Thursday, 14 March 2013

How to make it easier to get new entrants into UK Banking

Let your customers through.

There are many complaints from politicians and consumer lobbyists that there is not enough competition in UK banking and in particular that there are not enough new entrants. Whilst seven business day switching will be introduced in September 2013 as discussed in http://www.itsafinancialworld.net/2013/02/why-faster-bank-switching-will-not-turn.html this alone is not enough.

There are five actions that need to be taken together to encourage new entrants into the market and allow them to compete. These are:
  1. Speed up the process of issuing banking licences
  2. Speed up the process of approving executives
  3. Reduce the  initial capital required
  4. Provide low cost access to the payments system
  5. Make current account switching easier
Looking at each of these in turn.

The process of applying for and being granted a banking licence is tortuous, time-consuming and very expensive with no guarantee of success. This alone is putting off banks, particularly where the new entrant is foreign. Without a banking licence new entrants are not able to take deposits a vital source of funding given the costs of wholesale funding. Vernon Hill, founder of  Metro Bank, the UK's most visible new entrant, has said  that if he knew then what he knows now about how difficult it would be to get a UK banking licence he wouldn't have started.

This is a major barrier to entry not only for consumer banking, but also corporate and commercial banking.

The process of approving executives by the FSA is typically taking nine to twelve months. This is not only effecting new entrants but also existing players. Even when an executive of one of the Big 5 banks changes role it is often necessary for them to be re-approved for their new role, which makes it difficult for banks to be agile in changing their organisations, which means that poor performing executives are left in place because it is too difficult to replace them. Whilst an executive is going through the approval process they are not allowed to perform their new role. If an executive was approved for a role in an existing bank they will need to be re-approved for the identical role in a new bank. For new entrants this can cause a significant delay in launching the new bank.

Currently when a new entrant wishes to launch a new bank they will need to present their 5 year plan and put aside  from day 1 the 9% capital that they will require when they achieve their 5 year plan. This clearly represents a significant cost to the new entrant and effectively means that the initial capital may represent not 9% but anywhere up to and over 100% of the assets that they will have by the end of the first year of  operating. Whilst the government has annouced that new entrants will in the future not have to put up the full 9% but rather 4.5% this does not go far enough. What is needed for new entrants is that the capital put aside is allowed to increase in line with the assets that they take on. Whilst the practicalities of doing this real time may be too difficult certainly doing it on a projected year by year with a true up at the end of each year would be a far more reasonable approach.

One of the recognised barriers to entry for new entrants is access to the payments infrastructure, both local and international. The cost of this is seen as prohibitive, but without it they will not be able to offer customers the essential ability to withdraw cash from ATMs, make direct debits and standing orders and international payments. The government has talked about making the payments infrastructure a national utility or forcing the Big 5 banks to offer new entrants low cost entry. This sounds eminently sensible, but it cannot and should not be at an incremental cost to the current volumes that go across the payments infrastructure. The reason for this, just like for traditional utilities such as gas, electricity and water, is that the companies that provide them have invested billions of pounds to build the high performing, resilient infrastructure and need to constantly upgrade and improve that infrastructure and those investments need to be paid for by the users of that infrastructure. So whilst the politicians may say that processing of an ATM transaction can be measured in pence and that that is the price the banks should be charging other banks, a  price based on a fair fully loaded cost, including future investment, needs to be calculated. One way to address this would be to get an independent assessment of the cost of providing and investing in maintaining and upgrading these services. This could a role that the proposed Payments Regulator could play.

Finally, as already mentioned, making current account switching is already in progress and is due to deliver in September 2013.

The combination of these changes, announcements on which have either already been made or will shortly be made, will significantly reduce the barriers to entry for new players into the UK Banking sector, but what are the implications of these changes, have they been thought through sufficiently and will they be enough to shake up competition in banking?

Speeding up the issuing of banking licences should purely be about the efficiency of the FSA and its successor. It should not be about dropping the quality of the testing. It is clearly dependent upon the quality of the submission and this falls at the feet of the applying new entrant.

Simillarly speeding up the approval of executives needs to be about efficiency and re-thinking how this approval process is designed.  The current process is far too bureaucratic. There needs to be a distinction between whether the executive is new to the UK financial services sector, new to the role or simply performing the same role for a different bank. Questions need to be also asked as to whether the examiners know enough about the detail of the role to really evaluate the individual's suitability and fitness to hold the position. The current process requires executives to spend a considerable amount of time preparing answers to questions that go no way to deciding whether this person is fit to perform the role. However speeding up the process should not add risk to the banking sector.

Reducing the initial capital required for a new entrant undoubtedly does increase the risk should the new entrant fail. The question is whether that is an acceptable risk. Northern Rock was a retail business - it had no investment banking business. It was also not a large player. However it failed largely due to irresponsible lending. If Northern Rock had been permitted to hold lower amounts of capital the losses would have been even greater. In the rush to create disruption to the hold of the Big Five banks the regulators must get the balance right between making it easier for new entrants whilst still protecting customers from banks that are not as well established and who's balance sheets are not as well protected from changes in the market. Given the measures being taken to electrify the ring fence between retail and commercial banking that are being enforced on the large banks, the Big 5 banks will continue to be a safer option for customers than the new entrants following the introduction of lower capital requirements being proposed.

Forcing a reduction in the cost to use the payments infrastructure comes with the inherent risk that owning and managing the payments infrastructure will become increasingly unattractive to the current owners which could lead to a lack of investment which in turn could lead to a reduction in the resilience of the infrastructure which would in the long term be bad news for both customers and businesses. After 9/11 it was not the destruction of the Twin Towers that nearly brought the US to its knees, but the closure of the airspace which prevented the movement of cheques, which effectively stopped the payments structure working that was the biggest threat to the US economy. An economy cannot survive without an efficient and resilient payments infrastructure.

Faster switching will only encourage customers to move when there is a significant difference in the customer experience and value for the customer to make it worth their while.

As the government and the regulators look at the measures to create increase the number of new entrants coming into the banking sector rather than rushing these in to get good headlines thorough and considered analysis needs to be conducted to really understand the full implications of lowering the barriers to entry.

In the meantime the lack of competition in the UK banking sector should not be overstated. With the likes of Marks & Spencer, Tesco, Virgin Money, Metro Bank, Handlesbanken and Nationwide there has probably never been a time where there has been as much choice and competition in the sector.

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