Banking StandardsWritten evidence from Lloyds Banking Group
Executive Summary
Various questions and concerns have recently been raised during the course of the Parliamentary Commission on Banking Standards (PCBS) in terms of improving competition and financial stability through changes to the UK payment systems. A couple of options—full sort code and account number portability (“portability”) and a common utility banking infrastructure (“bank utility”)—have been proposed as solutions to address these concerns. As we made clear in António Horta-Osório’s letter to Andrew Tyrie (dated 21 November 2012), whilst we are supportive of the principle that competition and financial stability can and should be improved, there has been an unhelpful level of confusion about and conflation of these solutions and the benefits they aspire to bring to the market. We are also concerned that the significant benefits of the world class switching service, to be launched in September this year, are being lost and undermined in this debate, which is a terrible shame especially for consumers.
Therefore, we have undertaken further work to draw out the pros and cons of the various options being considered and the concerns they are trying to address. Some of what is being discussed poses significant risk, with concerning unintended consequences, which do not outweigh the benefits to UK consumers, businesses and society as a whole. Our views are based on real experience from the integration of LTSB and HBOS, the largest banking integration completed in the UK in the last 10 years, and our position as a major player in the industry, at the forefront of change. Moreover, we have developed an alternative solution which we believe merits consideration. We have shared this work with the PCBS’s expert Professor Dave Cliff.
We believe the most effective, efficient and speedy solution is not in a bank utility and/or portability—but also realise that the new switching service alone is not a universal panacea. We propose a four part solution building on developments already in progress and on existing “proven” systems which can be delivered in parallel at a fraction of the cost, time and risk of other solutions:
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We do understand that this is a complex and wide ranging set of issues and we would support a sensible independent third party cost/benefit analysis of the different available options, paid for by the industry, to confirm our thinking.
There are a number of UK payment system and banking issues currently under the spotlight
A number of stakeholders have suggested to the PCBS that competition and financial stability could be enhanced through changes to the UK payments system. Three key topics have been under the spotlight:
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A pragmatic combination of four initiatives could address concerns efficiently and effectively
As discussed in detail below, Lloyds Banking Group (LBG) believes that concerns with the payments system and banking infrastructure can be most sensibly addressed via a combination of four initiatives delivered in parallel which, at a fraction of the risk, complexity, disruption and cost of account portability or a utility infrastructure, will deliver improved consumer outcomes.
The new account switching service, to be delivered in September this year, will deliver the account switching outcomes that have been called for. It will provide a fast, hassle free and guaranteed switching experience, where all the risk sits with the bank rather than the consumer. Critically, the new redirection element of the switching service will ensure all transactions are automatically routed to the new account, providing consumers with certainty and confidence that they can change banks safely.
The Payments Council recently announced a Mobile Payments solution that will enable consumers to make spontaneous payments using just a mobile phone number—introducing an account portability-like identifier. Consumers will no longer need to share their bank account details for spontaneous payments, meaning payments can continue unaffected and uninterrupted should a consumer switch bank.
While a feasibility study would need to take place, in principle we believe that Mirror Bank accounts could provide a workable solution to the current resolution and recovery issue. Large banks could be compelled to implement Mirror Bank structures to ensure large institutions can be resolved in the event of a bank failure, with minimal impact on consumers. Under Mirror Bank structures, banks would maintain a duplicate consumer account into which FSCS could be paid in the event of a bank failure. These mirror accounts would be held on existing infrastructure, segregated from the principle account and under a separate legal entity. This would enable quick and efficient electronic FSCS pay out, providing continuity of banking services to customers of the failed bank via the mirror bank and mirror accounts, and the option to switch to another bank if desired.
LBG also proposes that the Payments Council in conjunction with Vocalink be compelled to lead the development of a new Payments infrastructure “lite” which would allow smaller institutions and new entrant banks direct access to payment systems and networks without the same underlying complexity or cost base as the bigger banks.
A high level comparison of these options with bank utility and portability is summarised in the following table.
By adding a new payments infrastructure “Lite” to the developments highlighted above, we believe that within four years and at a fraction of the risk, complexity, disruption and cost of a bank utility or portability, the same goals could be achieved by alternative means.
A significant switching improvement will be delivered in September 2013
The switching service delivers what consumers really want
In September this year a world class switching service will be delivered in the UK for retail customers, small businesses and charities. The switching service was designed using consumer research to deliver what consumers actually want—namely a way to change bank provider which is free, quick, simple, hassle free, guaranteed and with zero risk. Research has consistently shown that the specific process doesn’t matter to consumers as long as these objectives are met.
We are concerned that the benefits of the new switching service are being lost and confused
Some of the key features of the new switching service seem to have been forgotten or misquoted by a number of stakeholders.
The service is free for the consumer, with costs paid for by the new bank. The cost per switch to the new bank will be £7 to £15 per switch (not £50 as referred to in recent oral evidence). This compares favourably with the current ToDaSSo switching process, especially considering the many additional facilities included in the new service and the opportunity it will present to banks to simplify and automate internal processes.
The service is guaranteed, with all the risk sitting with the banks and not consumers. A critical element of this is the redirection facility, which automatically and seamlessly ensures that transactions (such as Direct Debits and Standing Orders) are routed to the new account. This redirection appears to have been overlooked by some commentators, but is one of the most important elements of the new switching service and provides consumers with assurance that payments will not go astray.
The entire service is fast and hassle free. Consumers need only to speak to the new bank, and only a single instruction is required throughout the entire process. The new seven working day timeline provides clarity and trust, with consumers confident that from the eighth day they can start using the new account exactly where they left off as the account balance and all other payment details will have been transferred overnight to the new account.
The switching service needs universal support to change consumer perception and behaviour
The new service will be delivered in September this year, and will be launched with a substantial independent marketing campaign to raise awareness, funded by the industry.
This is a rare opportunity to really change consumers perceptions of switching and enhance competition, which needs full universal support from all stakeholders rather than conflicting and confusing messages on account portability or bank utility platforms. The Independent Commission on Banking recommended that the benefits and outcomes of the new Switching Service should be reviewed in September 2015 having been given time to bed down, and more recently the OFT reiterated this, recommending that the FCA or CMA review the success of this new switching solution at least 15 months after it is delivered before considering alternative solutions. We strongly endorse this position.
Some have speculated that account portability might be a better solution to improve bank account switching
Account portability isn’t as simple as it sounds
Account portability, in simple terms, is a process that would enable consumers to retain their unique identifier (currently sort code and account number) if they choose to switch to another bank—removing any risk that payments (such as Direct Debits) would go astray. All consumers and businesses in the UK would need to be issued with some form of new unique identifier for every account they currently have, including not just current accounts (including personal and joint accounts), but also other types of account such as savings accounts, mortgages, etc. In practice, many consumers would have to have a number of unique identifiers, in many cases at least four (unlike mobile phones where most consumers only have one which they remember and attach a value to).
While it is technically feasible to implement account portability, it would be incredibly complex. Fundamentally separate bank infrastructures and payment systems would remain, but everything would need to be re-engineered to decouple sort codes and account numbers from the systems used to (1) route, (2) settle, (3) post/apply and (4) account for transactions between different banks. On top of this, a new central routing table would be needed to link unique customer identities to the multiple existing identifiers (for example international account identifiers). 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.
The key consumer benefits from account portability are already being delivered by the new switching process
Advocates of account portability believe that consumers would be more likely to switch if they retain their bank details, as there would be zero risk of direct debits and other regular payments failing. While consumer research does show that the risk of payments failing is currently a major concern for consumers, this is already being addressed as a priority by the new account switching service via the redirection facility which ensures that all transactions are routed to the new account. Supported by the switching guarantee, this means all the risk of switching sits with the bank and not consumers.
Some advocates have also assumed that account portability would deliver near instant switching, however in practice portability would still require three to five days for accounts to be opened and collateral to be delivered. In comparison the new account switching process will take a guaranteed seven working days, providing consumers with clarity and trust in the timeline. We also believe there is potential for competitive forces to reduce this over time.
Recent consumer surveys conducted by Which? and Quadrangle on account portability and the new switching service respectively have delivered similar results, demonstrating that consumers simply want an easier way to change banks and the specific process doesn’t actually concern them.
Comparisons to the mobile phone portability process ignore key product and consumer behavioural differences
Many commentators have drawn comparisons between mobile phone number portability and bank account switching. In practice, we believe these comparisons ignore significant differences between the products and consumer behaviour and are districting from the real issue at hand.
Consumers attribute a value to mobile phone numbers, as generally most consumers only have one phone number (making it easy to remember) which is shared with a large number of parties including friends, family, work colleagues and businesses. Without mobile phone number portability, the process of notifying all parties of a change of number would be arduous. In comparison, the majority of consumers have more than one set of bank details (for example some consumers hold several current accounts and many also have savings accounts etc), and bank details are generally only shared with a very small number of parties—predominantly businesses—who are automatically notified of any switch under the new switching service.
In fact, we believe the mobile phone portability process is inferior to the new bank account switching service. For example, unlike the new bank switching process, the mobile phone process involves consumers negotiating between the old and new provider (often subject to delays, errors and pressured retention sales), has no specific end-to-end switching timescale (leaving consumers carrying two phones and responsible for checking when the process has completed), often involves a loss of service for a period of time, and pay-as-you-go consumers forfeit any remaining credit balance when they switch.
In conclusion, account portability risks being a dangerous and expensive “white elephant”
All of the key consumer benefits that account portability would bring are already being delivered by the new switching service, which needs the full support of all stakeholders to avoid consumer confusion and the new service being undermined before it is even launched. Comparisons with mobile phone switching are only confusing the situation, a better comparison would be property post codes which are interconnected to many other services and functions.
While we do not dispute that account portability is technically feasible, the risks and costs involved would result in a negative consumer outcome. For example, during the implementation stage, which would take many years, innovation would be significant reduced as resources and expertise would inevitability be diverted to delivering portability. Existing systems would also be subject to a period of “lock down” to de-risk the implementation of such a fundamental change, again restricting innovation and discouraging new market entry. Consumers, businesses and international parties would also suffer direct disruption, as for example new collateral would likely need to be issued and Direct Debit originators would need to adapt to new identifiers replacing sort codes and account numbers. In practice it would be unlikely that all banks would be able to make the change at exactly the same time, resulting in a need for complicated conversion processes, with consumers and business confused as to what bank details are valid.
Given all of this, we urge universal full support of the new switching service to give it the best possible chance of success. Only if it does not have the desired impact, after a bedding in period, should any consideration be given to portability or alternative solutions.
Going beyond portability, a utility core banking infrastructure has also been proposed
Utility core banking infrastructure is an extreme solution
Both the new account switching service and account portability are tools to facilitate consumers moving between banks, fundamentally based on existing bank and industry infrastructure. A utility banking infrastructure is quite different, it would effectively wipe the slate clean and replace most existing bank and industry infrastructures.
Most simply, a bank utility is a single common core banking infrastructure which all banks access and use, with one accounting platform (holding customer and account information), one set of middleware (holding products and services) and one set of engines and gateways to manage transactions. Customer relationships would continue to be managed by individual bank channels (branches, internet, telephone, etc), but behind the scenes all the customer data and processing would be held and managed on the central utility infrastructure.
A bank utility could feasibly address concerns if the industry in the UK were starting with a blank piece of paper
We do not doubt that a utility infrastructure would be worth considering if we were starting with a blank piece of paper. It certainly would address the key concerns that commentators have raised, namely making it easier to switch, aiding recovery and resolution and providing “plug-and-play” facilities for small and new entrants. The problem is that we are not starting with a blank piece of paper; the UK has one of the most advanced banking and payments infrastructures in the world, the envy of many countries, 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. Furthermore, we believe that a utility banking infrastructure would create a new set of issues.
Based on real LBG experience, implementing a utility banking infrastructure would be a long and immensely challenging process
LBG is in a unique position to comment on such a significant banking infrastructure project having just last year delivered successfully the largest banking integration programme in the UK in the last ten years. LBG took three years to integrate LTSB and HBOS, which involved only a subset of the programme that would be required to build a bank utility infrastructure as we were migrating to a platform that was already in place and tried and tested. During this time, all developments on the legacy and target platforms had to be frozen to protect the delivery of integration.
Implementing a utility banking platform would in effect be like multiplying the LBG integration many times over, migrating each existing banks data to a new single platform. Unlike the LBG integration, additional time would be required to specify, procure, build and test the new infrastructure in the first place. It would only be possible to migrate one bank at a time, making it is difficult to see what bank would go first (and risk being on an untested platform) or last (and risk being some years behind other competitors). As demonstrated in the diagram below, we estimate that it would take at least eight years for a utility infrastructure to be implemented (of which at least five years would be migrating data onto the new infrastructure).
Each bank migration would pose huge consumer risks—35 billion pieces (equal to 2.5 petabytes) of data and £127 billion worth of balances were migrated when Halifax and Bank of Scotland moved to the LBG infrastructure. Leading up to the Halifax and Bank of Scotland migration, over 18 months of testing took place (c.250,000 test scenarios) with a total of eleven technical, business and full-scale migration dress rehearsals. The total aggregated cost of integrating LTSB and HBOS was £2 billion for a subset of the programme that would be necessary to create a banking utility.
The implementation of a utility banking infrastructure would have a hugely detrimental impact on consumers and business, with innovation effectively frozen throughout the process, products and services potentially being changed or withdrawn to cope with the harmonisation that would be necessary to move to the new infrastructure, high risk of service interruptions, confusion and compatibility issues during the migration phase and likelihood of new collateral being issued. With the current pace of technological innovation the infrastructure would also be at risk of being obsolete before the last bank migrates to it, putting the UK years behind other countries. All of this would be going on in the context of other massive industry change, including the LBG and RBS divestments, FATCA, Dodd Frank, Ring Fencing, etc.
A utility infrastructure could have a number of significant unintended consequences
During the implementation phase, a mandatory “lockdown” would be required across the industry to ensure compatibility with the new utility infrastructure. This would in effect stifle innovation for up to a decade, in particular during a time when technological advancements are anticipated to have a major impact on UK banking. The implementation phase would also likely restrict any new market entry as new banks would likely want to wait until the new infrastructure is built rather than invest in a legacy system. Overall, competition would be seriously hampered.
If implemented, we believe competition would continue to be restricted, rather than increased, by a utility infrastructure. Banks would be unable to develop and innovate beyond central infrastructure capability, and there would be a lack of incentive to collectively develop the infrastructure as there would be no competitive advantage to gain. Price would likely become the key differentiator between banks, with larger banks able to benefit from economies of scale and under-price smaller banks, leading to market consolidation.
While a utility infrastructure would likely be able to permit “tick-box” instant switching, this could actually work against financial stability by making a run on a bank quicker and more likely. For example an inadvertent rumour could spark a run and the demise of a bank within hours as customers vote on line with their feet.
All payment system users, not just banks, would need to update systems to accommodate new customer identifiers. Currently there are around 50,000 submitters of transactions, all of which would have to develop their own systems to cope with the change (and to manage during the transition when some banks have migrated and others haven’t).
A utility infrastructure would represent a single point of failure, the size of which has never been seen before. Any system failure, such as the issues faced by some banks in 2012, either during migration or once fully implemented, would effect every consumer and business in the UK (and potentially internationally), potentially bringing the economy to its knees. The infrastructure would also present a substantial target for a terrorist or cyber attack, and as every bank would use the same infrastructure there would be an increased likelihood of a “rogue” employee gaining access and damaging the system for all.
While this is by no means an exhaustive list of potential issues and unintended consequences, it demonstrates the seriousness of the risks posed by a utility infrastructure.
In conclusion, a utility core banking infrastructure is technically feasible but the benefits are significant out weighed by the risks
A bank utility infrastructure is technically feasible, and would address many of the banking payment system concerns noted previously. However in practice, a bank utility would be incredibly challenging to implement, with some kind of disruption to consumers and businesses inevitable. There is also a strong likelihood of the unintended consequences leading to worse consumer outcomes. We believe that this level of change and upheaval is unnecessary given other practical solutions which can also address the same goals at a fraction of the risk, time and cost.
A pragmatic combination of four initiatives could instead address concerns efficiently and effectively
We believe that developments which are already in progress allied to additional developments that could be built within current infrastructure with minimal risk and complexity represent the best way forward for the UK plc, consumers, businesses and competition.
As discussed above, the new Switching Service will be implemented in September 2013 and it will make it quick, consistent and hassle free for consumers, small businesses and charities to switch banks. This will be backed by a comprehensive guarantee provided by all participating banks, ensuring risk sits with the bank and not the consumer.
The new Mobile Payment solution announced recently will go live in April 2014 and will deliver portability like simplicity for making and receiving spontaneous payments using mobile phone numbers. With consumers confident that the new switching service will deal with redirecting all regular payments (such as Direct Debits for utility bills), and the new Mobile Payments solution effectively taking spontaneous payments (for example to friends and family) out of the equation when switching, there are no additional meaningful benefits from delivering account portability.
In addition to these world leading and exciting developments, LBG proposes two further workable solutions:
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LBG would support an independent cost/benefit analysis to consider a utility infrastructure in comparison to our four initiative plan. This should be conducted imminently and be paid for by the industry. We believe that this would confirm our thinking that an approach that builds on established and proven infrastructure is the most effective and efficient approach to address the concerns of stakeholders.
31 January 2013