The role of competition in banking markets
When I accepted the invitation to speak here today, I was conscious that for someone from the Competition and Markets Authority (CMA) to come to a conference of bankers might seem – to some – a bit like entering the lions’ den. It’s just 4 weeks since we announced our decision to launch a full market investigation into retail banking, and I know that this decision wasn’t universally popular in the banking community. But then the decision wasn’t universally unpopular either. True, a number of banks, in response to our consultation, expressed reservations about our proposal to launch the investigation – 4 banks, to be precise – but many others were supportive.
One bank, for example, told us: ‘the CMA is uniquely placed to conduct a thorough, objective analysis and to facilitate a robust evidence-based dialogue between all market participants’.
While another noted that the investigation represents: ‘a critical opportunity for the industry to work with regulators to address long standing concerns about competition’ (1 – see footnotes at the end).
And I am pleased to see that even banks who expressed reservations have said they will engage fully and constructively with the market investigation now underway.
I’m not going to spend the whole of this talk speaking about the market investigation. Now that we’ve taken the decision to launch it, the investigation is being conducted by a group drawn from our panel of expert members, and it’s no part of my role as Chief Executive to interfere with the independence of their decision-making or to make comments that anticipate the investigation process over the next 18 – now 17 – months.
I will, however, say something about our reasons for referring these markets for a full market investigation, following our ‘first-phase’ analysis in our market studies. I will also outline some of the other ways in which competition – and the CMA – are relevant to the banking industry. And set out how we see this competition agenda contributing to ‘Better Banking’ (today’s conference theme).
But let’s start with some basics. I realise that, although I have lived and breathed the CMA since I was appointed to the job just 2 years ago, not everyone will be familiar with what the CMA is or what we do. Sometimes we civil servants need to remind ourselves that those of you who are busy running businesses, and making the wheels of the economy turn, won’t always follow avidly every reconfiguration of government departments and agencies and every change of names. Many of you will have known, in the context of competition, the OFT – the Office of Fair Trading – and the Competition Commission (CC). On 1 April this year, those two august bodies ceased to exist, and were in effect replaced by a new unitary authority, the Competition and Markets Authority, or CMA, of which I’m proud and honoured to be the first Chief Executive.
The CMA has inherited the competition functions of the old OFT and CC, as well as many of the consumer protection functions of the OFT. We’ve managed to ensure continuity by taking on staff from the OFT and the CC, benefiting from their depth of experience and expertise. We have also injected some fresh blood by recruiting widely from other branches of government and regulators, and from businesses and professions in the private sector. I myself have experience in both public and private sectors. I worked for several years at the OFT and in what was the Department of Trade and Industry, now the Department for Business Innovation & Skills (BIS). Most recently, I headed Ireland’s telecoms regulator. I’ve worked in a number of major corporates, and for a few years ran a small company that I’d set up. So I know what it means to work with, and rely on, the banks.
As to what we do, it’s best summed up in the CMA’s main legal duty which is, in the words of the statute that established us: ‘to promote competition, both within and outside the United Kingdom, for the benefit of consumers’.
Competition and society
Now any of you who have encountered competition law or policy, or who’ve had to deal with competition authorities – whether in the UK, in Brussels, or elsewhere – will know that there is a fair bit of complexity, in the relevant legislation and case law, in the economic analysis, and in the procedures.
But, in essence, what competition law and policy are about is very simple and straightforward.
First and foremost, competition is – as our statutory duty makes clear – for the benefit of consumers. If a business supplying goods or services faces vigorous competition, the only way that business can make money is to win and retain customers. And that requires the business to offer to customers the most attractive prices and the highest quality (consistent with making a reasonable return or profit). That is true whether the business is a butcher, a baker, or a bank.
And in the context of banking, the most attractive price means, for those running overdrafts or otherwise borrowing, low interest rates, fees and charges, and for those in credit or making deposits, attractive interest rates and low fees. And the highest quality is about service standards, both at a mundane level – opening hours, ease of access to relevant information, the speed with which lost credit cards are replaced – and at a more sophisticated level, in terms of the availability of someone to give advice and the quality of that advice, or breakthrough innovations such as those made possible by new technologies.
As for consumers, banking performs a vital service across society. Virtually every household in the country uses retail banking services. In our market studies published in July, which led to last month’s launch of the market investigation, we heard that in 2013 there were 65 million active personal current accounts in the UK. Small and medium-sized businesses – SMEs – which employ 60% of the country’s workforce, hold business current accounts that collectively yielded for the banks £2.5 billion in revenue, and the value of outstanding term loans to SMEs in Great Britain was some £90 billion. And of course larger corporates depend on the banking sector for a wide range of financing facilities.
What’s more, banking is of course part of the essential economic infrastructure of our society. As well as being a major industry in itself, it underpins most other economic activity, both consumer and business. We’ve calculated from Payments Council figures that every day there are 59.1 million payment transactions going through our banking system. Up and down the country there are (in spite of branch closures) over 8,000 bank branches.
So retail banking is a market that really matters. When there’s vigorous competition in this market, the economy will benefit from higher quality and better value banking services. Conversely if competition is weakened or frustrated – whether through anti-competitive practices by businesses in the market, or through inherent features of the market – the incentives to offer consumers attractive prices and quality are correspondingly weakened. The CMA’s role is to ensure that competition is not weakened or frustrated in these ways, and that incentives to offer consumers attractive prices and high service standards remain high. So we will seek to combat anti-competitive practices, and we will address features of the market that seem to have adverse effects on competition.
And it’s every level of society that suffers if competition is weakened or frustrated. For example, in our market study on personal current accounts, we found that consumers were not being served well in terms of charges for overdrafts (2). And the consumers incurring these charges, and affected by what we thought might be a weakened degree of competition, were to be found in very large numbers – some 25 million personal account customers use overdrafts (3) – spread fairly evenly across all income levels in society (4).
Tackling the big subjects
In fulfilling our duty to promote competition for the benefit of consumers, the CMA won’t be afraid to tackle some big subjects. In our first few months, in addition to the banking inquiry we also launched another full market investigation into an area of intense public interest and concern: the energy sector.
Some people have suggested that our focus on energy and banking reflects political interference, at variance with our position as an independent competition authority. My view on this is that we’re independent, but we’re not in an ivory tower. Yes, both energy and banking have been much talked about by politicians and the media. But that reflects the fact that they are subjects of great public concern. In a democracy it’s inevitable that politicians, who depend on people’s votes, will voice people’s concerns. And it would be extraordinary if the CMA, as the country’s primary competition authority, were to shy away from responding to and addressing competition issues that are causing real concern to people in this country, so long as there is substantial evidence of competition problems.
The market investigation reference into retail banking
Let me now briefly reiterate for this audience the reasons we set out, in our published decision last month, for asking the CMA’s panel of independent members to conduct a full ‘market investigation’ into retail banking, or – as I should say more precisely – aspects of retail banking; namely personal current accounts and also some banking services for SME customers (mainly business current accounts, general business loans and other forms of bank finance to SMEs).
What our November decision means
The first thing to clarify is that this wasn’t a final decision that the market is anti-competitive. It wasn’t, as it were, a ‘guilty’ verdict. It will be for the panel members running the investigation to decide, at the end of a thorough and detailed 18-month investigation, whether any features of the relevant markets have an ‘adverse effect on competition’. If there is such an adverse effect, the panel members can then require measures to remedy that adverse effect. Those measures could in principle be structural – ordering businesses to be divested, as happened a few years ago after our market investigation into BAA, which led to the sell-off of airports in London and Scotland. But there are also other possible remedies if the panel members conclude that there is an adverse effect on competition – for instance so-called ‘behavioural’ remedies such as requiring greater transparency and comparability – and they could involve regulatory or legislative changes. All that is not for me, but for the panel of independent members to decide, after they have heard and assessed all the relevant evidence and arguments from interested parties.
Our decision last month was at a stage before that. The market studies we conducted into personal current accounts and SME banking, published in July, and the consultation that followed, showed reasonable grounds for suspecting that there were features preventing, restricting or distorting competition. On that basis, we decided that it was appropriate to refer these sectors for a full market investigation.
Reasons for our November decision
The reasons for our making the reference are set out in our final decision document, which we published last month. But I’ll try to give a rough summary, which I hope conveys the essence reasonably accurately.
To begin with there was a factor that closely relates to what I said earlier about what you can expect when there is vigorous competition in a market. Where there is a vigorously competitive market, the businesses that do the best job of servicing customers – in terms of price and quality of service – tend to win customers and gain market share. The ones that don’t can expect to lose customers and market share.
What we found in retail banking was that it didn’t seem to be working like this. For both personal and SME customers, very limited market share gains have been made in recent years by those banks with the highest reported levels of customer satisfaction. Conversely, those with some of the lowest satisfaction scores – relatively – didn’t seem to be losing significant market share as a result. This is not what one would expect to see in a well-functioning competitive market.
In fact the evidence suggested that market shares had remained remarkably stable over a sustained period. There were a number of possible factors contributing to this apparently muted competition.
First, there seemed to be relatively little switching and shopping around by consumers – which matters because the hope of winning customers, and the fear of losing customers, is of course one of the main drivers to businesses competing vigorously. The new seven-day current account switching service has made switching easier, but switching levels remain at about 3 or 4% a year – figures that compare poorly with other sectors, including the energy sector.
Part of the problem is the difficulty comparing overdraft charges. This is true of personal customers. A piece of work by Which? this year, involving 18 volunteer consumers, found that: ‘Across almost all the banks, the overall cost was so difficult to work out that even a principal inspector of taxes only got 1 of his 4 calculations right, and a retired headteacher got his answers all wrong’ (5).
As for SMEs, a survey conducted for our SME banking market study showed that many are concerned at how difficult it is to compare charges, with one Birmingham businessperson saying: ‘I haven’t got a clue what other banks charge. It’s something that we need to look into but I haven’t got the time…’ (6).
Second, there seemed to be considerable barriers to market entry and expansion. Barriers include the continuing need to maintain an extensive, and costly, branch network in order to be an effective scale competitor. Although people increasingly use online banking and mobile apps for their banking needs, the survey evidence we saw showed that both personal and SME customers still very much value having a branch of their bank near them. And this is reflected in the banks’ business models: despite all the news of branch closures, the larger banks intend to maintain very extensive branch networks; and amongst so-called ‘challenger banks’, Metro is establishing a substantial new network of branches. Another possible barrier we heard about was the suggestion that smaller banks face disproportionate difficulties and costs in gaining access to essential payment systems like BACS, CHAPS and Faster Payments.
Undertakings in lieu
We received proposals from the 4 largest banks to address the problems in SME banking, without a market investigation, by some measures to improve transparency and comparability. These were to be agreed by way of undertakings ‘in lieu’ of a market investigation. We took these proposals seriously, and consulted on them. No one, least of all us, wanted a market investigation if this was unnecessary. But we didn’t think the proposals were sufficient to address the considerations which, in our view, made it appropriate to launch a market investigation. And experience suggests that it would take considerable time to agree undertakings in lieu; this would not be a ‘quick fix’. Most respondents to our consultation who provided submissions on this issue agreed with us. Even the 4 banks did not seek to develop the proposals or make substantial arguments for them after our July provisional decision.
Nevertheless, as I’ve said, we thought these proposals for the SME banking sector had some merit, and we would certainly encourage the banks to take steps to improve transparency and otherwise facilitate competition sooner rather than later. We imagine that banks who are serious about improving customer outcomes will not want to sit out the 18 months of the market investigation before taking such further steps.
The burden of further inquiry
So, for these reasons, we decided to launch the market investigation. As we said when we announced our provisional decision in July (7), we are fully conscious that a market investigation involves considerable cost for the businesses under investigation in the sectors and other interested parties – and indeed for the public purse.
Some people pointed out that there have been numerous investigations by public bodies into banking – by the Financial Conduct Authority (FCA), the Treasury, the Bank of England, and our predecessor bodies, the Competition Commission and the OFT. Plus, of course, the Vickers report in 2011, the Parliamentary Commission on Banking in 2013 and Treasury Select Committee inquiries.
What, they asked, is the point of yet another regulatory intervention?
While I can’t predict the outcome of this market investigation, it’s worth pointing out that, unlike many of those earlier inquiries, the CMA has powers, following a market investigation, to order remedies to any adverse effects on competition that might be identified, rather than merely to make recommendations.
What’s more, many of those earlier reports – including Vickers in 2011, and the Parliamentary Commission in July 2013 – explicitly envisaged that there should be a market investigation by 2015 in the absence of a transformative change in the conditions of competition in the sector. While we recognise that there have been important developments – the current account switching service, for example – they don’t seem to us yet to have had the transformative effect hoped for, and the long-standing concerns about competition in retail banking largely remain.
So we’re confident the decision to launch a full market investigation was well justified. But we will keep firmly in mind the need to avoid unnecessary regulatory burdens.
Mitigating the regulatory burdens
Just to emphasise the point, in our decision to make the market investigation reference, we highlighted the need to: ‘be aware of the work of the FCA, the Payment Systems Regulator (PSR) and HM Treasury in these areas and that [they] will take this into account as appropriate, conscious of the need, so far as possible, to minimise duplication and to avoid imposing unnecessary burdens on the businesses concerned’ (8).
The issues statement from the group conducting the market investigation last month says: ‘We also wish to ensure that the investigation benefits from the in-depth knowledge of the relevant regulators and their ongoing work in the sector, and that we minimise burdens on the sector by ensuring that we do not unnecessarily duplicate the work of the regulators, in particular with regard to information requests. To achieve this we will liaise with the relevant regulators as appropriate’ (9).
The group have published their initial timetable along with the issues statement, and will continue to share and test their thinking as the investigation unfolds. The next key milestone is the provisional findings report, due in September 2015.
The need to be competition-compliant
I said that I wouldn’t dwell exclusively on the retail banking market investigation, although I appreciate that it’s a major and pressing preoccupation for many people here, and that’s why I wanted to spend some time explaining the thinking behind our launching of the investigation.
But there is more to competition than just market investigations. Effective competition is important, and valuable to society, not just as regards retail banking services for SMEs and personal current accounts, but across the whole range of banks’ activities, including wholesale market operations.
I said earlier that as part of our duty to promote competition – which benefits consumers and the wider well-being of society – we will seek to combat anti-competitive practices. Part of that involves enforcing the UK and EU competition prohibitions: the prohibition on agreements and concerted practices between businesses that restrict competition, and the prohibition on unilateral abuses of a dominant market position. The prohibition on ‘agreements’ between businesses that restrict competition can apply even if the agreement isn’t legally binding, and even to the most informal kind of arrangement or understanding, which may arise from emails or just conversations.
The Barclays / RBS case
Compliance is essential, and the sanctions for infringements can be severe. Many of you will recall the case just a few years ago, in 2011, when the OFT held that there had been an infringement of the prohibition on agreements restrictive of competition by both Barclays Bank and RBS. What had happened was that individuals from RBS’s professional practices division – which provides banking services to professional services firms such as accountants and solicitors – had met their counterparts at Barclays at various social, client and industry events. The OFT found that in conversation, the RBS people had disclosed future pricing information – both generic information about the markets and specific information about individual clients – to their Barclays counterparts. When a business shares with a competitor information about its price intentions, that’s precisely the kind of practice which can reduce the vigour of competition between them; if you know that your competitor is going to raise its charges, that is likely to reduce the pressure on you to cut charges so as to retain customers.
The OFT fined RBS £28.5 million for this infringement. And fines can be even higher: up to 10% of group turnover. Barclays was fined nothing for its involvement – the reward for ‘blowing the whistle’ to the OFT under what’s called the ‘leniency programme’, which provides an incentive for whistle-blowers and an important way in which competition authorities, including the CMA, find out about infringements.
Infringements of the prohibitions can have other harmful consequences. Directors of companies found to have infringed the prohibitions can be disqualified from holding directorships. Victims of the infringements – for example, customers who are paying higher charges as a result of the reduction in competition – can sue in court to recover damages for their loss. There is the huge and distracting cost in management time, lawyers’ fees, and so on, in having to submit to the investigation. And there is the reputational damage: it is not good for business to be investigated and found to have done down customers. That will, I think, be something of which banks involved in the European Commission’s competition investigations into Euribor benchmark fixing and into credit default swaps are acutely aware.
And personal involvement in the most serious kind of ‘hard-core’ cartel activity, such as where competitors agree prices or carve up markets, can result in the individuals concerned being prosecuted under the criminal cartel offence, which can lead to substantial personal fines, up to 5 years’ imprisonment, or both.
Compliance in wholesale markets
It’s not just retail banking services that concern us. The benefits of vigorous competition upstream, at wholesale level, feed through down the supply chain to end-consumers – including as holders of pension policies, insurance, and so on. And, likewise, the detriments of muted or distorted competition at wholesale level are also felt by us all in the end. The kind of practices which the European Commission says it’s found in the credit default swaps case – that is, major global banks leveraging their market power and control of inputs such as data so as to exclude competition from new entrants in trading financial instruments – would be of concern to the CMA, whatever the financial instrument or market. We expect competition law compliance in wholesale as well as retail markets. In that context we’re supportive of, and plugged into, the FCA’s current work on competition in wholesale financial markets. We are contributing to the Fair and Effective Markets Review, led by the Treasury, the Bank of England and the FCA, whose current consultation includes a number of competition-focused observations and questions. And of course we liaise closely with the European Commission, given its competition work in this sector.
It is also worth reflecting what part competition may have to play in improving the resilience of our banking system, from a macro prudential perspective. I can’t be alone in thinking that one of the many alarming features of the financial crisis was the lack of diversity in business models and risk management models, and all-too-evident herd and domino effects. Competition can help to stimulate useful innovations and more shock-resistant diversity and resilience. Key to effective competition is the potential to fail and exit, which in the banking context can lead to systemic risk. Hence the critical importance of the work by the Bank of England, the Financial Stability Board, and others to ensure we can safely allow banks to fail.
How competition compliance works
There’s a feature about compliance with competition law that I should highlight, which may be counter-intuitive in a sector where there are considerable compliance obligations imposed by financial regulators and financial legislation or directives. Competition law compliance, by contrast, is a matter of self-assessment. It’s not a box-ticking exercise, and for the most part you can’t go to the competition authorities – here or in Brussels – and get them to ‘sign off’ your practices as competition-compliant. As the lawyers and regulatory experts in the audience today know, it is for each business for each bank to ensure that it is competition-compliant in its practices. And compliance isn’t about the form but about substance: not so much about how your rules or contracts are worded (although that may be part of it), but about the underlying commercial practices (whether written down or not) and about the actual economic effect they have on the markets where you operate.
The CMA’s October 2014 decision on bundling undertakings
While we’re on the subject of compliance, I should mention that when we agree undertakings with businesses, we expect them to comply and we will take enforcement action if they don’t. In October this year we had to take action against a couple of banks, HSBC and First Trust, after we found evidence of non-compliance with undertakings given after the 2002 competition commission investigation into SME banking which prohibited retail banks from demanding that a customer has a current account with the bank in order to get a loan from that bank. We issued directions to enforce compliance.
The role of other regulators
And competition enforcement is about to be strengthened in the banking and other financial services sectors. From April next year, the regulatory powers of the FCA, and of the PSR, will be augmented by powers which both regulators will hold, concurrently with the CMA, to enforce competition law in their respective sectors. This will give them both the power to enforce the UK and EU competition prohibitions, and the power to make market investigation references to the CMA. Other regulators, such as Ofgem for energy, Ofwat for water, and so on, have long had these concurrent competition powers, and under enhanced arrangements including a new UK Competition Network we are working together to make sure these are effective and help bring the benefits of competition. In particular, to ensure that competition law is used where it is the more appropriate – less distortive – intervention to make.
Tackling anti-competitive regulation
But promoting competition in banking isn’t just about imposing compliance burdens on you. On the contrary we’re on your side when it comes to seeing whether we can reduce any excessive regulation that unnecessarily creates or reinforces barriers to entry, or dampens competition.
After the financial crisis, the priority, for the good of society, was to ensure that there were sufficient safeguards in place to minimise the risk of future bank failures. There was a widespread feeling that regulation over the previous decade or so had been, if anything, light-touch.But once that initial work had been done we have had to remind ourselves that excessive or disproportionate regulation – that ‘gilds the lily’ – can be counterproductive. Indeed in erecting or reinforcing entry barriers, or dampening competition, it can be harmful to the very consumers it was intended to protect, and damaging to society as a whole, for the reasons we’ve discussed.
That recognition is reflected in recent legislation that has given financial regulators competition objectives for the first time (quite apart from the competition law enforcement powers that the FCA will acquire next April). The FCA in April 2013 became subject to a duty to promote competition when discharging its general functions, and the Prudential Regulation Authority (PRA) in March this year became subject to a ‘secondary objective’ to act, ‘so far as is reasonably possible’ in a way which facilitates effective competition.
We were heartened that, in work initiated by the Bank of England and the old Financial Services Authority, and carried on by the PRA and the FCA, the authorisation process for new banks is being made faster and more cost-effective, and the capital requirements imposed on new banks are being made somewhat less onerous – measures designed to reduce entry barriers consistent with adequate prudential protection. We welcome these measures – and we will be strongly supportive of other measures taken by financial regulators to review new and existing regulatory rules to ensure that they do not unnecessarily dampen competition.
If you in the industry have evidence of avoidable harm being done to competition by misdirected or heavy-handed regulation, I trust that you will not be shy in bringing this to the attention of the authorities.
Banking in society
I hope it’s clear from what I’ve said today that we see competition in banking as essential to maximising the benefits the sector can bring to consumers in society and to the wider economy. Although it can sometimes seem otherwise, this needn’t be an antagonistic process. The competition authorities will come down hard on anti-competitive practices that break the law, but will work with banks to encourage compliance. The market investigation, even if not welcomed by everyone in the sector, offers an opportunity for constructive engagement about improving outcomes for customers. And we will support moves to remove disproportionate or excessive regulatory requirements that dampen competition. Focused on the need to serve society by ensuring vigorous competition, we look forward to working with the banks in these endeavours.
I would like to warmly acknowledge and thank Michael Grenfell, CMA Senior Director of Sector Regulation, who led our banking work from April to early November, for his considerable contribution to this speech.
- See retail banking consultation responses.
- See CMA PCA market study update, July 2014, paragraph 6.36.
PCA market study, para 6.33.
OFT PCA market review, January 2013, paragraphs 3.37 to 3.39.
Which? press release, Overdraft charges impossible to calculate, 17 January 2014.
- BDRC/OFT, SME business banking – qualitative debrief, 29 November 2013, page 63.
Summary, paragraph 3.
November 2014 decision, paragraph 2.68.
Issues statement, November 2014, paragraph 15, page 5.