended when it set out with restructuring four years ago, it is no longer clear that such a shape—with a continued significant presence in wholesale and overseas markets—delivers a sustainable business model which would be attractive to buyers. The plan to retain this wider range of activities also means that RBS will not be focused on what should be its core strength—the UK commercial and retail activity which is of greatest importance to the UK economy.

457. Another deterrent to potential buyers is RBS's limited ability to produce a dividend. The prospect of RBS resuming dividend payments depends on it both returning to profitability and reaching a capital position where it no longer needs to retain earnings. This may be difficult to achieve within the 18-month timescale suggested by RBS management. Proposals to sell the US bank Citizens and shrink the investment bank further may allow RBS to meet regulatory capital requirements, but look likely to still leave it relatively weakly capitalised. One recent analyst report on RBS stated that, "due to political, regulatory, and market pressures, RBS is seeing a massive reduction in its pre-provisions earnings capacity".[891] Another added "Management would like to pay a dividend in 2014, but this is optimistic, in our view, unless asset sales are made or we see a recovery in markets improving the group's earnings and capital".[892]

458. RBS is also constrained in its ability to pay dividends to private shareholders by the "dividend access share" which the Government holds. This requires RBS to pay the Government 250 per cent of any dividend they pay to ordinary shareholders, and only expires when the share price exceeds 650 pence for 20 days in any 30 day period.[893] Given the current share price, the access share has considerable value—estimated by some analysts at approximately £1.5-£2bn.[894] The Government would need to conclude a commercial agreement for RBS to buy back the access share, although the agreed price might differ from the share's theoretical value.

459. These factors help to explain RBS's current depressed share price, as does uncertainty about whether the Government might intervene in the firm's strategy. A recent analyst note on RBS shares reflected this, stating "High level of political uncertainty justifies discount".[895] RBS's price to book ratio as of 31 March 2013 was only 60 per cent, compared with 75 per cent for Barclays, 90 per cent for Lloyds Banking Group and 152 per cent for HSBC Group.[896] This demonstrates markets' lack of confidence in the supposed value of the firm. The share price is also likely to be depressed by the "overhang" of Government ownership—the knowledge that the Government wants to unload a large number of shares into the market at some point in the future.

460. In considering reprivatisation of RBS, the Government should try to ensure best value for the taxpayer and the wider interests of the UK economy.

461. The current plan for dealing with RBS risks being insufficient. Although RBS management claim they will be ready to at least begin flotation of the bank in 12 to 18 months, others have challenged the credibility of this claim. There remain on the balance sheet assets with uncertain value and limited relevance to the UK economy.


462. A number of different approaches for dealing with RBS have been mooted. These include:

·  beginning to sell the Government stakes —either in part or whole—immediately;

·  distributing shares in RBS to the public through a so-called helicopter drop;

·  a more radical internal restructuring and shrinking of RBS;

·  splitting RBS into a good bank and a bad bank as separate legal entities, before returning the good bank to the private sector; and

·  splitting up RBS's commercial operations, whether through the creation of a number of regional banks or through the establishment of multiple challenger banks.

463. The first of these options, involving a rapid sale without further restructuring, would achieve the objective of returning RBS to the private sector but would likely achieve poor value for the Government, for the reasons described earlier. The benefits to the Government's balance sheet of getting the cash back quickly would be limited, given current low borrowing costs, in comparison with the lost value.

464. The second option, of giving away shares to the general public, has been proposed by various people including the Secretary of State for Business Vince Cable, who in a recent speech argued that this, as well as other options, should all be kept in play:

    The early hope of re-privatisation now looks a very long way off, unless at an unacceptable loss. For the existing semi-state owned companies, there is a range of options from reprivatisation at a later stage to continued public ownership or mutualisation through public share distribution [...] We should keep all these options in play[897]

This public distribution could be done free of charge, which would involve a permanent loss to the Government balance sheet. Alternatively, one model put forward by Portman Capital and CentreForum involves giving away shares but only allowing individuals to retain profits above a certain floor price, the value of which would return to the Treasury when shares were sold.[898] The downsides of such approaches include their operational complexity, issues around fairness and the resulting highly diluted ownership of the bank.

465. A sale or distribution of the Government's stake in RBS would not by itself address the questions identified above about the bank's structure, sustainability and ability to support economic recovery. These are therefore at best partial solutions. Any complete solution must include a clear vision of RBS's ultimate shape. This is likely to require a more radical restructuring of RBS's operations.


466. The objective of splitting RBS and putting its bad assets in a separate legal entity would be to deliver a good bank that was free of RBS's legacy problems, focused on its UK retail and commercial activities and no longer distracted by overseas operations or a large investment bank. It is argued that such a bank would be able to make a strong contribution to UK economic recovery and would be far more attractive to investors, allowing it to be quickly returned to the private sector at a fair price. This approach has reportedly been considered several times before but never pursued, in part because of the considerable obstacles and in part because of the hope that RBS's situation would resolve itself over time without such radical measures.[899] Nearly five years on from the first intervention, RBS's situation, while improved, is not resolved. Some have said that it is too late to try a bad bank now as RBS's own restructuring is nearly complete, claiming that the prospects of a sale are just around the corner.[900] However, the same people often concede that a bad bank would have been the right solution several years ago.[901] By waiting and not acting now, it is argued that the UK would risk making the same mistake again. There are significant potential obstacles to such an approach including the fiscal impact, the operational complexity and the time it might take to complete. The key issues in relation to each are discussed below, but more detailed analysis is urgently required to assess to what extent these are real obstacles and not just excuses.

467. Sir Mervyn King strongly advocated such an approach:

    I do not think it is beyond the wit of man to devise a plan which would enable you to restructure RBS, to divide it into a bank that could be a new RBS that would be a healthy, well capitalised bank, capable of lending to the UK real economy and attracting funding to finance that lending, and therefore could be sold back to the private sector relatively soon. It does mean, however, being decisive in dealing with those activities that would go into the other part of the bank, which would be separated from the new RBS, which would then have to be run down over a period of time.[902]

In its Report on the 2013 Budget published in April 2013, the Treasury Committee also considered evidence on the partly State-owned banks, and recommended that by the time of the spending review in June 2013 "the Government publish its analysis of the pros and cons of creating a 'bad bank' for the banks in which the Government has a stake".[903]

The shape of a split

468. Good bank / bad bank splits have been done many times before, in the UK, most notably by the last Government who split Northern Rock into a good bank and a bank, as well as in other countries. After its nationalisation in January 2010 Northern Rock was split into a good bank which was subsequently sold to Virgin Money, and Northern Rock Asset Management (NRAM) which remained in public hands and is being wound down. The Republic of Ireland conducted a similar exercise with its banks, including those which are not fully nationalised, involving the forced sale of €74bn of troubled assets to the National Asset Management Agency at an average discount of 57 per cent to face value.[904] In the US, the Federal Reserve Bank of New York established and funded special vehicles to buy $73bn of bad assets from AIG and Bear Stearns in 2008, in what were known as the "Maiden Lane" transactions.[905] UBS placed approximately $60bn of assets in a bad bank funded by the Swiss Central Bank in 2008, generating a significant capital hole which the Swiss Government then filled. Looking further back, the Swedish authorities used a bad bank in resolving its banking crisis in the early 1990s.[906] Citibank conducted an internal good bank/bad bank split in 2009, creating Citicorp as the good bank and Citi Holdings to take approximately $850 billion of non-core assets—over 40 per cent of the group's balance sheet.[907]

469. An ideal good bank following a split would contain only assets which support RBS's strategy as a UK-focused retail and commercial bank, and which reflect new lending or refinancing in support of the UK economy rather than legacy loans in run-off. One analyst report suggested that this idealised good bank might only account for about £250bn of assets focused around UK retail, UK corporate and wealth divisions, leaving a bad bank of with assets of over £1 trillion including the whole investment bank balance sheet.[908] However, this is at one far and unlikely end of a spectrum of possible points of split. At the other a bad bank could simply take the existing £57bn of non-core assets. While such a minimalist approach would be unlikely to deliver the necessary level of change, there are several reasons why it might be appropriate to have a bad bank closer to this end of the spectrum.

470. First, there are other assets on RBS's current balance sheet which could usefully form part of even a slimmed down and UK-focused good bank. Stephen Hester argued that some markets activity would be an important complement to RBS's ability to service corporate clients:

    in order to fulfil our corporate mission, we had to have some markets activity to be credible in the things which corporates used, but they did not have to be anywhere close to the scale on which they were being undertaken. That is why we shrunk the investment banking activities more dramatically than any other bank in the world and exited huge swathes of them, but I do think that we would not have the role we have in serving corporates in this country if the answer was zero in the group.[909]

One Nomura analyst note pointed out that "RBS also has a leading Corporate Banking franchise in the UK. Thus material parts of the Markets as well as International Banking divisions would also be required within [the good bank]".[910] Some parts of Ulster Bank might also be left in the good bank because this is a business which actively supports the economies of Northern Ireland and the Republic, even though many of its legacy assets are likely to go to the bad bank.

471. Second, there are assets for which the intention should be to sell them off entirely, either during the period when restructuring would be taking place or shortly thereafter, such as Citizens and Direct Line. Finally, there may be some categories of assets where the benefits of moving them to the bad bank do not justify the cost or complexity of doing so. This might in particular include some of the markets division, since moving investment bankers and wholesale trading positions into a government-owned bad bank could be particularly challenging.

472. Alongside the process of splitting RBS into a good bank and a bad bank, it would also be important to accelerate the disposal of any activities which would not form part of a re-focused RBS but which the Government decided not to take into the bad bank. This should both re-focus the good bank and help RBS reduce its risk-weighted assets, thereby helping it meet the FPC's new capital requirements. In particular, it could be desirable for RBS to accelerate the full disposal of Citizens rather than simply prepare it for a partial IPO in two years time. RBS would also need to pursue a deeper and more rapid shrinkage of any parts of the investment bank left in the good bank beyond those required to service current and future corporate customers.

473. As we argued in our First Report, despite the important moves towards ring-fencing of UK banks, concerns remain about the impact of large-scale investment banking activity on standards of retail banks. There would therefore be wider benefits to standards from taking this opportunity to focus RBS more as a retail and commercial bank and away from its trading and investment banking activities. Such steps would also ensure that the new RBS was well-prepared to meet the incoming ring-fencing requirements well ahead of the 2019 deadline—something that RBS would have to do even if the good-bank / bad-bank split were not carried out.

474. Completing a good-bank / bad-bank split and winding down other non-core activities could reduce uncertainty. It could make the core of RBS a strong, profitable UK-focused business which would be much easier to value and therefore more attractive to investors. The Government would therefore be able to start selling its stake as soon as the split was completed if the necessary preparation were done during the interim. There are recent examples in the US in particular of how disposals of stakes in financial institutions can be successfully completed once restructuring is complete. By January 2012 the US Treasury had already received $211bn in repayments, dividends and interest on its original $205bn investment under the Capital Purchase Program.[911]

475. There are various options for how the stake could be sold. One approach would be for the Government to sell tranches of its stake to institutional investors or onto the stock market over time. Stephen Hester has said:

    I certainly think that the sale of the government shares will take quite a few years and have to happen in several different bites because the amount is simply too much to do in one go.[912]

476. Another could be to float some or all of the restructured good bank via an initial public offering (IPO), although this could only be achieved in circumstances where the good bank was being floated as a new entity, which could take longer to achieve. This could also have the advantage of bringing in new capital to strengthen the balance sheet and fill any capital holes resulting from write-downs of assets transferred to the bad bank. The existing minority shareholders could be given pre-emption rights in an IPO to help secure their cooperation with the restructuring and avoid nationalisation.


477. There are multiple ways of carving a good bank/bad bank split out of RBS, depending on what was transferred, how it was transferred and how it was paid for. Different approaches could give rise to a number of important specific and common challenges.

Valuing assets

478. One way of creating a bad bank would be for the Government simply to purchase assets from RBS, either in exchange for cash or government bonds or potentially along with a book of matching liabilities. This would be a commercial transaction, so would need to be negotiated with RBS management and minority shareholders. The key issue for negotiation would be the valuation of the assets. Transferring them at close to their current book value would involve the Government taking a risk if the assets transpired to be worth less, whereas the minority shareholders might be expected oppose transferring assets at a significant discount since this would crystallise losses. Transferring at a discount could also trigger a need for additional capital to be injected into RBS to fill the resulting hole.

479. Determining an appropriate value might require a complex and detailed valuation exercise, which could result in a significant delay given the volume of assets transferred.

Funding the bad bank

480. If the Government simply purchased assets for the bad bank, it would have to issue a significant volume of gilts which if done quickly could have undesirable consequences for gilt markets and the price of Government borrowing. One alternative could be to transfer some wholesale creditors of RBS to the bad bank as well, to reduce or eliminate the funding requirement. It might be possible to minimise the actual capital requirements for the bad bank, since it would not be a deposit taker. It is however likely that the Government would need to guarantee any debts transferred to the bad bank, which would create a contingent liability. Another alternative might be for the Bank of England to fund the bad bank, although again this would likely require a Government indemnity. All of these alternative funding models therefore result in some form of real or contingent liability for the Government.

Shareholder consent

481. The consent of minority shareholders would be needed to permit a deal, and they could block it and hold out for a price which the Government was unwilling to pay. An alternative approach could therefore involve fully nationalising RBS prior to a split, by acquiring the remaining 18 per cent of shares currently in private hands. It is likely that the Government would need to pay a premium to the current market price of the shares to acquire control. The market value of the shares has recently been trading in the range of £3-4 billion. Once the Government owned 100 per cent of RBS, it would have the advantage of being able to transfer assets without having to negotiate with shareholders.

482. One way to avoid a minority shareholder dispute and the need for nationalisation could be to purchase the assets at a discount, but offer minority shareholders some form of compensation, perhaps via some form of warrant, if the assets later turned out to be worth more than their transfer price. Another alternative to nationalisation could involve forcing the compulsory sale of assets from RBS to the bad bank, which would follow the example set by the Irish authorities in compelling the sale of assets from the Irish banks to NAMA.

483. The Government does not appear to currently possess adequate legal powers to compel nationalisation or the compulsory sale of assets if shareholder consent cannot be negotiated. Legislation might be passed to provide such powers, but this could cause significant collateral damage to the reputation and investability of the UK banking sector, and might have knock-on effects on Lloyds Banking Group, the other bank in which the Government also holds a large stake. In order to reduce the legal and reputational risks, the Government might need to commit to paying some form of independently-assessed compensation.

Operational complexity

484. RBS is, even following several years of shrinkage, still one of the world's largest and most complex banks. It is the product of multiple mergers and acquisitions and has tens if not hundreds of legal entities spread across the world. If RBS liabilities were placed in the bad bank to reduce the need for the Government to inject cash or bonds, this would affect the rights of third parties and could trigger counterparty consent or change of control provisions. This would likely be a particular barrier to transferring derivative positions, which could be significant obstacle to placing the markets division to the bad bank. Resolving this could require complex negotiations and legal processes, or might even require legislation. Again, legislating to over-ride creditor rights would not only create legal risk but could cause reputational damage to the UK as a place to do business.

485. There would also be operational issues to tackle, such as how legal title to assets would be transferred, what IT would be needed to run both the good and bad bank, and the division of staff between the two entities. Analysis of these factors would need to form part of the decision about the boundaries of the bad bank, in order to ensure that it had a meaningful impact but in the shortest possible time. It should be noted that RBS is already configured internally on good bank/bad bank lines.

Length of time to complete a split

486. Another potential obstacle to radical reform is the time it might take to complete. Sir Mervyn King asserted that "it should not take more than a year".[913] However, Sir Nicholas Macpherson, Permanent Secretary to the Treasury, warned the Treasury Committee

    When we set up the Asset Protection Agency, we did look at the option of a good bank-bad bank, and it may yet be the right way forward, but it does take time, and you only have to look at the Irish experience with issues around valuation of the assets affecting the transfer to see that it is far from simple. So it may be the right thing to do it, but you should be under no illusion that it will take quite a lot of time.[914]

He also warned that establishing a bad bank for RBS would be considerably more complex than for Northern Rock:

    This is not like splitting up Northern Rock, because Northern Rock had a very simple business model. It may have been the wrong business model, but it was a very simple one and therefore relatively easy to effect the change; but even in that case it took us a good period of time. So I think we have a much better grip of RBS than we had, as has the management, but it is still a fiendishly complicated organisation.[915]

Stephen Hester told investors in February 2013 "The sooner we are privatised the better for the taxpayer and the better for us".[916] A restructuring which could be completed in a shorter period than RBS's existing 18-month plan would clearly be optimal. However, there is considerable uncertainty attached to the timing and outcome of this plan. A longer restructuring might still be worth doing if it provided more certainty and a better economic outcome, but significantly longer timescale would nevertheless weaken the case for action.

487. There is likely to be a potential trade-off between the time it would take to complete a restructuring and the cost and risk involved. Conducting a lengthy valuation and negotiation with shareholders would provide more security, but could drag the process out. Being willing to offer up more value to third parties or accept greater risk of legal challenge could speed the process, but there are limits to what would be economically and politically acceptable.

The cost of acting

488. One of the main perceived obstacles to a more radical approach for RBS is its potential cost. In considering this, it is important to distinguish between the real additional costs from taking a different approach and those costs which are already present but which may not be fully visible. There are several potential sources of real additional costs, most importantly:

·  If minority shareholders are paid a premium;

·  If assets are transferred to the bad bank at above their fair value (this is in effect also a way of paying the shareholders a premium, because they gain 18 per cent of any premium paid on the assets);

·  If accelerating the sale of Citizens or the wind-down of the investment bank destroys value or results in opportunity costs;

·  There are likely to be significant transaction costs from conducting the valuation and executing the restructuring.

489. These costs are difficult to estimate for several reasons. For example, it is possible that the assets in the bad bank might perform better than expected and that the restructured RBS would become highly profitable, in which case buying out the minority shareholders even at a premium could result in a net gain for the Government. Assuming there are costs, these might be deemed worthwhile in order to secure the potentially large wider economic benefits. RBS itself would be unable to justify the costs of radical structural reform as being in line with shareholder interests, but, as Stephen Hester acknowledged, there could be broader public interests which would override this:

    Whether there is a public policy override is obviously not for us but when we have been asked to look at customer and shareholder risk, we come up, every time, with the route that we are on, painful as it might be, as being the best of the available routes.[917]

490. Depending on the approach taken, there could also be a significantly larger apparent cost or contingent liability, for example from buying the assets in the bad bank or guaranteeing its debts. However, it is important to note that these do not necessarily represent an additional burden on taxpayers, but are simply a different way of accounting for existing commitments. The Government already owns 82 per cent of the equity in RBS. It already bears 82 per cent of any losses up to the value of its equity stake. It could even be argued that, at least in the absence of a robust and well-tested bail-in regime, the Government would be likely to find itself forced to stand behind RBS's other liabilities in the event of a new crisis. Sir Mervyn King contended that accounting issues should not be allowed to stand in the way of action:

    It inevitably means accepting that there are losses. Those losses are there anyway. The fact that if we just let this muddle through the losses are not realised, does not mean that the economic losses are not there. It is just that they do not show up as losses to the taxpayer given the normal conventions of public accounts.[918]

491. The kind of restructuring under discussion would have an impact on the public accounts. The Government's ownership of RBS is already reflected in the ONS's measure of Public Sector Net Debt (PSND) so that the creation of a bad bank might not have a significant impact on that measure. However, the temporary financial interventions are excluded from the alternative measure PSNDex, which is the figure more commonly used to calculate the UK's debt to GDP ratio.[919] The liabilities associated with a bad bank might well count towards PSNDex, thus affecting UK's debt sustainability as recorded under this measure. For example, a £100bn bad bank could increase PSNDex from 75.4 per cent to 81.8 per cent of GDP if this all scored as additional PSNDex.[920] Sir Mervyn King argued that markets would recognise this was an accounting change rather than a real worsening of the UK's fiscal position:

    the financial markets do see through that; they realise that the losses out there at present don't go away just because we haven't recognised them in the accounts today. They are real losses, and it is better to face up to that [...] we should not worry about the consequential impact on the apparent scale of public debt.[921]

However, there would be a significant risk to the UK fiscal position if markets did not react so calmly. As an illustration, the Office for Budget Responsibility estimate that, if gilt rates were to increase by 1 per cent, the Government's debt interest costs could increase by £8.1bn a year by 2017-18.[922]

State aid

492. An additional obstacle could come from EU law. This prohibits national authorities from granting State aid, defined as "an advantage in any form whatsoever conferred on a selective basis to undertakings", except in carefully defined circumstances.[923] The European Commission put in place a special framework for the use of State aid for bank restructuring in response to the financial crisis.[924] This pursued two linked objectives:

    i) supporting financial stability, by giving legal certainty to rescue measures taken by the Member States and promoting long term viability, and ii) safeguarding the internal market and a level playing field across banks.[925]

The Commission imposes restructuring requirements on banks in receipt of State aid in pursuit of the second of these objectives:

    measures to limit competition distortion may include divestments, temporary restrictions on acquisitions by beneficiaries and other behavioural safeguards. These measures are designed not only to limit distortions between aided banks and those surviving and restructuring without State aid, and between banks in different Member States, but also to create conditions which foster the development of competitive markets after the crisis. [926]

RBS has already twice been the recipient of State aid in relation to the government interventions in 2008 and 2009, and it is likely that government intervention to take over its bad assets would be regarded as further State aid. RBS has still not completed its existing State-aid-mandated divestments, as we noted earlier. A third State aid intervention for RBS would therefore be expected to result in further restrictions, which could include additional divestments, limits on the amount of new lending RBS could undertake, or dividend restrictions. Onerous restrictions on the RBS good bank could undermine the objectives of restructuring by limiting RBS's ability to be a strong competitive lender and making a sale more difficult. The precise restrictions would be the subject of negotiations between the Government and the European Commission.


493. According to the OFT review of competition in retail banking in 2010, RBS provided 16 per cent of UK personal current accounts and 23 per cent of SME accounts, second only to Lloyds Banking Group.[927] RBS already faces State aid requirements to divest 318 branches including 2 per cent of the UK retail banking market and 5 per cent of the UK SME and mid-corporate market, a process which has been delayed. A major restructuring of RBS could present an opportunity to review the divestment plan and further increase competition, potentially by returning the good bank to the private sector as multiple mid-sized banks rather than a single dominant firm. This could take the form of several national challenger banks, or regionally-focused banks. Such a split could also help to address state aid concerns arising from further intervention in RBS. Additionally, a split could take place on functional lines, creating a commercial/retail bank while disposing of the investment banking function.

494. The benefits of additional competition from creating challenger banks were explored earlier in this chapter. The benefit of creating regional banks could include greater focus and commitment towards local businesses and a rebalancing of the UK economy away from London. A recent report from the New Economics Foundation looked at "stakeholder banks" across various countries and concluded that one of the main benefits from institutions such as the German Sparkassen is that they "promote local economic development by consistent support for SMEs, preventing capital drain from rural areas and regions, and maintaining access to bank branches even in remote areas". However, they did also note several concerns about stakeholder banks which contributed to their decline in the UK, such as "political interference and lack of accountability", "inefficiency" and "distortion of competition", pointing to some prominent recent examples of poor performance among German landesbanken and Spanish cajas.[928] There are also financial stability risks associated with regional banks tied closely to regional economies.

495. There would be significant additional costs from a full break-up of RBS. These would fall on the Government, both as the majority owner and since it would probably be necessary to buy out or compensate minority shareholders in order to be able to act. The experience of RBS and Lloyds Banking Group in preparing existing divestments shows how difficult, expensive and time-consuming it can be to separate integrated activities and put new structures and IT in place. António Horta Osório stated that post-tax cost to Lloyds Banking Group of preparing the "Verde" divestment will be approximately £1bn.[929]


496. The Government's strategic priority for RBS must be to create strong and competitive provision of its core services, including UK retail and corporate lending, freed from its legacy problems. This is essential, not just for the SME and retail sectors that RBS primarily serves, but also in the interests of the broader economy as a whole. RBS and the Government claim to share these reflections. However, the Commission doubts that the current proposals will achieve this outcome sufficiently quickly or decisively.

497. The current strategy for returning RBS to the private sector has been allowed to run for five years. Progress has been made but it is time to look at this afresh. The case has been put to the Commission for splitting RBS into a good bank and bad bank. There may be significant advantages in doing so, including focusing the good bank on UK retail and commercial banking and, by freeing it from legacy problems, strengthening its ability to lend and making it a more attractive investment proposition which could subsequently be privatised at a good price. However, there are also important questions which need to be answered before such a course of action could be recommended. These questions include:

·  The cost and risk to the taxpayer;

·  What assets would go into the bad bank and what would be left behind in the good bank;

·  The case for a wider split between retail and investment banking at RBS given the need to change the past culture at the bank;

·  The potential State Aid consequences on the shape of RBS of a further injection of state funds in terms of divestments or other involuntary restructuring; and

·  Whether or not such a course of action would be capable of returning the good part of the bank to the private sector more quickly than the course currently being pursued by the RBS management.

498. The Commission did not take extensive evidence on these questions and most can only be answered on the basis of detailed analysis conducted by those with access to the necessary information—namely the Government and RBS. The Commission recommends that the Government immediately commit to undertaking such detailed analysis on splitting RBS and putting its bad assets in a separate legal entity (a 'good bank / bad bank' split) as part of an examination of the options for the future of RBS. We endorse the Treasury Committee's call for the Government to publish its work on a good bank / bad bank split. If the operational and legal obstacles to a good bank / bad bank split are insuperable, the Government should tell Parliament why and submit its analysis to scrutiny.

499. The Commission envisages that this examination would be published by September 2013 and examined by Parliament. At the same time, the Government should also examine and report to Parliament on the scope for disposing of any RBS good bank as multiple entities rather than one large bank, to support the emergence of a more diverse and competitive retail banking market.

Lloyds Banking Group

500. Lloyds Banking Group (LBG) emerged from the merger of Lloyds TSB and Halifax Bank of Scotland (HBOS) in September 2008 at the height of the financial crisis amid serious concerns that HBOS would collapse without some form of external support. Subsequently and as a direct result of the merger, the combined group now has the largest presence of any bank in the UK retail market. It has the largest single market share in most segments of the market, including personal current accounts, savings accounts, mortgages, unsecured personal loans and credit cards.[930]

501. Both Lloyds Banking Group and HBOS received considerable Government support during the financial crisis. The taxpayer injected £8.5 billion directly into HBOS, while Lloyds Banking Group received a further £12 billion. The total of £20.5 billion provided by the taxpayer to both groups was all channelled into supporting HBOS. As at the end of March 2012, the Government held a total of 27.6 billion ordinary shares in LBG equivalent to 40 per cent of total share capital. The average share price at which the Government invested in the various constituent parts of LBG was 73.6 pence. LBG's share price on 30 April 2013 was 54 pence—equivalent to an unrealised paper loss of approximately £5.6 billion. When calculated net of the fee paid for participation in the APS, the break-even price was 63.2 pence.[931]

502. Lloyds Banking Group received other forms of taxpayer support. It participated in the Asset Protection Scheme, which was designed to provide protection against future credit losses on certain assets. Lloyds exited the APS in November 2009, instead conducting a rights issue in December 2009, Lloyds Banking Group paid a withdrawal fee to the Government of £2.5 billion, reflecting the implicit support it had received from the APS since March 2009.[932] LBG also benefited from participation in both the Credit Guarantee and Special Liquidity Schemes.

503. LBG was compelled to divest assets as a condition for EU approval of the Government support it had received. The LBG restructuring plan consists of the divestment of a retail banking business with at least 600 branches, a 4.6 per cent share of the personal current accounts market in the UK and up to 19 per cent of the Group's mortgage assets. The number of branches to be disposed of represents approximately 20 per cent of the LBG network. It was required to complete the divestment by 30 November 2013.[933] LBG had agreed to divest these assets to the Co-operative Group, but the deal fell through in April 2013.

504. Unlike RBS which has had, and continues to have, a significant investment banking arm, LBG can be characterised as a retail and commercial bank. Mr Horta-Osorio confirmed that this would continue to be the case:

    We said that we would be focussed on retail and SMEs and not on investment banking, trading, equities or exotic instruments. We have absolutely focussed the bank on delivering retail services and services to SMEs  [934]

Although not on the scale of RBS, LBG also has an international presence, but is now committed to being "totally focussed in the UK". As Mr Horta-Osorio told us:

    We had 30 countries internationally, we have committed to go from 30 to less than 15 in four years and, in 18 months, we have done 12 of the 15, so we are significantly ahead of plan.[935]

505. LBG has made considerable progress in terms of restructuring its business. In 2011, it returned to underlying profitability. In 2012, underlying profits rose from £638 million in 2011 to £2,607 million, although it ultimately made a statutory loss for the year primarily as a result of PPI provisions. At the same time LBG has taken steps to restructure the business through the reduction of non-core assets. As a result the LBG (non-core assets) balance sheet had fallen from £194 billion in 2010 to £98 billion in 2012. At the same time the bank has reduced its reliance on wholesale funding with a large reduction in the loan to deposit ratio from 154 per cent in 2010 to 121 per cent in 2012. Its capital ratio stood at 12 per cent at the time it announced its 2012 results.

506. Mr Horta-Osorio was bullish for Lloyds prospects for the future when he spoke at the LBG AGM on 16 May 2013:

    We expect us [Lloyds] to return to profitability this year and to grow our core business, to realise our full potential to deliver strong, stable and sustainable returns for you, the shareholders, and to allow UK taxpayers' investment in the group to be repaid[936]

Lloyds share price subsequently rose to its highest level in over two years and is, on some measures, close to its break-even price.

507. It was subsequently reported by the media that "as the bank's capital levels and profitability improve it [Lloyds] will seek permission from regulators to re-start paying dividends to shareholders, potentially next year". The implications of renewed dividend payments were made clear:

    That is seen as a key step on the road to privatisation as it shows the bank is healthy enough to give profits back to the owners instead of retaining them to strengthen its capital position.[937]

508. UK banks are now preparing to implement the Vickers recommendations on ring-fencing. The Treasury Committee heard that this would be a far greater challenge for RBS than Lloyds. Adam Young, Co-Head of Equity Capital markets, Rothschild, contrasted the impact on the two institutions:

    The implementation of the Vickers report has a fairly significant impact on the way the investment banking and the corporate banking parts of the RBS business are perceived by the marketplace, because there is no absolutely clear view about how the implementation of that regime might affect management's view of the economics of that business [...]

    For Lloyds Banking Group the impact of Vickers is much less profound. [938]

509. When asked about what more LBG needed to do before they could be returned to the private sector, Manus Costello, bank analyst at Autonomous, sounded positive. He told the Treasury Committee that Lloyds were "in a different position from RBS". This Mr Costello said was:

    partly because of the size of the Government stake and partly because of the nature of the business model itself. They [Lloyds] have also made some good progress in reducing their funding risks. There remain a lot of risks surrounding the UK macro environment and the asset quality of some parts of their book and [...] over the course of the next couple of years they need to demonstrate that they can build their capital ratios and manage their way out of some of these non-performing exposures.

Crucially, Mr Costello added, "that is what they are on track to do".[939]

510. Lloyds Banking Group is in a very different situation from RBS. The Government stake in the bank is far smaller and Lloyds appears to have made faster progress in terms of restructuring its business and returning to sustained profitability. To a large extent this 'faster progress' reflects the greater complexity of restructuring RBS, given its significant investment banking arm and international operations. Restructuring the business and returning to a path of sustained profitability has proved less difficult at Lloyds. It has successfully implemented the integration of HBOS and refocused on its core markets of commercial and retail banking. Lloyds appears to be increasing its lending to business.

511. Lloyds Banking Group has suffered far less from the effect of public ownership and the perception of political interference than RBS. Lloyds, a mainly retail and commercial bank, has also largely avoided the same intense public focus on remuneration policies. For these reasons the case for intervention in Lloyds is far weaker than is the case with respect to RBS. Lloyds appears better placed to return to the private sector without additional restructuring.

Financial literacy

512. The Commission heard a range of evidence on mis-selling and the complexity of financial products and services on which consumers must make decisions with consequences many do not, at the time, fully understand. We discuss below the role that banks and regulators can play in preventing this, but more informed consumers can also be empowered to challenge banks who try to mis-sell, contrary to their best interests. More importantly, financially literate consumers are able to exercise informed choice and impose market discipline on banks.

513. The UK has a poor track record when it comes to levels of literacy and, in particular, numeracy, as was demonstrated in the BIS Skills for Life Survey. The results showed that, in 2011, only 22 per cent of the working-age population in England (7.5 million adults) reached Level 2 or above in numeracy—roughly equivalent to attainment at A*-C at GCSE—compared with 57 per cent of the population (19.3 million adults) in literacy. The corresponding figures for 2003 were 26 per cent (8.1 million adults) for numeracy and 44 per cent (14 million adults) for literacy. Furthermore, 17 million adults in England (just under half the working-age population) are at 'Entry Levels' in numeracy—roughly equivalent to the standards expected in primary school.[940]

514. We examined the consequences of low levels of numeracy and financial literacy on competition and consumer outcomes in the retail banking sector. Martin Lewis, the TV pundit, has made explicit the link between low levels of consumer financial literacy, poor consumer outcomes and PPI mis-selling:

    Right across society, we struggle from genuine consumer illiteracy, if I can take the broadest term possible, where I would say 60 per cent to 70 per cent of the population simply do not understand many of the products that we have [...] I am dealing at the moment with a £9 billion payment protection insurance mis-selling scandal.

    If you want evidence of the size of this and the sheer tiny amount of money that we are talking about here that would make a big difference in terms of financial education, let us start with that one. An entire nation of millions of people who were conned or mis-sold into getting an insurance product that was often worthless for them and at best was hideously expensive. [941]

A number of witnesses identified a lack of financial literacy as a factor in customers not receiving the best service they could. Sue Edwards of Citizens Advice told us that the issue was broader than the need for mathematical skills: "There is a case for better financial skills throughout the population—not just financial skills, but how to be a savvy consumer. We are trying to play a part in educating people about how to use financial products and services safely and fairly".[942] A Regional Director for Lloyds also identified financial literacy as a problem:

    I think financial literacy is an issue with potentially quite significant implications if we do not do something about it. We know that we have a population that is broadly undersaved and underprotected, and will not have great retirement plans. I do not say that that is entirely due to financial literacy, but it can only get worse unless we do something about it.[943]

The Chief Executive of Lloyds, however, spoke of the benefits if literacy could be improved:

    If you have more informed consumers with more transparent products, and they have a choice, that creates a virtuous circle exactly because competition is good for improving quality standards. I believe that when you have greater competition, that is a powerful incentive for all providers in any industry to improve their standards. Therefore, the more informed customers are, and the more competition you have, the better that is for quality standards in general.[944]

515. The former Financial Secretary to the Treasury, Mark Hoban MP, also spoke of the importance of increasing consumer financial literacy in evidence to the Joint Committee on the Draft Financial Services Bill, when he said that:

    One of the aspects of my role which I least enjoy is looking at letters from colleagues where, clearly, consumers have not understood the products that have been sold and have not understood the full risks. That is not a very satisfactory outcome for either the industry or the consumer and there should be much more emphasis on ensuring that consumers understand it. That is why I am very supportive of financial capability. You cannot just rely upon firms to do this. You need to ensure that consumers have support to understand those products.[945]

516. The Joint Committee, however, noted that "financial education is a long-term process, and we are unlikely to see improvements in the short-term".[946] Peter Vicary-Smith agreed, calling improving financial literacy "a long-term game plan".[947] There is therefore a case for focusing resources on improving the financial education young people receive. In its written evidence to the Commission, pfeg note that "prevention is better than cure", and advocate financial education for young people in schools. It argues that this will "build a generation of empowered customers able to deal with financial challenges".[948] The Treasury Committee has also had a long-standing interest in this area. Its report on the Financial Conduct Authority stated that "the FCA and the MAS should work with the Department for Education to help ensure that young people receive at school the basic learning tools and skills required to make sense of financial advice later in life".[949]

517. Earlier this year, the Government announced the inclusion of personal finance education in the new draft National Curriculum for maths and citizenship, making financial education compulsory in secondary schools for the first time from September 2014. The curriculum for citizenship should "prepare pupils to take their place in society as responsible citizens by providing them with the skills and knowledge to manage their money well and make sound financial decisions," while the maths curriculum will include financial mathematics. [950] This reflects the cross-curricular approach recommended by pfeg and in a recent report by the APPG on financial education for young people.[951] However, the APPG also concluded that "in primary schools the current cross-curricular approach should continue but it is important that primary school teachers are fully equipped to teach basic maths and money skills in order to lay the foundation for secondary education." pfeg also noted that it was important to measures were needed to ensure that all financial education programmes "result in [...] sustained behaviour change.

518. In addition to lessons provided by schools, financial education is funded or delivered by external organisations. The APPG on Financial Education for Young People reported that:

    Outside organisations have the potential to boost the teaching of personal finance education in schools. However, schemes must be quality checked and it is clear that there is no capacity for it to be delivered universally by providers. A Quality Mark would ensure that teaching resources are linked into the current curriculum and that organisations do not market financial products or services."[952]

Pfeg also reiterated that "it is essential that [financial education] is led by teachers and supported by a comprehensive and progressive curriculum", and cited its own Quality Mark scheme, which currently kitemarks the majority of banks' financial education resources for use in schools, as "best practice".[953]

519. Waves of mis-selling and other forms of detriment suffered by consumers in the retail banking market reflect not just widespread financial illiteracy, but may also be the result of weaknesses in numeracy and literacy skills of some consumers. Wider concerns about the need for higher numeracy and literacy skills fall outside the scope of our inquiry, but they have contributed to poor levels of financial literacy. A more financially literate population will be better capable of exerting meaningful choice, stimulating competition and exerting market discipline on banks, which, in turn, can drive up standards in the industry. Greater financial literacy can also contribute to social mobility. Industry, regulators and governments must avoid a situation where the banks design ever more complex products and then blame consumers for not being financially literate enough to understand them. Alongside greater financial literacy, there is a need for a relentless drive towards the simplification of products and the introduction of clear, simple language. Mis-selling and undesirable cross-selling are very unlikely to be eliminated through higher financial literacy, but improvements to such literacy will help bear down on those problems and be more effective, in many cases, than ever more detailed conduct regulation. The counterpart of irresponsible lending is, in many instances, uninformed consumers. Regulation remains essential, but risks restricting choice and innovation. Increased competition, underpinned by financially literate consumers, can do much more to address irresponsible lending. To this end, we welcome the announcement by the Government earlier this year that it will include both financial education and financial mathematics in the National Curriculum.

Complaints and redress


520. EU legislation sets out the rights and obligations relating to the provision of payment services. [954] It provides that member states must put in place an adequate and effective out-of-court complaint and redress procedure for the settlement of disputes between payment service users and payment service providers. The adequate and effective out-of-court redress procedure used in the UK is the Financial Ombudsman Scheme (FOS) established under Part 16 of the Financial Services and Markets Act 2000 (FSMA).[955] The question as to whether the FOS has jurisdiction to hear a case is left to rules made by the FCA.[956]

521. The route of complaining to the Financial Ombudsman Service (FOS) is open to narrowly-defined micro-businesses. Sir Nicholas Montagu, Chairman of the Board of the Financial Ombudsman Service, explained this in a letter to the Treasury Committee:

    [...] It is important to note that our remit in respect of these cases is constrained. First because of the limit on our awards - now £150,000 (but until recently £100,000). Second, because we are unable to consider cases from businesses unless they are defined as micro enterprises (a new definition introduced in 2009). That means a firm must both have an annual turnover of up to €2 million (approx. £1.67 million) and have fewer than 10 employees. Practically therefore our remit seldom encompasses the larger business loans I believe are at the heart of the reported concerns.[957]

This means that some small firms unsatisfied by redress offered by their bank for interest rate derivative mis-selling may only have the expensive court route open to them. During a Commission Panel visit to Birmingham, SME owners expressed concern that this limit was unfairly preventing some very small businesses pursuing redress.[958]

522. Natalie Ceeney told the Treasury Committee that the FOS was open to a consultation on the possible limited expansion of its remit for the purposes of complaints about interest rate derivatives:

    From what we have heard, though, a lot of the firms we are talking about would be outside our limit, which is one of the reasons why we have been exploring with the FSA whether we extend our jurisdiction specifically for a swap scheme. As I mentioned, we have said to the FSA that if they want us to do that, we are up for consulting on doing so.[959]

After that evidence session, the FSA revised the size criteria of firms that will be eligible for inclusion in its review into interest rate swaps. The definition of customers to be included had become so complicated that the FSA published a flowchart in an attempt to explain which firms are and are not eligible for their scheme.[960] However, the FSA did not choose to consult on a change to the criteria for access to the FOS. Natalie Ceeney stressed that the FOS had not been lobbying for such a change:

    We offered, if it was helpful, to run it, and that if it wasn't, we wouldn't. It was a completely neutral offer, and we do not have a view. We were set up by Parliament to consider complaints; it is really up to others to set our jurisdiction.[961]

Other witnesses drew attention to the problems with any line drawn to determine eligibility. Tony Boorman told us that "drawing legal lines across the rich tapestry of small businesses, medium-sized businesses and how they have interacted over many years on this particular topic is a genuinely difficult task".[962]

523. The narrow definition of an "unsophisticated customer" used to determine eligibility for access to the Financial Ombudsman Service (FOS) for redress has been highlighted as problematic by the wave of cases relating to interest rate swap mis-selling to small businesses. Many small businesses have fewer than 10 employees. Such businesses are particularly vulnerable to potential exploitation by the banks they rely upon for finance, particularly in the case of complex derivative products. The Commission recommends that the FCA consult on options for widening access to the FOS.


524. Every six months, the FOS publishes a range of firm-specific statistics relating to customer banks' complaints. One of the most important of these statistics relates to the FOS' uphold rate in favour of customers. A high uphold rate by the FOS in favour of a customer could be seen as indicative of multiple failings of the bank on behalf of a customer as this represents not only poor levels of complaint handling service at the bank, but also poor service standards in relation to the nature of the root cause of the customer's complaint itself. PPI complaint uphold rates across the industry are currently much higher than is the case with respect to other financial products such as home finance and pensions. The latest FOS statistics, for the period of 1 July to 31 December 2012 show the following extremely high PPI uphold rates: for example, Black Horse (part of Lloyds Banking Group) 97%, CitiFinancial (part of Citibank) 94% and HFC (part of HSBC) 83%.[963]

525. We questioned bank executives from Barclays on the high uphold rate in favour of consumers and asked Mike Walters to explain why, over the past two years, the Financial Ombudsman Service has upheld about 40% of complaints against Barclays. Mr Walters, Head of Compliance at Barclays, acknowledged that this 40% figure was "far too high", but suggested that this was the case because "the numbers are informed by the PPI problem". However, we put to Mr Walters that the 40% figure stripped out PPI and was far higher when PPI is included. Again, when pressed on why the high uphold figures have been persistently high over a long period of time, Mr Walters told us that "they have been too high for a long time at Barclays and across the industry". He added that Barclays had "put in place a specific programme to look at this problem. This is something that our chief executive is very focused on". Natalie Ceeney told us that customers' increased use of claims management companies for PPI resulted from a lack of trust in how the banks had approached PPI mis-selling in general:

    unfortunately the lack of trust in banks that the whole episode had fuelled then fuelled the claims management industry, which piled in, saying, "You obviously can't trust the banks, here's us." So it left us in a much bigger mess than before. [964]

526. We examined the issue of a time bar for PPI complaints, which the BBA has been pushing for, as well as how best to ensure that all those affected by PPI mis-selling are contacted and given an opportunity to complain. Natalia Ceeney told us that it was "helpful [..]. that the FSA board has made a statement that it will only introduce a time bar if it is in the consumer interest, which I think is a very important statement". She said that there were:

    a few things that I think are important for the FSA to think through, and we have absolutely said this to the FSA. The first thing that I would say is that I think one of the myths around at the moment is that there are no time limits; of course there are. There are current time limits, which are three years from the point you are individually aware that there is a problem, or six years from the sale [..]

    there are some challenges particularly with PPI, because of the level of assumptive selling. Everybody in the UK might be aware that there is this thing called PPI, but would you individually necessarily know that you were sold PPI? You may or may not know—in fact, we have come across a lot of people who did not, because of the way that it was sold. That's the first thing.

527. So there are already time limits. One of the first questions that needs to be asked is why are those current limits inadequate? Bringing in a new time limit would suggest that they are, but they seem to work for everything else. The second question, I think, is whether or not the endowment experience actually offers a helpful precedent. You will remember that, in mortgage endowments, a time limit was brought in; it was actually brought in to extend consumer rights, not to limit them. To go back to my assumptive selling point in a way, in mortgage endowments, importantly, every customer was written to a number of times. That took it from a general issue about there being mis-selling of mortgage endowments down to the individual level of each consumer knowing where they stood.

528. At the moment in PPI, we are a long way from each consumer knowing where they stand. If a time bar is brought in, there will certainly be a challenge about how we deal with the issue of people being aware of PPI but not necessarily being aware of where they stand individually.

529. The large banks have a poor track record when it comes to complaints handling. This is clearly demonstrated by the high uphold rate by the Financial Ombudsman Service, especially when it comes to handling customer complaints regarding PPI. This is unacceptable and has clearly contributed to customers lack of trust in banks. The Commission expects to see a significant improvement in bank performance in this area.

530. A line will eventually need to be drawn under the PPI debacle, but that line will need to be drawn carefully and in a way that ensures that consumers do not lose out unfairly. Consumers require clarity about whether or not the PPI mis-selling scandal may have affected them personally. To deliver this clarity, the Commission recommends that the FCA urgently consider again the case for requiring banks to write to all identified customers, except those who have already initiated a PPI complaint or been contacted as part of any discrete FSA-led PPI process in the past, and report to Parliament on the outcome of its considerations.


531. The FOS is intended to act as a last resort for customers who feel their complaint has not been properly addressed by their bank. The FOS is free for eligible customers and claims management companies acting on behalf of bank customers, but a bank must pay a case fee for almost every complaint the FOS receives from its customers even if the FOS finds that the bank handled the customer's complaint appropriately. This case fee is £550 (with the first 25 cases for a firm being free of charge), although PPI complaints incur an extra £350 charge. In addition to automatic case fees, firms who are obliged to provide customers with FOS access are charged a pre-set levy which is agreed on annually following an FCA consultation process[965]. There is a risk that, under the current arrangements, banks may have an incentive to not take consumer complaints seriously in the expectation that consumers will then go to the FOS or because they expect consumers in any case to use the FOS or claims management companies to handle their complaints. This is because it may save costs and reduce administrative burdens on banks. When asked whether this was indeed the case, Mike Walters told us that was "really not right".

532. The evidence the Commission has received suggests that too often the banks have not taken customer complaints seriously. Many banks have had very high percentages of their complaints upheld by the FOS for far too long. The Commission recommends that the regulators consider this as a matter of urgency. This needs to change with banks motivated to respond to complaints appropriately the first time round. The Commission believes that one way to incentivise this behaviour would be for the FOS case handling fee not to apply to banks where the FOS finds that the bank has managed a customer's complaint fairly in the first instance. Conversely, banks who are found not to have handled a complaint appropriately would face a higher case handling fee. The Commission recommends that the regulators consider this as a matter of urgency.

Transparency in wholesale and investment banking

533. In its January 2011 market study into Equity underwriting and associated services, the OFT found "little or no competition at the time of the transaction".[966] It made a series of recommendations to companies and institutional shareholders designed to apply greater pressure on equity underwriting fees. There is limited evidence of changes in company or shareholder behaviour in the light of the OFT report. This may partly be due to low levels of capital-raising given the wider economic climate. The IMA said that "it is not obvious these recommendations have been fully endorsed".[967] However, the Association of Corporate Treasurers (ACT) said that "shareholder pressure has been noted" and the ABI said that such pressure "has helped improve corporate decision-making around whether and how to undertake transactions and associated capital raisings and to achieve cost-effective outcomes for the company".[968]

534. The Investment Management Association said that it was the responsibility of customers to ensure they were receiving good value for money in investment banking:

    is incumbent on a company as part of its governance process to review its relationships regularly to determine that it is getting value for money. Shareholders have a role to play in satisfying themselves that issuers are properly implementing this process.[969]

The ABI[970] and ACT[971] came to similar conclusions in their evidence.

535. Transition management, the process by which asset managers hire a custodian bank to aid in the liquidation or moving of a large portfolio of securities, has recently come under increased regulatory scrutiny. This follows allegations that State Street, which has a transition management arm, overcharged Ireland's state pension fund as well as several large UK corporate pension schemes. It was reported by The Financial Times in May 2013 that "the FCA is currently investigating allegations that several pension funds were overcharged by State Street's transition managers, although no formal enforcement proceedings have been brought", but that, in addition, "the regulator has already requested detailed information from a variety of organisations connected to the service, suggesting that the entire industry can face a fresh bout of scrutiny over the issue".[972] The FCA has been reported noting the risk that "unclear fee structures" lead to adverse outcomes for investors.[973]

536. Cross-selling and a lack of price transparency are not restricted to retail banking. Parts of investment banking are also characterised by opaque fee structures and some highly sophisticated companies have entered into complex transactions that they have not fully understood. This should not usually be an area for regulatory intervention: the principle of caveat emptor acts as an important force for market discipline. The regulator should not seek to shield sophisticated customers from the consequences of their poor decisions. However, it should be their duty, wherever possible, to ensure maximum price transparency at every level of banking. The lack of this transparency appears to be a problem even for sophisticated end users of, for example, transition management services.

597   "Ruling Capitalism", The Financial Times, 26 January 2012, Back

598   Ev 960 Back

599   Ev 1473 Back

600   IQ 109 Back

601   KQq 21, 32 Back

602   IQ 87 Back

603   HM Treasury, Promoting financial inclusion, December 2004, p 5  Back

604   Treasury Committee, Third Report of Session 2012-13, Access to cash machines for basic bank account holders, HC 544 Back

605   Q 3727 Back

606   KQ 4 Back

607   Q 3733 Back

608   Financial Inclusion Taskforce, Banking services and poorer households, December 2010, para 22 Back

609   KQ 116 Back

610   Commission Recommendation on access to a basic bank account, 2011/442/EU; Directive of the European Parliament and of the Council, COM(2013) 266 Back

611   KQ 4 Back

612   KQ 10 Back

613   KQ 64 Back

614   K Ev 32 Back

615   F Ev 95 Back

616   Ibid. Back

617   Q 2950 Back

618   F Ev114 Back

619   F Ev 95 Back

620   Q 2954 Back

621   "Industry shows mixed response to the Kay review", The Financial Times, 29 July 2012, Back

622   F Ev 98, 131 Back

623   F Ev 131 Back

624   Written evidence from the New Economics Foundation to the Business Finance Green Paper, 20 September 2010 Back

625   HL Deb, 12 November 2012, cols 1357-1358 Back

626   BBA, Statement following speech by Secretary of State for Business, Innovation and Skills, 6 February 2013 Back

627   Treasury Committee, Ninth Report of Session 2010-12, Competition and choice in retail banking, HC 612 Back

628   Q 2321 Back

629   Q 2324 Back

630   Q 2361 Back

631   Ev 1205 Back

632   FQ 52 Back

633   Q 3069 Back

634   Q 3070 Back

635   Ibid. Back

636   Ibid. Back

637   Q 2710 Back

638   Ev 1381 Back

639   EQ 16 Back

640   Q 4349 Back

641   Anthony Sampson, Anatomy of Britain (London,1962) Back

642   Ev 885 Back

643   The Banking Review, Competition in UK Banking: A Report to the Chancellor of the Exchequer, March 2000, para 30 Back

644   Independent Commission on Banking, Final Report, September 2011, para 6.8  Back

645   Bank of England, On being the right size speech, Andy Haldane, 25 October 2012, chart 2 Back

646   Q 2696 Back

647   Ev 1428 Back

648   FR Ev 157 Back

649   "Santander pulls plug on RBS deal", The Financial Times, 12 October 2012,  Back

650   "Santander UK comments on the RBS deal", Santander Stock Exchange Announcements, 15 October 2012,  Back

651   "The Co-operative Group Announcement re: Lloyds Bank Branch Assets", The Co-operative news, 24 April 2013, Back

652   Q 248, FQ 27 Back

653   Treasury Committee, Ninth Report of Session 2010-12, Competition and Choice in Retail Banking, HC 612-II, Ev 216 Back

654   FQ 3 Back

655   FQq 1-2, 27-28, 75 Back

656   FQq 66, 76 Back

657   Q 2322 Back

658   Ninth Report from the Treasury Committee, Session 2010-12, Competition and Choice in Retail Banking, HC 612-II, Ev 186  Back

659   "Time to open banking to new entrants", The Financial Times, 24 March 2013, Back

660   "Time to open banking to new entrants", The Financial Times, 24 March 2013, Back

661   FQ 3 Back

662   FQ 1 Back

663   "Time to open banking to new entrants", The Financial Times, 24 March 2013, Back

664   Ev 1424 Back

665   Bank for International Settlements Basel Committee on Banking Supervision, Fundamental review of the trading book, May 2012, p4 Back

666   FQ 54 Back

667   FSA and the Bank of England, A review of requirements for firms entering into or expanding in the banking sector, March 2013, pp5-9 Back

668   Ibid. p44 Back

669   Ibid. p10 Back

670   Ibid .p43 Back

671   Ibid. p53 Back

672   FQ 2 Back

673   Q 4452 Back

674   FSA and the Bank of England, A review of requirements for firms entering into or expanding in the banking sector, March 2013, p6 Back

675   Ev 899 Back

676   Q 234 Back

677   FQ 134 Back

678   HC Deb, 12 July 2012, cols 147-192WH [Westminster Hall] Back

679   Ev 1274 Back

680   Q 2366 Back

681   FSA and the Bank of England, A review of requirements for firms entering into or expanding in the banking sector, March 2013 Back

682   Treasury Committee, Eighteenth Report of Session 2010-11, The future of cheques, HC1147, p 3 Back

683   HM Treasury, Setting the strategy for UK payments, July 2012 Back

684   Ibid. p 6 Back

685   Ibid. p 7 Back

686   HM Treasury, Speech on the Reform of Banking by the Chancellor of the Exchequer, Rt Hon George Osborne MP, 4 February 2013 Back

687   HM Treasury, Opening up UK payments, March 2013 Back

688   Ibid. p 9 Back

689   Q 149 Back

690   "Time to open banking to new entrants", The Financial Times, 24 March 2013, Back

691   HM Treasury, Opening up UK payments, March 2013, p 8 Back

692   Ibid. p 19 Back

693   Ibid. p 10 Back

694   FQ 29 Back

695   Communities and Local Government Committee, Seventh Report of Session 2008-2009, Local Authority Investments, HC 164-I, para 29 Back

696   Q 2977 [Tony Greenham] Back

697   Q 2976 [Tony Greenham] Back

698   Ibid. Back

699   F Ev 89 Back

700   F Ev 52, 57 Back

701   Q 2966 Back

702   F Ev 60 Back

703   F Ev 52, 59 Back

704   F Ev 57 Back

705   F Ev 53 Back

706   F Ev 59 Back

707   Ibid. Back

708   F Ev 92 Back

709   F Ev 69 Back

710   Q 2961 Back

711   F Ev 68 Back

712   F Ev 92 Back

713   F Ev 46-47 Back

714   F Ev 89 Back

715   F Ev 58 Back

716   Ibid. Back

717   F Ev 60 Back

718   F Ev 70 Back

719   F Ev 60 Back

720   Ibid. Back

721   F Ev 58 Back

722   Ibid. Back

723   F Ev 90 Back

724   Ibid. Back

725   Ibid. Back

726   F Ev 47 Back

727   Q 2322 Back

728   Q 174 Back

729   Office of Fair Trading, Review of the personal current account market, January 2013, para 6.20 Back

730   Q 242 Back

731   FQ 34 Back

732   Independent Commission on Banking, Final Report, September 2011 Back

733   Payments Council, Improving current account switching, October 2011, Back

734   F Ev 116 Back

735   Q 593 Back

736   Ev 1202 Back

737   Q 1180 Back

738   EQ 158 Back

739   Q 605 Back

740   FQ 115 Back

741   EQ 158 Back

742   FQ 164 Back

743   Ev 1227 Back

744   F Ev 73 Back

745   Ev 1137 Back

746   Q 3516 Back

747   EQ 163 Back

748   Ev 1231 Back

749   FQ 164 Back

750   Ev 1232 Back

751   For example, Ev 1198 Back

752   FQ 120 Back

753   FQ 110 Back

754   Ibid. Back

755   Q 4359 Back

756   Q 2340 Back

757   FQ 87 Back

758   FQ 37 Back

759   Ev 1198 Back

760   Ev 1230 Back

761   F Ev 42 Back

762   Q 3163 Back

763   Independent Commission on Banking, Final Report, September 2011, para 8.60 Back

764   Ibid. Back

765   Q 768 Back

766   Ibid. Back

767   Q 3129 Back

768   Q 3402 Back

769   FQ 87 Back

770   F Ev 80 Back

771   Q 3080 Back

772   Qq 2338, 3130 Back

773   F Ev 139 Back

774   F Ev 140 Back

775   F Ev 139 Back

776   Q 3168 Back

777   Q 3516 Back

778   FQ 7 Back

779   EQ 158 Back

780   Q 2612 Back

781   Q 2334 Back

782   Q 3802 Back

783   Q 177 Back

784   Treasury Committee, Ninth Report of Session 2010-11, Competition and choice in retail banking, HC 612, para 121 Back

785   Q 605 Back

786   Q 1180 Back

787   HM Treasury, Speech on the Reform of Banking by the Chancellor of the Exchequer, Rt Hon George Osborne MP, 4 February 2013 Back

788   Office of Fair Trading, Review of barriers to entry, expansion and exit in retail banking, November 2010, pp35-57,  Back

789   Office of Fair Trading, Anticipated acquisition by Lloyds TSB plc of HBOS plc: Report to the Secretary of State for Business Enterprise and Regulatory Reform, 24 October 2008 Back

790   Independent Commission on Banking, Final Report, September 2011, p207 Back

791   See European Commission, Restructuring of Royal Bank of Scotland following its recapitalisation by the State and its participation in the Asset Protection Scheme,,14 December 2009, para 73 Back

792   Independent Commission on Banking, Final Report, September 2011, p167 Back

793   Letter from Ms Ana P Botin to the Chair of the Treasury Committee, 16 October 2012 Back

794   "The Co-operative Group Announcement re: Lloyds Bank Branch Assets", The Co-operative Group press release, 24 April 2013, Back

795   Independent Commission on Banking, Final Report, September 2011,pp 211-212 Back

796   Ibid. pp 231-232 Back

797   Ibid. pp 230-232 Back

798   Q 2368 Back

799   Office of Fair Trading, Review of the personal current account market, January 2013, p 4 Back

800   Ibid., p 7 Back

801   Q 4343 Back

802   Office of Fair Trading, Competition in UK banking, Clive Maxwell, 16 February 2012 Back

803   Ibid. Back

804   Office of Fair Trading, Competition in the financial services sector, Clive Maxwell, 20 June 2012 Back

805   Q 3071 Back

806   Ibid. Back

807   Q 3073 Back

808   Q 2366 Back

809   Q 4451 Back

810   AQ 9 Back

811   JQ 55 Back

812   Joint Committee on the draft Financial Services Bill, First Report of Session 2010-12, Draft Financial Services Bill, HC 236/HL 1447, para 112 Back

813   Ibid., paras 126 and 128 Back

814   HM Treasury, A new approach to financial regulation: securing stability, protecting customers, Cm 8268, January 2012, para A26 Back

815   Financial Services Act 2012, Chapter 6 Back

816   JQ 180 Back

817   EQ 122 Back

818   CQ 40 Back

819   JQ 55 Back

820   Joint Committee on the draft Financial Services Bill, First Report of Session 2010-12, Draft Financial Services Bill, HC 236/HL 1447, para 128 Back

821   AQ 10 Back

822   JQ 55 Back

823   AQ 288 Back

824   AQ 290 Back

825   Q 206 Back

826   Q 2321 Back

827   FSA, Discussion Paper 13/1, Transparency, March 2013, p 9 Back

828   Ibid., p 12 Back

829   JQ 685 Back

830   For example, Ev 802, 1118,1216 Back

831   JQ 637 Back

832   JQq 156, 636-8 Back

833   FSA, Discussion Paper 13/1, Transparency, March 2013 Back

834   JQ 726 Back

835   JQ 266 Back

836   F Ev 124-126 Back

837   National Audit Office, HM Treasury Resource Accounts 2011-12: The Comptroller and Auditor General's Report to the House of Commons, 13 July 2012 Back

838   Treasury Committee, Seventh Report of the Session 2008-2009, Banking Crisis: dealing with the failure of the UK banks, HC 416; National Audit Office, Maintaining financial stability across the United Kingdom's banking system, December 2009; FSA, The failure of the Royal Bank of Scotland, December 2011 Back

839   FSA, The failure of the Royal Bank of Scotland, December 2011 Back

840   "Royal Bank of Scotland Group PLC - Capital Raising", RBS press release, 13 October 2008, Back

841   HM Treasury, Royal Bank of Scotland: details of Asset Protection Scheme and launch of the Asset Protection Agency, December 2009 Back

842   UK Financial Investments Ltd, UK Financial Investments limited (UKFI) update on UKFI market investments, March 2010, p 8. RBS executed a reverse stock split in 2012, therefore a 50p price in 2008 is equivalent to a 502p price today. Current prices are used throughout for consistency. Back

843   Asset Protection Agency, Annual Report and Accounts 2009 - 10 of the Asset Protection Agency, July 2010, HC 259 Back

844   "RBS exits UK Government's Asset Protection Scheme", RBS press release, 17 October 2012, Back

845   "2012 Q1 Interim Management Statement", RBS statement, 4 May 2012 Back

846   Commission State Aid Decision (RBS restructuring plan) 422/2009; Commission State Aid Decision (Financial Support measures for the royal Bank of Scotland) 621/2009 Back

847   "Statement on disposal of UK Branch-based Business", RBS press release, 12 October 2012, Back

848   RBS, Annual Report and Accounts 2009, Back

849   RBS, Annual Report and Accounts 2012, Back

850   Q 4339 Back

851   Q 4535 Back

852   Q 4194 Back

853   Note: this excludes assets such as gross derivative positions. RBS's total assets at the end of 2012 were £1,312bn  Back

854   "Q1 Interim Management Statement 2013 - summary", RBS press release, 3 May 2013, Back

855   "Financial Policy Committee statement from its policy meeting", Bank of England, 19 March 2013, Back

856   "Statement on bank capital", Prudential Regulation Authority, 22 May 2013, Back

857   Q 4531 Back

858   Q 4340 Back

859   RBS Group, Annual Results for the year ended 31 December 2012,, pp 40 and 76 Back

860   Bank of England FLS data. Back

861   RBS Group, Annual Results for the year ended 31 December 2012,, p 3 Back

862   Q 4340 Back

863   A Ev 62 Back

864   A Ev 63 Back

865   Q 4542 Back

866   I Ev 35 Back

867   "Bank lending boost won't turn UK round", The Financial Times, 10 April 2013, Back

868   Department for Business Innovation and Skills, Boosting finance options for business, March 2012 Back

869   Q 4539 Back

870   Q 4341 Back

871   RBS Group, Annual Results for the year ended 31 December 2012,, p 3 Back

872   "Barclays PLC Results Announcement", Barclays, 31 December 2012, p 28; HSBC Bank Annual Results press release p 15. Back

873   IQ 4 [Colin Borland] Back

874   Speech by the Chancellor of the Exchequer at the Lord Mayor's dinner for bankers and merchants of the City of London, Mansion House, 15 June 2011 Back

875   Q 4532 Back

876   Q 4534 Back

877   Department for Business Innovation and Skills, Speech on Banking by the Secretary of State for Business, Innovation and Skills, Rt Hon Vince Cable MP, 6 February 2013 Back

878   Q 4333 Back

879   Oral evidence taken before the Treasury Committee on 23 October 2012, HC (2012-13) 672, Q 8 Back

880   Oral evidence taken before the Treasury Committee on 14 March 2012, HC (2010-12) 1896, Q 14 Back

881   RBS, Annual Results for the year ended 31 December 2011, p iv Back

882   Oral evidence taken before the Treasury Committee on 23 October 2012, HC (2012-13) 672, Q 5 Back

883   Oral evidence taken before the Treasury Committee on 15 May 2012, HC(2012-13) 73, Qq 28-29 Back

884   Q 4333 Back

885   Q 4192 Back

886   RBS Group, Annual Results for the year ended 31 December 2012, Back

887   "Q1 interim management statement 2013", RBS Group, 3 May 2013, Back

888   Q 4531 Back

889   Macquarie Equities Research, RBS Group struggling to deliver returns, 6 March 2013 Back

890   Q 4532 Back

891   Research commissioned by Autonomous, RBS: shrinking pains, 4 March 2013 Back

892   Research commissioned by Nomura Equity Research, 4 March 2013 Back

893   Letter from RBS Chairman to shareholders, 27 November 2009 Back

894   Research commissioned by Autonomous, RBS shrinking pains, 4 March 2013; Nomura Equity Research note on RBS, 4 March 2013 Back

895   Research commissioned by Exane BNP Paribas on RBS, 18 March 2013 Back

896   RBS, Interim Management Statement Q1 2013, 3 May 2013,, Barclays, Interim Management Statement, 31 March 2013,, HSBC, Interim Management Statement Q1 2013,; Lloyds Banking Group, Q1 2013 Interim Management Statement, 30 April 2013,  Back

897   Speech on Banking by the Secretary of State for Business, Innovation and Skills, Rt Hon Vince Cable MP, 6 February 2013 Back

898   CentreForum, Getting your share of the banks: giving the banks back to the People, March 2011, Back

899   "Treasury to burn midnight oil on 'bad bank' scheme", The Telegraph,16 January 2009,; "Underemployed APA unveils plans for RBS 'bad' bank", The Financial Times, 8 July 2011,  Back

900   Q 4192 Back

901   Q 4534 Back

902   Q 4532 Back

903   Treasury Committee, Ninth Report of Session 2012-13, Budget 2013, HC 1063, para 28 Back

904   National Asset Management Agency, Back

905   Federal Reserve Bank of New York, Back

906   Clas Bergström, Peter Englund and Per Thorell (Translation- Timothy Chamberlain), "Securum and the Way Out of the Swedish Banking Crisis", Center for Business and Policy Studies, May 2013 Back

907   "Citi to Reorganize into Two Operating Units to maximize value of Core Franchise", Citigroup Press Release, 16 January 2009, Back

908   Research commissioned by Credit Suisse, Good bank/bad bank: Looking at options, 12 March 2013 Back

909   Q 4176 Back

910   Research commissioned by Nomura Equity Research, 7 March 2013 Back

911   GAO, Capital Purchase Program: Revenues Have Exceeded investments, but Concerns About Outstanding Investments Remain, March 2012 Back

912   "The Andrew Marr show: transcript of Stephen Hester interview", BBC News, 26 February 2013, Back

913   Q 4535 Back

914   Oral evidence taken before the Treasury Committee on 26 March 2013, HC (2012-13) 1063, Q 386 [Sir Nicholas Macpherson] Back

915   Ibid. Q 387 [Sir Nicholas Macpherson] Back

916   Stephen Hester, Annual Results 2012 Analysts Presentation, 28 February 2013, Back

917   Q 4192 Back

918   Q 4532 Back

919   Office for National Statistics, Statistical Bulletin: Public Sector Finances, January 2011 Back

920   Office for National Statistics, Statistical Bulletin: Public Sector Finances, March 2013 Back

921   Q 4543 Back

922   Office for Budget Responsibility, Economic and Fiscal Outlook, supplementary table 2.2 Back

923   European Commission, State Aid Control Overview, Back

924   Commission communication on the return to viability and the assessment of restructuring measures in the financial sector in the current crisis under the State aid rules, Official Journal C 195, 19 August 2009 Back

925   European Commission, Restructuring banks in crisis-overview of applicable State aid rules, European Commission Competition Policy Newsletter 2009-3 Back

926   Ibid. Back

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

928   New Economics Foundation, Stakeholder Banks: Benefits of banking diversity, March 2013 Back

929   Q 3463 Back

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

931   UK Financial Investments Ltd, UK Financial Investments limited (UKFI) update on UKFI market investments, March 2010, pp 6-8 Back

932   Ibid. Back

933   Independent Commission on Banking, Final Report, September 2011, Box 8.1 Back

934   Q 3414 Back

935   Q 3414 Back

936   Lloyds Banking Group, Annual Report and Accounts 2012: Becoming the best bank for customers, March 2013, p 17 Back

937   "Lloyds privatisation gets closer as share prices soar", City A.M., 17 May 2013, Back

938   Q 22 Back

939   Oral evidence taken before the Treasury Committee on 15 May 2012, HC (2012-13) 73, Q 7 Back

940   Department for Business Innovation and Skills, BIS skills for life survey, 13 December 2012 Back

941   Uncorrected transcript of oral evidence taken before the Treasury sub-committee on 13 June 2012, HC(2012-13) 271-i, Q 62 Back

942   JQ 22 Back

943   AQ 619 Back

944   Q 3403 Back

945   Oral evidence taken before the Joint Committee on the Draft Financial Services Bill on 15 November 2011, Q1071 Back

946   Joint Committee on the draft Financial Services Bill, First Report of Session 2010-12, Draft Financial Services Bill, HC 236/HL 1447, para 123 Back

947   JQ 22 Back

948   S117 Back

949   Treasury Committee, Twenty-sixth Report of Session 2010-12, Financial Conduct Authority, HC 1574, p 53 Back

950   Department for Education, The National Curriculum in England: Framework document for consultation, February 2013, p 149 Back

951   All-Party Parliamentary Group on Financial Education for Young People, Financial Education & the Curriculum, December 2011 Back

952   All-Party Parliamentary Group on Financial Education for Young People, Financial Education and the Curriculum, December 2011, page 28 Back

953   Ev 1281 Back

954   European Directive 2007/64 on Payment Services, 13 November 2007m Back

955   Financial Services and Markets Act 2000, Amendments to Part 16 made by Schedule 6 to the Payment Services Regulations (S.I. 2009/209) provide that complaints can be brought to the FOS for the actions of a payment service provider. Back

956   Financial Services and Markets Act 2000 s226; PRA and FCA Handbook, DISP,  Back

957   Letter from Sir Nicholas Montague to the Chair of the Treasury Committee, 28 March 2012, available at Back

958   Members of Sub Committee A: Panel on the consumer and SME experience of banks visited Birmingham on 24 September 2012 to attend an event organised by Which? Back

959   Uncorrected transcript of oral evidence taken before the Treasury Committee on 30 October 2012, HC (2012-13) 701, Q 46 Back

960   FSA, Internal Revenue Service Flowchart, Back

961   JQ 690 Back

962   JQ 686 Back

963   Financial Ombudsman Service, Complaints Data - showing individual financial business, Back

964   JQ 705 Back

965   Financial Ombudsman Service, A quick guide to funding and case fees, Back

966   Office for Fair Trading, Equity underwriting and associated services, an OFT market study, January 2011  Back

967   G Ev 41 Back

968   G Ev 27 Back

969   G Ev 40 Back

970   G Ev 18 Back

971   G Ev 26 Back

972   "UK watchdog swoops on big banks", The Financial Times, 9 May 2013, Back

973   Ibid. Back

previous page contents next page

© Parliamentary copyright 2013
Prepared 19 June 2013