David Ruffley MP was a member of the Committee that wrote the following report

Saturday, 2 April, 2011

The Treasury Committee today (2 April) publishes its report, Competition and Choice in Retail Banking. In the report the committee concludes that thepre-conditions for effective competition in the retail banking market are notpresent.

The committee highlights in particular a lack of price transparency and comparability in the personal current account market, as well as the difficultyof switching. The report calls on the Government to make competition a primary objective of the new regulatory body, the Financial Conduct Authority (FCA). Italso recommends a "public interest test" based on competitionconsiderations for proposed future divestments of Government-held stakes in the banks.

For competition to beeffective, customers need to know what they are buying, how much they arepaying and to be able to transfer their custom from one provider to anotherwithout risk. Over the course of our inquiry we heard from not only the topexecutives at all of the major UK banks, but also smaller players, newentrants, competition regulators and experts.

The CEOs of the largeincumbents told the committee UK retail banking was enormously competitive, buta far larger range of witnesses described the industry as close to anoligopoly. We also received much evidence about low levels of consumersatisfaction and poor treatment of consumers by the major banks. We could notbut conclude from this that competition in the UK retail banking market is notstrong enough.

The CruickshankReport in 2000 identified problems with price transparency and the difficultyof comparing products. Over a decade on, these problems remain acute. They havebeen compounded by the fact that following the financial crisis there are nowgreater levels of concentration in the industry. The 'too big to fail' issueappears to place large institutions at an unfair competitive advantage tosmaller, less systemically important ones.

The Government can domore to prioritise competition in the way it regulates the industry; the FCAshould have competition as a primary objective. The Treasury can assistcompetition when it divests further bank stakes. Short-term profit maximisationshould not be at the long-term expense of the consumer.

We welcome the factthat the Independent Commission on Banking has competition as part of itsremit. The Office of Fair Trading (OFT) told the committee it is workingwith the banks to try to ensure greater transparency and we call on the banks tomake cooperating a priority.

Currentaccounts and switching

The report expresses concern at the continuing lack of pricetransparency and comparability in the current account market. Without clearinformation it is impossible for consumers to distinguish between the offersmade by rival providers. Lack of transparency moreover reduces the incentivesfor those providers to make distinctive offerings. The switchingprocess-despite improvements-remains cumbersome and does not always worksmoothly. Effective competition will remain elusive unless urgent steps aretaken to improve price transparency and comparability and the switchingprocess.

The fact that the current account is a 'gateway' product means dominancein this market by the large banks has competition implications elsewhere in thesector. This means that barriers to competition in the personal current accountmarket need to be scrutinised particularly carefully, the report says.

Moreover, so-called free banking is not free. The term free-in-creditbanking is a misnomer, given that consumers with positive balances pay throughinterest foregone, the report says. It is also clear that so-called freebanking has important distributional consequences. A minority of consumers,often those on lower incomes, pay explicit charges associated with overdrafts.This results in high prices and poor outcomes for a sub-set of consumers.Meanwhile, other consumers, often on higher-incomes, do not pay explicitly fortheir current account provision, in spite of the fact that their PersonalCurrent Account (PCA) provision clearly does incur a cost.

The report notes that, whilst it is undesirable from the perspective of'fairness', cross-subsidy is not always wrong. For example, it exists in theairline industry where customers who book early are cross-subsidised by thosewho book later. However, pricing is far more transparent and customers caneasily switch airline provider. These conditions are not present in the currentaccount market where cross-subsidy is opaque and switching costs are high, itsays.

Small and Medium Enterprise (SME) lending 

The report notes that the debate on SME banking has too often only beenfocused on the availability and cost of credit. Good customer service for SMEscan be as, or even more, important to SMEs. Competition and the ability toswitch is the most important spur to better service. There are still very highlevels of market concentration for SME banking, even though the sale of some ofthe RBS branches to Santander means the 'Big 4' in the SME sector could infuture become the 'Big 5'.

The importance of branches to many SME customers presents a significant barrier to new entrants and therefore to competition. The report recommendsthat the Independent Commission on Banking considers solutions such as animproved Inter Bank Agency Agreement and neutral shared branches as part of itsremit to promote competition.

Newentrants and Government divestments

Given the continuing importance many consumers attach to a branchnetwork, especially for current account services, the report notes that new entrants without access to an extensive branch network will be at aconsiderable disadvantage to established banks for the foreseeable future. Thismeans that the Government needs to examine carefully where it can help improvethe conditions for effective competition.

The sale of the RBS divestments to Santander was a missed opportunity toinject more competition into UK retail banking, the report says. Whilst Santandermay have met the EU state aid criteria and enjoyed only a small share in theSME market, it was already a leading player in other areas. Whilst none of thelarge five banks will be able to bid for the Lloyds divestments, the Committeebelieves a public interest test based on competition considerations should apply both to the Lloyds divestments and the sale of Northern Rock.

The report notes that Lloyds is currently the market leader in mostparts of the retail market. In some segments, Lloyds market share is almostdouble that of its nearest competitor and yet, there has been no assessment tosee what impact Lloyd's strong position has had on competition in the retailmarket. The Committee is concerned by the emergence of such a powerful playerand the potential competition implications. Though the divestments required bythe EU will go some way towards addressing this concern, as well as (inconjunction with the RBS divestments) reducing concentration levels in thesector, Lloyds will retain a leading position in many market segments evenpost-divestment. 

Government credibility would be undermined if a merger arrangementapproved by one administration was unpicked by another. It would riskpoliticising competition policy, create incentives for political lobbying anduncertainty for business. However, the need to respect the merger should notinhibit the Independent Commission on Banking from proposing radical changes t the market as a whole, the report says.

Regulation and competition

New entry and reductions to barriers to entry and expansion may aloneprove insufficient to tackle the problem of ineffective competition. As aresult, the Committee urges the Independent Commission on Banking (ICB) toseriously examine whether there is a case for further structural reforms, overand above the RBS and Lloyds Banking Group divestments, to reduce concentrationand promote competition.

Solving the 'too big to fail' problem is critically important from acompetition as well as a financial stability perspective. The ICB must alsoaddress this issue, which is crucial to achieving the objectives outlined inits terms of reference. The committee is encouraged by signs that the ICB isalready considering ring fencing as a possible solution and will monitor itsinterim proposals, due to be set out later this month, carefully.

The report expresses disappointment that the Government has not gonefurther in making competition at least one of the central operational objectives of the new Financial Conduct Authority. The report repeats thecommittee’s previous recommendation, in its Financial Regulation Report earlie rthis year, that the FCA should have competition as a primary objective. Failureto act on this would repeat a mistake made at the time of the FinancialServices and Markets Act (FSMA).