Select Committee on Treasury Minutes of Evidence


Further evidence submitted by the Consumers Association

INITIAL SCOPING ON KEY STRUCTURAL FACTORS IN THE PERSONAL BANKING MARKET

  The core of the relationship that the consumer has with the banking market comes in the shape of the current account. This relationship is the key both for the consumer and for the banks themselves. There are a number of key structural questions that need to be addressed when looking at the market and relationship. For the sake of brevity we have chosen to use the recent Competition Commission reviews of the banking sector (in the shape of the review of the proposed Lloyds/Abbey merger and the SME banking review) as routes into those issues. This is partly because the reviews present a "state of the art" in thinking about banking competition and because they present data and analyses previously largely hidden from public view. At this stage we are not drawing any conclusions as we have not yet completed our analysis. This paper is thus an outline of the areas we will be investigating further.

The key factors we will focus on are:

—  How to measure actual prices for consumers.

—  The existence of competition in pricing.

—  Current account profitability.

—  Innovation in current accounts.

—  Back book pricing.

—  Other factors: confusion marketing and cross selling and Cross subsidies in current account.

—  Switching accounts and new personal accounts.

SUMMARY OF KEY QUESTIONS FOR FURTHER RESEARCH

The key questions for further research are the following:

How to measure actual prices for consumers

If the SME inquiry identified interest foregone as a price for small business in what way is the current account market different. The difference in pricing between the big four and the smaller players is significant and long term. This would suggest that the price paid by consumers, in terms of interest foregone, is significant. The definition of pricing in the SME inquiry is important as it recasts the way in which we should view pricing for retail markets. There is no obvious reason why the formula used (in terms of interest foregone) cannot be applied to personal current accounts. It would be interesting to know if the banks view the assessment of their pricing in this way and if they see any reasons why it should not be applied to personal current accounts.

The existence of competition in pricing

How do banks themselves view the current account market? Are current accounts viewed as stand alone products or are they bundled with the other product holdings of consumers? As in other markets, does the bundling of products (see comments on profitability) indicate that there are Cross subsidies at work? What could cause an un-bundling of consumer retail financial product holdings? Is such an un-bundling being triggered by new entrants in secondary markets—or is the current account central to the equation?

Current account profitability

How is the profitability of the personal current account assessed by each bank? Is the value of the personal current account primarily as a route into cross selling? If so, if one includes the cross-sold products, does the profitability of the current account improve? If the retail profitability of the banks is as good as the Lloyds and Barclays statements suggest how does this tally with the current account not being profitable?

If the cost:income ratio for personal customers has improved significantly in the last few years—how much of this gain has been passed on to consumers?

Innovation in current accounts

If Lloyds TSB was prepared to offer a better current account to get the merger cleared—why has it not rolled it out anyway—to counter competition in the current account market? What are the details of the current account that Lloyds TSB were prepared to launch? If the account is not to be launched not interest rates reduced—why?

Lloyds TSB appeared to offer to limit backbook pricing (see next section) on current accounts. This would suggest that it sees the practice as against the consumer interest. Does it still view this as a problem and if so, what does it plan to do about it?

Back Book Pricing

  To what extent does back book pricing (ie consumers on obsolete accounts) occur? How many consumers are affected by this practice? Do the banks view this practice as acceptable? What is being done to minimise the number of consumers with such poor performing accounts?

Other factors: confusion marketing and cross selling and Cross subsidies in current account

Are there any plans to provide such a breakdown of interest charges for types of overdraft (ie authorised/unauthorised for personal current accounts? Are there any plans to promote sweep/off set provisions for all consumers? How does the existing promotion of such facilities relate to back book pricing and premier customer pricing? (ie are all efforts focused only on the most profitable customers?)

Do the big four consider that the existence of tiered products and bundled accounts make price comparison easier or more complex?

Do such cross subsidies still exist to any significant degree in the current account market? If so, is this seen as an indication that competition is not vigorous? Do the banks expect these Cross subsidies to lessen over time and if so what will be the likely driving force behnid this?

Switching accounts and new personal accounts

What remaining barriers to switching exist and how firm are they? What issues exist in access to credit scoring information in the UK compared to other countries, most notably the USA? Is access to credit information in the USA "better" at delivering greater switching in financial services markets? Does US consumer access to such scoring information enable consumers to be more active in seeking out new suppliers? Is the idea of a national insurance style current account feasible?

DETAILED ASSESSMENT

1. How to measure actual prices for consumers

  The first issue that is worthy of further investigation is the manner in which we view the "price" of personal current accounts. A good deal is made of the fact that personal current accounts are "free" to the consumer. However, the approach taken by the Competition Commission in their review of the small business market may prove instructive:

2.96  We considered the extent to which there were similarities in prices and price structure . . . Hence, where appropriate, in referring to prices (or charges), we include any element of interest forgone in the interest rates paid by the clearing banks on current and deposit accounts. Interest forgone may commonly not be thought of as a price, but if the market is not fully competitive then the difference between interest earned by the customer and competitive rates of interest is a benefit to the banks and consequently a cost to customers, commercially equivalent to excess charges for services. Our concern as to prices, therefore, includes the prices (or charges) explicitly levied by the clearing banks; the value to the banks of interest forgone on current accounts; and any element of interest forgone in the rate of interest paid on deposit accounts. (Competition Commission SME Banking Inquiry).

  2.107  . . . the similarity of pricing structures of the main clearing groups—namely not paying interest on current accounts, while also levying money transmission and other charges, and offering low rates of interest on short-term deposit accounts in relation to the benefit of funds employed by the banks—does not directly reflect the structure of the clearing banks' costs. Together with the ability of those banks to maintain such a policy despite the lower money transmission charges and higher deposit rates available elsewhere, such a similarity of pricing structure appears to restrict and distort price competition. It is true that there are different price structures for start-up businesses and some switchers which we discuss below, but this does not represent a move in the direction of a cost-based charging structure. (Competition Commission SME Banking Inquiry)

AREAS FOR FURTHER RESEARCH

If the SME inquiry identified interest foregone as a price for small business in what way is the personal current account market different. The difference in pricing between the big four and the smaller players is significant and long term. This would suggest that the price paid by consumers, in terms of interest foregone, is significant. The definition of pricing in the SME inquiry is important as it recasts the way in which we should view pricing for retail markets. There is no obvious reason why the formula used (in terms of interest foregone) cannot be applied to personal current accounts. It would be interesting to know if the banks view the assessment of their pricing in this way and if they see any reasons why it should not be applied to personal current accounts.

2.  The existence of competition in pricing

Even if the CCs approach in the SME inquiry is not applicable to the personal current account market (although we cannot see an obvious reason why it is not), there remains the issue of the degree of competition on price in the current account market. There are a number of key factors to assess in this regard. Firstly, one has to look for evidence of tacit collusion and secondly, the degree of price parallelism that would suggest that such tacit collusion occurs. The third factor is the existence of market power, singular or collective, that allows such parallelism to survive the onslaught of price competition. Fourthly, one has to look to barriers to switching that allows parallelism to survive.

COLLUSION?

  2.64.  . . ., we believe that the PCA (personal current account) market is vulnerable to tacit collusion in pricing. This would tend to exacerbate any adverse effects on competition arising from the loss of a significant player. (Competition Commission Lloyds/Abbey merger Inquiry.)

PRICE PARALLELISM?

  2.65.  The prices of the big four banks for their standard PCA products are very similar: currently they all make no transaction charge for the main money transmission services, pay 0.1 per cent interest on credit balances and charge interest at between 18 and 19 per cent on authorised overdrafts and between 29 and 34 per cent on unauthorised overdrafts. The prices of the other traditional clearing banks, BoS and the NAB subsidiaries Clydesdale and Yorkshire Bank, are also similar (Competition Commission Lloyds/Abbey merger Inquiry)

  2.439.  . . . we consider that conduct may prevent, restrict or distort competition by reducing competition without directly impeding competition from other persons. For example, where parties by their conduct do not engage in price competition as actively as could be expected under competitive conditions, they can properly be described in our view as "restricting" the extent to which they compete on price, and, also, in so far as the prices exceed those that could be expected under competitive conditions, as "distorting" the process of price competition . . . We also noted that, in an oligopolistic market, it may be that each of the oligopolists has incentives not to cut prices since each knows that its competitors will match those price cuts and cutting prices would, therefore, reduce profitability without increasing market share. We consider that such a situation is one in which competition is prevented, restricted or distorted because in an otherwise competitive market it would ordinarily be expected that competitors would compete on price. (Competition Commission SME Banking Inquiry)

  2.443.  . . . we noted that one way of distinguishing whether price parallelism reflects intense competition or failure to compete is the level at which price parallelism occurs. If it occurs at a level of prices broadly equal to the cost of capital, it is, in our view, more likely to be indicative of competition acting as a stimulus to reduce prices to such a level. If it is at a price level that gives excessive profits, then it would indicate a lack of competition. In a concentrated market, that would, in our view, arise from a mutual if independent recognition of the desirability of not significantly undercutting each other on price. (Competition Commission SME Banking Inquiry)

  2.448.  . . . most of the clearing banks restrict price competition between themselves in that they do not pay interest on most or all business current accounts (we would regard this practice as including the payment of only minimal rates of interest as on some personal accounts, although we are not aware of even minimal rates of interest generally being paid on any business current accounts). (Competition Commission SME Banking Inquiry)

  2.451.  . . . most of the clearing banks restrict price competition among themselves on smaller, short-term deposit accounts by offering low rates of interest in relation to the value of these funds to the banks (ie the benefit of those funds as employed by the bank). (Competition Commission SME Banking Inquiry)

  2.468.  . . . our view is that competition is a process of rivalry, primarily for resources and for consumer spending, and that prices (and profits) are an integral part of the process, signalling how firms and customers can most efficiently allocate their resources; and creating the correct incentive for firms and consumers to allocate their resources in this way. A price in excess of that necessary adequately to finance the business certainly distorts this process, by sending the wrong signals and creating distorted incentives. By maintaining prices at that level rather than cutting them, the clearing banks are refraining from price competition, and that is a restriction of competition. If, as here, most firms in the market, covering around 90 per cent of the market, all charge excessive prices, then there is little scope for consumers to find any lower, non-distortionary prices which may be available, and in this sense the conduct also restricts the competitive process. Moreover, the conduct of the four main clearing banks departs from the competitive norm ... in two respects; not only by setting excess prices, but also in other aspects of pricing policy we have discussed, in particular by charging differential prices to different customers. (Competition Commission SME Banking Inquiry)

  2.469.  In our view the clearing banks to a considerable extent refrain from price competition, in terms of charges and interest rates on loans, deposits and current accounts, as evidenced by a similar structure of prices for similar products and other parallelism of behaviour, and by the setting of excess prices and earning of excess profits. . . .We regard refraining from price competition and the setting of prices by all the clearing banks identified below at such levels as restricting and distorting competition among themselves. (Competition Commission SME Banking Inquiry)

PRICE PARALLELISM IN THE CURRENT ACCOUNT MARKET

  Given the pattern of entry into the current account market by new providers one would assume that, were this entry significant, the process would have a positive effect on prices and charges. For the current account market one must therefore assess whether the entry of the newer current account providers has prompted retaliatory action by the existing high street banks. We are assuming that the retaliation by the established players would tend to take the form of a reduction in the interest charges for overdraft and unauthorised overdrafts and an increase in the interest rate offered for positive balances on current account balances. We plan to use two proxy measurements of this scenario. Firstly, the absolute levels of interest rates and charges and secondly the spread between the rates charged by the new entrants and the established high street banks. However, a number of health warnings must be attached to the data. Firstly, the data may indicate a narrowing of differentials. This narrowing may be caused by a response to competition or an ability of newer entrants to maintain the differential. Secondly, the status of the newer entrants during the period surveyed has been in a state of flux. The conversion process from mutual to PLC will have had an impact on strategic options and on the ability to maintain interest rates.

INTEREST PAYMENTS ON CURRENT ACCOUNTS

One of the main marketing claims of the newer entrant current account providers has been the fact that they pay a higher rate of interest on current accounts. The data in the Table below tend to support this contention. As we argued above, if the entry of the newer current account providers was effective in providing competition for the established high street banks one would assume that the high street banks would raise their interest payments on account to nearer that of the newer entrants.

If one looks at the final column of the table one can see the difference between the average interest paid on current accounts by the big four and that paid by the smaller, newer entrants. The data indicate that the difference does indeed narrow for a period of time from the end of 1998 and start of 1999, before rising and stabilising again at a new equilibrium level at the end of 1999. There could, of course, be a number of explanations for this movement. We think that the majority of the narrowing at the end of 1998 came from a reduction in interest paid by the smaller players. It appears that the smaller players were unable to maintain the interest rate differential and were forced to cut their payments. This is evidenced most clearly by the cut experienced in the months of November and December 1998. The average interest rate paid by the newer entrants was reduced by 0.39 per cent while that paid by the big four fell 0.05 per cent. It is the cut by the newer entrants that explains the majority of the reduction in difference between the big four and newer entrant, rather than the established players responding aggressively to competition.

Interest payments on current accounts

Selected banks and averages.

Date
Abbey National (ANBA account)
Lloyds/TSB current account (classic November 1998 and December 2000)
Average of big four
Average of new entrants*
Difference
Nov 1998
0.75%
0.25%
0.30%
1.14%
0.84%
Dec 1998
0.75%
0.20%
0.25%
0.75%
0.50%


  This contention appears to be supported by the widening of the differential from April 1999. It appears that the average offered by newer entrants dropped to this point. The high street banks responded in kind, but continued to cut and then stabilise, while the smaller players started to increase their offering, widening the rate.

Interest payments on current accounts

  Selected banks and averages.

Date
Interbank 3 month bid rate
Selected retail banks base rate
Abbey National (ANBA account)
Lloyds/TSB current account (classic November 1998 and December 2000)
Abbey National Cahoot
Average of big four
Average of new entrants*
Difference
Jul 1996
5.72
5.75
0.90%
0.30%
  
0.26%
1.00%
0.74%
Aug 1996
5.69
5.75
0.85%
0.30%
  
0.26%
0.90%
0.64%
Sept 1996
5.84
5.75
0.85%
0.30%
  
0.26%
0.90%
0.64%
Nov 1996
6.31
6.00
0.80%
0.30%
  
0.26%
0.89%
0.63%
Dec 1996
6.38
6.00
0.80%
0.30%
  
0.26%
0.89%
0.63%
Jan 1997
6.22
6.00
0.80%
0.30%
  
0.26%
1.08%
0.81%
Feb 1997
6.13
6.00
0.80%
0.30%
  
0.26%
1.08%
0.81%
Mar 1997
6.28
6.00
0.80%
0.30%
  
0.28%
1.08%
0.80%
Apr 1997
6.44
6.00
0.80%
0.30%
  
0.28%
1.08%
0.80%
May 1997
6.53
6.25
0.80%
0.30%
  
0.28%
1.08%
0.80%
Jun 1997
6.78
6.50
0.80%
0.30%
 
0.28%
1.08%
0.80%
Jul 1997
6.94
6.75
0.80%
0.30%
 
0.28%
1.08%
0.80%
Aug 97
7.22
7.00
0.80%
0.30%
  
0.29%
1.08%
0.79%
Sep 1997
7.19
7.00
0.80%
0.30%
  
0.31%
1.14%
0.83%
Oct 1997
7.25
7.00
0.80%
0.30%
  
0.31%
1.20%
0.89%
Nov 1997
7.63
7.00
0.80%
0.30%
  
0.31%
1.20%
0.89%
Dec 1997
7.59
7.25
0.80%
0.30%
  
0.31%
1.20%
0.89%
Jan 1998
7.44
7.25
0.80%
0.30%
  
0.31%
1.20%
0.89%
Feb 1998
7.47
7.25
0.80%
0.30%
  
0.31%
1.24%
0.93%
Mar 1998
7.50
7.25
0.80%
0.30%
  
0.31%
1.24%
0.93%
Apr 1998
7.38
7.25
0.80%
0.30%
  
0.31%
1.18%
0.86%
May 1998
7.41
7.25
0.75%
0.30%
  
0.31%
1.16%
0.85%
Jun 1998
7.72
7.50
0.75%
0.30%
  
0.31%
1.16%
0.85%
Jul 1998
7.69
7.50
0.75%
0.30%
  
0.31%
1.24%
0.93%
Aug 1998
7.56
7.50
0.75%
0.30%
  
0.31%
1.24%
0.93%
Sep 1998
7.28
7.50
0.75%
0.30%
  
0.31%
1.26%
0.95%
Oct 1998
7.09
7.25
0.75%
0.30%
  
0.31%
1.26%
0.95%
Nov 1998
6.81
6.75
0.75%
0.25%
  
0.30%
1.14%
0.84%
Dec 1998
6.28
6.25
0.75%
0.20%
  
0.25%
0.75%
0.50%
Jan 1999
5.69
6.00
0.50%
0.20%
  
0.23%
0.56%
0.34%
Feb 1999
5.38
5.50
0.20%
0.20%
  
0.23%
0.49%
0.26%
Mar 1999
5.22
5.50
0.20%
0.10%
  
0.18%
0.43%
0.25%
Apr 1999
5.22
5.25
0.20%
0.10%
  
0.18%
0.39%
0.21%
May 1999
5.25
5.25
0.20%
0.10%
  
0.18%
0.39%
0.21%
Jun 1999
5.06
5.00
0.20%
0.10%
  
0.18%
0.39%
0.21%
Jul 1999
5.16
5.00
0.20%
0.10%
  
0.14%
0.39%
0.25%
Dec 1999
5.94
5.50
0.10%
0.10%
  
0.10%
0.41%
0.31%
Apr 2000
6.25
6.00
0.10%
0.10%
  
0.10%
0.51%
0.41%
Aug 2000
6.09
6.00
0.10%
0.10%
4.50%
0.10%
0.51%
0.41%
Dec 2000
  
  
0.10%
0.10%
4.90%
0.10%
0.45%
0.35%
*  New entrants defined as Woolwich, Nationwide, Halifax and Abbey National; Big Four are Lloyds/TSB, RBS Group, HSBC and Barclays.


  The conclusion we draw from the interest offered on current accounts is that the newer entrants were driven by a strategy of offering increasingly higher interest rates on current accounts as means of attracting new customers. For some, though not all, this strategy ceased to be sustainable during the end of 1998 and start of 1999. The high street banks did not respond significantly to the higher offering of the new entrants and did not raise their offering significantly prior to late 1998. Indeed up to this point the differential between the accounts actually tended to increase, indicating a decrease in competitive response from the high street banks. The position following the drop in rates offered by newer entrants has tended to indicate that the high street banks have again been unwilling to raise rates in response to a renewed strategy of rate raising by newer entrants. It should be noted that prior to August 1997 Lloyds offered a better interest rate than the average for high street banks, but tended to offer a worse one thereafter. Abbey National have tended to underperform in relation to other newer entrants but significantly out perform both the average for high street banks and Lloyds in particular.

Interest rates on overdrafts

  There are two interest rates of note for overdraft: those charged on authorised ovedrafts and those charged on unauthorised overdrafts. Table 8 below provides the position for authorised overdrafts. These data are a useful indicator of the cost of servicing an average account with an overdraft and so are part and parcel of the normal operation of an account.

  Again, we tend to find a pattern over the last few years in which the newer entrants tend to offer significantly lower rates for overdrafts, but find this difficult to sustain during 1999. At this point the margin between the big four and newer entrants narrows, before widening again at the end of 1999 and beginning of 2000.

Interest rate charged on authorised overdrafts

  Percentage rates charged by parties to the proposed merger, average for the big four and four newer entrants.

Date
Interbank 3 month bid rate
Selected retail banks base rate
Abbey National (ANBA account)
Lloyds/TSB current account (classic November 1998 and December 2000)
  
Average of big four
Average of new entrants
Difference
Jul 1996
5.72
5.75
11.90%
18.80%
  
17.88%
11.50%
6.38%
Aug 1996
5.69
5.75
11.90%
18.80%
  
18.13%
11.50%
6.63%
Sep 1996
5.84
5.75
11.90%
18.80%
  
18.13%
11.50%
6.63%
  
  
  
  
  
  
0.00%
0.00%
0.00%
Nov 1996
6.31
6.00
11.90%
18.80%
  
18.13%
11.50%
6.63%
Dec 1996
6.38
6.00
11.90%
18.80%
  
18.13%
11.50%
6.63%
Jan 1997
6.22
6.00
11.90%
18.80%
  
18.13%
11.75%
6.38%
Feb 1997
6.13
6.00
11.90%
18.80%
  
18.13%
11.75%
6.38%
Mar 1997
6.28
6.00
11.90%
18.80%
  
17.45%
11.75%
5.70%
Apr 1997
6.44
6.00
11.90%
18.80%
  
17.18%
11.75%
5.43%
May 1997
6.53
6.25
11.90%
18.80%
  
17.18%
11.75%
5.43%
Jun 1997
6.78
6.50
11.90%
18.80%
  
17.18%
11.75%
5.43%
Jul 1997
6.94
6.75
11.90%
18.80%
  
17.18%
11.88%
5.30%
Aug 1997
7.22
7.00
11.90%
18.80%
  
17.30%
11.88%
5.43%
Sep 1997
7.19
7.00
11.90%
18.80%
  
17.45%
11.88%
5.58%
Oct 1997
7.25
7.00
11.90%
18.80%
  
17.45%
12.34%
5.11%
Nov 1997
7.63
7.00
13.90%
18.80%
  
17.45%
12.84%
4.61%
Dec 1997
7.59
7.25
13.90%
18.80%
  
17.45%
12.84%
4.61%
Jan 1998
7.44
7.25
13.90%
18.80%
  
17.45%
12.84%
4.61%
Feb 1998
7.47
7.25
13.90%
18.80%
  
17.45%
12.84%
4.61%
Mar 1998
7.50
7.25
13.90%
18.80%
  
17.45%
12.84%
4.61%
Apr 1998
7.38
7.25
13.90%
18.80%
  
17.45%
12.84%
4.61%
May 1998
7.41
7.25
13.90%
18.80%
  
17.45%
12.84%
4.61%
Jun 1998
7.72
7.50
13.90%
18.80%
  
17.45%
12.84%
4.61%
Jul 1998
7.69
7.50
13.90%
18.80%
  
17.45%
12.84%
4.61%
Aug 1998
7.56
7.50
13.90%
18.80%
  
17.45%
12.84%
4.61%
Sep 1998
7.28
7.50
13.90%
18.80%
  
17.45%
12.84%
4.61%
Oct 1998
7.09
7.25
13.90%
18.80%
  
17.45%
12.84%
4.61%
Nov 1998
6.81
6.75
13.90%
18.80%
  
17.45%
12.84%
4.61%
Dec 1998
6.28
6.25
13.90%
18.80%
  
17.45%
12.84%
4.61%
Jan 1999
5.69
6.00
13.90%
18.80%
  
17.45%
12.84%
4.61%
Feb 1999
5.38
5.50
13.90%
18.80%
  
17.45%
12.84%
4.61%
Mar 1999
5.22
5.50
13.40%
18.80%
  
17.45%
12.71%
4.74%
Apr 1999
5.22
5.25
13.40%
18.80%
  
17.45%
12.71%
4.74%
May 1999
5.25
5.25
13.40%
18.80%
  
17.45%
12.71%
4.74%
Jun 1999
5.06
5.00
13.40%
18.80%
  
17.45%
12.71%
4.74%
Jul 1999
5.16
5.00
13.40%
18.80%
  
17.45%
12.71%
4.74%
Dec 1999
5.94
5.50
13.40%
18.80%
  
18.08%
12.64%
5.44%
Apr 2000
6.25
6.00
13.40%
18.80%
  
18.22%
12.65%
5.57%
Aug 2000
6.09
6.00
15.40%
18.80%
  
18.22%
13.15%
5.07%
Dec 2000
  
  
15.40%
18.90%
  
18.25%
12.65%
5.60%


AREAS FOR FURTHER RESEARCH

  How do banks themselves view the current account market? Are the current account viewed as stand alone products or are they bundled with the other product holdings of consumers? As in other markets, does the bundling of products (see comments on profitability) indicate that there are Cross subsidies at work? What could cause an un-bundling of consumer retail financial product holdings? Is such an un-bundling being triggered by new entrants in secondary markets—or is the current account central to the equation?

3.  CURRENT ACCOUNT PROFITABILITY

Much is made by the banking industry of the poor profitability of the personal current account. However, evidence from the two CC inquiries in the area point to a more nuanced picture. This evidence would tend to point to two things: firstly, that profitability depends on whether the current account is isolated from other related products. This occurs in statements of profitability, but not in terms of how the banks view current accounts as gateways to secondary products (loans, credit cards etc). Secondly, there have been significant gains made in reducing the cost:income ratio for personal customers. However, there does not appear to have been any evidence that any benefits that have accrued to the banks from this process have been passed on to consumers in their personal current accounts.

ISSUES IN ASSESSING PROFITABILITY

2.100.  The issue of PCA profitability is complex. We would note the following aspects:

(a)  Network costs have a major influence on PCA profitability for branch-based suppliers. This is not just a matter of the quantum of the costs but also how they are accounted for, which will vary from supplier to supplier. As regards the quantum of costs, we note Lloyds TSB's statement that the former building societies benefited from smaller and more cost-effective networks than the traditional banks (see paragraph 2.60).

(b)  Both Lloyds TSB and Abbey National told us that the profit they made on individual customers varied hugely. Lloyds TSB, for example, said that in any one month around *  *  * per cent of its PCA customers were loss making, based on PCA results alone, if all costs were taken into account (although most made a contribution towards overhead costs). The customers who were, on average, profitable were those with high balances (whether credit or overdraft). The profitability of an individual bank's PCA business therefore depends heavily on the type of customer that it has.

(c)  As we have noted (see paragraphs 2.79 and 2.89), it is likely that entrants have to offer better prices than the incumbents in order to grow their market share. To the extent that PCAs are not very profitable, it follows from the above analysis that the reasons for this situation may differ as between providers. Abbey National's recent experience suggests that it is possible for an entrant to make profits from PCAs while offering relatively favourable prices. (Competition Commission Lloyds/Abbey merger Inquiry).

2.101.  The profitability of PCAs cannot in any event be seen in isolation. PCAs are the core of Lloyds TSB's retail banking business. *  *  * of the costs of its branch network are allocated to PCAs, which are also widely seen as giving excellent opportunities for cross selling more profitable products such as credit cards and deposit accounts. Abbey National told us that PCAs were a rich source of information on customers' financial circumstances and behaviour, as well as allowing frequent communication with them. Lloyds TSB's strategy document of September 2000 described PCAs as "the key relationship product". (Competition Commission Lloyds/Abbey marger Inquiry).

2.102.  At group level Lloyds TSB has made a post-tax return on shareholders' funds of around 30 per cent in each of the last three years. . . . Although Lloyds TSB argued that, on a realistic valuation of its capital employed, its return on capital would be much lower than this, in its 2000 report and accounts it described itself as one of the most profitable banks in the world. Since Lloyds TSB has a strong focus on retail markets, these figures substantially reflect its performance in those markets. Internal documents show that the company itself regards the profitability of its retail businesses as having been high. (Competition Commission Lloyds/Abbey merger Inquiry).

3.26.  Lloyds TSB said that customer profitability was driven by several factors of which number and type of product held and the average balance maintained were primary factors. Secondary factors included transaction levels and product opening and closing patterns. Low PCA profitability was not explained by high transaction costs since there was a positive relationship between average transaction costs and average customer profitability, nor by bad debt risk as the average level of provisions increased with customer profitability. More profitable customers tended to hold value-added accounts, with *** per cent of gold accounts and *** per cent of Select accounts being held by the most profitable [1] per cent of customers. Lloyds TSB also said that customers would move between profitability deciles over time as their product holdings changed.

5.62.  Table 5.4 shows Barclays' operating income by type of customer from 1989 to 2000. During this period, income from personal customers increased *** per cent from £*** billion in 1989 to £*** billion in 2000, income from SME customers grew *** per cent from £*** billion in 1989 to £*** billion in 2000, and income from corporate customers showed no consistent pattern of growth. Barclays said that the higher rate of income growth within the personal customer activity was due to growth in consumer lending and personal loans, growth in personal mortgage lending, increased income from Barclaycard and new income streams such as the introduction of card protection insurance. Over the period, the contribution from personal customers to total income grew from *** per cent in 1989 to *** per cent in 1998 then fell back to *** per cent in 2000, whilst the contribution from the SME banking business declined from *** per cent in 1969 to *** per cent in 2000. Barclays told us that the reduction in the contribution from the SME banking business to overall group income was due to the higher rate of growth of the personal customer and strong income growth in recent years in investment banking. (Competition Commission SME Banking Inquiry)

COST: INCOME RATIOS FOR PERSONAL CUSTOMER

  Per cent. (ie ratio of cost to income for personal customers)

  
Barclays
Lloyds
HSBC
1989
93
  
  
1990
84
  
  
1991
86
  
  
1992
70
  
  
1993
62
  
  
1994
64
  
  
1995
70
  
76
1996
69
65
73
1997
65
62
67
1998
62
59
64
1999
57
55
60
2000
55
61
66

AREAS FOR FURTHER RESEARCH

  How is the profitability of the personal current account assessed by each bank? Is the value of the personal current account primarily as a route into cross selling? If so, if one includes the cross-sold products, does the profitability of the current account improve? If the retail profitability of the banks is as good as the Lloyds and Barclays statements suggest how does this tally with the current account not being profitable?

If the cost:income ratio for personal customers has improved significantly in the last few years—how much of this gain has been passed on to consumers?

3.  INNOVATION IN CURRENT ACCOUNTS

As part of their efforts to get their proposed merger with Abbey National cleared Lloyds TSB were prepared to offer a new form of current account for at least three years.

2.263.  In such circumstances, Lloyds TSB argued, it would be appropriate and practicable to secure that, as a condition to clearance of the merger, Lloyds TSB:

(a)  gave guarantees to maintain the relative attractiveness of existing Abbey National branch-based mortgage, savings, loans and overdraft products, and any specified SME product, for a period of two years following the merger; and

(b)  for three years after the merger offered a new PCA product, with specified features, which would:

(i)  secure that an appreciable proportion of the merger benefits were immediately passed on to customers;

  (ii)  change the competitive dynamics of the PCA market; and

  (iii)  further intensify competitive pressure in that market; and

  (iv)  introduce an account with a more cost-reflective price structure.

  Lloyds TSB said that it would also be prepared to cut the interest rate which it charged on PCA overdrafts. It would undertake to inform all PCA customers within six months of the merger which of its PCA products was most appropriate for them, thus addressing any concern that it would seek to benefit from customer inertia. (Competition Commission Lloyds/Abbey merger Inquiry)

AREAS FOR FURTHER RESEARCH ON LLOYDS TSB

  If it was prepared to offer a better current account to get the merger cleared—why has it not rolled it out anyway—to counter competition in the current account market? What are the details of the current account that Lloyds were prepared to launch? If the account is not to be launched nor interest rates reduced—why?

Lloyds appeared to offer to limit back book pricing (see next section) on current accounts. This would suggest that it sees the practice as against the consumer interest. Does it still view this as a problem and if so, what does it plan to do about it?

4.  BACK BOOK PRICING

2.78.  One factor which concerns us is "back book pricing" whereby established customers are left with worse terms than those offered to customers when new products are introduced. . . .It acknowledged that it still had about 850,000 customers with old, non-interest-bearing current accounts, and 500,000 on accounts with some per-item charging, though it said that both these numbers were falling quickly, partly as a result of customers switching to its added-value accounts. Lloyds TSB also referred to its offer of interest-free overdrafts for customers switching to it from other banks as a case where one category of new customers received preferential treatment for a limited period. (Competition Commission Lloyds Abbey merger Inquiry).

2.79.  Although the "back book" is less important in the PCA market than in some other personal finance markets, its existence brings out the point that incumbent suppliers with sizeable market shares have to take account of the effect of price initiatives on the profitability of their existing customer base. If a market is characterised by switching costs and/or customer inertia, suppliers can focus on new customers when competing through price, assured that cutting prices to new customers is likely to have little impact on retaining existing customers. Abbey National submitted that, in markets with switching costs, firms with low market share tended to grow (or "sow") their share by competing aggressively and through price, while those with high market share tended to exploit (or "harvest") theirs by preserving or increasing margins on the existing customer base. (Competition Commission Lloyds/Abbey merger Inquiry).

AREAS FOR FURTHER RESEARCH

To what extent does back book pricing occur? How many consumers are affected by this practice? Do the banks view this practice as acceptable? What is being done to minimise the number of consumers with such poor performing accounts?

INFORMATION PROVISION

2.496.  We have identified two instances of failure to provide adequate information to SMEs. First, we have noted a lack of breakdown on bank statements of interest payable between authorised and unauthorised overdrafts and the balances to which they apply. Secondly, we have noted a failure to promote the scope for savings for use of set-off/sweep facilities to all SMEs that could benefit from them. (Competition Commission SME Banking Inquiry)

AREAS FOR FURTHER RESEARCH

Are there any plans to provide such a breakdown of interest charges for types of overdraft for personal current accounts? Are there any plans to promote sweep/off set provisions for all consumers? How does the existing promotion of such facilities relate to back book pricing and premium customer pricing? (ie are all efforts focused only on the most profitable consumers?)

5.  OTHER FACTORS

5.A  CONFUSION MARKETING AND CROSS SELLING

  2.69.  . . .Several banks, including all the big four, now offer packaged or "added value" accounts which gives customers additional benefits in return for monthly fees. These accounts, which have been introduced within the last few years, represent a segmented approach to pricing and product design. Lloyds TSB offers three grades of packaged account, consistent with its strategy of offering enhanced value for target customers. Part of the added value comprises favourable terms on non-PCA products such as personal loans which are designed to increase cross selling, albeit at reduced margins. Such products represent an increase in complexity and a reduction in transparency of pricing; these factors, as well as the perceived value of the accounts, may have the effect of deterring customers from switching to telephone or internet PCA products. Lloyds TSB told us that about 20 per cent of its PCA customers had chosen to switch to one of the bank's added-value accounts, which were first introduced in 1997, and that the number was growing rapidly. (Competition Commission Lloyds/Abbey merger Inquiry).

AREAS FOR FURTHER RESEARCH

Do the big four consider that the existence of tiered products and bundled accounts make price comparison easier or more complex?

5.B  CROSS SUBSIDIES IN CURRENT ACCOUNT

2.77.  Current pricing patterns benefit customers who have low average credit balances and high levels of transactions, and who do not use overdrafts, at the expense of those with high balances, low transactions and heavy overdraft use. If competition increases, it can be expected that Cross subsidies will be squeezed out. (Competition Commission Lloyds/Abbey merger Inquiry).

AREAS FOR FURTHER RESEARCH

Do such Cross subsidies still exist to any significant degree in the current account market? If so, is this seen as an indication that competition is not vigorous? Do the banks expect these Cross subsidies to lessen over time and if so what will be the likely driving force behind this?

6.  SWITCHING AND THE MARKET FOR NEW CURRENT ACCOUNTS

Total new current accounts (all types) opened in year to March 2000

  Per cent of total and million accounts.

  
Per cent of total
Million
Lloyds TSB
18.50
0.39
RBS Group (incl Virgin Direct and NatWest in 2000)
19.00
0.40
Barclays (incl Woolwich in 2000)
18.80
0.39
HSBC/Midland (incl First Direct)
14.30
0.30
Halifax
4.70
0.10
NAB Group (Yorkshire/Clydesdale)
4.50
0.09
A&L (incl Girobank)
3.70
0.08
Abbey (incl Safeway)
3.20
0.07
Nationwide
2.30
0.05
BOS
2.10
0.04
Co-op (incl Smile)
2.10
0.04
Other
6.80
0.14
Total
100.00
2.10

SECTION II: BREAKDOWN OF TYPE OF NEW ACCOUNT HOLDER

Type of new current account holder

  Grossed up figures over time, million, all new current account holder in last 12 months.

Year to
First ever
Switcher
Internal transfer
Other
main
Main account
re-entrant
Account main since open
Any secondary
Total
March 1996
0.8
0.5
0.3
0.4
0.0
0.0
0.6
1.9
March 1997
0.8
0.6
0.3
0.0
0.1
0.1
0.5
1.9
March 1998
0.9
0.6
0.4
0.0
0.1
0.2
0.6
2.1
March 1999
0.8
0.6
0.4
0.0
0.1
0.2
0.6
2.0
March 2000
0.7
0.6
0.4
0.0
0.1
0.2
0.6
1.9
Base: All new current account holders last 12 months.
Source: Xpress.


The first-ever current account

—  The key dynamic in this market is the fact that the cost of choice for the consumer can be assumed to be the same irrespective of institution. Whereas a consumer with a pre-existing account has to incur costs (both fiscal and psychological) in switching accounts, the new entrant will incur the same sort of costs (largely time) irrespective of the institution chosen. While each institution will attempt to minimise entry costs and simplify procedures, there is probably relatively little that can be done (outside of the online environment) to distinguish significantly ones service as a bank, from that of ones rivals.

  Key factors in this sub-market are likely to be:

—  access to basic facilities and network benefits;

—  access to branch networks;

—  risk avoidance;

—  brand recognition.

The switcher account

  Key factors in this sub-market are likely to be:

—  poor experience/service from existing supplier;

—  barriers to switching;

—  benefits to switching.

Switching = (B1xQ1)/P1)~((B2xQ2/P2)*Cs))

Where:

B1 = bundle of services in existing current account

Q1 = quality of existing service

P1 = price of existing service

B2 = bundle of services in alternative current account

Q2 = quality of competing service

P2 = price of competing service

Cs = cost of switching

The internal transfer market

  Trading consumers "up" the product chain also allows for targeted efforts to minimise defections to rival banks. This can be done both by packaging ever more products within the bundle of current account services and offering more "relationship" opportunities to build loyalty.

Type of new current account holder, year to March 2000

  Type of new current account taken out at all banks, per cent of total at all banks external switchers, as indicated in Table IV, is around 480,000, which is around 1.26 per cent of the stock of current accounts. The number of first ever accounts stands at 609,000 (1.6 per cent of stock) and the internal transfer number at 336,000 (0.9 per cent of stock).

  
March 1996
March 1997
March 1998
March 1999
March 2000
First ever
33
35
33
31
29
Switcher
19
24
23
22
23
Internal transfer
12
13
14
17
16
—other main
17
2
1
1
1
—main account rent
0
4
4
3
3
—Account main since open
0
6
7
6
6
Any secondary
23
22
22
23
25
Total*
104
106
104
103
103
Total Million
2.2
2.2
2.2
1.9
2.1
Note: *Do not add due to excessive rounding in original data.
Base: All new current account holders last 12 months.
Source: Xpress.


Type of new current account holder, year to March 2000

  Type of new current account taken out at all banks, number of individual accounts

  
March 1996
March 1997
March 1998
March 1999
March 2000
First ever
726,000
770,000
726,000
589,000
609,000
Switcher
418,000
528,000
506,000
418,000
483,000
Internal transfer
264,000
286,000
308,000
323,000
336,000
—other main
374,000
44,000
22,000
19,000
21,000
—main account rent
0
88,000
88,000
57,000
63,000
—Account main since open
0
132,000
154,000
114,000
126,000
Any secondary
506,000
484,000
484,000
437,000
525,000
Total
2,288,000
2,332,000
2,288,000
1,957,000
2,163,000

SECTION III: OVERALL MARKET SHARES IN NEW CURRENT ACCOUNTS

  Once one has a picture of the importance of the different elements of the new current account market one has to see what the market share of those sub-markets is by provider. This allows one to see the ferocity of competition in the new current account market and the degree to which those opening new accounts would have had an effect on a merged Lloyds-TSB-Abbey National combination.

ALL OPENING FIRST CURRENT ACCOUNT—MARKET SHARE OVER TIME

  
March 1996
March 1997
March 1998
March 1999
March 2000
Barclays
14
19
19
23
23
Lloyds TSB
26
19
22
17
19
HSBC
13
19
18
16
15
NatWest
17
14
11
10
11
Halifax
8
8
8
5
5
RBS
2
2
3
4
4
Abbey National
3
3
3
4
3
Bank of Scotland
3
3
3
4
3
Nationwide
1
1
1
2
3
Yorkshire Bank
5
4
2
2
3
Woolwich
1
1
0
2
2
Alliance & Leicester
0
1
2
3
1
Clydesdale
1
1
1
1
1
Co-op
1
1
1
0
1
First Direct Bank
1
0
1
0
1
A&L Giro
1
0
0
1
1
Other
3
4
5
6
4


Type of new account holder by brand, year to March 2000

  Per cent of each bank's new account by type of account.

  
Any new
Barclays
Lloyds TSB
HSBC
NatWest
RBS
Abbey National
A&L
First Direct
Halifax
Nation- wide
Woolwich
Yorkshire Bank
First ever
29
37
29
38
22
23
29
20
11
31
22
19
26
Switcher
23
20
20
19
13
31
24
8
35
30
33
24
27
Internal transfer
16
13
24
12
28
23
0
12
2
2
2
22
21
—Account main since open
6
5
3
10
6
3
23
4
4
10
5
3
0
—Main account re-entrant
3
2
2
2
4
3
5
4
0
5
0
5
0
Other main
1
3
1
1
1
0
3
0
0
2
0
0
0
Any secondary
25
21
22
19
27
19
16
60
50
18
42
30
24
Total
103
101
101
101
101
102
100
108
102
98
104
103
98


Type of new account holder by brand

  Per cent of total new accounts at bank accounted for by new accounts.

  
First ever
HSBC
38
Barclays
37
Halifax
31
Lloyds TSB
29
All banks
29
Abbey National
29
Yorkshire Bank
26
RBS
23
NatWest
22
Nationwide
22
A&L
20
Woolwich
19
First Direct
11


Switched current accounts by brand

  Per cent of total new accounts at bank accounted for by switched accounts.

  
Switcher
First Direct
35
Nationwide
33
RBS
31
Halifax
30
Yorkshire Bank
27
Abbey National
24
Woolwich
24
All banks
23
Barclays
20
Lloyds TSB
20
HSBC
19
NatWest
13
A&L
8


Internally transferred accounts by brand

  Per cent of total new accounts at bank accounted for by internal transfers.

  
Per cent
NatWest
28
Lloyds TSB
24
RBS
23
Woolwich
22
Yorkshire Bank
21
All banks
16
Barclays
13
HSBC
12
A&L
12
First Direct
2
Nationwide
2
Halifax
2
Abbey National
0

SECTION V: CONCENTRATION MEASURES IN THE NEW CURRENT ACCOUNT MARKET

Effective competition in current account stock and new accounts

  Numbers equivalent Herfindahl Index; Merger data to third quarter 2000; new current account data year to March 2000.

Herfindahl
Effective
competitors
Pre-merger current account
6.97
Post-merger current account
6.03
All suppliers first ever current account
6.38
Current account switcher
7.04
Current account internal transfer
5.22
Source: Calculated from FRS data.


Concentration ratios for new account types

  CR4 and CR5-8.

Per cent share
First ever
Switcher
Internal
transfer
Any
secondary
Total new
accounts
Pre-merger
stock current
account
CR4
76.29
69.86
81.06
57.38
69.41
74.02
CR5-8
14.81
18.05
9.27
18.63
15.74
14.96


Estimation of attrition

  No of accounts different between position in new account market and position in stock of account market; negative figure indicates loss of position, positive figure indicates positive position; ranked by largest difference; million.

  
1997
1998
1999
2000
Lloyds TSB
-0.10
-0.07
-0.09
-0.07
Abbey (inc Safeway)
0.01
0.00
0.00
-0.04
Nationwide
0.01
0.00
0.00
-0.01
Halifax
0.06
0.04
0.02
0.00
BOS
0.00
0.00
0.02
0.00
NatWest
-0.14
-0.15
-0.05
0.00
Woolwich
0.00
0.00
0.01
0.00
Co-op (incl Smile)
0.02
-0.02
-0.01
0.01
A&L (incl Girobank)
-0.02
-0.01
-0.01
0.01
HSBC/Midland (incl First Direct)
0.09
0.11
0.04
0.01
NAB Group (Yorkshire/Clydesdale)
-0.06
-0.05
-0.03
0.01
Barclays (incl Woolwich in 2000)
0.05
0.06
0.01
0.02
RBS Group (incl Virgin Direct and NatWest in 2000)
0.00
0.02
0.03
0.02
Other
0.07
0.06
0.07
0.06


Conclusion

  It is reasonable to assume from the above analysis that there are a number of impediments to switching beyond the simple mechanics of the process. The degree to which these impediments can delay greater switching activity has yet to be tested by a concerted effort on behalf of consumers to drive the market.

Areas for further research

  What remaining barriers to switching exist and how firm are they? What issues exist in access to credit scoring information in the UK compared to other countries, most notably the USA? Is access to credit information in the USA "better" at delivering greater switching in financial services markets? Does US consumer access to such scoring information enable consumers to be more active in seeking out new suppliers? Is the ides of a national insurance style current account feasible?

May 2002


 
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