The UK’s Competition and Markets Authority (CMA) has been investigating the low level of competition between banks in the UK. They released their provisional findings today, but backed away from any measures that would enable true competition. As we warned in our initial submission to the Commission, it’s an illusion to think that switching between four large and almost identical banks is true competition. We argued that there’s much greater chance of real competition if tech firms are allowed to compete with banks to provide current accounts to individuals and businesses. But the CMA’s recommendations do nothing to enable that.
The UK is unique in having just a few massive banks
“The four largest banks (LBG, HSBCG, RBSG and Barclays) in Great Britain (GB) accounted for approximately 70% of active Personal Current Accounts and 80% of active Business Current Accounts in 2014.” (CMA, p8)
This concentration of current accounts with the four big banks is one part of the “Too big to fail” problem. If RBS had been allowed to fail during the crisis (rather than being rescued by the taxpayer) then potentially 15-20% of the population would have been unable to make payments or withdraw cash. This could have led to wide scale panic, runs on all cash machines, stockpiling of food by those who still had working accounts, and general chaos. Even Gordon Brown, prime minster at the time the crisis hit, is alleged to have worried that “If banks are shutting their doors and the cash points aren’t working”, it would lead to “anarchy”. This was one of the reasons the government had to step in to rescue the banks rather than let them face the consequences of their unstable business model and reckless risk taking.
Positive Money argues that splitting the payment accounts from the banks’ risky lending business would go a long way to avoiding this problem in future. But until that happens, we should encourage competition that would reduce the market share of the big four banks.
- Levelling the playing field between the big four banks and their smaller competitors and new entrants to the current account industry
- Making it easier for customers to switch
- Actually giving customers reasons to switch
The CMA’s findings list 15 “remedies” that they think will improve competition. But all of the remedies are focussed on making it easier for customers to switch and prompting them to do so. (The full list is here.) None of the remedies work towards levelling the playing field and removing the main advantages that currently protect the big four banks.
The Real Advantage Protecting the Big 4 Banks
Unlike the rest of the world, current accounts in the UK tend to be “free” to the account holder. We don’t usually pay fees for payments, withdrawals and other services. Since interest is charged on overdrafts, these accounts are known as “Free If In Credit” (FIIC).
But of course, these accounts aren’t actually ‘free’. The banks incur costs to run its administration, internet banking, providing debit cards, postal statements, customer service, marketing and so on. All these costs have to be paid for one way or another. It’s just that in the UK, instead of a transparent pricing structure where you know what you’re paying for, it’s hidden.
For example, in 2013, banks made a total of £8.1bn in revenue (not profit) for running current accounts. Of this amount, £2.9bn came from overdraft charges (including interest and unauthorised overdraft fees). One of the main reasons that banks provide current accounts for ‘free’ is that it allows them to lend to you – either through overdrafts, or because you’re more likely to apply to them over other banks for a mortgage or personal loan.
But more importantly, £3.2 billion of this revenue came from something called “net credit interest”. This comes about because while the bank pays interest close to 0% on bank deposits (the numbers in your current account), it uses its ability to create this type of current account money in order to make loans. By making loans, it acquires financial contracts (i.e. the loans) which pay it a higher rate of interest than you receive on your deposits.
This £3.2 billion of revenue, therefore, comes from the ability of banks to create money. This revenue source can only exist in financial firms that mix up the businesses of providing payment accounts (which need to be safe) with the risky business of making loans.
This is a huge barrier to competition. It makes it incredibly difficult for competitors that want to provide current accounts but don’t want to place customers’ money at risk.
Positive Money has argued that technology firms or tech startups could provide current accounts that take no risk with customers’ money. Instead, customers’ funds would be held risk-free at the Bank of England. Because these current account providers would take no risk, they wouldn’t need much of the regulation and supervising that is imposed on ordinary banks. And because they would be tech firms rather than banks, they’re more likely to innovate useful services than the behemoth banks.
We’ve proposed this to the CMA and Payment Services Regulator, and argued that real competition is more likely to come from the tech industry than from getting the established banks to compete with each other.
But these firms are on a very unlevel playing field, which makes it hard to compete with the big banks.
Firstly, because these current account-only providers wouldn’t take risks with customers’ funds, they can’t benefit from net credit interest. But this net credit interest makes up nearly 40% of the current account-related income for banks. So any tech startup that wants to compete with banks for current accounts, but without adopting the same risky business model, is automatically disadvantaged, because it doesn’t have this revenue source. There’s no way to address this unfair advantage of the banks apart from requiring banks to separate their payment accounts from their lending business – something that we would definitely advocate, but which is too radical for the government right now.
Secondly, any new entrant that chose to only provide current accounts and not place customer’s money at risk would be unable to cross-subsidise those services by earning “net credit interest”. In other words, it would need to charge for the payment services it provides. This makes it harder to compete with banks who are able to cover the cost of their current accounts by acquiring risky assets (all the while benefitting from the government’s guarantee on their liabilities if everything goes wrong).
So while the CMA has considered the problems with “free if in credit” (FIIC) accounts, it has decided that they are not a sufficient barrier to competition:
“While FIIC reduces to some extent awareness of the costs (direct and indirect) that customers are incurring, we have not found that the FIIC model is contributing to low switching rates. The UK is almost unique in having this pricing structure, but switching rates are also low in countries 18 where customers pay for their PCAs. Rather than the FIIC model itself, the lack of triggers and customers’ perceptions of the lack of benefits of searching and switching are the most significant factors for low customer engagement.” (p18)
But again, the CMA is only thinking about encouraging competition between the big few homogenous banks. They fail to recognise that ‘free’ current accounts are only possible because the big banks mix up a payments service with a risky lending business underwritten by taxpayers. And they completely fail to notice that the real opportunities for competition come from outside the banking sector.
If the government really wants to increase competition in banking, then reading our short paper on opening up competition in payment services might just be more productive than the CMA’s 18 month inquiry.