Following a two year market investigation into the supply of retail banking services to personal current account (PCA) customers and to small and medium-sized enterprises (SMEs), the Competition and Markets Authority (CMA) published its final report on 9 August 2016 (Report). In this article, Andrew Barber and Emma Radmore of Bond Dickinson look at the regulatory implications of the Report.
The investigation follows a number of reviews into the UK banking sector and concerns raised about retail banking. In light of the reviews, the CMA investigated areas including whether:
- A lack of engagement and/or barriers to searching and switching reduces the incentives on banks to compete on price and/or quality and/or to innovate;
- There are barriers to entry and expansion in the market which has led to constraints on the ability of banks to enter or expand in the market; and
- The level of concentration is having an adverse effect on customers.
Overall, the CMA found that while the larger retail banks, which account for the large majority of the retail banking market, do not have to work hard to win and retain customers, it is difficult for new and smaller providers to attract customers. This has led to a lack of competition and innovation in the banking sector, which needs to be addressed through the investment in new products and services or reduction in prices and improvement in service quality.
Summary of the main concerns identified
The main concerns identified by CMA include that:
- The charging structures for current accounts are complex and customers do not have enough knowledge about the charges and service quality provided by other banks. This makes comparisons difficult;
- Personal and business current account relationships are open-ended and do not have regular trigger points, which might otherwise prompt customers to shop around;
- The Current Account Switch Service (CASS), which makes it easy for customer to switch current accounts from one bank to another, is not widely known;
- Charging structures for overdrafts are complicated and make it difficult to compare providers;
- Most owners of small businesses obtain their business loans from their main bank, with little or no shopping around; and
- Getting new customers is difficult and costly for banks, which leads to established banks having an advantage over smaller banks wishing to expand into the market.
What CMA considered
CMA noted several relatively recent developments in the banking world, all of which were relevant to the investigation, and all of which have a regulatory impact. Among the developments it identified were:
- The divestment requirements on the RBS and Lloyd's banking groups;
- The contraction in lending by larger banks creating opportunities for new market entrants and non-bank lenders;
- Implemented and ongoing regulatory requirements (which relate to all kinds of products and services), aimed at greater choice, flexibility and transparency for the customer;
- Continuous technical innovation though increased use of internet and mobile banking, contactless and mobile payment systems; and
- The effects of digitalisation of banking meaning both that entry costs to the markets and parts of them is cheaper and the way in which customers use branches and engage with their accounts.
Regulatory changes already in place
CMA noted the various changes, mainly stemming from EU legislation, that have recently affected banks, or which are about to come into force. Not least, the Payment Accounts Regulations implementing the Payment Accounts Directive (although many aspects of the Directive's requirements were already in place), and the regulations under the Small Business, Enterprise and Employment Act 2015 under which designated banks must provide information about smes to designated credit reference agencies which must in turn provide information to lenders.
CMA treated Northern Ireland as a separate market to the rest of the UK, after examining the habits of consumers in each constituent part of the UK. It examined the largest market players, of which there are five in Great Britain, with around 40 smaller banks and building societies, as well as credit unions and alternative finance providers. It identified five more key entrants to the market since 2010, as well as existing market players who increased their presence. Finally, it noted a number of very recently authorised banks, or applicants in the process of becoming authorised.
The report looked at the small percentage of accounts that are basic bank accounts, or student/graduate accounts. It also noted the significant increase in the number of accounts being opened as reward accounts, and the decrease in both "standard" accounts and packaged ones. Banks tended to have profitable personal banking businesses, with packaged accounts generally providing the greatest profits as the monthly fee customers pay exceeds the cost to the bank of the benefits the package provides.
A key theme running through financial product choices is the ability to compare prices. A key problem in enabling consumers to compare prices of personal current accounts is that prices depend on usage, and that many banks offer several different pcas with significant differences in prices. A common theme is the cost of overdrafts, which just under half of customers use. The indications from the survey were that although the larger, longer-established banks offered both cheap and expensive products, customers were more likely to be using the expensive ones, and that the longer the customer had been with the bank, the more expensive their product tended to be. The newer market entrants, on the other hand, generally offered cheaper products.
The CMA investigated whether customers were perhaps happy to pay a higher price for a better customer service, but the evidence did not suggest this. However, banks offering better priced products or better quality customer service were only gradually gaining a greater market share. This could be explained by the high percentages of customers who had been with their bank for many years and who had neither searched for better value accounts nor switched. The small percentage who had searched or switched tended to come from higher-income, higher-value customers with higher levels of education. The more frequently a customer used an overdraft, and particularly if the overdraft was unarranged, the less likely they were to switch, despite potentially being the customers who would benefit most from doing so.
The CMA noted several interesting points around customer engagement, and how digitalisation could have helped this. A key point was that because pcas have no end date, there is no trigger to prompt a consumer to check whether it is the best product for them. Many customers also thought they were satisfied with their products, even where in fact many could have gained by switching. Many customers who do not incur charges did not think there would be much to be gained by switching. Even if they wanted to switch, the CMA found that, despite developments like the Midata initiative, it is hard to get and analyse information on account usage and pricing structures of other accounts. Moreover, despite the introduction of CASS (which FCA research in 2015 showed nearly half of respondents had not heard of), customers still think switching is a hassle and that something was likely to do wrong in the process. Overdraft users were particularly unlikely to switch for a variety of reasons, including difficulty in comparing, lack of understanding of usage, and timing of new overdraft approvals.
The issues SMEs face are, of course, different to those consumers face. They tend not to switch because of the length and perceived difficulty of the account opening process, and concerns over loss of data and access to lending. It is, if anything, more difficult to get data and compare products for the SME markets than for pcas.
Barriers to entry
The CMA looked at a number of potential difficulties that new entrants into the banking market may face in comparison to those that are already established within the market. Particular areas of concern include capital requirements; the costs of funds for lending; and information asymmetries between banks.
In assessing the barriers to entry, the CMA found that while previous reviews concluded that the authorisation process for banks was thought to be an issue, it is no longer thought of as a barrier. The revised authorisation process which the New Bank Start Up Unit has brought has enabled a more flexible approach enabling banks to become authorised with restrictions before committing to large potentially irreversible upfront investment. In addition, the CMA looked at anti-money laundering regulations and did not find that these were a barrier to entry and expansion.
In an attempt to tackle the problems highlighted in the Report, the CMA introduced a wide-ranging and integrated package of remedies.
As part of its foundation measures, remedies include open banking standards, service quality information and customer prompts. Most notably, the open banking standard includes the development and implementation of open Application Programming Interfaces (APIs). The APIs will permit authorised intermediaries to access information about a bank's services, prices and service quality and customer usage, in anticipation that new services delivered to customers will be tailored to their needs. As this involves accessing customer data, privacy and security will be of paramount importance.
In respect of customer prompts, the CMA has recommended that personal and business customers should receive occasional reminders to encourage them to review their banking arrangement. In implementing this remedy, the CMA has asked the FCA to undertake a programme of customer testing to identify which prompts will be most effective in changing customer behaviour and then to implement these prompts.
Current account switching measures
The CMA wishes to increase customer confidence in their ability to switch accounts. In doing so the CMA states in its Report that the performance of CASS will need to be improved, as well as an increase in customer awareness of and confidence in the service.
The Report found that many customers find it difficult to keep up with their use of arranged and unarranged overdrafts and failing to do so can be costly. In order to tackle this issue, the CMA is introducing additional measures to enable personal customers to take more control over their use of overdraft services, For example, banks will be required to alert customers when they are going into unarranged overdraft.
The CMA has recommended that the FCA explore ways to make it easier for overdraft users to shop around and switch banks, including online overdraft eligibility tools. In addition, the CMA has asked the FCA to undertake further research on overdraft alerts and grace period and to look at how the process to open current accounts could be used to make customers more aware of the features and overdraft costs.
Banking services for small businesses
The remedies relating to small business includes the development of a comparison website to allow them to compare the price, quality of services and lending criteria offered by different providers.
In addition, lenders will be required to publish their prices for smaller, non-complex lending products, drawing from the approaches used under the personal consumer credit regime.
FCA's response to the investigations
The implementation of a number of the remedies included in the Report requires the FCA's involvement. While the FCA is yet to publish its response to the Report, setting out details of the work the FCA intends to undertake to develop and implement the relevant remedies, it is highly likely that the FCA will be supportive of the recommendations set out in the Report.
In June 2016, the FCA released a statement in response to the CMA's provisional decision on remedies from retail banking market investigations commenting that it was supportive of the CMA's provisional decision to make recommendations to the FCA to take forward a range of remedies, namely on service quality information; prompts and overdraft measures. These recommendations are reflected in the Report and are in line with the FCA's key priority of the treatment of existing customers and work on competition in retail banking.
The recommendations for remedies, of course, will in some cases affect regulators. In fact, none of the remedies go to the heart of regulation or will require any fundamental changes to prudential regulatory requirements. Ultimately, what the remedies need to address is the willingness of customers to engage with the switching process. So FCA in particular has to look at how to mitigate customer concerns – whether this is because it is too hard to get information that would allow an informed comparison, or because the process or consequences of switching would (or would be feared to) be at best long-winded and difficult and at worst detrimental in terms of ongoing services such as overdraft or lending limits. So FCA's "to do" list will focus on:
- What it can do, and what it should be getting banks and others to do, to prompt consumers to review their pcas (and smes to review their accounts), and make changes to its rules to require additional customer information and reporting requirements, maybe with standard forms and information formats;
- Additional measures of providers' service performance to allow assessment of how different providers perform – and indeed different packages offered by the same provider, or even the same package offered to different customers over time;
- How best to encourage customers to understand their overdraft usage and charges. In principle, this seems likely to need both a public awareness campaign and require banks to provide customers with more relevant, timely and comprehensible information on the effects of authorised and unauthorised overdrafts and charges for them;
- Assessing the effectiveness of the monthly maximum charge (MMC) that the review requires PCA providers to set covering all unarranged overdraft charges. FCA will also have work to do around disclosure of the charge;
- Consider requiring providers of pcas to offer online tools showing overdraft eligibility. FCA will need to consider very carefully how such tools should be calibrated, given the proven variety of conditions that can apply to overdrafts, to ensure the tools are used correctly and give the right information in a meaningful manner. Again, it seems likely FCA would need to prescribe the format of tools to enable worthwhile comparisons; and
- Investigate how to engage customers more in considering overdraft features during the PCA opening process: the most difficult part of opening a PCA is often the money laundering checks. That apart, there is little need for personal engagement with the customer as the PCA opening process is in many ways less personal than other processes for what may be a long-term customer relationship in the financial services sector.
In helping to implement the recommendations, FCA must be aware of the continuing need for regulation to ensure firms continue to offer support and forbearance for customers in financial difficulties.
Now that the Report has been published, the focus will be on the implementation of the remedies. The Report includes a timetable setting out the proposed deadline for putting each of the remedies in place. Provided there are no delays, it will take until summer 2018 for all elements of the package to come into force. This means regulators will need to move quite quickly, to consider actions, consult and put in place the necessary rule changes.