Saturday, 12 October 2013

Why the new Payments Systems Regulator needs to avoid rushing in change


The UK government has announced that the bank dominated Payments Council is to be replaced by a competition-focused utility style regulator for payment systems, under the Financial Conduct Authority (FCA), part of the Bank of England. This new body will assume its powers in late 2014 and will be fully operational by Spring 2015. The focus will be on providing competition, innovation and responsiveness to consumer demands in the payments system. It is hoped by the government that the Payments Council will in turn reform itself into a more traditional trade body.

Talk of reforming the payments system has been going on for a very long time with the Cruikshank Report into competition in banking  back in 2000 recommending the setting up a full blown payments regulator, the so-called ‘Payco’. That recommendation was never acted upon, not only because of the active lobbying by the banking industry but also because of the size of the investment required to set up the regulator and the fear of disruption to the payments system in the process. Little progress has been made since 2000 except the slow introduction of Faster Payments and the reluctant abandoning of end of cheques, which had been due in 2018.

The new Payments Systems Regulator may want to show that whilst the creation of the body has taken a long time that it is a body with a mission and at pace. However whoever heads this body should be wary of rushing in change too quickly.

The UK has one of the best set of payments systems in the world – in many ways the envy of the rest of the world. After 9/11 it wasn’t the fact that the Twin Towers had come down or that the US had been attacked on its own soil and that hundreds had died that nearly brought down the US economy, but rather the grounding of all the airlines. In the US at that time (and even today)  because the economy was highly reliant upon cheques (or checks if you are outside the UK) the fact that the planes could not fly the cheques raised on one bank to deliver them back to their originating bank for clearing meant that the US economy almost ground to a halt.  The flow of money was stopped. Given similar circumstances in the UK the impact on the UK economy would have been far less. The UK has a highly resilient, highly reliable payments infrastructure. Britain should be proud of the long history of a payments infrastructure that is only invisible to most because it works and customers take it for granted that when they make a payment it will arrive where it is meant to in the time that it is meant to. This is despite the fact that the systems have, primarily, been built by those 'empires of evil', as portrayed by the politicians, the big four banks (Barclays, Royal Bank of Scotland, Lloyds Banking Group and HSBC).

However the UK payments infrastructure has been slow to change, has failed to grasp innovation and has had to be dragged and screaming towards the twenty first century. The Payments Council dominated by the Big Four banks has had the unenviable task of leading by consensus and with each of the Big Four being competitors has rarely got to consensus and where it has it has been through a suboptimal compromise.

The new regulator has the challenge of addressing the level of competition in the industry, increasing the innovation and making sure that the consumer’s voice is heard.
Despite all the reviews and all the parliamentary committees which have reviewed and reviled the banking industry, a forensic analysis of the payments industry has not really been carried out. Whilst the small banks and building societies who process low volumes of transactions and the new challenger banks may complain they are unfairly charged for access to the payments system the arguments seem to be based on little data and a lot of emotion.
One of the first tasks that the new regulator should commission is an independent, forensic analysis of the costs to both build and operate the existing infrastructure. The natural instinct will be to use one of the Big 4 accountancy firms to do this, however they are so dependent upon fees from the big banks that it is questionable whether they will be seen to be independent. The purpose of this analysis of the costs will be to determine what a fair cost to use the infrastructure should be (allowing for investment to build the next generation infrastructure) and compare that against what is being charge today.
The new regulator has an unenviable task because there is a clear conflict between significantly reducing the cost of using the infrastructure and encouraging investment and innovation into that infrastructure. It is analogous to Ed Miliband, the UK leader of the Labour opposition, saying that he will freeze the cost of utility bills whilst still expecting those utilities companies to invest in green technologies and maintaining and upgrading the creaking infrastructure.
This brings into question whether there can be real and speedy investment and innovation into the payments infrastructure while the big four banks still collectively own it. Over the last forty or so years they have demonstrated that getting to consensus has inhibited progress and has compromised innovation. There has also been a chronic lack of investment in building the next generation infrastructure. Is there any reason to believe that this will change?
The new regulator needs to decide whether the three objectives assigned to the regulator of creating competition, encouraging innovation and responding to consumer demand can be met while the ownership of the payments infrastructure remains with the big four banks.  A solution could be that the big four banks are forced to dispose of the payments infrastructure to an independent business to which they will become customers just like the smaller banks, building societies and challenger organisations. The acquiring organisation will need to demonstrate not only that they have the experience to run the infrastructure the resilience and reliability of which  is of national importance but also have a realistic strategy for the payments industry going forward and how they will fund both innovation and maintenance of that infrastructure whilst actively engaging with consumers. This is not a task for those who are looking for a quick in and out with a healthy profit. Only an organisation that is prepared to run the infrastructure independently of the banking sector for the long term will make any sense.
Without taking a measured, fact driven and courageous approach to changing the payments industry with cross-party support (given the length of time any programme will take to enact) this regulator will be no better than the Payments Council it is replacing. 

Sunday, 15 September 2013

Why Seven Day Current Account switching will not turn up competition

The launch this week of the Current Account Switching Service whereby UK banks will have just seven working days to switch customer's current accounts to a rival has been heralded as a key enabler of competition in the UK retail banking. In particular the Chancellor sees it as a way of encourage new entrants to build up market share.

The banks have been forced to spend hundreds of millions of pounds to rapidly put in place a system that will enable this to happen, however the expectations set by the Chancellor are unlikely to be met.

For a start this assumes that there is pent up demand to switch bank accounts that is held back simply because the process of changing accounts is too complicated or too slow. The reality is that most customers are simply consumers of banking services and see banking as a commodity much like gas, electricity or water. Despite what the banks might want to believe most bank customers rarely or never think about their banks. Who provides their banking service simply isn't  that important to most customers as long as it works.

Not only that but most customers think all banks are alike. Why would they change from one bank to another, even if the new switching services makes it marginally easier than before. Just the effort of researching an alternative bank and initiating the process of changing is more effort than most customers think is worth for the benefit they will get.

With so called 'free banking' it is even more difficult for banks to differentiate themselves for the average customer. When there is no perceived charge for writing cheques, paying bills and taking money out of a cash machine, then how do the banks make a difference in the mind of customers?

The slow take up of the M&S Bank Account can be partly attributed to the requirement to pay monthly fees, particularly given that that the target customers probably do not  believe that they pay anything for their existing accounts.

So-called 'value-added' accounts, where for a monthly fee customers can receive a bundle of addtional services such a travel insurance, breakdown cover and airmiles, have had some moderate success, but research shows that either customers do not use the additional services or they could have bought them cheaper as individual items. They are also potentially the next product to be subject to a misselling investigation given the similarity with the incentives and targets to sell these offerings to customers as were there for  Payment Protection Insurance.

The Chancellor has suggested that if the seven day switching service does not create the flood of switching that he is expecting then account number portability may be imposed on the banks. Account number portability is seen as the equivalent of phone number portability, except it blatantly isn't. Where traditionally people have had to know each other's telephone numbers to contact each other (even for this with the advent of the smart phone the number is stored and not really 'known'), there is little need to know bank account numbers in order to use the banking system. A customer only shares their bank account number with a few people and very infrequently in comparison to their telephone number. The use of bank account 'aliases' avoids the customer ever needing to know their bank account number. Having to have a new bank account number is not the reason people don't switch banks.

Should the Chancellor decide to ignore the evidence and impose account number portability then this will make the several hundred million pounds spent by the banks on the switching services look like loose change. To architect a long term solution to industry wide account number portability (unlike the switching service which has been thrown together with little thought about architecture and long term durability and has created an expensive legacy solution to maintain) will require very significant changes to the underlying banking infrastructure and the cost will be measured in billions and will be borne not only by the existing players but also new entrants. See http://www.itsafinancialworld.net/2011/01/why-portable-bank-accounts-arent-going.html

Fortunately the head of the FCA (Financial Conduct Authority, one of the two bodies that has replaced the Financial Services Authority), Martin Wheatley,  at his reason appearance before the Treasury Select Committee has already made it clear that the CASS (Current Account Switching Scheme) should be allowed to run for at least a year to see whether it has had the desired effect before any further consideration or detailed studies of the costs of providing account portability should be started. This effectively kicks it into the long grass and to after the General Election, which will be a great relief to many bank CEOs.

The Chancellor has also suggested that making direct debits and standing orders be moved from one bank to another at no cost to the switching customer should also be imposed on the banks if switching doesn't create the movement that he is looking for. This idea seems reasonable and it is reasonable as that is what the banks do already today, but is not a material factor in encouraging customers to switch accounts.

The ease of movement of  customers is only one half of the argument that the Chancellor and consumer lobbyists make for the introduction of the switching service. The other reason is to encourage new entrants and competitors into the banking industry.

However the ease of attracting and on-boarding customers is not the reason for there being so few sizeable new entrants in the market. With the increasing regulation, the higher levels of capital that need to be held (even if it can be raised and afforded in the first place) and the reduction in the ability to make a fair profit from retail banking makes entering the UK retail banking market unattractive to new entrants. Even Vernon Hill, the entrepreneur and founder of Metro Bank, the first new entrant to the UK for many years, 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. One of the reason that Tesco Bank has been delayed in its full launch has been the time it has not only taken to get a banking licence but also the time it has taken to get its executive's FSA approved.

So now that seven day switching is introduced will the big banks be quaking in their boots trying to lock the branches to stop customers leaving, making amazing offers to make them stay? Will new entrants such as Tesco Bank, M&S Bank, Virgin Money and banks we have not even heard of yet be having to close offers because of the volume of customers trying to switch to them? The answer is almost certainly 'no' because seven day switching is not the answer to creating competition in the market and the time and money spent on it will prove to have been a poor investment.

Sunday, 1 September 2013

Another blow to Government ambitions for SME lending as Nationwide postpones launch to 2016

The announcement that Nationwide Building Society is postponing its push into SME banking until 2016 is a blow for the UK coalition government, particularly coming on the back of disappointing SME lending figures this summer. The Nationwide suspension comes despite the new governor of the Bank of England, Mark Carney, announcing that the largest eight banks and building societies (which includes Nationwide) will be allowed to hold less capital once above the 7% level to encourage more lending to the SME segment.

This builds on the bad news earlier in the year for SME lending that Santander was withdrawing from the purchase of the RBSG branches. These branches have been selected specifically for their SME focus. The uncertainty as to who, if anyone, will replace Santander in taking on that business is a further blow. For while the Chancellor has talked about new entrants coming into the UK banking sector and Vince Cable, the Trade Secretary, has pushed for the banks to increase their lending to businesses and even talking about setting up a government funded bank for business, competition in lending to the SME sector has decreased rather than increased. The decision of the Co-op to stop any new lending to corporate sector has been effectively the withdrawal of another player in the market.

But should anyone feel surprised that this is the case? As one of his parting gifts the former Governor of the Bank of England, Lord King of Lothbury, pushed for banks to hold far higher levels of capital than they did prior to the financial crisis. The newly formed PRA then went on to enforce this. With the Nationwide, somewhat surprisingly given the risk averse nature of its book, being told to hold significantly more capital than it has been used to and with a growing residential and buy to let market, both of which require far less capital to be held than for SME banking and represent a far less risky way to make money, it is no real surprise to see that the Nationwide decided there were better places to use its capital at this time.

Of course this is not the whole picture. Nationwide has been for some time been going through the painful process of replacing its core banking platforms. Like Commonwealth Bank of Australia which has declared victory on its implementation of the same system two years late and with a budget that doubled to AUD1.2bn, Nationwide is finding carrying out a full heart, lungs and liver transplant of its systems is not plain sailing. It may well have been that Nationwide has not only delayed the entry into SME banking for financial reasons, but also because the new systems are not ready.

Whilst overall competition in SME banking is reduced there are one or two new entrants that are making their mark, albeit on a relatively small scale. The largest of these is Handelsbanken with in excess of 150 branches and a high level of customer satisfaction despite being very profitable. There is also Aldermore which, whilst keeping a low profile is making  notable progress.  The owners of Aldermore are members of one of the syndicates bidding for the RBSG 316 branches, so the Aldermore approach to banking may get the opportunity to scale up.

The Government may be satisfied that the UK has a safer banking environment but the price that is being paid for the additional regulation, the higher levels of capital and increased interference is that there is not only less competition in SME banking but less lending going to small businesses to fuel the growth of the economy.

Sunday, 11 August 2013

Who should buy the RBS branches?

On the face of it the Lloyds Banking Group's and the Royal Bank of Scotland Group's forced disposal of their branches look quite alike. Even the numbers of branches being disposed of, in a dyselexic way, are the same 631 and 316 respectively. Both were imposed by the European Union as a result of state intervention. to save the banks brought about by the 2008 financial crisis. Both Groups have struggled to find buyers for their branches. Both banks have had potential buyers walk away from their deal late in the day - the Co-op in the case of Lloyds Banking Group and Santander in the case of Royal Bank of Scotland Group. Both are now pursuing floatation of the severed entities due to a lack of interest from potential buyers.

However fundamentally the offerings for potential buyers are different and therefore the people and organisations that should seriously consider and be considered for the acquisitions are quite different.

The reason that Lloyds Banking Group have been instructed to sell 631 branches and their associated customers is because, following their arms being severely twisted by the Government to save HBoS by acquiring it, LBG was left with a very dominant market position in unsecured lending, mortgage and current accounts for consumers whilst being underpinned by government support.

For RBSG selling their 361 branches was both due to the level of government support that required to save them from their self-created problem and their overwhelming dominance of the SME market segment. Thus the customers that RBSG is selling are small and medium sized business customers.

Some might say that retail and SME banking are not that different. Indeed that debate has been running for decades with banks periodically changing where SME banking sits in their organisation between within the retail and within the corporate bank. Business Banking has not sat comfortably in either organisation being neither fish or fowl.

As is being evidenced by Santander in its results, Business Banking is nowhere near as straightforward as retail banking and requires significantly more capital for every loan. Santander who is one of the few banks that has been able to build a global retail banking platform (that has enabled to make numerous successful acquistions across the globe) has found it very challenging to bend their Partenon banking platform to support UK Business Banking customers needs. Indeed it was IT issues that were cited by Santander as the reason that the acquisition of the RBSG branches was halted.

The difference from retail banking extend way beyond just capital and technology and into the most important part of banking - the people who work in it and the skills and competencies they require. It is not impossible to move from retail banking to SME banking, but  it requires a different mindset and different skills.

Another difference between the LBG and the RBSG disposals is the condition of the IT systems. Lloyds Banking Group has, as a result of the acquisition of HBoS and the need to fundamentally reduce costs, been through an exercise of migration and simplification of banking systems. The starting point, the TSB systems, were newer and better designed than either Lloyds Bank, RBS or Natwest systems, so provided LBG with a far better starting position than RBSG finds itself in. The problems that RBSG has had with its banking platforms over the last few years are well documented and have been very obvious to their customers.

Whoever acquires or enters into a joint venture with RBSG needs to recognise that they will need to partner with RBSG IT for at least the next five years as it is very unlikely that moving onto a new platform and separating from the old one could be achieved any faster than that. This means that the acquirer's business will be dependent upon RBSG being able to provide IT services to keep their business going. This was clearly something that Santander found to be unpalatable.

This raises the question of who should acquire RBSG's branches? Given that the deals risks are already high (amount of capital, market risk, IT risk), then when RBSG considers who to partner with then a consideration has to be which of the potential buyers reduces the deal risk the most whilst still offering an attractive commerical proposition. One of the key ways to reduce the risk is to sell to a buyer who fundamentally understands and has a proven track record in SME banking.

Anacap who's bid is led by Alan Hughes the former First Direct (a retail bank) boss also owns Aldermore the UK banks that focuses solely on SME banking. Anacap has the experience of setting up a new SME bank, putting in new platforms and writing profitable business. This has to count for a lot.

The Standard Life bid (teamed with Corsair Capital and Centrebridge) is being led by John Maltby the former head of SME Banking (and Kensington Mortgages the buy-to-let specialist) at Lloyds Banking Group. This consortium also has the backing of the Church Commissioners, though whether this suggests any divine preference is doubtful.

Finally there is the consortium led by Andy Higginson the former Tesco Finance Director who has experience of working with RBSG when he was involved in the launch of Tesco Personal Finance.

Competition in the SME banking market has changed since 2008 when the EU decision to force RBSG to dispose of market share with the increasing presence of Santander, Aldermore and Handelsbanken, it is a very different market with different regulatory requirements.

So for whoever decides to buy the RBSG branches the latin expression could not be more appropriate - caveat emptor!

Tuesday, 2 July 2013

Can TSB really be a challenger bank?

With the letters going out to effected existing Lloyds' customers and the announcement that from September 632 Lloyds Banking Group branches will be re-branded 'TSB' does this herald a new competitor in the UK banking market or it just a mini-me Lloyds Bank brand? This is a question that will not only be asked by those customers being migrated to the 'new' bank but also by existing Lloyds' customers, politicians, banking regulators and the European Union. Ultimately it was the European Union that has forced the launch of TSB as a consequence of the state intervention required after Lloyds TSB was compelled to buy HBoS.

From September TSB will have the same products, the same propositions, the same terms & conditions, the same computer systems (or at least a copy of them), the same staff  and the same executive team as they do now and have had for some time. The branches will be re-branded but the staff that work in them will be the staff that worked in the same Lloyds TSB branch, working to the same incentives.

In many respects for customers who have chosen to join Lloyds TSB and are being forced to switch to TSB this could be seen as positive as their new bank will be re-assuringly the same. However over time, if TSB is to become a challenger to the established banks then this will need to change.

One of the most important requirements for TSB to become a challenger is to have different ownership. Lloyds Banking Group has applied to the EU for a two year extension to the deadline to sell off the 632 branches. As this is written there has been no indication whether this has been granted. Whether this comes from an IPO (most likely) or from a single or syndicate of investors wishing to buy TSB time will tell. However Verde, as the project  to separate and sell the branches and supporting infrastructure was called, has been running for some years already and no one has come forward with a compelling and executable proposition to buy the business. (The Co-op's proposition proved to unviable and the NBNK proposal was rejected by Lloyds Banking Group as being insufficiently commercial, though whether that was a political decision is a moot point)

Whilst TSB is still fully owned by Lloyds Banking Group it will be no more of a true challenger to the Big 5 banks (Barclays, RBSG, Lloyds, HSBC and Santander) than its sister brand, Halifax.

Credit where credit is due Lloyds Banking Group knows how to run separate brands off the same systems and processes and has done it very successfully since the integration of Lloyds TSB and HBoS was successfully completed. Halifax is seen as an edgier, cost conscious brand than the more conservative Lloyds brand. The Halifax executive team have largely been kept in tact and have been able to retain much of the culture of the bank prior to takeover.The staff still identify with the brand they work for. Indeed to many customers Lloyds and Halifax are quite separate banks and there are customers who move to Halifax to get away from Lloyds and vice-versa. However ultimately both banks report into the same Lloyds Banking Executive, Alison Brittain and she reports to Lloyds Banking Group CEO, Antonio Horta-Osario. Both banks answer to the same shareholders principally the government.

It is a fallacy that there is no competition in UK banking, there are an increasing number of players out in the market offering retail banking services - Nationwide, Yorkshire Building Society, Yorkshire Bank, Clydesdale Bank, M&S Bank, Co-operative Bank, Tesco Bank, Sainsbury's Bank, Metro Bank, Virgin Money to name just a few. However it is true that the Big 5 still continue to have the dominant market share. With the introduction of easier switching in the Autumn the excuse that it is too difficult to change banks will be taken away. The fundamental reason that customers don't switch banks as much as politicians and regulators would like is that banking is to a large extent seen by customers as a commodity and really not that interesting. Banks are also seen as being as bad as each other so why customers can't be bothered changing when it really won't make a lot of difference.

For TSB to be a real challenger then it needs to be able to answer the question of what can it offer that will make those not compelled to become its customers to switch their banking business to TSB.
This has the potential to be a bigger hurdle for TSB than for some of the other players. The executive team of TSB are highly capable people, but they have worked for Lloyds Banking Group for a considerable period and a question is whether have been immersed in that culture and that way of doing business are they able to come up with a fresh way of delivering banking that will be attractive to their customers? If they are able to come up with a fresh proposition will they be able to actually deliver it given that they will be dependent upon Lloyds Banking Group and its legacy systems to deliver their proposition? Given their size in comparison to Lloyds Banking Group and the other Big 4 will they be able to invest enough, particularly in all things digital and mobile to be able to compete with the far larger budgets that the others have?

Is the reality that despite all the best intents and capabilities of the leadership of TSB that with the restrictions laid on them such as ownership, access to capital, size and dependency on Lloyds Banking Group that the best that can be expected from TSB is a slightly less good mini-me?

Only time will tell, but for the good of consumers and for the health of the retail banking industry in the UK it is has to be hoped that TSB will emerge as a strong challenger bank.

For official answers on how TSB will operate go to
<a href="http://www.tsb.co.uk/">www.tsb.co.uk/</a>

Friday, 7 June 2013

Will challenger banks make a real impact on UK lending?

Antony Jenkins, the CEO of Barclays, told investors that the challenger banks will fail to make a real impact on the lending market in the UK in the coming years.

His argument was that those who look to acquire the branches available by the forced sale of Lloyds Banking Group and Royal Bank of Scotland branches when customers are using branches less and less in favour of online banking are buying a wasting asset.

Simplistically this is right, however even in markets where customers are carrying out a greater proportion of their banking business online such as The Netherlands, where 50% of branches have been closed, when a customer has a complex financial problem that needs fixing those customers are still showing a strong preference to address these face to face in a branch.

Even in a digital world the branch is still an important part of the marketing and branding for all the world's major banks. Branches are perceived as a reassuring sign of the stability of the bank, that by having a physical presence the bank is not going to disappear overnight.

What Anthony Jenkins did not explore is how the role of the branch is and needs to evolve (something which Barclays as an organisation is very aware of). The challengers recognise that branches are generally under-utilised assets and are being far more creative about their role in the community whether it be for business meetings, book clubs, music soirees or simply somewhere to go for a coffee. Banks such as Oregon's Umpqua (www.umpquabank.com) and Virgin Money with their lounges (http://uk.virginmoney.com/virgin/about-lounges/) are taking forward the thinking on the future of the branch. Antony Jenkins is right that the big five banks are increasingly closing branches but the challengers with their far smaller branch footprint are opening new branches rather than closing them. Handlesbanken (www.handelsbanken.co.uk) have been quietly opening branches and have been having a not insignificant impact on the market particularly on business lending.

When Jenkins referred to the challengers he appeared to limit that to those who might acquire the Lloyds Banking Group and the Royal Bank of Scotland branches, but of course this is not where the only challenge to the lending market is going to come from. Tesco, M&S and Sainsbury's banks already have very large branch networks they just happen to be retail outlets. Betting against these three making a success of their banking business is the height of folly.

Where Jenkins is completely correct is that for a challenger to simply open branches, and specifically traditional branches, would not be a wise move given the evolution of the customer and the banking industry. However the main challengers are not doing that. They are looking at an omni-channel strategy where online, mobile, call centre and branches come together to provide a new and better customer experience. There is a recognition that even in the branch customers may want to access their mobile or online banking services, that digital opens up the range of services that a branch can perform.

Taken at face value Antony Jenkins' comments that challenger will have little real impact on the UK lending industry smacks of complacency which the challenger banks should be delighted to hear. However given Jenkins' experience and knowledge of retail banking the challengers should not underestimate the fight they have on their hands. This can only be good for customers.

Monday, 27 May 2013

Why the Co-op is right to stop new commercial lending




Commercial lending has been a significant contributor to the downfall of a number of financial services organisations. This was the primary reason that HBoS failed and subsequently took Lloyds Banking Group down with it. It was also the principle cause of the failure of Bradford & Bingley who made a major play into the buy-to-let market. Alliance & Leicester kept out of that market until the temptation of high margins and growth became too great to resist and paid the ultimate price by, like Bradford & Bingley, having to be 'rescued' by Santander. Britannia Building Society, which the Co-op acquired, aggressively entered the commercial lending market prior to its acquistion. Indeed it is the size and the problems within the Britannia Building Society commercial lending book that has fundamentally caused the huge capital gap and the down grading of the Co-op's credit rating.

A question has to be why so many safe building societies/mutuals have been tempted into commercial lending and got it so wrong?

There is no doubt that in the good times that commercial lending is highly attractive with guaranteed rents and better margins than for residential lending. The size of deals are far larger than for residential lending and for those who are motivated by numbers signing a deal measured in millions rather than hundreds of thousands is very attractive.

There is also no doubt that market for commercial lending is very much more volatile than for residential lending. Up until 2008 it was always the perceived belief that the only direction for residential housing prices to go was up - the expression 'as safe as houses' was for good reason.

The residential housing market is also more homogenous than commercial lending. Commercial lending has a wide variety of segments such as hotels, offices, retail and industrial. These segments operate in different ways, have different cycles and require specialist knowledge.

Commercial lending requires high amounts of capital, has a far broader range of risks than residential lending and requires having a large diversified portfolio to be successful in the long term.

For residential lending there is a lot of data about the market available, the amount of capital for each individual deal is a lot less, there is a huge amount of historical data, so making fact based decisions is relatively straigh forward.

The same cannot be said for commercial lending. What is critical for success in commercial lending is both internal and external data on what is going on in the market. This includes knowing and understanding what the competitors are doing. If a bank is winning all the commercial lending deals and others are withdrawing from the market then the executive need to be asking why. A question is whether the banks that failed had the data and the analytics in place and, if so, why they didn't respond to it?

For many years banks have wrestled with the decision of whether SME banking sits with the retail bank or the commercial and corporate bank. At least one lesson that should be taken from the financial crisis is that the skills, knowledge and understanding that is required to lend to consumers and the mass market is quite different from those to lend to businesses. To move from retail to commercial lending is not a continuum but to move into a totally different business. It appears that the new CEO of the Co-op gets this and has wisely decided that commercial lending is a step too far. The question outstanding is still whether the Co-op should be in banking at all?

Wednesday, 15 May 2013

Should Co-op exit banking?

As incoming CEO, Euan Sutherland, reviews his options for raising potentially in excess of £1bn extra capital, given the issues he faces, rather than considering selling off his funeral business (a recession proof, profitable business), a logical option would be to look at selling off Co-op Bank.

The problems that Co-op Bank has both with the quality of the debt and the IT sit squarely with the misguided acquistion of Britannia Building Society. It is Britannia's foray into commercial property that has resulted in the downgrading of the Co-op's debt. It is the poorly executed integration of Britannia into the Co-op bank that has cost more, taken longer and has not left the Co-op with a viable banking platform. Both of those facts not only de-railed the Verde deal but should have been enough of a warning to both the Treasury and the FSA (as the regulatory body at that time) not to proceed with the Co-op as the preferred buyer of Verde.

A question that Euan Sutherland needs to answer as part of his strategic review is does it make strategic sense for the Co-op to own a bank? If it does, what will it cost to take what he currently has and turn it into a significant competitor in the market?

Tesco has invested heavily and continues to in Tesco Bank. It is taking more time and costing a lot more than it  was orignally envisaged to re-launch it as a full service retail bank. However its starting position was and is very different from that of the Co-op. For a start Tesco is world class at customer analytics and applying that to its business. With the launch of the Tesco Clubcard and the acquisition of the customer analytics business Dunhumby, Tesco has a wealth of information and insight about its customers which it already leverages and with the launch of current accounts and mortgages will be able to leverage further for its bank. Secondly Philip Clarke, the CEO of Tesco, recognises that digital is the second curve (the first curve being the stores) that Tesco must invest in to win in the market. Having a large estate of stores is not enough anymore to win in Financial Services or Retail. Tesco is investing millions in digital for both marketing and selling. With Tesco Mobile as part of its offering it is also very well positioned to lead in mobile payments and banking.

Although Sainsbury's was the first amongst the UK supermarkets to launch a bank, it allowed Tesco to overtake it. With the announcement by Sainsbury's that they have bought out Lloyds Banking Group's share of Sainsbury's Bank and will be investing £260m over the next 42 months to put in place a new banking platform, the seriousness of Sainsbury's intent to become a significant competitor for financial services is clear. Like Tesco, Sainsbury's will leverage the synergies from their stores and the customer insight they get from the Nectar card. Like the Tesco Clubcard Nectar will be a critical part of it's differentiated offering. Sainsbury's too is investing in digital (though it lags Tesco) and recognise the need to deliver omni-channel propositions i.e. allowing customers to interact with the bank over multiple channels simultaneously. Sainsbury's will in many ways be playing catch up on Tesco, however in comparison to Co-op are still significantly ahead.

Co-op still needs to complete the integration of Britannia Building Society, would need to invest significantly in digital for both the retail and banking offerings to even compete. To  be in a position to leverage the synergies between the bank and the rest of the Co-op Group will require significant investment beyond that required to meet regulatory requirements.

When Euan Sutherland looks at all of this, the capital he will need to inject onto the bank's balance sheet, the  size of the investments he will need to make to even get close to Tesco and Sainsbury's in terms of financial services, the time it will take and the likely returns he will need to consider whether this really is the best place for both his customers and members to place his bet.

However who will be interested in buying and how much they will be willing to pay for Co-op Bank with it's junk status debt given that there are at least two other banks available on the market - the 316 RBSG branches and the 632 Lloyds Banking Group Verde branches? There is no doubt that Euan Sutherland has some tough decisions to make in his first few months.

Wednesday, 24 April 2013

Will Verde be Co-op's ABN Amro?


In April 2007 John Varley, then CEO of Barclays, in an attempt to vault Barclays into the Premier League of investment banking made a bid for ABN Amro. Not to be outdone Sir Fred Goodwin put together a consortium consisting of RBS, Santander and Fortis to put in a counter bid.

Through the spring and summer of 2007 a battle took place to win ABN Amro. It could be said that it stopped being entirely about the business sense of acquiring the bank and more about winning the deal, beating the other CEO. This was a deal that appeared to be personal. The price continued to rise.

Finally in early October John Varley and Barclays conceded defeat and withdrew their offer. Barclays was rewarded with being paid 200m Euros as a break fee by ABN Amro. Even at the time of Barclays' withdrawal analysts were saying that RBS was paying too much. One said that RBS was going to be struck by 'the winner's curse'.

The rest, as they say is history. The capital required, the slow down and eventual crash of the global markets and the complexity of the integration all contributed to the situation RBS finds itself in now.

Looking at the Co-op's pursuit of the  632 Verde branches that Lloyds Banking Group has to sell, there appear to be some parallels with the ABN Amro pursuit. Could it be that the Co-op will also be struck down with 'the winner's curse'?

The pursuit of Verde has not been as long as for ABN Amro but it appears to have been as personal. In July 2012 Peter Marks, the CEO of Co-op, boasted that he has taken the shirt off the back of the  Lloyds Banking Group CEO, Antonio Horta-Osario, as they agreed to a £750m price tag. Given that the expectation had been that Verde would sell for between £1.5-2bn, he may have had a point, though he may have been better keeping his opinion to himself.

However Co-op is also paying a big price in other ways to raise the capital it needs to acquire Verde. With the announcement of the sale of its Life & Pensions and Savings business to Royal London and its instruction of Deutsche Bank to find a buyer for its General Insurance business, the Co-op's existing financial services business is being taken apart in order to raise the capital for Verde. Aviva is rumoured to be interested in acquiring the General Insurance business.These deals are not dependent on the Verde deal going through, so should the deal fail the Co-op will be in a much poorer state.

Similarly RBS had to raise a lot of money in order to pay the price it had agreed for ABN Amro. In RBS's case it went to the market and executed a huge rights issue for which in a class action it is now being sued). This left RBS with a highly weakened balance sheet, which made it unable to absorb the massive change in the market. How would RBSG have fared if they hadn't pursued and won ABN-Amro? They certainly would still have had problems with their exposure to Ireland through Ulster Bank and the investment banking business would still have been hit, but with a stronger balance sheet and without the exposure to the PIIGS (Portugal, Italy, Ireland, Greece, Spain) that ABn Amro brought the size of the bailout required from the UK Government would have been significantly lower. Fred Groodwin would almost certainly be Sir Fred Goodwin and his pension would be intact.

Should the acquisition still go ahead, which is looking less likely, this will not be a simple integration by any stretch of the imagination. The integration of Britannia Building Society has proved to be a major challenge for the Co-op, Verde will far more complex. Again looking back at RBS, Sir Fred Goodwin went into the ABN Amro integration full of confidence that the bank knew how to do integrations, but Natwest was fundamentally a larger version of RBS so it was a homogenous integration, ABN Amro was an integration of something quite different from RBS and the costs of integration ballooned.

One of the worst scenarios for the Co-op is that they sell off the assets they need in order to complete the Verde transaction and then fail to close the purchase. This would leave the Co-op in a weakened position in terms of Financial Services and overall in a poorer strategic position.

Whilst Peter Marks may have got what appears to be a rock bottom price for Verde the Co-op will be tied to Lloyds Banking Group for many years to come since they have agreed to pay for and use the Lloyds Banking Group systems for the Verde branches. It will take hundreds of millions of pounds and  years to move off these systems and onto a modern architected banking system so Co-op and Lloyds Banking Group will be partners for many years to come.  The Co-op may need to be reminded of the expression that revenge is a meal best eaten cold.

In the meantime Santander has withdrawn from the acquisition of the 316 branches that RBS is being forced to sell. Santander is a bank that appears to always make smart deals - Abbey National, Bradford & Bingley, Alliance & Leicester and Antonveneta to name a few. Antonveneta was owned by ABN Amro and was one part of Santander's element of the consortium bid led by RBS. In true Santander style it sold Antonveneta on to Banca Monte dei Paschi di Siena before Santander had even taken possession making a $3.5bn profit in the process. For Peter Marks it would be sensible to contemplate why Santander withdrew from the RBS branch purchase and reflect on how that might apply to the Verde deal.

As the crunch point approaches when Co-op must decide one way or another to complete or walk away from the deal and Peter Marks looks forward to his retirement, it would be good to have one last reflection on the deal and to decide whether he would rather be John Varley, who walked away from a bad deal with his reputation intact, or Fred Goodwin who was struck down by the winner's curse.

Update April 24th 2013.

So Peter Marks made the almost certainly right decision to walk away from the Verde deal. For the Co-op to have been burdened with the debt and enormous risks of the Verde deal would not have been a good leaving present.

However it does bring into question the future of financial services within the Co-op. Having sold the life and savings business to Royal London and with the general insurance business on the blocks a question has to be whether the Co-op should pull out of financial services altogether. The integration of Britannia into Co-op Financial Services has been a major challenge and it has not resulted in a real challenger to the Big 5 banks. The Co-op is at a crossroads and needs to decide whether financial services is really a business it can be successful in.

Monday, 22 April 2013

Are drive thru branches really relevant in the 21st century?

Metro Bank has announced that it will open in May the first drive thru branch in the UK this century. The branch will be alongside a dual carriageway in Slough the town that was the setting for Ricky Gervais' 'The Office'. It will consist of its own dual carriageway - one for ATM and automated deposit services and one for access to a teller for day-to-day transactions.

The UK does not have a history of drive thru bank branches with only three having been recorded - the first in 1959, the second in 1966 and finally one at Hatton Cross near Heathrow Airport in 1998. Given that there has been so little success with drive thru branches in the past the question has to be asked why not and what is different this time?

Most banks  are increasingly trying to drive transactions out of the branches rather than through them encouraging their customers to carry out routine transactions online either through internet or mobile banking. Along with this and the use of cash declining, this  move on Metro Bank's part seems counter intuitve. However Metro Bank was launched on the basis that it did not want to be like other banks.  Vernon Hill, the American founder of Metro Bank, is not someone to follow the herd. Hill grew Commerce Bank, the successful banking business in the US, based on his experience of running McDonald's franchises. He sold TD Bank before coming to the UK and based on that experience launched the first new bank in the UK.

Metro Bank has focussed on providing a different, louder, more US-styled experience for customers with features such as 'magic' coin-counting machines that look like Vegas slot machines, lollipops and free dog biscuits.

Metro Bank proudly does not compete on price but on the customer experience it provides. The launch of the drive thru bank is part of this differentiated experience. It comes ahead of the launch of seven business day switching that all UK banks will need to adhere to from October 2013 and in anticipation of increased competition from other new entrants such as Tesco, Marks & Spencer and Virgin Money.

Banks for many years now have actively attempted to re-purpose branches from transaction processing to retail outlets where the customer is encouraged to spend the time required to open more complex products such as current accounts and mortgages.

The Metro Bank drive thru branches will clearly be servicing not sales centres, however they will be paired with a more traditional branch where sales can be carried out.

However the more recent trend in retail banking is very much towards omni-channel where digital is integrated into the whole customer experience irrelevant of which channel is used. This is where the leading banks are investing. This includes bringing internet and mobile banking into the branches and through digital bringing the contact center operative and the banking advisor into the home or onto the smart phone or tablet.

Tesco another new entrant into full service banking is investing heavily into digital and omni-channel banking prior to its full launch. Metro Bank does have an online banking service but does not major on this or reflect that in their current seventeen branches.

It is unlikely that the launch of drive thru banking is going to be the breakthrough strategy for Metro Bank that takes them from being a small but attention-grabbing player to being a significant threat to the big 5 banks, but it will certainly get them some free publicity.