Select Committee on Treasury Appendices to the Minutes of Evidence


Memorandum by Lloyds TSB Group plc



  1.1  Lloyds TSB is delighted to respond to the Treasury Select Committee's request for written evidence in respect of its investigation into the banking industry, and welcomes the opportunity to comment on the Cruickshank Report (the Report), and many of its recommendations, particularly those relating to:

    —  full and open competition (paragraph 28, page xii[1]);

    —  enhanced transparency of product pricing (paragraph 54, page xx);

    —  removal of regulatory distortion of competition (paragraph 32, page xiv); and

    —  encouragement of competition at a European level by Government so that UK suppliers may compete and expand overseas (paragraph 31, page xiii).

  1.2  Lloyds TSB provides a wide range of good value, competitively-priced services and products. It provides excellent service to its customers and is continuously seeking to improve its products offers.

  1.3  Lloyds TSB welcomes the Report's acknowledgement that there are a significant number of new entrants as providers of financial services, that there is increased competition (paragraph 4.87 and 4.93, pages 131 and 132) in the market, and that "SME and personal customers get reasonable value for money from UK banks" (paragraph E70, page 316).

  1.4  Lloyds TSB believes that UK banking is competitive and not hindered by barriers; entry is open, as evidenced by the number of new entrants in recent years, including non-banks.

  1.5  Lloyds TSB disagrees with the Report's contention that banks earn excess profits (paragraph C.135, page 227), as:

    —  Lloyds TSB contends the Report's analysis that returns above cost of capital constitute evidence of a competition problem, is overly simplistic. If applied to all economic sectors, most successful UK companies would be deemed worthy of investigation.

    —  Much of the Report's analysis was based on historic accounting standards or conservative valuation measures, understating the capital base and overstating profitability. The focus on successful banks adds to an overstatement of profitability.

    —  Much of the profitability analysis focuses on 1998, a year not representative of the economic cycle. Indeed, examined over the entire cycle, Lloyds TSB about covered its cost of equity capital, and similarly successful banks in Europe and the United States were more profitable.

  1.6  Lloyds TSB is also concerned about the proposals to create a PayCom:

    —  Mr Cruickshank himself acknowledges that UK payment systems perform well on several criteria, and some aspects are world class (paragraph 3.48, page 65).

    —  Maintenance of the integrity of the system is paramount.

    —  Money transmission is not a utility: the market must be allowed to set prices.


2.0  Introduction

  This section addresses Chapter 2, The New Policy Framework, and Recommendations 20-35 in the Executive Summary.

2.1  Rationale for Government Intervention, The Regulatory Contract (2.5-2.34)

  2.1.1  We agree with the analysis in 2.6-2.10, that the potential for "systemic risk" in banking systems justifies Government intervention to ensure that fundamentally solvent "banks are not put at risk from the unexpected failure of another bank", and "to protect retail depositors' funds in the event of a bank failure". We equally agree with the statement in 2.11, that such intervention should not be applied to insolvent firms, and that not only is a "zero failure" regime impossible, but attempts to achieve it would be onerous and therefore stifle innovation and competition.

  2.1.2  The Cruickshank Report propounds the argument that there is a de facto requirement that new entrants to the banking sector are linked to an established bank, and that this is a mechanistic stranglehold that limits "the number of new entrants into a market" (2.19). We would contend that there are flaws in his argument, partly because the Report does not support its case with concrete examples, and also because the partnership agreements between banks and non-banks mentioned are excellent examples of competitive solutions. Having said this, we agree that the FSA could give further information on the principles by which it assesses individual applications (2.22). That a new entrant may be asked to put up greater capital requirements than major diversified players (2.23) seems neither illogical nor unfair. It is a trade-off between allowing new market participants and maintaining the integrity of financial markets: the mitigation of "systemic risk" must remain the top priority. The application of identical capital requirements for all players would fail to distinguish between relative risks and penalise better quality operators with potentially dangerous consequences.

  2.1.3  We are surprised at the examples given in 2.26 to argue that the "big four" (Barclays, HSBC, Lloyds TSB and RBS/NatWest) have privileged positions and that these "cause problems for new entrants".

  Competition has never been as intense, and is associated with an explosion in number of new entrants—notably non banks. For example:

    —  there are currently 28 companies providing current accounts in the UK, with 10 new entrants since 1989: these are the Halifax, Woolwich, Flemings, Citibank, Virgin, First-E, Egg, Cahoot/Abbey National, First Direct/HSBC and Smile/Co-op;

    —  there are currently 140 providers of mortgages in the UK, with 19 new entrants since 1989: GMAC-RFC Ltd, The Mortgage Business plc, Wesleyan Home Loans Ltd, Direct Line, Kensington Mortgage Co, Virgin, Scottish Widows Bank, Winterthur Mortgage and Management Services, Preferred Mortgages, Sainsbury's Bank, Southern Pacific Mortgages, Platform Home Loans, First Active, Future Mortgages, Mortgages plc, Egg, Verso Ltd, Standard Life, and Norwich Union Personal Finance; and

    —  65 companies provide credit cards to consumers, 12 of which have entered the market since 1989: MBNA, GM, Marbles/HFC, Centrica/Goldfish, RBS, People's Bank, The Associates, Sainsbury's, Tesco, Capital One, Egg, and Morgan Stanley Dean Witter.

2.2  The Impact of Future Developments in Banking (2.64-2.106)

  2.2.1  In respect of the EU's Financial Services Action Plan (2.95), Lloyds TSB strongly agrees that (a) as many as possible of the remaining barriers in the Single Market should be removed, and (b) European consumer interests must be safeguarded if consumers are to be confident in buying goods and services from suppliers in other Member States.

  2.2.2  Lloyds TSB also supports the Commission's stated priorities (2.96). It has responded to each of the five Forum Group consultation papers, and is assisting the Commission in a number of areas including its study on customer redress procedures.

2.3  Developing The New Framework (2.107-2.186)

Executive Summary Recommendations 20-35

2.3.1  Transparency (2.114-2.126, Recommendation 22)  Transparency is a good principle because it enhances clarity in regulatory decisions and provides evidence of a reliable track record and performance, which leads to greater confidence in the system.  We therefore support the Recommendation, that "the Government should encourage the FSA in its efforts to make the regulatory process more transparent". We note the Report's acknowledgement that the FSA is improving its transparency, and the acceptance of this recommendation by the Government in its response of August 2000.  We agree that greater disclosure would reinforce supervisory decisions and actions through market discipline. It would also allow for better comparison between different banks. However, there could be difficulties in achieving these aims of the Cruickshank team unless the information provided was consistent and comparable across different banks.  We support the proposition that "the Government should examine the costs and benefits of requiring authorised firms to publish disclosure statements of their risk exposures and risk strategies, across all activities, in advance of the implementation of the new Basel Capital Adequacy framework. The statements should also include details of regulatory requirements such as capital asset ratios". We welcome the Government's stated intentions to review and draw together the many strands of this work, and to publish a proposed way forward by the end of this year. We also welcome its acknowledgement that these disclosure issues should be handled with care.

2.4  Institutional incentives (2.127-2.145, Recommendations 23-27)

  2.4.1 We take no exception to the Recommendation that the Government should monitor the effect which the Financial Services and Markets Act (FSMA) will have had on competition, in two years' time, as consistent with the principle that regulation should not impede competition. We note the Government's intention that the FSA will conduct cost benefit analyses on its new regulatory rules to include their effects on competition.

  2.4.2  We agree that the FSA should be independent of the Government, and of the banking sector, in order properly to discharge its public interest functions. However, disbarring officers from member institutions would deplete the expertise and experience available to the FSA and we therefore note with interest the Government's statement of "great confidence" in the current FSA Board.

  2.4.3  We have no problem with the suggested topics for inclusion in the FSA's future annual reports. It would be in the general interest to have official updates on the state of competition, the effects of regulation, and transparency, and we note that the Government has taken these requirements on board.

2.5  Effective competition scrutiny (2.146-2.166, Recommendations 28-31)

  2.5.1  The Cruickshank Report recommended that "the financial services sector should not enjoy any unnecessary exclusion from general competition law". We welcome the Government's acceptance of this recommendation.

  2.5.2  Turning to the following sequence of Recommendations to the Government, we:

    —  have no issue with new competition tests to maintain/promote competition, facilitate new entries, and improve goods and services to consumers;

    —  firmly support level playing fields; and

    —  believe that mergers in the financial services sector should be treated the same as in other sectors: it would be wrong for an increasing list of merger criteria to be applied to financial services imposing greater compliance than on other sectors and reducing clarity and confidence in the merger control clearance process.

  2.5.3  Having said this, we would be interested in understanding what the Cruickshank Report means by "material shares" in the contexts of 2.165 and Recommendation 30, that the Government should "refer all mergers between financial suppliers to the Competition Commission for investigation if the merging entities have material shares of the relevant market, or if each has material shares in related markets. . . .".

  2.5.4 We warmly welcome the Government's acknowledgement, in its response to the Cruickshank Report, that "the fact that two entities have a material share of a market does not automatically mean that a merger would have an adverse effect on competition." We also welcome its decision to allow the current arrangements on merger control to continue.

  2.5.5 As for the European dimension, we support the recommendation that competition should be encouraged throughout the Single Market. Lloyds TSB—as indeed does the Government—strongly supports the European Commission's wish to remove remaining barriers to competition.

2.6  Eliminating regulatory distortions (2.167-2.177, Recommendations 32-35)

  2.6.1  As for the Recommendations, which the Government has also accepted, that it "apply competition scrutiny systematically to all its policies and regulations in the financial services sector to ensure that they are proportionate and minimise distortions to competition", and "ensure banks are not accorded exclusive participation or preferential treatment in developing government initiatives" without legitimate reasons for doing so, having special regard to e-commerce developments, we:

    —  firmly endorse the principle, that scrutiny should be proportionate to the issue addressed, as the Report states: indeed, this should be a general rule covering all areas of government—or "watchdog"—supervisory activity;

    —  wish to see a "level playing field", and are not seeking preferential treatment; and

    —  contend that if we participate in government initiatives, we do so on a competitive basis, and, conversely, banks should not be forced to undertake initiatives, which have no commercial case without reasonable compensation.

  2.6.2  Turning to the areas which the Report believes merit special attention:

    —  the rules governing the new "t-scheme" are being worked on by the BBA and APACS, with Lloyds TSB support: the objectivity of their application will be based on transparent technical and operational standards; and

    —  the proposal that "the Government should review the definition of financial services for the purposes of VAT to ensure that there is no discrimination between in-house provision by financial suppliers and outsourcing" is logical: while participating in the Government review of this issue, currently in process, we recommend that the VAT liability applicable to outsourced financial services be determined in accordance with European legislation and decided case law, both of which provide that the majority of such services are properly exempt from VAT.

  2.6.3  Turning to money laundering, we would comment that:

    —  the compliance for banks in applying the terms of the Money Laundering Directive has been high, but the importance of reducing money laundering—especially in the City markets, and given the increasing tide of related serious crime—is and must remain a top priority; and

    —  the banking sector is seeking to simplify the identification procedure, and a government project is underway which would enable electronic access to existing identity records: it will be important to ensure that further details, when they are released, are available for public discussion.


3.0  Introduction

  This section addresses Chapter 3 on Money Transmission, and Recommendations 36-41 in the Executive Summary. The final paragraphs (Conclusions) also refer to the corresponding section in the Government response issued in August 2000.

  We entirely agree with the statement in the Cruickshank Report, that money transmission, or more precisely its payment system component (see 3.1 below), is "a vital part of everyday life" as it underpins all economic activity and so is key to the economic well being of the UK. We also agree unreservedly with the desired outcomes identified in the sections of the Cruickshank Report relating to money transmission.

  We welcome the Cruickshank Report's acknowledgement that the system "performs well on a number of criteria . . . operates to a high level of security, processing large volumes and values of payments. Some aspects are world class . . . [it] has also shown itself able to adapt to new circumstances and to implement change" (paragraph 3.48).

  This response does not address issues regarding plastic card schemes (3.5-3.8) nor the aspects of card scheme interchange arrangements (3.106-3.118), which have their own governance and are not under the sole responsibility of UK banks. We trust that the card schemes will wish to make their own submissions to the Treasury Select Committee. Lloyds TSB would expect to play its part in contributing to such submissions.

3.1  Money Transmission and Payment Systems

  3.1.1  We are concerned about the analysis contained in Chapter 3. The Report acknowledges the distinctions between "money transmission" and "payment systems" (3.3-3.20). However it confuses the two, and falls short of explaining that money transmission refers to the end-to-end process of a payment transaction: it encompasses the entire sequence of activity in a given transmission of money.

  For example, in a cash withdrawal, this involves the initial ATM transaction at the bank, the resulting back office operation including reconciliation of debits and credits and, if the person drawing the cash is the customer of another bank, there is also an exchange of value and data with one or more third parties as the paying bank seeks—and receives—compensation for the cash advance from the customer's bank. This entire process is money transmission. Most of it occurs within the banks involved; that aspect involving transfer of data and value between the banks calls on the services of a payment system.

  Another example is a cheque transaction, relevant because cheques are still the main method of payment for business-to-business transactions. A customer of bank A writes a cheque and gives it to someone, who is either also a customer of bank A, or the customer of bank B. The recipient of the cheque pays it in to his or her bank, which then accounts for it internally and processes it for payment through its (internal) clearing operation.

  If the parties are customers of different banks, bank B—the payee's bank—seeks compensation from bank A—the payer's bank—through the Cheque and Credit Clearing Company. The money transmission is this entire process; the payment system involves the process and settlement through the clearing company. The involvement of a payment system would be nil, if both customers had the same bank.

  The relevance of this distinction is that the payment systems themselves are a relatively small subset of money transmission. They are estimated to account for less than 10 per cent of end-to-end money transmission cost. Their impact on total costs is thus minor.

  The major element of money transmission costs falls within banks themselves, in their clearing departments, payments processing operations, branch networks and other distribution channels, all in competition with each other. Lloyds TSB is constantly seeking ways of reducing costs and improving its efficiencies, and benchmarking its operations to seek quality excellence. A recent example of such innovation is the decision to out-source Lloyds TSB's internal cheque clearing operations to a new joint venture with Barclays and Unisys, called Intelligent Processing Systems Limited (iPSL).

3.2  The benefits of payment intermediaries and payment schemes—Network effects

  3.2.1  We agree with the "social" benefits of having payment intermediaries (3.38), and of the value of the "common contracting framework" which they provide (3.40). The distinction we have suggested between "money transmission" and "payment systems" (see 3.1 above) should, however, be borne in mind when considering the "network effects" as presented in paragraphs 3.42-3.47.

  3.2.2  We agree with the view expressed in the Report, that "payment systems demonstrate the benefits that each user gains from the addition of further users" (3.42), and that an increase in the number of participants can provide opportunities to enhance the functionality of different payment systems, and hence the benefit conferred by providing an efficient switching mechanism.

  3.2.3  However, the Cruickshank Report's example of debit cards, which are more useful the more widespread their acceptance by retailers, provides an excellent illustration of the potential confusion between the terms "money transmission" and "payment systems". As much of the cost and competitor decision lies within issuing banks, there is immense competition in card issuing. Not only are an increasing number of banks offering cards, but there is also a choice of payment systems that banks can use to support their activities—eg Switch or Connect for debit cards, and Visa or MasterCard for credit cards.

  3.2.4  The Report acknowledges there is increasing competition between banks for personal customers, and in the servicing of their money transmission requirements. Money transmission is characterised by competing providers using a common payment system. In such cases, the payments systems involve competing third parties to facilitate end-to-end transactions: this does not confirm the Report's view, that competition between networks is associated with inefficiency and lack of innovation (3.45).

  3.2.5  Nor is the assertion that the existing structure stifles innovation, supported by the fact that in the 15 years of co-operative activity under the Association for Payment Clearing Services (APACS), the UK payment industry has overseen:

    —  efficient and open payment and messaging services in automated bulk clearing through BACS (where payment volumes grew by some 240 per cent between 1985 and 1999, and continue to grow at approximately 11 per cent per annum);

    —  the successful development of real-time gross settlement through CHAPS in February 1996 (the UK was first EU country to do so), recognised in 3.49;

    —  the creation of CHAPS Euro on 1 January 1999, despite the fact that the UK was not in the first wave of the euro zone; the development and creation of the interbank cheque data exchange network in November 1997; and

    —  the decision to roll out chip cards nationally.

  More importantly, the UK Payments system has proved robust in a number of testing situations, notably the Conversion Weekend of 31.12.98 to 4.1.1999, when the euro was introduced to institutional, market and wholesale operations, and in the transition to Year 2000. Given the global status of the London market, and its premiership within Europe, these were no mean feats. The work Lloyds TSB contributed to that effort left us in no doubt of the quality, commitment and flexibility of our existing institutions, and this was publicly acknowledged by the Government at the time.

3.3  The need for change: Areas of good and bad performance

3.3.1  Areas of good performance

  We welcome the recognition that "the UK payment system . . . operates to a high level of security, processing large volumes and values of payments" and that "some aspects are world class" (3.48). We welcome the statement that "the UK payment system has also shown itself able to adapt to new circumstances and to implement change" (3.49).

3.3.2  Anti-competitive restrictions on access (3.67-3.94)  The Cruickshank Report argues that access to payment systems should not be restricted to banks and other deposit-taking institutions, but be made available to any institution able to meet access conditions based on explicit criteria reflecting the risks involved. It is important to note that such risks will be faced not only by the new entrant, but also by existing members of the payment system with whom the new entrant will settle.  We note the Cruickshank Report accepts there are legitimate reasons for regulating access to payment systems and applaud the analysis of risks in high value payment systems contained in Annex D1. We note the deduction that "there is very limited scope for opening up these systems to non-banks" (3.68). We believe that such restrictions on non-banks are justified on the grounds of credit risk and liquidity, bearing in mind the exposure of such settlement systems to "systemic risk" if a member failed and—a key concern of the European Commission—the need to justify and retain complete consumer confidence in our financial markets and institutions.  We welcome the principle of allowing access to properly regulated non bank institutions, and, indeed, we welcome the entry of non-banks and other new players into payments systems. The fact that rules have been amended where necessary to enable membership by institutions, which were previously ineligible, demonstrates the flexible approach taken by APACS—eg the admissions of MBNA Bank and, more recently, the Post Office.  As APACS indicated in its own comments, it did institute objective entry criteria to each of its clearing companies. The principle of objective entry criteria is contained in Section 4 of the Child Report, which led to the establishment of APACS in 1985.  It is critical for the protection of the consumer and for the reputation of the UK financial services industry that our payment systems demonstrate the utmost integrity. At present, the Bank of England/Financial Services Authority carry out, de facto, the "vetting" of potential members through granting institutions banking licences. This ensures that the institutions concerned have the balance sheet strength, liquidity and treasury expertise required both to be deposit-taking institutions and to participate in high-value payments systems.  It is worth observing APACS' comment, that actual demand for full membership of the clearings has been less than expected at the time of its creation in 1985. The principal reason has been that the market for "agency" access to the clearings (procedures through which non-member organisations can access the clearings' facilities through member institutions) has been highly competitive. For many players with relatively low volumes, "agency" access provides good value because it allows them access at the same service standards without the overheads and responsibilities of direct membership. Some financial institutions have left APACS to take up agency status, for example The Bradford and Bingley Building Society (left BACS/APACS) and Credit Lyonnais (left CHAPS/APACS). Others with agency status chose to continue as such even when their volumes had grown sufficiently to qualify for direct membership, examples being Bank of Ireland (agent: Lloyds TSB) and Halifax (agent: Barclays).  For all these reasons, we would challenge the Report's conclusion, that the "membership criteria of the main UK payment schemes distort competition by restricting full access to banks . . . [which] restriction cannot be justified by the risks involved and leads to reduced competition and innovation" (3.94). We believe access criteria are justified because:

    —  nothing should override the need for robust, safe high value clearing and settlement systems given the potential "systemic" risks which may be involved;

    —  issues of access do not merely concern risk, but also the economics of volume/scale;

    —  as most costs of providing money transmission services lie within member banks' operations, with approximately 10 per cent only accounted by the payment systems themselves, the main pressures for competition will be in the member institutions; and

    —  as payment systems provide generic services, the main thrust for product innovation lies not in the clearings but in member institutions, which are in direct competition.

  We cannot over-emphasise the importance of retaining sound and robust payment systems and markets. This is not only an issue of security, safety and integrity of City systems, but also a question of protecting customer transactions, and their funds.

3.3.3  Lack of innovation in the use of existing payments infrastructure (3.124-3.129)  There is always room for improvement, but the judgement in the Cruickshank Report on the effectiveness of the governance of UK payment systems surprises us. The pressures to keep up the track record of innovation, already mentioned, are likely to override any unreasonable resistance by an individual bank, and APACS has already indicated its intention to review its governance. Lloyds TSB fully supports APACS's initiative, and will participate fully in the review. It has introduced a voting system for important decisions, and is considering future governance options through its Future Payment Systems Development project.  Lloyds TSB continues to be an active participant in developing new forms of payments mechanisms. For example, it participated in Phase 1 of the WATCH project, designed to set up an international clearing mechanism for low value, non-time dependent cross-border payments. This will replace many of our correspondent banking relationships, and result in a more reliable and lower cost payments mechanism.  We are also keeping under review the developments on the Continent following the launch of the Euro. At present, we are members of three Euro clearing systems—CHAPS Euro (a state-of-the-art real time gross settlement system), EBA Euro 1 (a multilateral netting system), and the ECB's TARGET system which links the national Euro real time gross settlement systems.

3.3.4  Adapting to e-commerce (3.136-3.145)  In March 2000, APACS announced that an Electronic Commerce Protection Scheme was being created to provide a secure end-to-end e-commerce service for business-to-business payments. This scheme would be a world leader in its field. Its development committee is chaired by Lloyds TSB.  A further announcement, on 23 March 2000, advised that APACS members would be starting work on the development of an internet-based, secure, same-day payment mechanism. This high priority development is part of a plan to re-engineer the UK clearings in the next few years. The Cruickshank review team was briefed on this Future Payment Systems Development project, but made no mention of it in its Report. Lloyds TSB would be happy to provide further details of these plans, if this were felt helpful.

3.3.5  Poor transparency to end users (3.146-3.147)  We agree entirely with the Cruickshank Report that, "for competition in retail markets to work effectively, customers must know the price they are paying for goods and services". Indeed, over the last decade we have been working closely with consumer and industry groups to improve the Banking Code, especially to do with pricing information provided to our retail customers. Examples of our recent product literature are available on request. We provide these to all new customers, and to existing customers when there is a change in tariff. However, this is distinct from the issue of price transparency in payment systems. Our experience indicates that customers may be mainly interested in the overall price of a transaction, not its individual components. As already mentioned, the cost of the payments switch component is less than 10 per cent of the total money transmission cost.

3.4  Recommendations in Chapter 3 of the Cruickshank Report—Proposed creation of a new payments system commission "Paycom" (3.181-3.224)

[Also ref: Money Transmission section in the Executive Summary (36-41)]

  3.4.1  Turning to the Cruickshank Report's recommendations, the key one is that "Government should establish a licensing regime to regulate competition in payment markets" (3.186). We seriously question the need for, and benefit from, the introduction of such a regime. We believe a licensing regime would run counter to the objectives we share with the Cruickshank Report, for the future of the UK payments system. It would move away from the overarching goal—expressed throughout the Report—of an efficient, effective and transparent market. It would undermine the benefits of the existing system, notably its ability "to adapt to new circumstances and to implement change" (3.49).

  3.4.2  A licensing regime would impose a further regulatory barrier to the development of new payments systems, which improved technology and cheaper computing and communications are making increasingly possible. It would also inhibit new entrants to the 90 per cent of the money transmission value chain lying outside the central "switch".

  3.4.3  A licensing regime is typically used as a regulatory solution in industries subject to natural monopoly, such as utilities, or where access to a common resource needs to be allocated by central government to avoid a "tragedy of the commons" (eg fishing licences). The UK money transmission industry presents an entirely different proposition as a major part of it is global, and increasingly so. It is undergoing fundamental change driven by technological and e-commerce developments, by the recently-created euro zone, and other competing pan-European payment systems.

  3.4.4  Given the growth in competing payment networks, an increase in regulation is likely to encourage banks to shift to more lightly regulated territories. Bilateral agreements, while potentially less efficient than open platform payment systems, may become preferable for industry players if the latter became highly regulated. Moreover, growth of alternative markets and the increase in the number of global providers of financial services will make it easier for market participants to shift their activities. For example, the Euro Banking Association (EBA) offers an embryonic Euro-based alternative to the APACS systems in the UK, which could grow to rival and surpass our domestic arrangements, particularly if the UK were to adopt the Euro. Under such a scenario, the EBA could offer an established system to clear Euro payments across Europe.

  3.4.5  The creation of a new body, "a legal person . . . granted effective powers to monitor compliance" (3.186) could add confusion and fragmentation in an industry already subject to regulation by a number of government bodies. The UK banking industry is already overseen by the Financial Services Authority, the Office of Fair Trading, the Bank of England, and HM Treasury. More recently, the Cabinet's Social Exclusion Unit has been active in looking at the provision of basic banking services.

  These are in addition to bodies (eg Health and Safety Executive) which regulate all industries, and to the growing influence and legislation of European Union institutions, whose focus on payment systems and services has increased considerably over the past 10 years.

  3.4.6  We are, therefore, disappointed that the Government, in its response to the Cruickshank Report, has accepted the recommendation to establish a licensing regime, PayCom, and has stated its determination to tackle what it perceived as "competition concerns in this area".

  Having said this, we welcome the Government's acknowledgement of the complexities involved in legislating in this area, and its stated intention to consult fully with the industry and its current regulatory institutions: a consultation in which we intend to play a full part.

3.5  Conclusions

  3.5.1  We agree with the principles underlying the Cruickshank Report's desired outcomes for UK payment systems. We support its stated objectives for price transparency, good governance, non-discriminatory access, efficient pricing and free trading. We stand by to co-operate in the consultation exercise which will follow the competition initiatives outlined in the Chancellor's March 2000 Budget and referred to in the Government's response to the Cruickshank Report.

  3.5.2  We welcome the fact that many competitive improvements are recognised in the Cruickshank Report. The Government's response also appreciates the developments which have followed the publication of the Report, not least the reforms announced by LINK and the changes in ATM pricing announced by individual banks, which have not only added to "transparency" but also represent substantial reductions in the pricing of the related services.

  3.5.3  However, we have fundamental questions about and reservations on the Report's practical proposals. A licensing regime, PayCom, would, in our view, move the industry further away from the objective of securing an efficient market in financial services and banking. It would stifle innovation, reduce UK global competitiveness, also create a disproportionate and unnecessary regulatory burden. Already, banks need to balance the needs of five different government bodies. A sixth would exacerbate this situation.

  3.5.4  We entirely support the Government's intention to address questions of (a) scope, (b) linkages with existing UK and EU competition law, (c) interaction with banking supervision and the fundamental objective of financial stability and (d) interests of free trade, in its preparation of legislative proposals. We stand by to contribute further comments in the ensuing consultation process.

  3.5.5  UK payment systems have generated benefits for customers, providing secure reliable transaction services. They have a proven track record of innovation, and security. Whilst it is important to ensure systems meet the needs of a rapidly changing industry, there is always the risk that new regulations destabilise a system which has demonstrated impressive efficiency, integrity and flexibility. We would recommend that the improvements proposed in the Report be pursued through existing institutions, enhanced as necessary, without the need for a new regulatory structure and prescriptive regulation.


4.0  Introduction

  We welcome the opportunity to comment on the section of the Cruickshank Report which addresses Banking Services and External Finance for SMEs (Chapter 5), and Recommendations 49, 52, 53, 54, 55 and 59 in the Executive Summary, while taking into account the comments on the Government's response of August 2000.

  Concurrent with this submission, Lloyds TSB has responded to the Competition Commission's investigation into the supply of banking services by clearing banks to small and medium sized enterprises in the UK, following the Chancellor of the Exchequer's and Secretary of State for Trade and Industry's decision that the Commission should inquire into the sector.

  As a general comment, Lloyds TSB contends that the Cruickshank Report does not acknowledge a number of the essential characteristics of SME lending, nor recognise the interrelationships between them. Much argument in this chapter is, by Mr Cruickshank's own admission, anecdotal, not substantiated by fact, and does not convincingly identify serious competition problems in the SMEs marketplace. We have reservations over the quality of its analysis and find it regrettable there was such limited dialogue between the Banking Review Team and Lloyds TSB on these issues.

4.1  Executive Summary

  In this response, we wish to highlight the following key points, that:

    —  there is no simple or widely agreed definition of what constitutes an "SME", and, therefore, no straightforward definition of this market;

    —  this is a competitive market, within which there are many providers;

    —  Lloyds TSB has unrivalled and continuous expertise in this sector, built up over many years;

    —  Lloyds TSB is, therefore, committed to the delivery of the highest standards of customer service in this market; and

    —  Lloyds TSB does not consider itself to be among the group of providers who Mr Cruickshank contends overcharge customers and offer them poor service.

4.2  Small and medium sized enterprises (SMEs)

  4.2.1  In a crucial technical sense, Lloyds TSB does not use the term "SME" in the planning and conduct of its business. Lloyds TSB believes that the definition of an SME contained in 5.4 of the Cruickshank Report, purely based on turnover and staff numbers, is greatly over-simplified. To illustrate this point, it is worth noting that Government departments, the Office of Fair Trading (OFT), and our competitors each use subtly or significantly different definitions of an SME. For SMEs do not display uniform characteristics. Their operations and organisational structure range from the sole trader, struggling with the demands of keeping financially afloat and "independent", to the sophisticated, organised and well managed private trading entity with years of positive financial track record and on its way to a successful stock market flotation.

  The immense diversity of structure, activity, financial performance and, therefore, retail demand-side financial requirements in the SME sector—indeed one could say that no two SMEs are the same—is not recognised in the Report.

4.3  Lloyds TSB's product offer

  4.3.1  Lloyds TSB is very proud of its record in the SME market. It has historically worked hard to develop relationships and consistently improve service so that it can compete effectively against not only its current range of competitors but also future competitors who may well be encouraged to enter if benign economic conditions continue.

  4.3.2  We have been in the market for many years, and are not "fair weather" bankers. Our commitment to the SME sector is exemplified by the loan book losses that we have periodically incurred. In the 10 years to 1998, Lloyds TSB wrote off in excess of £9 billion of bad debts, equivalent to 37 per cent of total profits. In 1989, in the depths of the last recession, we recorded a pre-tax loss of £560 million.

  4.3.3  We believe our customers (our Business Banking and Commercial Banking units have approximately 570,000 and 16,000 customers respectively) are comfortable with the range and quality of services we offer them. Our customer satisfaction survey for March 2000, for instance, showed that 90.7 per cent of our business banking customers were "satisfied" or "very satisfied".

  4.3.4  Lloyds TSB has made considerable investments in finding out what kinds of services business customers want from their bank, and in refining our products to reflect our customers' needs. This has involved extensive market research, planning, product design and staff training (see 4.3.1 above).

  4.3.5  Central to both our product offering, and the successful evolution of our services, is the Lloyds TSB relationship manager, who, supported by the diverse operations of the Lloyds TSB Group, provides a high level of experienced face-to-face business support and advice to the SME customer, and listens to and processes requests for new and revised products. A crucial aspect for Lloyds TSB has been the training of its business banking managers, which in several areas has required on-the-job and central training programmes over and above those which a personal banking manager would receive. More specialised areas covered include business lending, agricultural lending, and courses to enhance managers' appreciation of "developing businesses" and "managing/financing growing businesses". Lloyds TSB continues to develop new training courses for managers involved with SMEs.

  A recent Lloyds TSB development designed to improve performance of new businesses is to offer business customers a choice between four levels of support service: "business focus", in which their relationship manager will help the business analyse financial and planning matters face-to-face; "business response", where the primary communication is by telephone but the Lloyds TSB manager is always available to respond to specific issues and problems; "business express", involving direct telephone access by businesses to a dedicated team of Lloyds TSB specialists; and "business partner", for customers requiring an in-depth, face-to-face relationship with their Lloyds TSB business manager, who will act as their consultant and help them unlock the full potential of their business.

  4.3.6  With reference to section 5.56 in the Cruickshank Report, Lloyds TSB agrees that SMEs should have access to effective redress procedures in the event of need. Lloyds TSB is a lead participant in, and strongly supportive of, the Financial Ombudsman Service.

  4.3.7  With regard to 5.57, Lloyds TSB also has a dedicated team for the handling of complaints from SMEs, as well as for personal retail banking customers. As part of its customer service and aim to achieve the highest level of customer satisfaction, Lloyds TSB has complaints handling procedures which are easy to understand and accessible. Wherever possible, it will resolve a complaint internally. This has been the case for the vast majority of personal retail banking customers. If a complaint cannot be resolved by a branch (or other delivery channel) or by our central Customer Care department, Lloyds TSB will issue a letter of deadlock confirming that its complaints procedure has been exhausted, enabling customers to seek a resolution from the Financial Ombudsman Service.

  Lloyds TSB has taken a keen interest in the proposals for bringing the Ombudsman schemes together under the newly-created Financial Ombudsman Service. While the new Ombudsman proposals include rules for providers' own internal complaint handling, Lloyds TSB already has its own well developed, publicly available procedures and already complies in this respect.

  4.3.8  Lloyds TSB supports the recommendation that the FSA devote greater resources to consumer awareness to enhance their access to—and use of—information (5.97). We believe much information is available to SMEs, which may not make use of it. As a major lender and risk-taker in this market, Lloyds TSB welcomes greater consumer information because it would enhance the quality of SME management and, therefore, their performance and credit quality.

  We agree with the Government's view that the information needs of small businesses are different (and more complicated) from personal banking customers because the services they purchase are tailored to their specific needs. Equally, we concur with the Government's call for the FSA to balance the use of its resources as it deems fit, and by reference to practical experience.

4.4  Diversity of banking products: some key issues

  4.4.1  Mr Cruickshank says that we "bundle" our products. We dispute this claim: it is purely an inference drawn from our total product offering.

  4.4.2  Lloyds TSB considers the provision of current account services to be a single entity in that facilities to pay in cash and cheques for credit to a current account, the receipt of direct funds transfers to the account, and the making of payments to third parties by cash withdrawal/cheque/electronic transfer form a "package" of facilities all related to the operation of a current account.

4.5  Profitability and cyclicality

  4.5.1  We aim to provide a high value, high quality service to our customers, consistent with good value for money. The pricing of our offers is always competitive and takes very careful consideration of market conditions.

  4.5.2  As indicated above, Lloyds TSB has provided services to SMEs for many years, and is not a "fair weather" bank. The profitability of our SME operation is cyclical, and this is exemplified by loan book losses periodically incurred.

  We trust that these comments help explain the reasons for the concerns we have expressed with this chapter of the Cruickshank Report.




5.0  Introduction

  Chapter 4 of the Cruickshank Report contains an analysis of the retail financial services market by product group, addressing degrees of concentration, pricing and customer behaviour (4.1-4.47). It then assesses the current level of competition (4.58-4.85), market dynamics (4.86-4.100), and follows on with Recommendations (4.101-4.127). This chapter is closely linked with Annex D4, which covers automatic teller machines (ATMs), Chapter 7 of the Report, entitled "The provision of a basic banking service," and Recommendations 63-66 in the Executive Summary, which also cover Basic Bank Accounts.

  Lloyds TSB's response comments on market issues, and recommendations. It also takes account of the Government response of August 2000.

  Lloyds TSB welcomes many recommendations in the Cruickshank Report, particularly those recognising that the retail banking market is increasingly competitive. By the report's own comparisons, UK consumers get value for money from the UK banks. In other countries, consumers would have to pay over £100[2] a year for what they receive for free in the UK. Over 80 per cent of Lloyds TSB personal customers receive free banking.

5.1  The financial services market—fundamental structural change

  5.1.1  As a general observation, Lloyds TSB does not believe that the Cruickshank Report fully reflects the fundamental structural and behavioural changes which the UK financial services industry has experienced in the past decade, nor does it sufficiently acknowledge the massive market evolution certain to come in the next five to 10 years. These changes have essentially been driven by consumer power, and a need by financial services providers properly to respond to increasingly diverse and discriminating consumer needs for greater choice in products and services.

  5.1.2  Competition has never been so intense, and is associated with an explosion in number of new entrants—notably non-banks. For example:

  5.1.3  There are currently 28 companies providing current accounts in the UK, with ten new entrants since 1989: these are the Halifax, Woolwich, Flemings, Citibank, Virgin, First-E, Egg, Cahoot/Abbey National, First Direct/HSBC and Smile/Co-op[3].

  5.1.4  There are currently 140 providers of mortgages in the UK, with 19 new entrants since 1989: GMAC—RFC Ltd, The Mortgage Business plc, Wesleyan Home Loans Ltd, Direct Line, Kensington Mortgage Co, Virgin, Scottish Widows Bank, Winterthur Mortgage and Management Services, Preferred Mortgages, Sainsbury's, Southern Pacific Mortgages, Platform Home Loans, First Active, Future Mortgages, Mortgages plc, Egg, Verso Ltd, Standard Life Bank, and Norwich Union Personal Finance[4].

  5.1.5  65 companies provide credit cards to consumers, 12 of which have entered the market since 1989: MBNA, GM, Marbles/HFC, British Gas/Centrica/Goldfish card, RBS, People's Bank, The Associates, Sainsbury's, Tesco, Capital One, Egg, and Morgan Stanley Dean Witter[5].

  5.1.6  These new entrants, normally without the overheads of traditional "bricks and mortar" branch networks, "cherry pick" high income, high margin customers. They tend not to offer mass market services to all sections of society, but target low risk/high value "niche" markets to the exclusion of lower income people.

  5.1.7  In 1999, new entrants developed significant competition in a range of key markets. Whilst, for instance, there has been steady growth in Lloyds TSB mortgage lending, competition remains intense.

  5.1.8  Lloyds TSB is responding to the demands of increasing competition by launching a range of innovative products and services. For example, while in 1985 the industry only offered standard variable rates on repayment or endowment mortgages, C&G now offers a broad variety of options, such as "interest-only" mortgages and no mortgage indemnity guarantee premiums (since 1994). It has also introduced flexible mortgages, capped and fixed rates. It has greatly improved customer flexibility on prepayments, and was the first lender to offer a CAT marked mortgage.

  5.1.9  Increasingly, many non financial services companies offer their own financial products, such as credit cards, in order to extend brand loyalty and tie in customers, eg the British Gas/Centrica Goldfish card, Sainsbury's and Tesco.

  5.1.10  The globalisation of financial markets and the erosion of trade barriers particularly in Europe, as we move towards a single market for financial services, have also resulted in new competitors in the UK, for example First-E and MBNA. Technology and associated consumer demand—fuelled by the e-commerce phenomenon—are adding to the pace of innovation and competition. There is also a cultural shift evolving towards a 24-hour society, which has resulted in a huge growth in the use of new distribution channels. Customers now routinely use telephone banking, ATMs, internet services and, more recently, mobile phone and digital TV technology to meet their banking needs. Over 1,000 customers a day are registering for Lloyds TSB internet banking services.

  5.1.11  Also underpinning these technological changes and developments in different delivery channels has been a continuing huge investment in staff training, both for financial planning and service-related roles.

5.2  Lloyds TSB—branch network

  5.2.1  Lloyds TSB is committed to maintaining a wide and well balanced network of retail branches, which will remain its primary distribution channel; indeed, we think our branch network is vital to the Group's continued prosperity.

  5.2.2  The Lloyds TSB branch network gives its customers access to no fewer than 2,200 branches, and 4,400 Lloyds TSB cashpoint machines. In addition Lloyds TSB customers may withdraw cash free of charge at 17,500 Post Offices, and can use cashback facilities at a further 28,000 locations.

  5.2.3  However, as a result of changes in how our customers carry out their day-to-day banking transactions (see 5.1 above), fewer consumers are using the traditional Lloyds TSB branch network, particularly in satellite suburbs. In response to these changes in demand patterns, Lloyds TSB has closed non-viable branches. The proportion of our branches in rural communities is on the increase although only 8 per cent of our customers use our rural branches, which represent 17 per cent of our network. Like other retailers, banks must also compete with new competitors, whose overheads are lower and whose commitment to full service banking for all sections of the community is notably absent.

  5.2.4  Where Lloyds TSB closes a bank, its does so for carefully considered reasons. Our principal focus is—and will remain—to close branches only where there is another one nearby. Whenever we do close a branch, we take every step to ensure the impact is as little as is possible, and each case is studied. Indeed we believe we have set the trend among the big banks in ensuring that customer fallout is minimised. Lloyds TSB has had a code in place for the past two years under which eight weeks' notice was given in the event of closures, and up to 12 weeks' notice if the branch was the "last bank in town". The new banking code, which comes into effect on 1 January 2001 and to which Lloyds TSB subscribes, follows our own eight weeks precedent.

  As part of our determination to support communities, we introduced a new commitment, unique in the banking sector, on 1 May 2000, not to close a branch where Lloyds TSB is the "last bank in town". We hope that our "last bank in town" policy will encourage other institutions to continue to serve communities, which otherwise would be left without a banking presence.

  Lloyds TSB accepts and is keen to honour fully its social responsibilities to the communities in which it operates. It wishes to continue to support the communities it has served in the past, wherever possible.

5.3  Charging and Access to ATM Networks

  5.3.1  We welcome the recognition in Annex D4 of the Cruickshank Report that the UK is one of the cheapest countries in the world in which to undertake ATM transactions. Lloyds TSB has always ensured that use of its own 4,400 ATMs would be free to its 16 million customers, and has invested significantly to develop one of the biggest ATM networks in the UK. Of its 4,400 ATMs, 620 are off-site, eg in supermarkets, railways, and motorway service areas.

  5.3.2  Lloyds TSB announced in July its intention to make its ATMs free to all users as from 1 January 2001. At present, only 4 per cent of Lloyds TSB customers incur "disloyalty" charges. The vast majority enjoy free cash withdrawal facilities. Many of those who do incur charges do so by conscious choice, given the proximity of free machines. As the Cruickshank Report states in 4.69, "customers will be willing to pay more for cash withdrawal if, for example, they place a high value on their time".

5.4  Competitive environment for ATMs—Lloyds TSB's participation and influence

  5.4.1  Lloyds TSB was the first bank to call for double charging to be banned: we are delighted the industry has followed our lead.

  5.4.2  In March 2000, Lloyds TSB issued an ATM Code of Conduct. It confirmed that it would not double-charge customers, that it would continue not to charge its customers for using Lloyds TSB machines, and that customers would be given prior notification of any charges at cashpoints before they withdrew cash.

  5.4.3  As already mentioned, Lloyds TSB will make its ATM services free of charge to non-customers as well as customers, from 1 January 2001. This decision was taken to simplify the position from the market's and customers' points of view. Lloyds TSB will, of course, continue to incur the related overheads. Lloyds TSB in fact has repeated costs of installation and on-going running costs in the operation of its ATM estate.

5.5  Lloyds TSB—one of the most inclusive providers of UK financial services

  5.5.1  Lloyds TSB is one of the most inclusive UK financial services companies. It provides more current accounts than any other provider. It is proud of its rôle in serving the greatest number of low-income customers of all UK financial services providers, contrasting with many new entrants and building societies who "cherry pick" high income savers and mortgage borrowers.

  5.5.2  Indeed, Lloyds TSB, the product of Lloyds Bank and the former TSB Group, has a deep heritage with a traditional presence in the old "heavy" industrial centres in such areas as Wales, Merseyside, the North East, and in Scotland, where it has traditional links with lower income customer groups.

5.6  Scope of the Problem of Financial Exclusion—People who do not have bank accounts

  5.6.1  In order to understand the nature and root causes of financial exclusion, also how best to extend financial products to those without bank accounts, Lloyds TSB participated in the funding of a BBA research project. Elaine Kempson of the Personal Finance Research Centre undertook the research, independently, at Bristol University. Her report "Access to current accounts" was published in August 1998. It demonstrated that financial exclusion is a complex issue: there is no single problem or solution. The report concluded that:

    —  6-9 per cent of the adult population (about 3 million) have neither current nor savings account, a figure which has been confirmed by the Performance Innovation Unit report "Counter Revolution—Modernising the Post Office Network";

    —  of these, only 0.3 per cent (about 100,000) had been refused an account or had an account closed by a bank or building society;

    —  2.6 per cent (just over 1 million) had not tried to open an account, preferring to transact in cash and believing banks are "not for them" nor interested in them;

    —  1.9 per cent (around 750,000 mainly elderly people) had always operated in cash and did not want to start using a bank account;

    —  about 2.3 per cent of adults (almost 1 million) had previously had an account but had closed it themselves after getting into debt, choosing to deal in cash to control their finances and avoid the dangers of lapsing into debt again; and

    —  0.6 per cent of adults (about 250,000, mainly younger) people had no account, as they had no secure job.

5.7  Lloyds TSB's pilot basic banking account—the "Lloyds TSB Bank Account"

  5.7.1  In order to meet the needs of some people on low incomes, Lloyds TSB developed a Basic Bank Account, allowing customers access to money transmission services, and to their cash, without the risk of entering inadvertently into debt.

  5.7.2  Lloyds TSB launched the Lloyds TSB Bank Account in Scotland in February this year. This pilot project gave Lloyds TSB the opportunity to assess the operational practicalities of running a Basic Bank Account. The experience has enabled us to plan the rollout of a Basic Bank Account at a national level, in October.

  5.7.3  The key components of this account, which must remain in credit, are:

    —  an ATM card, which can be used at 27,000 machines in the UK, for free;

    —  nominal credit interest;

    —  no bank charges for everyday transactions such as on current account, direct debits and standing orders;

    —  access to the services of over 2,200 branches in the UK;

    —  24 hour telephone banking through PhoneBank Express for paying bills and inquiries on account balances;

    —  an £10 overdraft buffer; and

    —  a booklet "Managing your Money", which explains how to manage a bank account, obtain cash, pay bills and pay money in, and also describes the workings of telephone banking, cheque clearing, and complaints procedures.

  5.7.4  We note in particular, and fully concur with, the comment that, if the Government considered it necessary to intervene to provide universal access to basic banking services, any such intervention "should seek to bring competition gains, and not distort competition by engineering permanent cross-subsidies" (7.24). Similarly, with respect to Recommendation 65 (7.23), Lloyds TSB agrees with the principle that competition should not be distorted by "engineering permanent cross subsidies" in seeking to "define a universal service".

  5.7.5  Mr Cruickshank has suggested that basic bank accounts could be profitable for those offering them. While this may be true in some cases, as customers progress to more mainstream financial arrangements, Lloyds TSB's experience indicates that Basic Bank Accounts are not profitable and are unlikely to become so.

  5.7.6  In offering these accounts, therefore, Lloyds TSB will need to cross-subsidise the costs of providing them from other profitable businesses and this is likely—in time—to distort competition. Indeed it would run precisely counter to Mr Cruickshank's recommendation (7.24) that any such intervention by the Government "should seek to bring competition gains, and not distort competition by engineering permanent cross-subsidies".

  5.7.7  We endorse Mr Cruickshank's recommendation 64 (7.23), that the Government should give top priority to developing a benchmark for basic banking services, and note the Government's positive intentions in this regard. We look forward to participating in the consultation process on benchmarking this Autumn.

5.8  Lloyds TSB and Agreements with the Post Office

   5.8.1  In 1997, Lloyds TSB was the first high street bank to create agency arrangements with the Post Office. These have been expanded to allow personal customers—at no cost—to use 17,500 Post Offices throughout the UK for essential banking transactions such as paying in funds, paying bills and withdrawing cash. These additional outlets are in addition to our retail branch presence set out above.

  5.8.2  Lloyds TSB hopes this arrangement will alleviate the effects of branch closures by providing valid local alternatives for customers, particularly the elderly and those without access to transport. This arrangement also supports the viability of the Post Office network, particularly in rural areas. Between April 1999 and April 2000, the Post Office handled 828,000 transactions for Lloyds TSB customers. This volume is expected to rise to 2.5 million by the end of the current financial year.

  5.8.3  For such reasons, Lloyds TSB has noted, with interest, the recent government proposals for the Post Office, which include provisions for a "Universal Bank". We have serious commercial concerns as to the practicability and likely behavioural effects of those proposals—this particularly given the proposed involvement of the Post Office, which would effectively mean that we would fund a direct competitor. However, Lloyds TSB reserves its judgement and will scrutinise the formal business plans being prepared by the Post Office and its advisers. Meanwhile, we have indicated our willingness to work with the Post Office, the DTI and HM Treasury to consider whether the Universal Bank presents a practicable and viable solution.

  5.8.4  In addition, Lloyds TSB is still unclear at the time of writing how the proposed rollout of the basic accounts provided by banks will sit side-by-side with the Post Office's plans for Universal Banking services. We are currently looking to the Government to clarify whether it envisages requiring banks both to introduce basic bank accounts and sign up to the Universal Bank, or whether it will expect banks to take only one of the above options.

  5.8.5  Whatever the outcome, it is imperative that the Government seeks to apply a level playing field in such an exercise, and involves all providers of retail financial banking services including new entrants and non banks in its deliberations and proposals.

  5.8.6  We would equally suggest that the application of CAT standards should be handled with circumspection as too rigid an approach may be expected to stifle innovation and competition between the providers of these services.

5.9  Other measures designed to combat financial exclusion

  5.9.1  In addition to our Basic Bank Account, Lloyds TSB has amended its account opening procedures to ensure maximum flexibility in the acceptance of non standard forms of identification. Hence, those without passports or driving licences are no longer impeded from opening accounts. Our internal procedure follows a number of verification criteria, depending on the customer category; types of ID include driving licence, official bills (eg Inland Revenue, Council Tax), and, in certain cases, verifiable letters of introduction. This flexibility has been made possible while complying with the money-laundering rules.

5.10  Lloyds TSB comments on other Recommendations in the Cruickshank Report

  Our responses to specific Recommendations in the Cruickshank Report follow:

Recommendation 47—(4.106) [27]

  Lloyds TSB agrees that banking services should not be designated as regulated activities by the FSA, as competition is the best way of ensuring the consumer obtains the best deal, and we note that the Government, in its response, does not intend extending the scope of the Financial Services and Markets Act (FSMA).

Recommendation 48—(4.110) [28]

  Lloyds TSB welcomes all improvements to consumer information. It would appreciate the opportunity to participate in the Government's consultation process when it considers establishing an independent Financial Services Consumer Council covering all financial services as a result of this recommendation.

Recommendations 48 and 54—(4.112, 4.113) [29 and 30]

  Lloyds TSB is a lead participant in, and strongly supportive of, the UK Banking Financial Ombudsman Service. It shares, however, the Government's and FSA's stated concerns that giving the Ombudsman a greater regulatory rôle could lead to the introduction of regulation without the accountability and cost benefit checks required of the FSA. As the Government response suggests, the Ombudsman "is primarily a dispute solver rather than a . . . regulator", and it is important that this distinction continues to be adhered to.

  As for the recommendation that the new Ombudsman consult, draw up guidelines, and then use them to determine whether a "supplier's actions are `fair and reasonable' ", the Banking Code, which sets standards of good banking practice and is subject to three yearly review, already embodies such principles. Further guidelines would duplicate what the Banking Code sets out to do.

  The function of the Ombudsman is to act as independent arbiter of complaints. If he himself draws up the guidelines, he may be less able to adopt a dispassionate attitude in the face of unresolved complaints.

  As already stated, Lloyds TSB supports the Banking Code, drafted in association with the Ombudsman, Consumers Association, the OFT and the Treasury. We believe the Banking Code Standards Board [BCSB] auditors, PwC, will enhance compliance with the Banking Code. We also believe that the Banking Code and BCSB should be given time to demonstrate enhanced consumer protection.

  We continue to take steps to enhance our staff's understanding of the requirements of the various regulatory codes to which we subscribe. Meanwhile, we await the Government review group report toward the end of this year.

Recommendation 48—(4.115)

  We agree that the new Financial Ombudsman Service should offer voluntary membership to foreign firms offering banking services to UK consumers from outside the UK, provided that (a) awards can be similarly enforced on them and (b) membership of the UK scheme would not "mask" standards less rigorous than for FSA regulated firms.

Recommendation 52—(4.124)

  We have no objection to the principle that the FSA should publish comparative tables ranking, among other things, benchmark services by supplier according to price; grouping non-benchmark services into categories ranking these, too, by price; and highlighting material differences between services. The details, would, however, need to be considered carefully. Some products—for example investments—compete principally on the strength of performance: benchmarking on the basis of price alone would, in such cases, be misleading.

Recommendation 53—(4.125) [35]

  With respect to the recommendation that the Ombudsman publish comparative tables of complaints received and how they are dealt with (5.99), Lloyds TSB has concerns with such an approach. Care would need to be taken that the proper comparisons are made, and that they correctly convey the degree of seriousness. Relatively large providers of financial services, with wider delivery channels and greater market shares, are likely to face a higher number of complaints than their smaller competitors. A similar disadvantage may be experienced by those firms which encourage complaints to maximise the quality of their services. At the other extreme, certain suppliers may feel under pressure to conceal the complaints they receive. Any public comparison should carefully consider such issues as these, otherwise the position they will represent is certain to be distorted.

Recommendation 54—(4.127)

  Lloyds TSB is happy to work with the FSA in its promotion of financial awareness amongst the public. We are already in discussion with the FSA on this issue, and note that the Government, in its response, identifies this as one of the FSA's main tasks.


6.0  Introduction

  Annex C of the Cruickshank Report comments upon the profitability of the UK banking market. The conclusions reached at paragraph C.135 (page 227) are:

    —  the banking sector is currently earning significantly more than its cost of capital;

    —  if this continues for any length of time consumers will be paying materially higher prices than necessary;

    —  the major source of excess profit are personal and SME customers;

    —  the costs of serving these customers are unlikely to rise in the short term to absorb these excessive profits; and

    —  if these excess profits are not to be made over the short to medium term, prices should fall.

  We do not concur with a number of aspects of the analysis undertaken or the conclusions reached. Our comments are set out below.

6.1  Excessive emphasis on the cost of capital

  6.1.1  In the analysis undertaken in the Report, we consider that a somewhat mechanistic approach was adopted which seemed to conclude that a return in excess of the cost of capital is sufficient evidence of a competition problem. We find this an overly restrictive and simplistic approach. If applied to all sectors of the economy, the majority of successful UK companies would be deemed worthy of investigation. In the past economic cycle, Lloyds TSB's profits on a current accounting policy basis have only just exceeded its cost of capital. It has also earned a lower return on capital than similarly successful banks in Europe and the United States.

  6.1.2  Lloyds TSB believes that an analysis of profitability should form part of a wider examination of competitive conditions in the industry, particularly the feasibility of entry, which the Competition Commission is currently investigating. We pointed out to the Review Team on a number of occasions that competition, particularly from new entrants, continues to drive down prices, margins and thus profitability in a number of key segments of the market. These segments include mortgages, savings products and credit cards, with the number of new entrants and the impact on prices being especially marked in the past two years. This period falls largely outside the financial period covered by the Review.

6.2  Deficiencies in the accounting methodology used

  6.2.1  Much analysis by the Review Team was based on historic accounting data. The statutory accounts of a bank may understate the true economic capital employed in its business, since the rules under which statutory accounts are compiled may preclude balance sheet recognition of certain assets the bank has established by investment over the years. Moreover, since accounting rules have changed over the period under review, anomalous results may be achieved by placing undue reliance on accounts prepared under the then prevailing accounting rules.

  6.2.2  For example, Lloyds TSB has been involved in major mergers and acquisitions. The goodwill arising from these was, under prevailing accounting standards, written off against the capital base of Lloyds TSB. It is this diminished capital base against which the profitability of Lloyds TSB has been assessed. Application of current accounting standards would have added some £3.3 billion, or nearly 45 per cent, to the capital base of Lloyds TSB at the end of 1998, the benchmark date used for the Report.

  6.2.3  Other adjustments to the capital base to reflect conservative valuation measures applied or accounting standards not in line with international accounting standards, would have increased the Lloyds TSB capital base by a further £2.6 billion, or 35 per cent. Application of these adjustments and of current accounting standards to the average capital employed by Lloyds TSB in 1999 would halve the reported post tax return on capital, from 31.1 per cent to 15.5 per cent.

  6.2.4  Moreover, none of these adjustments take into account the value of intangible assets such as brands, customer databases, bespoke computer software, business processes and human resource processes such as the value of trained staff. Lloyds TSB write off all these investment costs against revenue.

6.3  Determination of product profitability and overall profitability

  6.3.1  Lloyds TSB, as with other major banks, provides an integrated banking and financial services products offering to its customers, mainly from a common set of distribution outlets. Many products are supplied jointly by, for instance, an extensive branch network.

  6.3.2  Whilst the allocation of costs and income between product areas is undertaken on a consistent and rational basis, it is not an exact science given the joint supply, especially as far as costs are concerned. In addition, allocation of capital, other than regulatory capital, which forms a relatively small part of the overall capital base, cannot be undertaken with precision.

  6.3.3  Given the complications inherent in the preparation of such data, substantial amounts of financial and statistical data, with copious qualifications and explanations, were supplied to the Review Team, although it was not possible to supply all the details requested. We were, therefore, disappointed that no meaningful attempt was made by the Review Team to discuss the data, or to seek to understand it fully. This, despite innumerable offers on our part to take the Review Team through the data.

  6.3.4  Hence we have serious concerns as to the basis on which the Review Team undertook its analysis, and the substance of the conclusions it reached.

6.4  Sample bias in calculation of returns

  6.4.1  It is notable that the Cruickshank Report excludes heavily loss-making firms which have left the market from the scope of its analyses. It also seems to exclude unsuccessful entrants, such as Citibank and a number of other foreign banks which have tried without material success to enter British retail banking, and established participants such as the UK merchant banks who withdrew from the SME lending market due to lack of profitability.

  6.4.2  By focusing on successful firms alone, the Review is unrepresentative, and overstates the profitability of the banking sector as a whole.

6.5  Inconsistency over treatment of cyclical returns

  6.5.1  Throughout the course of the Cruickshank Inquiry, Lloyds TSB stressed the importance of taking account of the economic cycle when assessing returns in the banking sector (particularly in the provision of services to SMEs). Following publication of his Report, Mr Cruickshank asserted that UK customers were paying excess prices of between £3 billion and £5 billion. It is still not clear to us how these figures were calculated. Moreover, the Report seems to be inconsistent over its treatment of the cyclicality of profits, commenting in paragraph 2.49:

    "Over the period 1989 to 1998 (with estimates for 1999) the firms in the sample have on most reasonable assumptions at least covered their cost of equity. More importantly, if the trend in returns continues, the high level of profits that are currently being made will push average returns over the economic cycle firmly into excess. [Emphasis added]"

  6.5.2  In other words, over the economic cycle, the Report agrees that the banks sampled more or less earned their cost of capital. The perceived competition problem is based on the extrapolation of current ("top of the cycle") profit levels and is, therefore, a deduction based on an incomplete—and unrepresentative—sample of the economic cycle.

6.6  Summary

  In summary, Mr Cruickshank has not presented a convincing case to support the contention that banks are earning excess profits or that customers are paying billions of pounds through excessive pricing.

September 2000

1   References throughout this paper are to the Cruickshank Report, except where otherwise indicated. Back

2   Lloyds TSB customers have free access to branches, ATMs, staff, cheque books, debit cards, standing orders, direct debits, inter account transfers, BACS payments, telephone banking, bill payments, cash exchange statements, financial advice and Post Office banking services. For equivalent banking services in Spain, customers pay approximately £114 pa, £64 in Germany and £68 in the USA. Back

3   Source: The British Banking Association, Money Matters, Money Net, Money Advice, Mortgage 2000, PwC research document entitled The Cruickshank Review: Market Dynamics and Profitability Drivers. Back

4   Source, ibid. The British Banking Association, Money Matters, etc. Back

5   Source, ibid. The British Banking Association, Money Matters, etc. Back

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