Saturday, 11 January 2014

Removing incentives won't stop bank mis-selling


The news that Lloyds Banking Group has been fined £28m ($46m) by Britain’s FCA (Financial Conduct Authority) for having a bonus scheme that put pressure on sales staff to mis-sell products once again brings the spotlight to bear on the culture of banks and specifically, in this case, retail banks.  In Lloyds’ case it was not only the benefits of meeting or achieving targets that created inappropriate behaviour but the sanctions for missing targets including demotion and base salary reduction that put staff under pressure. For at least one sales person they felt under such pressure not to fail that they inappropriately sold products that they could not afford to themselves and their family as well as their colleagues.

The typical media and political response to incidents such as this is to suggest that incentives are bad, that remuneration shouldn’t be related to achieving targets as incentives lead to the wrong sets of behaviours.

However simply removing the explicit link between sales performance and pay will not remove the pressure to achieve sales targets.

The pressure comes right from the top. While the new CEOs of banks may publicly talk about changing the culture of banks, putting the customer at the heart of the bank, winning through providing a differentiated service and they may be completely sincere in those sentiments, by the time that that message is passed down through the organisation to the sales people at the frontline it will be measured in terms of targets, which will need to be achieved. Anglo Saxon businesses are run with a performance management culture where achieving or exceeding targets and  giving greater rewards to those who meet those targets than those who don’t  is fundamental to how those businesses operate. While it may never have been the intention of Antonio Horta-Osario, CEO of Lloyds Banking Group, that the staff be put under such pressure that they coerced customers into buying products that they did not need, by the CEO setting his or her direct reports stretch targets that was the almost inevitable consequence.

The reason for this is simple: banks are commercial businesses that have investors who are looking for returns and always have the option to invest their money elsewhere if the return is better. As such CEOs of banks are competing for investment and are accountable to their shareholders. This applies as much to new entrants and challenger banks as it does to the established banks. All of the new entrant banks without exception have investors backing them whether it is parent companies such as retailers, hedge funds, Private Equity funds or individual wealthy investors. Even the building societies and mutual have to look to the external market for capital and those who lend capital have options as to where they lend to and are doing to achieve competitive return.

But is a culture that is about beating the competition, about achieving the best that you can for your organisation really such a bad thing? Certainly the impression that many politicians gives is that yes it is. The sentiments being expressed have strong parallels with the period where some schools banned competitive sports because politicians believed they were harmful to children.  It wasn’t good for children because it meant that some of them would have to experience losing.

The politicians who rally against the banks and banker compensation schemes can’t have it both ways. On the one hand they say don’t want those in banks to be incentivised to sell customers products but on the other hand they want competition. Competition by its very nature requires a level of aggression, it requires you to play to win and for your opponents to lose.

To demonstrate that they are not solely focussed on financial outcomes most banks today use a balanced set of financial and non-financial measures to monitor the performance of the bank and their employees.   Typical non-financial measures include Net Promoter Score (NPS), customer satisfaction, numbers of complaints and staff engagement.  The argument being that by having a balanced set of measures sales staff are incentivised to treat customers fairly and to only sell customers what they need.

Some banks such as Barclays and HSBC have removed all financial incentives for their staff to sell customers products. Instead their staff are paid a basic salary with the ability to share in a bonus depending on the performance of the bank. However, even when that is the case, every customer facing bank employee who has responsibility for helping a customer to apply for a mortgage or open a savings account knows that, at the end of the day, when it comes to the annual performance review whether they have achieved or missed their financial targets will always be more important than whether they have achieved their non-financial ones. They know that their opportunity to receive a pay rise, to get a bonus or to progress their careers is dependent upon their ability to deliver profits for their bank. The financial incentive may not be explicit but it is still there.

There exceptions to this.  A bank that has taken a very different approach is Handelsbanken. At this bank if the profitability exceeds the average rate of its peers, then surplus profits are put into a fund and distributed to all the staff. However they can only receive these accumulated benefits when they turn 60, thus encouraging long-term thinking and loyalty. The staff, including the executives, have flat salaries with no bonuses. There are no sales or market share targets. Handelsbanken has very high customer satisfaction and is highly profitable. The bank has had no problems with mis-selling or wrongdoing.

However this model will not suit everybody. This is very much a Scandinavian model and the pace of growth whilst highly profitable will not be attractive to all investors. Detractors of this approach will argue that no highly talented executive would be attracted by this reward model when there are banks across the globe prepared to reward more in the short term. The sustained excellent results that Handelsbanken have delivered speak for themselves.  Handelsbanken  would probably argue that it has no desire to attract the sort of executives who are interested in only the short term and will move from bank to bank simply for better rewards.

Given that the reality is the Handelsbanken model cannot and should not be imposed upon all banks, what is the answer and how can this type of mis-selling be avoided in the future?

The reality is that it will never be totally eliminated. Indeed if there were never any complaints or if there were never any practices that could be open to question it would suggest that the hunger to be the best, the passion to grow the business was missing. Every sportsman who wants to be the best knows that you have to go the edge to succeed.   There will always be employees who are too aggressive or dishonest. It is that they are identified and the way that they are handled that sends out the signal to their fellow employees as to what is acceptable behaviour. That has to be called out loud and clear and demonstrated by actions from the top of the organisation.

Secondly, while many banks operate a balanced scorecard of financial and non-financial metrics to measure the performance of the bank, the financial rewards need to be truly aligned to that Scorecard and not just to the bottom line. Not only must reward be aligned to the scorecard it needs to be seen to be aligned. This means that for instance if customer satisfaction or employee engagement scores are part of that scorecard and those measures are not met or regulators impose fines despite financial targets being met, that the executives’ rewards are significantly financially reduced. This is something that has not been reflected across the banking industry despite the enormous financial fines handed out to the likes of JP Morgan and Barclays.

Thirdly there needs to be a recognition by investors that the days of retail banks being a licence to print cash are over, that most banks need significant investment both in terms of capital to fund the business but also to provide the infrastructure that a bank needs to have to compete in the 21st century and finally that an investment in a bank is for the long term – measured in double digit years.

Changing the culture of retail banks is not as easy as simply removing incentives, neither it is something that can be done overnight. To have a vibrant and competitive banking industry there needs to be some friction and a world without it will be a lot worse for the consumer.

Friday, 15 November 2013

The end of the COO/CIO experiment at Barclays?

The news that Shaygan Kheradpir, Chief Operations and Technology Officer, has resigned from Barclays to join Juniper Networks as CEO appears to mark the end of what was a brave experiment by the British bank. Back in January 2011 bringing in the former CTO from Verizon as COO of Barclays Retail and Business Bank was a surprising move given that Kheradpir had no apparent background in either banking or operations, let alone in the UK. HoweverKheradpir shook Barclays up from the start. Changing the historical relationship of CIOs reporting into COOs not only in Barclays but in banks and most other organisations across the world by making both equally accountable he made a bold statement. It’s a financial world wrote about this at the time http://www.itsafinancialworld.net/2011/05/barclays-cooscios-joined-at-hip.html . Whilst it was clear that not many banksagreed with this move (ANZ and WestPac being examplesthat went the opposite way), there was a lot of interest in seeing whether this radical change was going to make the difference to Barclays Retail and Business bank. This came at a time when Barclays’ investment bank, Barclays Capital, led by Bob Diamond and his close knit team were seen as aggressive, agile and highly successful; something that could not be said about the staid Barclays Retail and Business bank.  Kheradpir challenged the way that Barclays brought new ideas to market introducing agile and the first fruit of this approach was the launch of Pingit, the P2P payments solution.  He also brought in other like minded individuals from Verizon and those with a software background to reinforce the cultural change that he wanted to make. Following his early success, Kheradpir was promoted to Chief Operations and Technology Officer at the Group level and was responsible for driving the cost reduction elements of Antony Jenkins, the CEO of Barclays, ‘Transform’ programme. Much of which has yet to bear fruit.
Kheradpir leaving to go back to the Telco industry less than three years after he joined Barclays cannot be seen as a ringing endorsement for the effectiveness of bringing into a bank at such a senior level someone with no experience of the industry. Certainly there is an argument that bringing someone in from outside the industry brings a fresh perspective and enables them to ask the questions, just like the small boy in the story of the Emperor with no clothes that no one else dares to ask for fear of looking stupid. There is also the perspective, often argued by the consultants McKinsey that bringing someone in from another industry opens up the opportunity to leverage what worked well in that other industry. No one could honestly argue that banking doesn’t need to change. However banking and specifically retail banking in the UK has experimented with this before. The major banks hired retailers to teach them how to put the retail into retail banking. The ramifications of that are still being felt today. Yes bank branches may look smarter, may look more like GAP stores from the beginning of this century, but would there have been the PPI (Payments Protection Insurancemisselling scandal without those retailers for whom selling extended warranty policies which customers didn’t want or need was secondnature?
There is fundamentally nothing wrong with bringing in a senior executive from a different industry to challenge the way that things are done and have been done for many years, to argue for treating customers differently, to change the way that IT systems and change programmes are delivered but for this to succeed there are two critical requirements.
Firstly the new executive must not be so prejudiced or arrogant that they don’t listen and try to understand why the banking industry operates in the way that it does. That doesn’t mean that once they have taken the time to listen and to understand the industry that they apply their experience from outside the industry and fundamentally change the way that banking is delivered.
Secondly the new executive needs to surround him- or herself with open-minded experienced banking executives who he or she can rely upon for their integrity and to provide advice and a safe environment to allow the executive ask the dumb questions. The executive also needs to be confident that the executives working for him/her will tell them when they are talking rubbish. This sadly appears not to have happened in the run up to the financial crisis.
Kheradpir by making the COO and the CIO jointly responsible for the performance of the business units working for him was acknowledging that IT is not simply a supplier to the business of banking but that it is absolutely fundamental to being successful in banking. He was also recognising that today there are not that many banking executives out there that have the skills, experience and competencies to master both the COO and the CIO roles and therefore the next best step was to make them jointly accountable. Antony Jenkins, CEO of Barclays saw Kheradpir as one of the new generation of Renaissance COOs who are young enough to have been brought up with technology that it is so deeply ingrained in their DNA that the barriers between operations and IT can be effectively broken down by being encapsulated in one person.
With Shaygan Kheradpir moving to the CEO role at Juniper Networks the result of the experiment that Barclays undertook can only be inconclusive. Kheradpir simply will have not stayed long enough at Barclays to prove that the new model worked, whether it would have fundamentally changed the way that Barclays delivers banking which is a loss not only to Barclays but also to the banking industry that was watching with interest.

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.