Monday, 5 November 2012

Why Sandy could be good for the Insurance industry


There is no doubt that Superstorm Sandy has wreaked damage across both the Caribbean and the east coast of the United States of America. To the layman claims of $15-20bn sounds like a financial disaster for the Insurance industry. However the financial consequences of Sandy may be positive for the London Market and the Commercial Insurance sector in the long term.
It's a financial world (iafw)  talked to Christopher Ling (CL), Commercial Insurance expert and Head of Insurance for BearingPoint in the UK to understand more about why Sandy could have long term benefits for the industry as well as the short term causes. We started by asking him about the size of the loss.
CL: In terms of financial loss this is a medium severity Catastrophe Loss. This makes it large enough for the market to think about buying more reinsurances in the near future without the reinsurers being impacted by a major loss. Rates and hence margins will rise. Sandy should act as a stimulus in encouraging US primary property insurers (more attractive than US liability business) to go out an place orders for more reinsurance business in the London Market. This will lead to an influx of  new risk capital and players creating demand for consultancy services, with the consequential increase in fee income.
People will always need Insurance and losses like this, as sad and as dreadful as they are, serve to remind clients and customers of this.
iafw: So who pays for Sandy and how much?
CL: Catastrophe Modelling Agencies have been busy. Economic total loss estimates have been put at  $30bn-$55bn with some $15bn-$20bn needed to fund estimated insurable indemnity losses.
The consensus is primary US general insurers are likely to bear the brunt of the thousands of small to medium flood, wet damage, denial of access and loss of profits claims. The net written premium of Lloyds of London is currently some £24.8bn ($40.0bn). Whereas economic total loss estimates have been put at  $30bn-$55bn with some $15bn-$20bn needed to fund estimated insurable indemnity losses. US Insurable Cat loss estimates tend to exclude claims under the National Flood Insurance Program as well as the significant parts of the Infrastructure and municipal clear-up costs that are likely  arise. The Queens’ fires could hit Cat treaties, but the biggest unknown is the extent of the Loss of Profits indemnity, which is being driven by clear-up resources and prolonged power outages. It will probably be a couple of months before a level of confidence in the final estimate emerges.
The New York Metro could possibly be led by a major underwriter and reinsured around the market. The Power Plants written on Specialty Risks Energy policies, and there will be some Catastrophe Claims – but generally it is likely that many Reinsurers will have been lucky.
iafw: Whilst there wasn't snow in Manhattan a lot of snow fell elsewhere on the eastern seaboard, Why is it important when the snow melts?
CL: The combination of the two air masses led to intense snowfalls in the Eastern USA. As it is still October, it is likely that as well as disruption, the snow will melt rapidly in the next few days. Depending when it melts will impact the future loss severity. If it melts in 2 weeks’ time,  the tides will be on  Springs again, then it is likely that narrower reaches in urban areas will experience significant localised flooding, which will also impact  lower lying areas of New York.    If it melts in 1 or 3  weeks’ time on  Neaps tides that are not so high, then flooding will be markedly less.
iafw: We've seen a lot of natural disasters over the last few years, how have the  Reinsurance Catastrophe Market been?
CL: The Windstorm Catastrophe Reinsurance market losses in recent years have been benign. The market has broadly been profitable since 2005 (Hurricane Katrina and total Catastrophe Losses estimated at US Insurable losses tend to exclude claims under the National Flood Insurance Program as well as the significant parts of the Infrastructure and municipal clear-up costs that are likely  arise. $118bn).  Even through the Japanese Tsunami, Thai floods and New Zealand earthquakes, the market by and large  managed to fund losses out of cashflow rather than its capital base. The 2011 underwriting year was in fact the second largest Catastrophe loss year on record (to 2005) but the strength of the market and its modelling capabilities has resulted in depressed margins rather than recapitalisation calls.
After the losses of 9/11 (2001), which were comparable in real terms to Hurricane Andrew (1992) a whole new set of investors entered the reinsurance and specialty market as rates rose by 30%  over the subsequent 2 years. This was  the “Class of 2002” – several  major Lloyds capital vehicles created to fund and underwrite Catastrophe and Specialty loss business at these increased rates without the baggage and funding commitments of previous Lloyds involvements and losses.
Since 2002, these capital vehicles have generally made very good returns against their A or A+ paper and the reinsurance market has tended to remain profitable, whilst the primary general insurance market is just coming out of the bottom of a prolonged market cycle dip. However, as with the rest of the economy, there has been nothing to stimulate extra demand for insurance – until 4 days ago.
iafw: This was the first time that we have seen Manhattan hit by such bad weather. Why did this particular storm have such a big effect? 
CL: It must be appreciated that losses of this type are dreadful to the average man in the street or to businesses and some deaths have occurred. However, although winds only gusted at 70-90mph, New York was devastated by a much higher tidal “Storm Surge” of 13’11”  (as opposed to the originally anticipated 11”) caused by wind and negative barometric inversion. The offshore islands acted as limited breakwaters and devastation is likely to be higher here.  Importantly, direct wind-damage losses were not as significant as originally envisaged.
This surge led to severe flooding in Lower Manhattan (much of which is below High Water Springs sea-level) and significant flooding on the Lower East-side from Brooklyn to Queens. Over 375,000 people were evacuated and 650,000 households in the NY  were left without power, including all properties below 42nd Street. Furthermore, a power plant exploded in Queens and there was a major fire burning over a 100 properties. Luckily the New Jersey side of New York harbour has managed to escape the brunt of the flooding due to not being in the path of the travelling flood waters.
Outside of New York,  Atlantic City, Ocean City and parts of Baltimore, Maryland etc. were also  severely hit by flooding and Storm Surges. It should be noted that Levee and flood defence building in the US has not taken priority for many years.
iafw: We've heard a lot about 'Storm Surges' and 'Negative Barometric Inversion' during the coverage of this story as being the loss causes - What are they?  
CL: Sea water piled up into Eastern Seaboard  Estuaries leading to flooding caused by a number of combining  factors;-
·         An intense and highly unstable, humid, anti-clockwise rotating, air-mass; colliding with a cold stable clockwise rotating northerly air mass; led  to extremely rapid condensation (torrential rain),  and the air mass being accelerated in a North Westerly direction to at speeds of 23-28mph (and hence waves) straight up the Eastern Seaboard rivers.
·         Extreme low pressure – sub 940Mb literally “sucked” water-levels up, which were already at a peak due to equinoctial  Spring tides. The average global barometric pressure is 1013.2 Mb. A reduction of 1 Mb results in an INCREASE of just under 1cm in sea-level.
The” bath-tub effect” of water surging  up the Eastern Seaboard  Estuaries caused levels to rise even further when reaching geographic constrictions, such as the Long Island Sound, leading to even higher water levels

iafw: Sandy is undoubtedly a human tragedy which will continue to have a devestating impact on people, particularly as the weather gets colder. As was seen after Katrina, it sometimes takes a disaster of this scale to get the investment in infrastructure that could have prevented the worst effects of the storm to be made. For many years it has been obvious that Manhattan was vulnerable to water levels rising and that the equivalent of the Thames Barrier was needed to prevent this. Irrespective of which candidate is elected as President hopefully the lessons will be learnt from Sandy and the necessary investments in infrastructure on the eastern seaboard will be made which will be good for the economy, good for the residents and will be good for the commercial insurance industry. 

Friday, 19 October 2012

Do banks need to be IT experts?



The news that Santander is walking away from the acquisition of 316 branches from RBS (Royal Bank of Scotland) due to delays in  the IT project to deliver the branches and customers to Santander once again brings attention to the dependency of banks on IT. This comes hot on the heels of the problems RBSG had with providing customers access to their Natwest and Ulster Bank accounts, the loss of access to ATMs that Lloyds and Halifax customers had recently and similar  periodic outages that Australian banks have continued to have over the last eighteen months.

There is no doubt that banks are hugely dependent upon technology to deliver services to their customers, however there are significant differences between banks as to how they address this need.

Santander for many years has been clear that having ownership of world class IT competencies is critical to the success of the bank and has underpinned the growth of their business. As the Executive Vice-President Operations and Technology at Santander CIO, Jose Maria Fuster, has said “At Santander, technology has always been considered a competitive weapon". In the early 2000s Santander put in place what is effectively their own internal IT company called Isban, which was responsible for building their core banking platform, Partnenon, and their core front end, Alhambra. These two platforms that have enabled Santander to deliver the synergies from acquisitions across the globe including in South America, and Abbey National, Alliance & Leicester and Bradford & Bingley in the UK. The strategy of having a single global platform for all their banks across the globe, whilst it has had its challenges, has enabled Santander to be one of the most efficient banks in the world. Others have tried to emulate this, HSBC and Citibank amongst them, but none have achieved it to the extent of Santander. The customers of RBS associated with the 316 branches would have been migrated onto Partnenon had the deal gone through to completion.

A bank that is taking a radically different approach to Santander is National Australia Bank. Gavin Slater, Chief Operating Officer, says "While we are an information technology driven company, we aren't an IT company". Banks today "do not have the expertise or R&D budgets" to invest in building its own systems. "I don't want to be owning boxes, I don't want to be owning networks, switches, software," NAB instead wants to be an orchestrator of technology services and introduce variability into its cost base by only paying for what it uses. Not only does NAB not own the kit sitting in its datacentres or the network infrastructure, but NAB looks to suppliers to carry out the systems integration.

The model that NAB has implemented changes fundamentally the role and the competencies required of the IT function. For a start it means that the CIO  should be able to spend far more time focussing on understanding the businesses requirements and both how technology can enable them as well as provide new opportunities for the bank. It also means that the CIO has to have exceptionally strong supplier management skills. The IT function will be dramatically different from that of an organisation such as Santander. It will be a far slimmer organisation with the principle competencies being relationship management (both internal business and external suppliers), enterprise architecture and innovation.

Santander and NAB are at two extremes of the models for IT for banks. Barclays went through the process of outsourcing significant parts of its application maintenance competency to Accenture only to bring it back in house again. Lloyds Banking Group has outsourced a large proportion of its application development and maintenance competency to a set of competing Indian offshore organisations. HSBC is more akin to Santander seeing IT as a core competency that it wishes to keep in house but, unlike Santander, largely offshore.

Whilst it has been accepted wisdom that IT is a differentiator for banks and that the intellectual property encapsulated within the software should be guarded and treated as top secret not all banks agree. With the increasing use of free and open source software banks such as Deutsche Bank and Credit Agricole have announced initiatives to share their software and their APIs with competitors and external software engineers much as Apple encourages programmers anywhere to develop apps for its App Store.

Deutsche Banks' Lodestone Foundation's aim is to “quickly and convincingly build the go-to non-profit open source foundation for financial markets”. That would mean attracting developers who are able to write software that can then be used by the whole industry. Sharing market software, Deutsche says, will save it and other big global banks some of the billions of dollars and euros that they would otherwise have spent building or improving on individual technology systems.

Credit Agricole has launched its CAStore where software engineers can download Credit Agricole APIs, build apps which customers will then be able to download. An example of crowdsourcing for application development.

As increasingly the major banks across the globe find their ancient systems creaking, failing and in need of replacement while at the same time the demands for technology-enabled solutions largely driven by the rise and rise of digital grow, the question bank CEOs and COOs need to be asking is whether the existing model for delivering IT is sustainable. As Gavin Slater of NAB points out when is a bank ever going to compete with the $2.5bn investment in R&D that the likes of Oracle makes?

Is NAB right? Is the Santander model no longer cost effective? Only time will tell, but one thing is sure banks across the world are watching and waiting to see what lessons they can take and apply.

Tuesday, 2 October 2012

Is Bank of Ireland leading the way for UK banks?



The Bank of Ireland is making some bold moves that the UK banks have to be curious to see whether they are successful. From November customers with the Bank of Ireland will need to maintain a current account balance above 3000 Euros (£2400) to avoid paying charges for banking services. The UK banks will certainly be interested to see how customers react to this, what is essentially an end to free-banking for a large proportion of the Bank of Ireland customers. There are two obvious outcomes from this move. Some customers will simply accept the charges  and some will leave, either for other banks and building societies or will join the ranks of the unbanked. The customers who stay  with the bank will become more profitable, certainly a requirement for the bank to overcome the problems it continues to face as a result of the financial crisis. However will the bank be less profitable as a result of the customers leaving? The majority of the customers who will take their banking relationship elsewhere will be those with low current account balances, arguably some of the least profitable customers they have, so the bank may not be that upset to see them leave. Indeed the Bank of Ireland may actually be delighted to see these customers joining competitors taking up their rivals time and resources.

The second bold move on the part of the Bank of Ireland is to reduce over the counter cash services in 40 branches to only three days a week. In these branches on the days when a teller service is not available customers will be able to use self-service devices. The Bank of Ireland argues that in their successful pilots 80% of over the counter cash transactions can be serviced by other banking channels. When you examine the personal customers that continue to use teller executed cash transactions the vast majority will fall into the low current account balance segment that will be hit by the introduction of bank charges, those who are currently unprofitable and therefore those that the bank wants to either pay their way or are happy to see leave. However it is the business customers who carry out the majority of over the counter cash transactions and these are, generally, profitable customers. It is these customers that the Bank of Ireland will want to retain and hope to do so by persuading them to either use self-services machines, other banking channels or restrict their cash transactions to Mondays, Tuesdays and/or Fridays. Of course ultimately if customers can live without tellers for two days a week the Bank of Ireland must be hopeing that in the end they live without them at all.

The reason that these moves by the Bank of Ireland are particularly interesting for the UK banks are that they are faced with pressure from the Government to end so-called 'free banking', there are too many customers who are simply unprofitable and all the UK banks have too many branches. If Bank of Ireland can prove that the introduction of fees does not result in a significant defection of profitable customers to rivals then it is to be expected that the UK banks will follow suit. If the Bank of Ireland can also demonstrate that business customers can be persuaded to use other banking channels and self-service devices for over the counter cash transactions then UK banks can look at reducing the costs of branches by reducing the number of staff that are employed in them or even closing them.

When it comes to personal customers using teller services all of the major UK banks with the exception of Santander, have signed up with the Post Office to allow their customers to carry out these transactions in the Post Office branches. It doesn't take a great stretch of the imagination to hear the banks make the argument that if there is a Post Office in town then there is no need for a bank branch and for branches to subsequently close. This could lead to the Post Offices processing the vast majority of over the counter cash transactions. The irony of this outcome is that the bank behind the UK Post Offices financial services is none other than the Bank of Ireland.

Tuesday, 18 September 2012

The end of the Retail experiment in Retail Banking?






With the announcement that Joe Garner, CEO of HSBC's UK retail bank and First Direct, will leave the bank early next year, following in the footsteps of Deanne Oppenheimer (Barclays), Andy Hornby (HBoS) and Helen Weir (Lloyds Banking Group)  the era of  former retailers running UK banks appears to have come to end.

The recognition that Retail Banking had lessons to learn from the retail industry was really born with the launch in 2000 of the 'Occasio' branches by Washington Mutual under Deanne Oppenheimer's leadership. These were completely novel bank branches with the screens between the tellers and the customers removed, bright open spaces which looked much more like a retail outlet than a branch. They even included areas with toys for children to play with while the parent took out a mortgage or a loan.

This concept of moving from 'branches' to 'stores' took off across the world. Abbey National (now part of Santander) openend up branches co-located with Costa Coffee outlets The thinking being that when a customer popped in for their cappuccino they might just take out a loan or open a savings account.

This model was taken even further in one bank in Puerto Rico where bank tellers were expected to take their turn operating as a barista in their branches handing out bank-branded coffees.

In Australia this concept took a uniquely Australian twist with one bank offering to wax your surf board while you did your banking.

Behind all of these radical changes to the design of  bank branches was the core retailing philosophy of the importance of footfall i.e. increasing the number of customers in the branch. The thinking behind this was that if there were more customers in a branch then this would increase sales, which is certainly true in retail.

However whilst having a coffee shop in a book store may have sold more books, with the Abbey National Costa branches it would appear that it was the sale of coffee that went up more than that of financial products.

One of the retail concepts that Joe Garner has brought to HSBC is the January Sale. For the last few years at HSBC branches loans have been offered at special deals and branches have had signs in the windows advertising the January sale. Again this is all about increasing footfall to increase product sales. In retail the usual reason for the January sales is to make room for new stock by selling off old stock at a discounted price rather than having to write off the value of the stock. That concept does not exist in retail banking. There are no old mortgages or old personal loans that are sitting around in the banks taking up branch space. Equally while in retail the January sales can result in impulse buys a loan or a mortgage is not and, never should be, an impluse purchase.

Meanwhile in The Netherlands the idea of making financial services products more physical was taken up. With one Dutch bank when a customer took out a loan they would leave the branch with a smart looking box. Quite what was in the box and what the customer would do with this 'physical' loan is still a mystery. Needless to say this experiment was quietly dropped.

Another concept that has been introduced into HSBC branches is HSBC Radio. Again this is a concept brought in from retail. Fashion shops such as Top Shop have for some time had their own radio stations both to improve and extend the shopping experience as well as increasing basket size. However the reality is that retail banking customers do not want to spend any longer than they possibly can in a branch. While they are queuing to pay in cheques running adverts for loans and mortgages is no more likely to create an impluse purchase than the January sales.

A concept brought from the white goods retail sector of heavily discounting the cost of appliances such as televisions, fridges and washing machines and then making up for the discount by selling highly profitable extended warranties was brought to the retail banking sector at the height of the credit boom in the form of low interest personal loans, credit cards and mortgages along with PPI (Payment Protection Insurance). In many cases the interest rate of personal loans was below cost (due to the high wholesale loan interest rates driven up by the excess demand over supply) making it essential for the banks to sell PPI in order to make a profit.

Finally introducing the retail compensation model of low basic salaries with commission based on sales targets including large incentives to beat targets into the retail banking sector has been key to the misselling of products to customers.

There is no doubt that the way branches looked and operated needed to change. Certainly a lot of the branches today are far more attractive and appealing places than they were before the injection of retail experienced executives into the banks.

However it would appear that the retail experiment is largely over. When Chase took over Washington Mutual  it took a conscious decision to refit the Occasio stores and make them look more like traditional branches.Underpinning Chase's decision was the reality of who the users of branches are today. With the exponential increase in the use of smart phones and other ways of connecting with the internet the vast majority of personal customers do not visit branches on a regular basis. Most personal customers will not either remortgage or take out a new mortgage more than once very three years (and increasingly longer than that), therefore their need to visit a branch (and even here increasingly mortgages are taken out online) is almost never. The users of branches today tend to be small businesses and private banking customers. The open style of branches with the bank private radio playing does not work for either of those segments of customers. Those customers want, and need, a difference experience.

The last 10-15 years has seen the injection of retailing ideas into retail banking. It has had some benefits for customers, but also has had some serious downsides. What we are now seeing is a recognition that banking has always been about servicing, and focusing on the total customer experience across all possible points of contacts is the most important way to retain customers and build loyalty. It is also clear that there are industries other than retailing that excel at delivering a great customer experience that banking should learn the lessons from.

Monday, 10 September 2012

Winners and losers if 'free banking' ends



With UK politicians appearing to see the end of so-called 'free banking' as a panacea for the woes of retail banking, bringing about more competition and a fairer deal for customers, who would the winners and losers be if the end of free banking came about?

If there is to be transparency about fees, which is the whole point of the end of free banking, then the charge will need to be related to the cost of providing that service.

Certainly those who use branches for transactions will be worse off. So the person who comes into the branch on the daily basis to have a chat with the teller and withdraw £10 (as I witnessed at my branch recently) is going to find that experience expensive. Some of the most vulnerable people in society who have low balances and see their branches as part of the community and a way to break the monotony of life will find that this will no longer be affordable to them.

As is already being seen for customers of RBS and Lloyds TSB with basic bank accounts (accounts where there is no overdraft facility and the most basic debit card)  who are already not being allowed to use ATMs which don't belong to the bank who their account is with. This is due to the charge each bank makes to other banks for allowing their customers to use their cash machines Come the end of free banking when charges for making a withdrawal from an ATM will kick in, as already exists in Australia, then those customers with basic bank accounts and low income earners who will be worse off.  Having a bank account will become for many of these people a luxury that they can't afford. The knock on effects will not be limited to the individual, but also government. Government relies on bank accounts to pay benefits into. By the number of people without bank accounts rising and the continued closure of post offices the cost of getting benefits to individuals will rise.
The knock on effect of not having a bank account for the individual is far more than the loss of banking services. The cost of  utilities - gas, water, telephone, etc rise if customers are not able to  have direct debits, since these attract discounts. This will drive low income households further into poverty.
Charges for transactions in branches will inevitably be higher than transacting online or via a call centre (due to the costs for banks being higher to provide these services). As a reuslt there is likely to be a drop in the number of transactions being carried out in branches, which will inevitably lead to branch closures. Many branches, particularly in rural areas, already struggle to be profitable because of the low volume of business transacted in them, so once again the vulnerable, particularly those without access to public or private transport, will be hit the hardest.

One of the arguments for the end of free banking is that charges will be fairer and, in particular overdraft charges will drop. However with the end of free banking interest on balances will need to be paid, and not at the paltry 0.1% banks had been paying prior to the financial crisis. With the wholesale markets expensive, attracting customer balances is a lower cost way of banks raising funds. This will be where competition may well come in as banks and new entrants compete for customers who have a high average balance from month to month. This could lead to a situation where rather than overdraft charges falling they may rise as the balance of the number of customers with large balances to fund those overdraft moves to the competition and  hence the cost of funding the overdrafts for the banks rise.

Another set of losers will, ironically, be those who manage their current account well. These are the people who maintain a low current account balance, don't go over drawn and use direct debits and standing orders to pay their bills. These are the customers who are currently subsidised by those who maintain high current account balances and those who regularly go overdrawn. These smart users of banking accounts, however only become profitable when they use other facilities such as mortgages, credit cards and loans. There is clearly an argument that these are precisely the people who should be paying a fair price for the services they use.

The fundamental challenge for any government who brings about the end of free banking is how to address the issue of the unbanked and the low earners. Certainly with the introduction of fees competition could increase, but it will be competition for the profitable customers, which does not represent the majority of the customer base of the big five banks. Without the economies of scale of a large customer base the big five banks will not be able to maintain the large branch networks they currently do.Compelling the big five banks to offer basic bank accounts and maintain a large branch network, but not compelling new entrants to do that, whilst populist, cannot be a long term strategy. Already the banks being forced to sell basic bank accounts are demonstrating that they are no longer prepared to do this at a signifcant loss.

The alternative is to take the unbanked and basic banking sector out of the commercial sector and have a state funded and run basic banking service. The level of investment required to set this up, particularly given the current economic climate, makes this option unlikely in the extreme.

So whilst the politicians can clamour for the end of free banking it is highly unlikely that anyone will be brave  (or foolish) enough to actually bring this about.

Tuesday, 28 August 2012

Is free banking holding back competition?



The UK Parliament review of the banking sector following a summer of scandals across the sector has, once again, raised the question of whether the end of the British system of so-called 'free banking' would introduce further competition into the sector. There are many who argue that free banking is a major barrier to entry for new competitors in the sector. However there is no evidence that this is the case.

In Australia, where there is the greatest transparency the cost of banking, where almost every transaction attracts a fee, the market is dominated by the so-called Four Pillars - ANZ, Westpac, Nab and Commonwealth Bank. There are smaller players such as Bendigo Bank, but despite the lack of free banking the split of the market is almost identical to that of the UK.

A number of new entrants already operate, or have announced that they will, exclusively non-free banking. Handelsbanken, the most successful of the new entrants with over 100 branches and the highest customer satisfaction of the UK banks (see http://www.itsafinancialworld.net/2012/01/customers-love-banks-who-charge-them.html), does not offer free banking. Marks & Spencer have announced that their current account will charge fees and even Virgin Money, the consumers' champion, has announced that its current account will charge a 'small fee'.

So whilst there is increasing competition in the UK retail banking sector why are the new entrants not able to make any more than a small dent in the share of the big five banks (Barclays, Lloyds Banking Group, RBS, HSBC and Santander)? One of the key reasons is the economies of scale required to be profitable in retail banking.

Owning and operating the infrastructure (the ability to process standing orders, direct debits, transfer money, access to ATMs etc) required to process billions of transactions reliably requires very large amounts of capital. Whilst the recent issues that RBS recently had with processing transactions, the UK banking infrastructure is amongst the most reliable in the world. Returning to Australia, the banks there have had far more problems with their payments infrastructure than the UK, despite having far lower transaction volumes.

New entrants today are able to use the Big Five's infrastructure. Whilst they may argue that the cost they pay is unfair and has little transparency as to the basis of  the charge, it is certainly a lot cheaper than building their own. In itself these costs are not the reason that holds back their success against the Big Five.

The biggest scale advantage that the encumbents have is  operating capital. This was most recently illustrated by the competition for the Verde branches that Lloyds Banking Group had been forced by the EU to dispose of following the state bail-out after the acquisition of HBoS. Whilst there are a not insignificant number of players who would like to enter or grow their footprint in the UK banking market such as JC Flowers, Virgin, Metro Bank and NBNK, they either weren't able to or were unwilling to raise the amount of capital required to become a significant player in the market. This situation has become further exacerbated since 2008 with capital being even harder and more expensive to find. To make the situation worse the amount of capital required to be held has been raised higher following the banking crisis. Here the established banks have a distinct adavantage as the requirement for capital is lower for them than for new entrants to the market. This is clearly a major barrier to entry.

Another significant barrier to entry for new entrants is the increased scruitny and additional regulation as a result of the banking crisis. This means that it takes longer and is far more difficult for any new entrant to get a banking licence and to get its executives approved to run a bank. This was one of the major hurdles that has held up the launch of Tesco Bank.

It is very convenient for politicians to blame the lack of competition for the Big 5 on free banking, however those politicians need to reflect on their own role in making it more difficult for new competition. The UK government wants to have a safer banking sector and in so desiring and by its actions has made it more difficult for new entrants.

Tuesday, 21 August 2012

Free banking didn't cause misselling




With the UK Parliament about to launch a major review of standards in banking, there is much talk of free banking being one of the problems that led to poor behaviour by the lenders. However the two issues are quite separate and there is no evidence that shows the two items are related.

One of the primary reasons behind the PPI (Payments Protection Insurance) misselling scandal was that the banks began to believe that they were retailers. As a consequence they started hiring retailers into the banks, people who had no understanding of either banking or the essential values of banking. Many of these retailers came in from white goods retailers where the model is to sell a product, be it a fridge, a television or a camera, at a highly competitive, loss-making price and then make all the profit from selling them an extended warranty on the product at a very high price and with high confidence that the customer will never claim on the insurance because they'll either forget they have it, not understand how to claim on it or what happens to their product will not be covered by the insurance. In this retail model there is absolutely no need or desire to build a long term relationship with the customer.

This retail model was launched in retail banking whereby mortgages, personal loans and credit cards were 'sold' to customers as prices that the banks were not making any money on. This was because there was so much demand for credit that wholesale interest rates rose and so much competition for customers that retail prices fell. As a consequence if a bank wanted to be in the retail lending space they needed to find another way to make money and this is where the retailers told their 'not so smart' banking colleagues about the secret of their success - extended warranty. Of course no banker worth his salt could allow the customers to realise that banking is essentially a simple business, so a more obscure, erudite, confusing name for the product had to be created and hence PPI was born.

Getting rid of so-called free banking is not going to change the ways that bankers will look for new ways to make money; that has been a fundamental characteristic of banking since the industry began.

However there has been a recognition amongst most of the banks that trying to emulate the retailers was a failed experiment. Retail banking is not retailing. Mass retailing is anonymous and transactional, it is not about building a relationship, it is not about the long term. Gone are the coffee shops in banks, gone are the branches that look like retailers and gone, hopefully, is the pile 'em high, sell them cheap offers from the banks. What needs to be ensured is that culture does not return and that the leaders of the retail banks are led by people who have a deep foundation of retail banking and live the values required for long term relationships.

Monday, 23 July 2012

Is Co-op really a contender with Lloyds' Verde?


Lloyds and the Co-op?


What Co-op is acquiring is the 632 branches that Lloyds has had to sell, with all the Lloyds TSB Bank branches in Scotland, the Cheltenham & Gloucester branches across the UK and the rest made up of other Lloyds TSB branches. They will also get the CEO of Verde, Paul Pester, his team and the management and the staff for those branches. Lloyds Banking Group will provide and manage the systems for the foreseeable future.

What does this mean? Starting with the customers there is no guarantee that the customers for those branches will move to Co-op. Whilst Lloyds Banking Group can't market to those customers to transfer their business back to Lloyds, customers are not obligated to stay and could easily move their accounts to another bank, including Lloyds. Evidence of this was seen when Santander bought the RBS branches that had to be sold. Customers did not like the idea of being sold and many have moved their accounts before the transaction went through. As a consequence the value of the deal to Santander has gone down significantly.

Looking at the leadership and staff of the new bank - it is the old leadership and staff. Many of these people will have been at either Lloyds or TSB for many, many years, so there is no guarantee that they won't continue to deliver banking the way that they always have done. Indeed the systems will enforce the processes and incentives of the existing Lloyds Banking Group. Verde, or TSB as it will be branded, could be just a mini-me Lloyds Bank, without the scale to compete.

Having Verde run on the Lloyds' existing systems for the foreseeable future has two distinct disadvantages for the Co-op.

Firstly, the acquisition benefits of rationalising systems and processes that usually underpin any M&A deal are not going to be realised. Instead the Co-op will end up running their Co-op and Britannia branches using the Co-op systems and processes (assuming the completion of the migration of the Britannia systems onto the Co-op platform) and the TSB branches using the Verde systems and processes. Many of the synergies that the bank would have hoped to realise from their 1000 branches will not be achieved until they can move onto a single platform. Due to the complexity and the cost of the Verde systems the migration has been kicked into the long grass. The Co-op will have all the overheads of having to support three brands in the market, Co-operative, Britannia and now TSB. Not only is there expense in running multiple brands, but significant scope for confusion amongst customers. Rather than having a new 1000 branch contender there will be three brands fighting to compete for customers all with less scale than the Big 5.

Secondly Antonio Horta-Osorio, the CEO of Lloyds Banking Group, recognises that the systems underpinning Lloyds are simply not good enough to compete in today's retail banking market. This is why he is spending hundreds of millions of pounds on the 'Simplification' programme to improve the efficiency and effectiveness of the banking systems to enable them to compete in the mutlichannel, always available, digital world. However those improvements will not be applied to the Verde systems. To use an Olympics analogy it is like your older brother giving you his old Nikes while he is upgrading to the far superior ones. Who would you expect to win in those circumstances?

With the size and scale of Lloyds Banking Group there is far more scope for investment in making the retail bank fit and efficient than there is for the Co-op. Not only that, when the Co-op wants to make upgrades to their TSB systems they will be dependent on Lloyds Banking Group to make those changes for them. Whilst Lloyds can be recognised for its history and experience of  excellence in retail banking it is not well known for its provision of IT services and certainly not as a commercial provider of IT services. The Co-op may find itself held back by the speed and agility of not only its systems but also its IT services provider.

The celebrations of the Co-op creating a contender of scale to compete against the Big 5 banks may be a little premature.

Saturday, 23 June 2012

RBS pays the price of underinvestment as systems fail



It was for good reason that Fred Goodwin, the former CEO of Royal Bank of Scotland, was nicknamed Fred the Shred. Slashing costs and running a lean bank was what he was famous for. However the retail bank was not just lean, it was positively anorexic. RBS was very proud of the way that the merger with Natwest was delivered on time and below budget. They were also very proud of the fact that they had the lowest cost:income ratio amongst Western banks. However it is not difficult, in the short term, to have a good efficiency ratio if you starve the business of investment. In the longer term this lack of investment will come back to bite the organisation.

The impact of the lack of investment is being realised at RBSG (which owns the RBS, Natwest and Ulster Bank brands) as the bank has had one of the worst customer visible, publicly embarassing technology problems a UK bank has had in recent times. Many customers have not been able to access their accounts online and balances have not been correct due to 'technical problems'. Branches have had to extend hours both at the beginning and the end of days and even, shockingly, opening on Sundays. It couldn't have happened at a worst time of the month as this is the time when many salaries are being paid in and bank balances are typically at their lowest.

RBS, Natwest and Ulster Bank share the same systems. This was a significant part of the business case for the merger of  RBS and Natwest. The merger was based on migrating the Natwest systems onto the RBS platform. One of the reasons that the merger was completed on time and below budget was because of the no arguing approach that regardless of whether the Natwest IT was better it would be migrated onto the RBS platforms. This reduced costs which could have resulted from extended debates between the two banks as to the virtue of the systems. This philosophy came about following the Lloyds Bank and TSB merger where, after lengthy debate and two years pursuing a strategy of migrating onto Lloyds Bank's platforms, the decision was reversed and the Lloyds' platforms were migrated onto the TSB ones, which were far more modern and flexible than Lloyds'. The RSB management were determined not to make the same mistakes as Lloyds TSB had made.

The consequences of RBS, Natwest and Ulster Bank all being on the same platform is that the technical problem has impacted all three banks, albeit Natwest has been hit the most. The extent of the impact is further evidence of the lack of investment in re-architecting what are very old systems to give them greater resilience.

The impact of the lack of investment in RBS systems has not only caused the very public problems for customer service but also major delays in the handing over of the branches that Santander has acquired from RBS as a consequence of the forceed sale that RBS was required to make following taking state aid to stop it going under. Where the transfer of the branches was meant to take place in 2011 it is now projected to be completed in 2013. Not only is RBSG going to incur signifcant additional project costs for the separation, but also the amount that Santander will eventually pay for the branches will be substantially reduced due to the fall in bank valuations in the meantime. Separating the set of branches from the mothership has proved to be far more difficult than expected due to the archaic nature of the systems. These systems, many of the designers of which retired some time ago, were designed in a monolithic fashion rather than in a modern, modular way, meaning that it is the equivalent of removing a part of a limb from a live body nerve by nerve, vein by vein.

RBS is not alone in facing the symptoms of having creaking, old, underinvested systems. Nab (National Australia Bank) and CBA (Commonwealth Bank of Australia) have had a number of very public systems failures over the last couple of years, see http://www.itsafinancialworld.net/2011/04/deja-vu-as-nab-systems-down-once-again.html , however the difference is that both Nab and CBA have had major programmes underway for several years to replace their core ageing systems. Neither of these replacement programmes have gone smoothly, both are significantly late and over budget, but they will emerge with better systems, designed for the 21st Century and able to deliver a customer service designed with the digital age in mind.

The reality is that most of the major banks across the globe are facing the same problem of ageing systems and a reluctance to spend the money necessary to replace them. These are major programmes and for many CEOs will take longer than their tenure at the top of the bank, so there is little incentive for many CEOs to do anything about it.

Antonio Horta-Osorio, the Lloyds Banking Group CEO has recognised the challenge. On completing the merger of Lloyds TSB and HBoS he immediately kicked off a major simplification programme. He recognised that having all the brands on a single set of applications was only the first step towards making the bank ready for the 21st century. However simplification is not a core banking replacement programme, which is actually what is needed. It could make some difference. However it could simply be an exercise in rearranging the deckchairs on the Titanic. Simplification is like putting a patient with chronic coronary heart disease on a better diet and exercise routine rather than giving them the heart transplant they require.

Horta-Osorio came to LBG from Santander where the importance of the core banking system is recognised as being key to delivering the bank's strategy. Santander has its Partenon platform that has been instrumental in enabling the success of many of Santander's takeovers of banks across the globe including Abbey National, Alliance & Leicester and Bradford & Bingley.

Out of the public humiliation of RBS and the financial impacts of the delay in transferring the sold branches to Santander it is to be hoped that some good will come. Stephen Hester, the RBSG CEO should take this opportunity to take a long hard look at the investment that is needed to get RBS the banking systems that it needs to service its customers in the 21st century.

Friday, 8 June 2012

M&S to take on high street banks



UK retailer Marks & Spencer is to launch M&S Bank, rolling out 50 branches over the next two years. A 50:50 joint venture with HSBC with current (checking) accounts to be launched in the Autumn and mortgages 'later'. This gives M&S a head start on Tesco who has had to delay the launch of its current accounts until 2013. Ironically these two 'new' retail-based banks are frequently adjacent neighbours on retail parks across the UK, where the big four high street banks are rarely to be found, so it maybe that they find themselves competing with each other rather than taking on the big boys.

Of course neither Tesco or M&S are really new entrants into Financial Services both have been offering products for some time. M&S first started offering FS products in 1985 and has the successful &more credit card, but this will be the first time it is calling itself a bank.

The timing of M&S's announcement is good. Not only does it come after a set of disappointing results for its retail business, it comes at a time when the high street banks are both unpopular and mistrusted. This can only be good for M&S with it's slightly older, more affluent and loyal customer base.

With the opening hours of the branches being the same as the retail stores and the initial prototypes of the branches looking very retail, calm and sophisticated and, as they are keen to point out, with fresh flowers, this will, to coin their phrase, not be any bank it will be a Marks & Spencer Bank.

But will it really shake up competition in the banking sector? Fifty branches over two years is not that many. Given that Virgin already has 75 branches (since its acquisition of the 'good' Northern Rock), Yorkshire Building Society has 227, Handelsbanken (the least well known, but the bank with the highest customer satisfaction) has over 100 branches and whoever (Co-op, NBNK or a flotation) acquires the Verde branches, that Lloyds Banking Group has to dispose of, will have 632 branches, just like Metro Bank with its 12 branches, this is not going to be an immediate threat to the high street banks.

Certainly in the short term it will not make a significant difference to the M&S share price. However it has every chance of being a success that will build over time. M&S has decided not to take the route that Tesco is finding to be so challenging of going it alone without a bank behind it. M&S by partnering with HSBC is able to stick to what it does best - retailing while HSBC can focus on managing the banking operations. The CEO of M&S Bank, Colin Kersley, was with HSBC for 30 years, so he knows the bank extremely well. The UK CEO of HSBC is Joe Garner, who spent his early career with Dixons. The two organisations have worked together for a number of years (HSBC acquired M&S Money) and understand where each is coming from, so this has to be a significant advantage.

Overall from a consumer perspective this move by M&S is to be welcomed. Whilst Joe Garner is quoted as saying that this is 'the most significant innovation that HSBC has carried out since First Direct' only time will tell whether he is right.