19 October 2017
Alex Letts

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Alex Letts - U

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Disruption in Retail Banking

Growth in internet and mobile technologies has transformed many industries and economies. The market forces and competitive landscape has completely changed in many sectors. iTunes has fundamentally changed music industry, Amazon has driven most big brick and mortar book sellers out of business, Expedia is one of the worlds' biggest travel company….. the list goes on. Internet and mobile technologies are big disrupters for most industries. What started (and tapered a bit!) with the dot com boom of 2000 has become a lethal threat to most business models today. Powered by mass adoption in mobiles phones, proliferation of smart phones and cheaper band-width, internet and mobile technology have changed many industries. The banking industry in has been dominated by a handful of big global or regional banks for 100s of years. While the credit crisis has shaken this industry, the core market forces for the industry have not changed. Will Innovation in Internet and Mobile technologies disrupt retail banking? Will there be 5 new names in global top 10 retail banks in 2020?

Why the banking model could break the UK economy. Part Two.

31 July 2017  |  7712 views  |  1

In Part One I wrote about the problem with the UK banking model and why it undermines the UK economy. In summary, banks need to lend to make their current account model work; this helps a lot of people, but for a huge swathe society it can be less beneficial, encouraging a debt mentality and a debt spiral that many will never escape, nor repay. In Part 2 here, I try to recommend what can be done to create a better model.

Disclaimers:

  • I am not a disinterested commentator. At my company, we compete with the model of the banks.
  • We are not anti-borrowing. People need to borrow to fund all sorts of things in their lives. Credit is useful and often a force for good. In moderation.
  • I am pro-bank. Without the banks, there could be no economy, no prosperity, no future (and, indeed, no U).
  • I am, however, strongly opposed to the banking model in which the banks are trapped. So, we do need NEW models, not a fudge by the incumbent banks.

The bank debt model of subsidising the provision of personal current accounts (PCAs) through revenues derived from credit products such as overdrafts and credit cards, is not evil, nor even bad.  It just isn’t right for every customer. Indeed, it is arguable that for the 60%+ of people in the UK who earn only £400 per week at most, and who have little or no savings, it is not appropriate.

The solution is not more banks. As I have argued elsewhere, that strategy has not worked. Neo-banks have universally embraced the same old lending-based free PCA model, but within low cost digital frameworks. More of the same, but done better.  Cool, yes, but not the answer to this problem.

Equally there is no evidence (yet) of how neo-banks providing PCAs can become profitable, not least because of onerous regulatory and Basel III capital requirements. I have observed that regulation is in danger of having the opposite effect in this case.  It may reduce, rather than increase, competition.

Free market competition is one way to address this debt spiral problem, and the onus is on us, new non-bank fintechs with new non-lending models to break into this space and dismantle the entire tenet that PCAs cost nothing.  PCAs do cost money (for the banks, the real figure is probably around £200 per year per customer).

But, because of the massive power of the banks, with 6 operators owning over 95% PCA market share, free competition can only thrive if the regulators move their focus away from reducing bank charges (which is self-defeating in many ways) on to prevention of cross-subsidisation.  All those free accounts are subsidised by interest “foregone” by customers on their deposits, and overdrafts and related charges; the problem is that only half of customers use overdrafts.  So, this is unjust on the overdraft users, especially those least well-off, who subsidise those others, often wealthier, who don’t have overdrafts. It also appears to be an anti-competitive practice, in that it prevents new entrants with new non-lending models from competing on a level playing field.

In other words, the banks need to be regulated into charging people for what they use, fairly, instead of over-charging some and under-charging others.

Don’t get me wrong:  most banks would welcome this.  They talk about the free banking model quite openly as the worst mistake they ever made (pointing the finger of blame squarely at Midland Bank which introduced it in late 1980’s).  But try telling your customers that what they always got “for free”, they now have to pay for.  And imagine the media storm.  So instead, the banks are looking to the FCA to enforce a major policy change in how PCAs are charged for.  I have no idea if the FCA has the required courage, and we won’t find out until its PCA charging review is published in the spring of 2018.

If the FCA does act to stop this anti-competitive practice, then the banks will no longer have a commercial imperative to sell credit to their customers to subsidise the provision of PCAs.  In turn, this would encourage competition by introducing a level playing field for new non-bank PCA providers. It would also reduce the commercial pressure for easy credit to those for whom it is really not beneficial for their long-term financial well-being. 

That should and almost certainly would reduce consumer borrowing and bad debt; this would help to reduce the UK’s dangerously high consumer credit balance. 

 

TagsRisk & regulationRetail banking

Comments: (1)

James Piggot
James Piggot - Finastra - London | 07 August, 2017, 13:09

Agreed, the problem is politicians don't want to be the bearer of bad news, propose raising taxes, charging for bank accounts, borrowing limits, force people to save more for pensions and you risk being voted out of office at the next election if not before. Perhaps the solution is to have cross-party agreement on what needs to be done then legislate accordingly? As you say its not realistic to expect banks to solve societies problems.

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