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Committee publishes findings on competition and choice in banking sector

The Treasury Committee recently (2 April) publishes its report, Competition and Choice in Retail Banking. In the report the committee concludes that the pre-conditions for effective competition in the retail banking market are not present.

The committee highlights in particular a lack of price transparency and comparability in the personal current account market, as well as the difficulty of switching. The report calls on the Government to make competition a primary objective of the new regulatory body, the Financial Conduct Authority (FCA). It also recommends a "public interest test" based on competition considerations for proposed future divestments of Government-held stakes in the banks.

Committee Chairman Andrew Tyrie said:

"For competition to be effective, customers need to know what they are buying, how much they are paying and to be able to transfer their custom from one provider to another without risk. Over the course of our inquiry we heard from not only the top executives at all of the major UK banks, but also smaller players, new entrants, competition regulators and experts.

The CEOs of the large incumbents told the committee UK retail banking was enormously competitive, but a far larger range of witnesses described the industry as close to an oligopoly. We also received much evidence about low levels of consumer satisfaction and poor treatment of consumers by the major banks. We could not but conclude from this that competition in the UK retail banking market is not strong enough.

The Cruickshank Report in 2000 identified problems with price transparency and the difficulty of comparing products. Over a decade on, these problems remain acute. They have been compounded by the fact that following the financial crisis there are now greater levels of concentration in the industry. The 'too big to fail' issue appears to place large institutions at an unfair competitive advantage to smaller, less systemically important ones.

The Government can do more to prioritise competition in the way it regulates the industry; the FCA should have competition as a primary objective. The Treasury can assist competition when it divests further bank stakes. Short-term profit maximisation should not be at the long-term expense of the consumer.

We welcome the fact that the Independent Commission on Banking has competition as part of its remit. The Office of Fair Trading (OFT) told the committee it is working with the banks to try to ensure greater transparency and we call on the banks to make cooperating a priority."

Current accounts and switching

The report expresses concern at the continuing lack of price transparency and comparability in the current account market. Without clear information it is impossible for consumers to distinguish between the offers made by rival providers. Lack of transparency moreover reduces the incentives for those providers to make distinctive offerings. The switching process—despite improvements—remains cumbersome and does not always work smoothly. Effective competition will remain elusive unless urgent steps are taken to improve price transparency and comparability and the switching process.

The fact that the current account is a 'gateway' product means dominance in this market by the large banks has competition implications elsewhere in the sector. This means that barriers to competition in the personal current account market need to be scrutinised particularly carefully, the report says.

Moreover, so-called free banking is not free. The term free-in-credit banking is a misnomer, given that consumers with positive balances pay through interest foregone, the report says. It is also clear that so-called free banking has important distributional consequences. A minority of consumers, often those on lower incomes, pay explicit charges associated with overdrafts. This results in high prices and poor outcomes for a sub-set of consumers. Meanwhile, other consumers, often on higher-incomes, do not pay explicitly for their current account provision, in spite of the fact that their Personal Current Account (PCA) provision clearly does incur a cost.

The report notes that, whilst it is undesirable from the perspective of 'fairness', cross-subsidy is not always wrong. For example, it exists in the airline industry where customers who book early are cross-subsidised by those who book later. However, pricing is far more transparent and customers can easily switch airline provider. These conditions are not present in the current account market where cross-subsidy is opaque and switching costs are high, it says.

Small and Medium Enterprise (SME) lending 

The report notes that the debate on SME banking has too often only been focused on the availability and cost of credit. Good customer service for SMEs can be as, or even more, important to SMEs. Competition and the ability to switch is the most important spur to better service. There are still very high levels of market concentration for SME banking, even though the sale of some of the RBS branches to Santander means the 'Big 4' in the SME sector could in future become the 'Big 5'.

The importance of branches to many SME customers presents a significant barrier to new entrants and therefore to competition. The report recommends that the Independent Commission on Banking considers solutions such as an improved Inter Bank Agency Agreement and neutral shared branches as part of its remit to promote competition.

New entrants and Government divestments

Given the continuing importance many consumers attach to a branch network, especially for current account services, the report notes that new entrants without access to an extensive branch network will be at a considerable disadvantage to established banks for the foreseeable future. This means that the Government needs to examine carefully where it can help improve the conditions for effective competition.

The sale of the RBS divestments to Santander was a missed opportunity to inject more competition into UK retail banking, the report says. Whilst Santander may have met the EU state aid criteria and enjoyed only a small share in the SME market, it was already a leading player in other areas. Whilst none of the large five banks will be able to bid for the Lloyds divestments, the Committee believes a public interest test based on competition considerations should apply both to the Lloyds divestments and the sale of Northern Rock.

The report notes that Lloyds is currently the market leader in most parts of the retail market. In some segments, Lloyds market share is almost double that of its nearest competitor and yet, there has been no assessment to see what impact Lloyd's strong position has had on competition in the retail market. The Committee is concerned by the emergence of such a powerful player and the potential competition implications. Though the divestments required by the EU will go some way towards addressing this concern, as well as (in conjunction with the RBS divestments) reducing concentration levels in the sector, Lloyds will retain a leading position in many market segments even post-divestment. 

Government credibility would be undermined if a merger arrangement approved by one administration was unpicked by another. It would risk politicising competition policy, create incentives for political lobbying and uncertainty for business. However, the need to respect the merger should not inhibit the Independent Commission on Banking from proposing radical changes to the market as a whole, the report says.

Regulation and competition

New entry and reductions to barriers to entry and expansion may alone prove insufficient to tackle the problem of ineffective competition. As a result, the Committee urges the Independent Commission on Banking (ICB) to seriously examine whether there is a case for further structural reforms, over and above the RBS and Lloyds Banking Group divestments, to reduce concentration and promote competition.

Solving the 'too big to fail' problem is critically important from a competition as well as a financial stability perspective. The ICB must also address this issue, which is crucial to achieving the objectives outlined in its terms of reference. The committee is encouraged by signs that the ICB is already considering ring fencing as a possible solution and will monitor its interim proposals, due to be set out later this month, carefully.

The report expresses disappointment that the Government has not gone further in making competition at least one of the central operational objectives of the new Financial Conduct Authority. The report repeats the committee’s previous recommendation, in its Financial Regulation Report earlier this year, that the FCA should have competition as a primary objective. Failure to act on this would repeat a mistake made at the time of the Financial Services and Markets Act (FSMA).

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