Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 140 - 159)



Mr Beard

  140. I do not think the argument surrounds the word "excessive". The implication of what is being said is that the four large banks are exploiting a dominant position to make these very large profits from small and medium-sized enterprises who find it extremely difficult to move from your grasp.
  (Mr Goodwin) No evidence was put forward of exploitation of a dominant position. It was a desktop exercise done based on the formula we have been describing to determine excess profits. No evidence was put forward of dominant behaviour in the marketplace or behaviour that was inappropriate in the marketplace as to how we conduct our business.

  141. But you are dominant, you have a dominant share of that small and medium-sized enterprises market.
  (Mr Goodwin) Which is exactly what you would expect to see in a mature, highly competitive marketplace.
  (Mr Ellwood) There are 12 providers of SME current accounts and it really is fairly straightforward to switch, indeed we all try to take business off one another. There are tens of thousands of accounts each year which move from one supplier to another and that is likely to increase.

  142. But a succession of reports has found that it is very difficult for small and medium-sized enterprises to move. It is only recently that the switching has been made much easier.
  (Mr Ellwood) Under the Business Banking Code we have committed now to give advice about standing orders and direct debits within five days and to make sure that the accounts are moved very quickly indeed. There is a total commitment to do that.

  143. I agree that there is a commitment now, but that has not been the case over the last three years, has it?
  (Mr Ellwood) It has been formalised more recently. It has been possible to switch accounts and accounts do get switched from one supplier to another.
  (Mr Goodwin) A possible misconception around switching is that we do not benefit; certainly our view is that we benefit from switching. Last year we grew our customer numbers, so we do want to attract new customers and to enable that to happen they cannot all just be business start-ups. We have to get customers to switch from other banks. The facts of the matter are that customers have been switching between the banks.

  Chairman: We shall take up switching later on.

Dr Palmer

  144. I am just trying to follow your arguments. You are saying on the one hand that it does not matter if you make lots of profits because the customers are happy. You are saying that okay, the profits might be very large but it is only in the last three years and before that they were more reasonable. In some cases, Royal Bank of Scotland for instance, you are saying that you do not actually know what the profit is because you do not take the trouble to analyse this sector of the market as far as the costs for your groups go. It does seem to me that your responses are all over the shop. The suggestion is not that there is some level of profitability at which it is unreasonable to operate; that is obviously not reasonable in a free market. The suggestion is that you have a cosy market in which it is possible to achieve very high levels of profitability because the customers do not have a reasonable alternative, so they accept what they get.
  (Mr Goodwin) It is precisely the Commission's assertion that there is an appropriate amount of profit to make. That is precisely what the methodology does. It calculates an amount which the Commission considers to be normal profit and then sets out to calculate what we have made and compares the two. That is how it arrives at excess profits. It is actually fundamentally premised on setting a level of profit which is considered to be appropriate.

  Chairman: We shall leave that, but it does seem to us a little odd that we have the Director General of Fair Trading commenting on the Competition Commission's proposals. According to Sir Bryan Carsberg, a former Chairman of the International Accounting Standards Board accepting that methodology, the perception in society is that you are making excess profits and you telling us that everybody is talking a load of baloney and they are wrong and you are not wrong. Meanwhile this perception is going to be building up. This morning we had a press release from Which, which is challenging the big banks to end their £500 million rip-off. I would suggest to you gentlemen that you do have a problem of perception in society.

Mr Mudie

  145. As I understand your argument, we have to take the good with the bad and we have to take it over the cycle, therefore the last three years have been the good years and you are going to offset them against the bad years. You said you are at the peak. Can we therefore anticipate that your profits will go down in the next couple of years?
  (Mr Barrett) I hope not.

  146. You are not at the peak then, are you? You used that word "peak". As far as I am aware, when you are at the peak there is only one way you can go.
  (Mr Barrett) There are taller peaks.

  147. You would have some difficulty getting to them. I am taking the point you made which is a fair point. There are bad years and good years. It is unfair to alight on a good year. Fine. Now you have had your good years and you mentioned a peak, so can we anticipate that overall you will start giving a bit back to your customers. That is what the customers would ask.
  (Mr Barrett) It would depend. One should not be dismissive. Somebody commented on the fact that customers are satisfied. The highest customer satisfaction levels we have in a worldwide business at the moment is our small- and medium-sized enterprise business in the UK. I do not think that should be dismissed, because to dismiss it would assume that these are not rational grown-up people. They are sophisticated and they are running businesses. When they list the number of challenges that they confront in their business life, banking and access to finance ranks down sixth or seventh and way ahead of it are things like red tape and tax and payroll taxes, etcetera. One should not assume that these are captive people who are ignorant of what their choices or their options are. Let me go back to your point on the profitability peak. It depends going forward on the economy. For example, we saw a lot of stress last year in sectors because of foot-and-mouth disease and related industries; we saw a lot of stress in that sector. It depends on the economy, it depends on interest rates in the economy it depends on demand for their products and services. What happens is when strain is felt on the economy, then loan losses escalate very dramatically in that particular business because a lot of people are working very close to the edge. When demand drops credit losses go up. It is difficult. Over a normal cycle the cycle has cyclical downturns in it and over a normal cycle you would expect loan losses to climb quite dramatically. As a businessman, what one tries to do is offset that. You offset that by trying to increase productivity, change the business model, improve risk management approaches, etcetera. I would hope—I guess to be blunt that is what we are employed to do—to try to find ways of smoothing our businesses through different periods of difficulty, but the history of small- and medium-sized business all around the world is that it is a very dangerous sector and subject to major cyclical corrections from time to time.

  148. Would you like to comment then? I would expect you to have satisfied customers at the moment because in a growth market they may not like your charges, but there is an ability to pass it on to customers, because it is a buoyant economy. It is when the economy gets bad that the experience of small and medium-sized businesses is that you stop being that friendly bank manager and they are the first port of call for retrenchment. Then you have dissatisfied customers. When the bad times are bad small businesses are the first to feel it. When the good times are good, there is no recognition from you that these are very good times and you can treat your customers a bit better. It is one way. When it is good, it is very good for you. When it is bad, it is very bad for them not you.
  (Mr Goodwin) I do not think there is a model which says it is very good for us at a time when it is bad for the customers. If we start incurring credit losses it is very bad for the customer because it is their business that is going under and it is not a good time for us. We share the pain through the cycle with our customers. It is fair to say that some element of customer satisfaction reflects on how well their business is doing. A survey which the Commission commissioned on customer satisfaction said that 84 per cent of our business customers were satisfied with their bank.

Mr Fallon

  149. The Federation of Small Businesses in evidence to us on this particular point, your argument about the cycle, pointed out that in the early 1990s small businesses were very poorly capitalised. At the last point they measured it in 2001, they actually banked more with you than you lent to them. That is the point in the cycle presumably where they tend to focus on the interest being paid to them on their accounts and that is where the overcharging arises.
  (Mr Ellwood) I do not accept that at all. If you look at the bad debt charges in the early 1990s, they were about six times greater than they were last year and the year before. We are affected by that economic cycle and clearly when we see huge write-offs like that, it has a massively poor effect on the profit, so we suffer in exactly the same way as the customers.

  150. You are now making them suffer presumably because they are banking with you.
  (Mr Ellwood) It is interesting. If you ask them what they are worried about, first of all they are not worried about access to finance, that is the eighth thing they are worried about. They are worried about low turnout, they are worried about Government red tape. Bank charges as a material issue did not feature on some SME research done by the Competition Commission itself. They are not concerned.
  (Mr Goodwin) It is also worth recognising that those SMEs which have funds tend not to keep then in a current account, they move them into many of the products which we all have available where they earn interest on the balance. It is not that they are denied interest on the money that is simply in current accounts where in return for the availability of relationship managers there is no interest on that account.

Mr Tyrie

  151. I want to ask whether and to what extent provisioning policy should be taking account of the cyclical variation in your profits.
  (Mr Goodwin) Provisioning policy in our case is very simple. You provide as and when you believe there is going to be a loss. It is not appropriate or indeed possible for us to provide in any other way than that. In some respects it would make profits very smooth if you could somehow charge an amount each year through the cycle, but that would require you to be able to predict precisely the impact of the cycle, precisely the duration of the cycle, precisely where you are in the cycle and would require you to suspend all known auditing and accounting standards. It just would not fly.

  152. Do you have specific as well as general provisioning in your accounts?
  (Mr Goodwin) Yes, we do.

  153. I would obviously be referring to the general provisioning here. Does anybody else want to comment on this?
  (Mr Ellwood) The general provision we have is a fallback. The principal provision is the specific provision. We think the only accurate way is to do that on an "as it arises" basis rather than to try to smooth it over the cycle to the extent that you do not really know what is going to happen over the course of the next two or three years. We have seen some huge swings in the economic cycle but to try to predict them could lead to some inaccuracy in the level of provisions going forward.

  154. Everybody will accept—all of you will accept—that there is a level of monopoly control in the market which will lead to excess profits. The question is whether you are in that oligopolistic or monopolistic situation. There is a need for some meaning to the term. Would it not be helpful if you, as a group of banks, maybe together with other banks who are not represented here today, produced your own estimates of at what trigger point you think a signal would be being given by a level of profitability that there was an oligopoly in the market, which took account of the fact, for example, that some banks go bust or have very difficult times, Baring's, BCCI got themselves into corruption, so that people have some other measure by which to assess whether the Cruickshank report got it right?
  (Mr Goodwin) There is an important issue of behaviour in the market rather than being tied to any specific amount of profit. It is what happens in the marketplace. You could have inappropriate behaviour and inappropriate competitive behaviour with very low levels of profitability. Profitability is one part of it, but an examination of what actually happens in the conduct of business is equally important and that was part of the inquiry which did not ever get off the ground.

  155. Why do you not publish your own version of what you think would be a useful trigger?
  (Mr Barrett) The problem is that it is a very arcane and esoteric subject. It seems to me that the critical issue is that profits are egregious or excessive, if there is abusive behaviour in the marketplace. Abusive behaviour can come from monopoly or collusive oligopolistic behaviour. It seems to me the critical issue therefore is not what the profit is, but whether the market is contestable, what the barriers are to entry for other people. If you are making excess profits, clearly other people like to make those kinds of profits and they enter a market. The issue then is what is restraining additional competitors entering that market to make what seems to everybody outside the business easy money. There was nothing in the report; nothing, which pointed to any abusive behaviour; none. There is intense competition in this market, multiple providers, each of us are employing thousands of people in this market whose contracts require them to raid business from the other guy. So I do not accept that there are any of the abusive behaviours which are classically in competition theory, which are classically associated with either collusive oligopoly or monopoly situations. Given that the market is contestable and there are some remedies to make it more contestable, that was an appropriate area of investigation by the Commission. To come down with its price controls, in the absence of explicit evidence of abusive behaviour, I find extraordinary.

  Mr Tyrie: I agree with you that the methodology is flawed. All I am doing is asking you to produce your own evidence.


  156. We will move on now. It is a very good point. The perception is that you are making these excess profits. What we are saying as a Committee is that if you, in communicating with the Competition Commission and others try to find some middle ground then people could perhaps understand where you are coming from. That is a really important issue.
  (Mr Dalton) May I comment on that and the point about what level? It seems to me that people could argue the point but the issues here are around what level is excessive and the criterion which has been used is anything in excess of the cost of capital. Then there comes the question of how it is calculated. There are at least a couple of things in the calculation which deserve debate and that is happening. Then if you say that return on equity (ROE) is the measure which is being used, it seems to me that it is reasonably fair to look at other ROEs, to see whether they are at the same level and if so, whether these are excessive. It is true, it is a fact, if we look at the ROEs in the United Kingdom, that the bank ROEs rank eleventh out of 32 industries in the FTSE100 in terms of the level of them. There are at least ten which are above that and that is other industries. If you decide to look across the world and look at other banking systems, if you look at the UK banking system, the ROE over the last five years has been about 30 per cent and so has the US. If you look at Europe in 2002, the ROEs in the banking system were 28.6 per cent and the UK was 30 per cent. We have the same ROEs in the UK as exist in many other banking systems.

  157. That is very good, but as Mr Barrett said, it is an arcane and esoteric subject. Could you try to make it simple for us little subjects?
  (Mr Barrett) It is a good point because what happens is that one-liners like £500 billion rip-off take two seconds to deliver; it takes two hours to dismantle them.

Mr Beard

  158. Recently there have been two inquiries into banking for small and medium-sized enterprises: one was Cruickshank and one was the Competition Commission. They both effectively came to the same conclusion, that small and medium-sized enterprises are not getting a fair deal. All we have heard this morning is the four of you absolutely solid in refuting that but without any real particulars to detail why these are being rejected.
  (Mr Goodwin) What we have been doing for the last ten minutes is wheeling out particulars of what was wrong. Cruickshank and the Competition Commission used precisely the same methodology; precisely the same. No-one should be surprised that they came up with the same answer.

  159. But that methodology is not disputed.
  (Mr Goodwin) You are right that there are perception issues here which are important and which we need to work on.

previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2002
Prepared 4 September 2002