Banking StandardsWritten evidence from Tony Greenham

Parliamentary Commission on Banking Standards Pre-Hearing Statement

1. Implicit Subsidy

The First Report references Haldane’s TBTF calculation on page 17. We have produced figures for 2010 and 2011 using Haldane’s methodology (and he has referenced our work in his speeches).

I attach the press release with the 2011 numbers (£34 billion), and the relevant extract from the report with the 2010 numbers (Quid Pro Quo)—£46 billion.

2. Banking as a Public Good

There is a strong public interest element to banking. 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.

It has qualities of a public good,1 such as defence, because banks create credit, the acceptability of which is enforced by law. It also has qualities of a merit good, such as health, because there are positive externalities from its provision, such as full citizen participation to e-commerce, helping disadvantaged regional and local economies to develop, and providing opportunity for enterprise.

One further feature of financial services tends toward market failure. The nature of financial products is that the seller has much great information about the quality, value and suitability of the product than the customer. Such information assymetries will prevent pure competition from delivering optimal outcomes. Mis-selling is the result and is as predictable in theory as it is evident in practice.

For all these reasons, if we rely entirely on profit-maximising shareholder banks then it is guaranteed that the retail banking system will be sub-optimal from the point of view both of many customers, and of the economy as a whole. It will leave sections of the population, sectors of the economy, and areas of the country underserved.

Other countries address this problem by having a diversified banking system that includes stakeholder banks as well as shareholder banks. Stakeholder banks, such as customer-owned co-operatives, pursue a broader range of objectives, for example, maximising customer value. They operative on a commercial basis, but balance financial and social goals rather than focusing exclusively on the former.

Last but not least, the stability of the financial system as a whole is an important public good. Systems that are more diversified are more stable and resilient to shocks, and the UK’s retail banking system is unusually concentrated and homogenous.

For example, Switzerland’s large international banks, UBS and Credit Suisse, reduced their stock of loans by 34% between the end of 2007 and 2011 as they retrenched after the crisis. However, Switzerland also has local public banks in every Canton that specifically serve that Canton with retail banking services. The Cantonal banks increased their stock of loans by 22% over the same period. Figures in Germany where -10%, and +16% for large commercial banks and local savings banks respectively.

When we look at the UK, we find that our large banks reduced their stock of loans by 16% between the end of 2007 and 2011. But the UK has no equivalent to the Swiss Cantonal banks, or the German savings banks, or US local banks. Our SME and personal lending has suffered by comparison and our economic performance suffers as a direct result of the structure of our retail banking industry.

3. Competition and Choice

We argue that there is an important distinction between policy that fosters competition and that which improves choice. In some circumstances, competition will erode choice, and choice is important.

The universe of possible lending opportunities can be divided into three groups:

Definite yes: loan applications from customers with excellent credit histories, a clear proposition and good collateral.

Viable but not straightforward: loan applications that are probably economically viable, but not yet clearly bankable.

Definite no: loan applications that are not commercially viable.

At any prevailing set of interest rates and economic conditions, the proportions between the three groups will vary.

The third group should not be given credit.

The first group is well suited to private shareholder banks that operate at national or international scale, with centralised credit scoring and underwriting systems. This issue here for the UK is lack of effective competition, as has been more than adequately documented. I believe that progress being made on lowering barriers to entry and encouraging challenger banks will help. I also believe that the role of disruptive business models such as crowd-funding and peer-2-peer lending will be a significant factor in driving competition. I do not have much to add to this that others present and previously before you cannot better express apart from one thing.

It must be clearly understood that licensed deposit-takers create money. They create new, additional bank deposits when they lend. P2P lenders cannot create money, and are pure intermediaries, transferring existing bank deposits from savers to borrowers. If P2P lenders gain significant market share of the personal and SME lending market, then there will be an impact on the expansion and contraction of the money supply and hence a macro-economic impact will result from these structural changes in banking. This has not been given any recognition in my view, but should be investigated.

The second group is where I would like to focus attention. Successful lending to this group requires more intimate knowledge of the customer and his circumstances. The loan size might also be on average lower, and for all these reasons the transaction costs are therefore higher. These commercially viable loans are not always profitable for large centralised national banks, who can deploy capital across multiple sectors, regions and countries.2

It is crucial to note that this economically viable lending does not take place purely because of structural factors in the banking industry. There are broadly two approaches by our industrial competitors to address this problem:

1. Public service obligation on private banks. This is the US approach through the Community Reinvestment Act. It uses transparency and other regulatory mechanisms to incentivise commercial banks to provide capital and other support to specialist community finance institutions that have the skills and expertise to serve the economically viable but not straightforward group.

2. Public service banks. This approach is characterised by European co-operative and public banking sectors. Either state-owned or mutual, these banks target a lower rate of return and effectively cross-subsidise to serve unprofitable customers and ensure provision of essential banking services (including branches) to all areas of the economy.

4. Recommendations

There are two elements to improving competition in UK retail banking:

Measures to increase competition for easy to serve customers;

Measures to ensure choice and diversity of provision for customers that are not easy to serve.

The second element could be achieved by.

measures to support the scaling up of the UK community investment sector, including incentives for private commercial banks to support financial provision by this sector;

creation of new mutual and public interest banking institutions, possibly with the involvement of local authorities;

retaining RBS as a public sector bank, stripped down to the core high street business and disaggregated into a network of local banks (at City and County level) with local stakeholder representation and objectives.

28 January 2013