The Economist, 14 December 2005
Allegations of market failure plague banks in their most profitable year ever
For an industry that likes to think of itself as staid and grey-suited, Britain's banks have been getting far more attention than they would like. Last week the Office of Fair Trading (OFT), a competition watchdog, said that it planned to scrutinise the market for payment-protection insurance on loans, valued at £5.4 billion in 2003. Profit margins on loan-insurance policies appeared high, the regulator said. Just a month earlier, the Financial Services Authority (FSA), the industry's main regulator, said that investigators who went undercover to check into the matter found firms at risk of mis-selling these policies.
The OFT probe is just the latest in a long line of recent inquiries into British retail banking. The Competition Commission, another watchdog, has three investigations in progress. Other British regulators and a parliamentary committee have another ten or so in the works.
In fact, bank customers in Britain pay less overall than those in many comparable economies. As the chart shows, the average British consumer spends €65 (£44) a year on banking services, according to a 2005 study by Capgemini, a consulting firm. That compares with €113 in Italy, €98 in Germany and €93 in the United States.
Yet for all the rivalry between the country's banks, which include three of the world's ten largest, there is a disquieting lack of competition in some areas of the market. Lenders compete fiercely to make mortgage loans; and a review that David Miles, an academic, carried out at the government's behest said last year that the mortgage market was generally working well. But the same level of competition is not evident across all financial products. Several OFT studies have found restricted competition in store-branded payment cards, doorstep loans and credit-card transaction fees, for example.
This suggests that there has been relatively little change since 2000, when a government-appointed review headed by Don Cruikshank, formerly director general of Oftel, the telecommunications regulator, found market failure in the provision of banking services to consumers and small businesses.
“The government has a problem with the banking industry,” said David Lascelles, a director of the London-based Centre for the Study of Financial Innovation, a think-tank. “To some extent that problem is legitimate. There is a surprisingly small amount of competition.” Observers posit two contrary explanations for this: too much regulation and too little.
In an industry such as banking where there are high barriers to entry, adding rules simply makes it more difficult and expensive for new entrants to compete. It can also carry unintended consequences, as the Competition Commission found not long ago.
A two-year study into banking for small businesses, completed in 2002, found that weak competition was allowing big banks to charge excessive fees. The government ordered them either to provide free services to small businesses or to pay interest on their current accounts.
But the remedy may have compounded the illness. Abbey National and Alliance & Leicester, Britain's sixth- and eighth-largest banks, complained that the regulator's intervention in fact stunted their growth.
While the big banks were merrily whacking their small business customers over the head, their smaller rivals had been tempting clients with offers of free banking or interest-bearing accounts. When bigger banks were required to do the same, customers had less incentive to switch and, arguably, competitive forces in the market were reduced. The OFT plans to review the measures next year.
But there is also merit in the argument that more regulation can help to boost competition. Sir Callum McCarthy, chairman of the FSA, argued in a speech last month that to achieve competitive markets regulators must make detailed rules compelling firms to provide information to their retail customers. Only then can consumers make informed choices.
This, broadly, is the approach that regulators are now following. In the past year, they have made banks explain more clearly the interest rates they charge on credit-card debt and the fees for withdrawals from cash machines.
For transparency to succeed, however, consumers must exercise their power. Sadly, they cannot always be relied upon to do this. At least 75% of customers have never switched banks, according to figures from MORI, a polling firm.
Perhaps, however, this should not come as a surprise. According to the FSA, a fifth of all bank customers don't understand percentages.
Allegations of market failure plague banks in their most profitable year ever
For an industry that likes to think of itself as staid and grey-suited, Britain's banks have been getting far more attention than they would like. Last week the Office of Fair Trading (OFT), a competition watchdog, said that it planned to scrutinise the market for payment-protection insurance on loans, valued at £5.4 billion in 2003. Profit margins on loan-insurance policies appeared high, the regulator said. Just a month earlier, the Financial Services Authority (FSA), the industry's main regulator, said that investigators who went undercover to check into the matter found firms at risk of mis-selling these policies.
The OFT probe is just the latest in a long line of recent inquiries into British retail banking. The Competition Commission, another watchdog, has three investigations in progress. Other British regulators and a parliamentary committee have another ten or so in the works.
In fact, bank customers in Britain pay less overall than those in many comparable economies. As the chart shows, the average British consumer spends €65 (£44) a year on banking services, according to a 2005 study by Capgemini, a consulting firm. That compares with €113 in Italy, €98 in Germany and €93 in the United States.
Yet for all the rivalry between the country's banks, which include three of the world's ten largest, there is a disquieting lack of competition in some areas of the market. Lenders compete fiercely to make mortgage loans; and a review that David Miles, an academic, carried out at the government's behest said last year that the mortgage market was generally working well. But the same level of competition is not evident across all financial products. Several OFT studies have found restricted competition in store-branded payment cards, doorstep loans and credit-card transaction fees, for example.
This suggests that there has been relatively little change since 2000, when a government-appointed review headed by Don Cruikshank, formerly director general of Oftel, the telecommunications regulator, found market failure in the provision of banking services to consumers and small businesses.
“The government has a problem with the banking industry,” said David Lascelles, a director of the London-based Centre for the Study of Financial Innovation, a think-tank. “To some extent that problem is legitimate. There is a surprisingly small amount of competition.” Observers posit two contrary explanations for this: too much regulation and too little.
In an industry such as banking where there are high barriers to entry, adding rules simply makes it more difficult and expensive for new entrants to compete. It can also carry unintended consequences, as the Competition Commission found not long ago.
A two-year study into banking for small businesses, completed in 2002, found that weak competition was allowing big banks to charge excessive fees. The government ordered them either to provide free services to small businesses or to pay interest on their current accounts.
But the remedy may have compounded the illness. Abbey National and Alliance & Leicester, Britain's sixth- and eighth-largest banks, complained that the regulator's intervention in fact stunted their growth.
While the big banks were merrily whacking their small business customers over the head, their smaller rivals had been tempting clients with offers of free banking or interest-bearing accounts. When bigger banks were required to do the same, customers had less incentive to switch and, arguably, competitive forces in the market were reduced. The OFT plans to review the measures next year.
But there is also merit in the argument that more regulation can help to boost competition. Sir Callum McCarthy, chairman of the FSA, argued in a speech last month that to achieve competitive markets regulators must make detailed rules compelling firms to provide information to their retail customers. Only then can consumers make informed choices.
This, broadly, is the approach that regulators are now following. In the past year, they have made banks explain more clearly the interest rates they charge on credit-card debt and the fees for withdrawals from cash machines.
For transparency to succeed, however, consumers must exercise their power. Sadly, they cannot always be relied upon to do this. At least 75% of customers have never switched banks, according to figures from MORI, a polling firm.
Perhaps, however, this should not come as a surprise. According to the FSA, a fifth of all bank customers don't understand percentages.
