Jonathan Ford, Financial Times
New entrants thriving but financial crisis left ‘too big to fail’ lenders even harder to displace
It is one of the paradoxes of the financial crisis. A cataclysm that showed the perils of “too big to fail” banks led also to the largest financial institutions getting even bigger.
Britain was among the worst offenders, sanctioning vast agglomerations of market power during the meltdown. Lloyds Banking Group was allowed to buy HBOS and Santander to gobble up Alliance and Leicester. Consequently an already dominant “Big Five” emerged from the debacle with a bigger market share than when it went in.
The UK has a thriving “challenger” sector, spanning retail and business banking. It ranges from start-ups to bank brands like TSB spun out of the Big Five and supermarket groups such as Tesco. Several challenger banks have floated on the stock market in the past year. Some have growth rates and returns superior to those enjoyed by the Big Five.
Job done then? Not quite. Britain’s challenger banks may be thriving, but they account for just 4 per cent of banking assets. The entrants that have flourished are those serving niche markets neglected by traditional banks, such as small business loans. Key segments such as personal current accounts remain the province of the Big Five. They matter because they are a “gateway” to selling other financial products.
Yet here the Big Five enjoy huge advantages linked to the UK’s fixation with “free in credit” banking. A chunk of the income the banks make from these accounts comes from not having to pay interest on customer balances. As challengers don’t by definition hold these balances to begin with, but must build the infrastructure to support them, they are obliged to bear a substantial deadweight cost.
Virgin Money, for instance, estimates it would need £6bn of customer balances to be on the same footing as Lloyds in funding personal current accounts. At present it has less than a 20th of that.
Of course, the idea isn’t for each challenger simply to ape the incumbents. Metro Bank, for instance, aims to compete by delivering a high level of service through a focused branch network.
Digital banking, meanwhile, offers the chance to play with different models. Low costs could make charging for accounts more palatable. Mining customer data could be a way to finance day-to-day services, luring customers by offering desirable perks.
But launching such innovations isn’t easy in a world where switching accounts remains the exception. In spite of reforms to facilitate this, just 1.5 per cent of current account customers switched last year.
One suggested way forward would be to introduce “account number portability”. This essentially involves creating a single database on which all accounts would be logged. Customers could move their accounts intact from one provider to the next, choosing a bank purely on its ability to provide desirable services. The model is the mobile telephone market, where number portability led to much higher switching, ultimately unleashing the digital cornucopia delivered by the smartphone.
The UK’s challenger banks have made inroads, but theirs is an unfinished revolution. Further growth may come, not least because the Big Five are continuing to shrink their balance sheets for regulatory reasons. But whether this will be enough to spark genuine innovation is moot.
A freer market would deliver real benefits. A more balanced and diverse structure would be safer. Greater innovation would provide better service to the customer — almost certainly at lower cost.
But in the way stands the Big Five; lacking in capital and energy but with 80 per cent of the UK’s deposits. How to surmount it is something the Competition and Markets Authority must determine as part of its investigation into the sector.
One option is to pursue further reform with the aim of levelling the playing field. But while free banking exists, making switching easier or tweaking access to payment systems may be insufficient.
The alternative is to supplement these initiatives with structural change, breaking up existing players to create bigger challenger banks. The problems exacerbated by 2008 may only ultimately be undone by reversing it.
The CMA should not shy from splitting up Lloyds and even Royal Bank of Scotland — two partially state-owned banks the chancellor, George Osborne, is racing to sell.