Select Committee on Treasury Fifth Report



COMPETITION COMMISSION REPORT: FINDINGS AND REMEDIES

Findings of Competition Commission

  1. The Competition Commission was required to investigate and report on whether a monopoly situation exists in relation to the supply of banking services by clearing banks to SMEs; if so,
      • by virtue of which of the provisions of section 6 to 8 of the Fair Trading Act 1973 that monopoly situation is to be taken to exist;
      • in favour of what person or persons that monopoly situation exists;
      • whether any steps (by way of uncompetitive practices or otherwise) are being taken by that person or persons for the purposes of exploiting or maintaining the monopoly situation and, if so, by what uncompetitive practices or in what other way;
      • whether any action or omission on the part of that person or persons is attributable to the existence of that monopoly situation and, if so, what act or omission and in what way it is so attributable; and

    The findings of the Competition Commission against these five tests (a) - (e) are shown in Table 3, on page 19.

  2. On Findings (a) - (d), the Competition Commission found that the Royal Bank of Scotland Group met the definition of a scale monopoly situation, as it supplies more than 25 per cent of banking services to SMEs with business accounts.[69] The Competition Commission also found that Abbey National plc, Barclays Bank plc, National Australia Bank, HSBC Bank plc, Lloyds TSB Bank plc, The Royal Bank of Scotland Group and others[70] comprise a complex monopoly.[71]
  3. The Competition Commission also concluded that in respect of the complex monopoly and by the practices carried out by banks: Abbey National plc, Barclays Bank plc, National Australia Bank, HSBC Bank plc, Lloyds TSB Bank plc, The Royal Bank of Scotland Group and others, were found to benefit from the monopoly, and to restrict and/or distort competition thus maintaining the monopoly situation.[72] The issue of price parallelism was also raised by the Competition Commission, who observed that "firms setting similar prices can be evidence of either competition or the lack of it".[73] However they noted that "if is at a price level that gives excessive profits, then it would indicate a lack of competition".[74]
  4. In their written submissions, Barclays and Lloyds TSB argued that the SME market is competitive, Lloyds TSB believing this as their "managers compete day in day out on the high street for SME business".[75] However this was disputed by the Chairmen of HBOS and Abbey National plc, who agreed with the Competition Commission that there was insufficient competition in the SME market.[76] In addition, the Cruickshank report concluded "there is powerful evidence that a small number of banks have significant market power in the local markets for providing current account services and other banking services to SMEs".[77] The Committee found that the SME banking sector is still dominated by the major four clearing banks, despite new entrants, and that insufficient competition exists. The cost of this monopoly situation is borne by SMEs, a vital component of the UK economy, and as such remedial action is required.
  5. On Finding (e) and the generation of excess profits, the Competition Commission found that: Abbey National plc, Alliance & Leicester plc, Barclays Bank plc, The Co-operative Bank, HSBC Bank, Lloyds TSB Bank, National Westminster Bank and RBS Bank were able to generate "excess profits" through their practices within the complex monopoly situation.[78] However, because of their very small market share, the Competition Commission did not believe that Abbey National Bank, Alliance & Leicester and Girobank or the Co-operative Bank operate or may be expected to operate against the public interest.[79]
  6. The Competition Commission concluded that the four largest clearing groups had made excess profits, in England and Wales, of about 725 million a year over the last three years with adverse effects on SMEs or their customers.[80]
  7. The four largest clearing groups challenged the methodology used by the Competition Commission to calculate a level of "excess profits".[81] Barclays Chief Executive commented "If the underlying assumption is that anything exceeding the cost of equity and a one or two per cent premium above it by definition constitutes excess profits, that is in my opinion, completely flawed".[82] The banks' principal complaints were that:
      • The calculation was based upon the last three years of trading, which were good years in the business cycle and therefore ignored the years where bad debts were higher.[83]
      • If the methodology was applied to other industries, 22 out of 38 industry sectors in the UK would be excessively profitable.[84]
      • The returns on equity earned by UK banks are no higher than in other countries.[85]
      • The banks' price/earnings ratios indicate that they are not earning excess profits.[86]

  8. We put these complaints to the Office of Fair Trading, Competition Commission and Sir Bryan Carsberg (who provided an expert review of the Competition Commission's methodology for the Government). They all rejected the complaints. Their summarised counter-arguments were as follows:[87]
      • Whilst the Commission used the data on profits earned over the past three years, it also recognised that bad debts vary over the course of the business cycle, and that in recent years the level of bad debts had been relatively low. The early 1990's was a particularly bad period for banks, which has led to improvements in credit risk assessments. Furthermore the recession in the early 1990s, was characterised by monetary policy explicitly aimed at the external value of the pound rather than domestic considerations.[88] As a result it would be inappropriate to give too much weight to that early period. "The Commission therefore applied a one-third discount to the period 1990-94. This produced an estimate for the long-run bad debt ratio of 1.2, compared to the average outcome for the four banks of 1.6 over the period 1989 to 2000 and 0.48 over the most recent full year".[89]
      • The existence of excess profits is not sufficient to identify an adverse effect on the public interest. It was the fact that the excess profits arose, in a complex monopoly where the banks' practices restricted and/or distorted competition to maintain the monopoly, that led the Competition Commission to identify an adverse effect on the public interest.
      • Any international comparison is problematic as it will be affected by varying accounting practices, and the Director General of Fair Trading commented that "the information quoted at question 156 appears to relate to the banking industry as a whole rather than the provision of services to SMEs".[90] Furthermore counter-argument (b) above applies.
      • The price earnings ratio is the ratio of share price to earnings per share. The share price will reflect a number of factors, primarily investors' expectations of future growth in profits and dividend payments. As a result it is unclear why the price earnings ratio is likely to provide a useful measure of whether a firm is, at present, earning excess profits.

  9. The Committee notes the criticisms of the methodology used by the Competition Commission put forward by the four main clearing banks. However, HBOS, Abbey National plc, and National Australia Bank did not complain about the methodology employed by the Competition Commission; indeed National Australia Bank commented that "it is a calculation which is broadly sound".[91]
  10. Proposed Remedies of the Competition Commission

  11. The Competition Commission proposed:
      • a requirement for the four largest clearing groups[93] to offer all SMEs operating current accounts in England and Wales an account that pays interest at Bank of England base rate minus 2.5 per cent or a current account free of transmission charges or a choice between the two;
      • a requirement for the four largest clearing groups to notify to the Director General of Fair Trading any increase in tariff-based money transmission charges. (Essentially a measure to prevent avoidance of measure (b));
      • amendments to the BBA Business Banking Code of Practice for SMEs with an annual turnover of 1million.

    Behavioural Remedies (a)

  12. The behavioural remedies are intended to remove barriers to entry and included assistance to switching, transparency of bank statements and sharing of branches.[94] HBOS and National Australia Bank supported the behavioural remedies,[95] as did the Federation of Small Businesses.[96]
  13. The Committee found an expectation that the remedies would not significantly increase competition in the short to medium term. HBOS and National Australia Bank expected the Big Four's share to fall by 5-10% over the next five years.[97] The Federation of Small Businesses only expected a modest shift if the Cruickshank and Competition Commission reports were implemented, and any increase in competition would be "very slow".[98] Indeed the Competition Commission admitted that "we do not believe that these remedies will have sufficient impact on competition within the next two or three years to ensure that the incidence of excessive prices we have identified of the four largest clearing groups in England and Wales would disappear in a reasonable period of time".[99]
  14. The Committee welcomes the proposed behavioural remedies but is concerned that they will not on their own be sufficient to increase competition. In light of these concerns the Committee recommends that the Director General of Fair Trading reassess competition in the industry after the remedies have been implemented and to report further to Parliament by March 2003.
  15. Structural Remedies (b)

  16. In light of the Competition Commission's concerns about the timescale over which the behavioural remedies will have an impact, the possibility of structural remedies was investigated by the Commission:

  • possible tax or licence fees were ruled out as they would do nothing to help SMEs.[101]

  • regulation of charges was proposed for the four largest clearing groups, with the Competition Commission proposing that: "a requirement that the four largest clearing groups offer to all SMEs operating current accounts in England and Wales an account that pays interest at Bank of England base rate minus 2.5 per cent or a current account free of money transmission charges or a choice between the two".[102]

  1. The Committee has sympathy with the Competition Commission's view that because the behavioural remedies will not have a significant impact for a few years, additional remedies should be considered to benefit SMEs in the short term.
  2. Concerns were raised over the requirement for the four largest clearing groups to make interest payments. The Bank of England had "serious misgivings about such detailed intervention, which could damage rather than improve the provision of SME financing, which was its major concern, and deter entry".[103] National Australia Bank raised concerns, which were echoed by other banks, that:[104]
      1. It may reduce innovation and eliminate a differentiating product feature of new entrants to the market who offer interest bearing current accounts for SME's.
      2. Costs may be recouped by the big four clearing banks elsewhere, although the Committee notes that the Competition Commission has implemented measures to monitor money transmission charges to ensure they are not used to recoup costs incurred paying interest.
      3. It is already easy for SME's to transfer their funds to interest paying deposit accounts, so this does not necessarily provide anything new.
      4. There is a risk that paying interest on SME current accounts will discourage them from moving funds to higher interest bearing deposit accounts

    However, these criticisms were considered by the Competition Commission and rejected.[105]

  3. The Chief Executive of HBOS also commented that the use of price controls was "unhelpful at the margin" as it limited the distinction of its products with the four major clearers.[106] HBOS, Abbey National plc and National Australia Bank believed portability and transparency were the two big issues for them as they tried to break into the market share of the four major clearers.[107]
  4. The balance of the evidence suggests that lack of portability and transparency are the main barriers to increased competition in the SME banking market and this has generated calls for price controls. The Committee was not convinced that price controls were the appropriate solution, and shares the misgivings of the Bank of England about their effectiveness in securing competition. However, we accept that in the short term the reduced charges will have a beneficial effect on SMEs. We are concerned that crude controls of this kind could damage rather than improve SME financing, and could well deter entry of the smaller banks into SME lending. The Committee is also concerned that regulation of charges could hinder competition, by reducing or eliminating a differentiating feature of new entrants' products in particular.
  5. Implementation of Remedies

  6. In March 2002, the Chancellor approved the timetable for implementing all remedies within six months.[108] In the Office of Fair Trading report all remedies, except for two of the behavioural remedies, were envisaged to be negotiated within six months. These two behavioural remedies are to be finalised after the results of studies, and are likely to require a longer timescale of 15 months.[109]
  7. On 14th June 2002, the OFT sent a progress report to HM Treasury and the Department of Trade and Industry on implementing the remedies.[110] Due to the commercially sensitive nature of this report, its contents have not been disclosed to the Committee. However, the Treasury recently informed it that the Director General of Fair Trading (DGFT) has now given his advice to the Chancellor and the Secretary of State for Trade and Industry on the outcome of discussions with the clearing banks to obtain undertakings from them to implement the transitional remedy. In view of the Chancellor's original wish to have this remedy in place ahead of the behavioural remedies, we look to Ministers to make an early announcement on this matter.[111]
  8. The Committee notes that it has been over four months since the Competition Commission report was laid before Parliament, with a timetable of six months for implementing all remedies. The Committee believes that the largest clearing banks should not profit from procrastination, and recommends that the DGFT should report to Parliament by the end of September 2002 on the progress made on implementation of the transitional remedy, including if necessary further proposals.[112]
  9.  

    TABLE 3:

    FINDINGS OF COMPETITION COMMISSION AGAINST TERMS OF REFERENCE BY COMPANY OR GROUP OF COMPANIES

    (Number in brackets relates to paragraph reference in Competition Commission (CC) Report.)

     

    (a) -Comprise a

    Scale Monopoly (CC 2.432)

     

     

    (a) -Comprise a Complex Monopoly (CC 2.476)

     

     

    (b) monopoly situation exists in bank's favour (CC 2.432, 2.476 (b), (d))

     

     

    (c) Steps taken by bank to exploit or maintain monopoly situation

    (CC 2.478 - 80)

     

     

    (d) Action or omission on part of bank is attributable to existence of monopoly situation (CC 2.478 - 80)

     

     

    (e) Operates or may be expected to operate against public interest

    (CC 2.512)

     

     

    Allowed to generate excess profits (CC 2.479)

     

     

    Subject to Structural Remedy (CC 2.609 (b))

     

     

    Subject to Behavioural remedy (CC 2.609 (a))

     

    Abbey National plc

     

     

    l

    l

    l

    l

     

     

    l

     

     

     

     

    Alliance & Leicester plc

     

     

    l

    l

    l

    l

     

     

    l

     

     

     

     

    Bank of Scotland

     

     

    l

    l

    l

    l

     

     

     

     

     

     

    l

    Barclays Bank plc

     

     

    l

    l

    l

    l

    l

    l

    l

    l

    National Australia Bank (including Clysdale and Northern)

     

     

    l

    l

    l

    l

     

     

     

     

     

     

    l

    The Co-operative Bank plc

     

     

    l

    l

    l

    l

     

     

    l

     

     

     

     

    Girobank plc

     

     

    l

    l

    l

    l

     

     

     

     

     

     

     

     

    HSBC Bank plc

     

     

    l

    l

    l

    l

    l

    l

    l

    l

    Lloyds TSB Bank plc

     

     

    l

    l

    l

    l

    l

    l

    l

    l

    Nationwide Building Society

     

     

    l

    l

    l

    l

     

     

     

     

     

     

     

     

    The Royal Bank of Scotland Group (including RBS, NatWest and Ulster Bank)

    l

    l

    l

    l

    l

    l

    l

    l

    l

    AIB (trading as First Trust in Northern Ireland)

     

     

    l

    l

    l

    l

     

     

     

     

     

     

    l

    Bank of Ireland

     

     

    l

    l

    l

    l

     

     

     

     

     

     

    l

     

     

    SUMMARY OF CONCLUSIONS AND RECOMMENDATIONS

      • The Committee notes the banks' verbal commitment to basic bank accounts, but is disappointed by the limited progress made since the last report. The Committee believes the banks need to engage in more pro-active and innovative marketing if they are to be taken seriously on their expressed commitment and to overcome financial exclusion (paragraph 8).
      • The Committee welcomes the banks' involvement in educating young people in financial matters including school visits for that purpose, but believes the setting up of accounts should be separated from that exercise. The Committee recommends that young people should be given a breathing space between an educational visit to a school and the offering of a bank account (paragraph 9).
      • The Committee welcomes the commitment of the major banks to the "Universal Bank", but concludes that the "Universal Bank" is primarily an attempt to bolster Post Office business and to preserve access to pensions and benefits where such access would be lost by Post Office closures. Furthermore the Committee is concerned that this duplicates rather than complements the basic bank account. We believe that the limited scope of services is likely to be of interest to a minority of potential banking customers, and will in practice for the most part be used for those unable to access banking services through a commercial service provider. The "Universal Bank" is likely to be a long-term commitment, as it will not be easy for people to graduate to full bank accounts. Consequently the long-term success of the "Universal Bank" may rely upon the continuing strength of the Post Office network. (Paragraph 11).
      • The Committee welcomes the pilot study into branch sharing, and looks forward to receiving the results of this study. However it is disappointed by the lack of enthusiasm shown by the largest clearing banks, and the limited scope of the BBA pilot study. The Committee recommends that, following the pilot study, the BBA publishes a report on the scope for a more comprehensive range of services to be handled in shared branches. In light of this, the Committee may look further at this matter to review progress, in particular we should welcome examples of bank sharing in areas which have lost all banking facilities (paragraph 15).
      • The Committee considers the Post Office network may have a contribution to make to increase access to business banking services (paragraph 16).
      • The Committee believes that the lack of transparency in the credit and charge card industry acts against meaningful competition, and is therefore against the consumers' interest. The Committee recommends that credit and charge card companies should publish, with equal prominence, all the variables that make up the actual cost of credit. This should be done in a way which allows consumers to make straightforward comparisons between the costs of credit offered by all credit and charge card products (paragraph 19).
      • The Committee recognises that product differentiation can be an important feature of competition and satisfying customers' differing needs, but is concerned that for individuals to understand interest rate calculations requires an unreasonable amount of time and effort. The Committee recommends that every credit and charge card statement shows the "estimated interest charge if only the minimum balance is paid by the due date", as a number do already (paragraph 20).
      • In light of confusion revealed over interest rates and charges on credit and charge cards, the Committee expects to carry out further investigation of this matter (paragraph 21).
      • The Committee welcomes the recommendation of the Competition Commission for a behavioural undertaking, by the eight main clearing groups, to include transparency of overdraft charges on bank statements (paragraph 23).
      • The Committee is disappointed by the lack of clear progress made by the banks in reducing the overall clearing time for cheques (paragraph 24).
      • The Committee welcomes the willingness of Abbey National, HBOS and National Australia Bank to try and improve transparency in their literature, and looks forward to reviewing the revised literature. The Committee hopes that this positive attitude is shared by all banks. The Committee urges all the banks to review their promotional material with a view to achieving genuine transparency (paragraph 26).
      • The Committee believes it is vital that SMEs have confidence that any switch of bank accounts will be trouble-free and timely. The Committee recommends that the five-week target for account switching (where no borrowing is involved) is strengthened to a guarantee, with non-delivery triggering a compensation payment to the SME (paragraph 29).
      • The Committee welcomes the proposal for portable credit history to be included in the Business Banking Code, monitored by the Banking Code Standards Board (paragraph 30).
      • The Committee found that the SME banking sector is still dominated by the major four clearing banks, despite new entrants, and that insufficient competition exists. The cost of this monopoly situation is borne by SMEs, a vital component of the UK economy, and as such remedial action is required (paragraph 34).
      • The Committee notes the criticisms of the methodology used by the Competition Commission put forward by the four main clearing banks. However, HBOS, Abbey National plc, and National Australia Bank did not complain about the methodology employed by the Competition Commission; indeed National Australia Bank commented that "it is a calculation which is broadly sound" (paragraph 39).
      • The Committee welcomes the proposed behavioural remedies but is concerned that they will not on their own be sufficient to increase competition. In light of these concerns the Committee recommends that the Director General of Fair Trading reassess competition in the industry after the remedies have been implemented and to report further to Parliament by March 2003 (paragraph 43).
      • The Committee has sympathy with the Competition Commission's view that because the behavioural remedies will not have a significant impact for a few years, additional remedies should be considered to benefit SMEs in the short term (paragraph 45).
      • The balance of the evidence suggests that lack of portability and transparency are the main barriers to increased competition in the SME banking market and this has generated calls for price controls. The Committee was not convinced that price controls were the appropriate solution, and shares the misgivings of the Bank of England about their effectiveness in securing competition. However, we accept that in the short term the reduced charges will have a beneficial effect on SMEs. We are concerned that crude controls of this kind could damage rather than improve SME financing, and could well deter entry of the smaller banks into SME lending. The Committee is also concerned that regulation of charges could hinder competition, by reducing or eliminating a differentiating feature of new entrants' products in particular (paragraph 48).
      • In view of the Chancellor's original wish to have the transitional remedy in place ahead of the behavioural remedies, we look to Ministers to make an early announcement on this matter.[113] (Paragraph 50).
      • The Committee notes that it has been over four months since the Competition Commission report was laid before Parliament, with a timetable of six months for implementing all remedies. The Committee believes that the largest clearing banks should not profit from procrastination, and recommends that the DGFT should report to Parliament by the end of September 2002 on the progress made on implementation of the transitional remedy, including if necessary further proposals (paragraph 51).

 


68   Competition Commission Report: Appendix 1.1 Back

69   Competition Commission Report, paragraph 2.432 Back

70   See Table 3, page 19 Back

71   Competition Commission Report, paragraph 2.476 Back

72   Competition Commission Report, paragraph 2.479 and 2.480 Back

73   Competition Commission Report, paragraph 2.443 Back

74   Competition Commission Report, paragraph 2.443 Back

75   Ev 61, paragraph 16.2 Back

76   Q284 Back

77   Cruickshank Report: Paragraph 5.73 Back

78   Competition Commission Report, paragraph 2.479 Back

79   Competition Commission Report, paragraph 2.501 Back

80   .Competition Commission Report, Para 1.8 Back

81   QQ131 - 159 Back

82   Q137 Back

83   QQ134-138 Back

84   Q137 Back

85   Q156 Back

86   Q176 Back

87   .Ev 137, Appendices 8 , 9 & 15 Back

88   Ev 138, Appendix 9 Back

89   Ev 156, Appendix 15 Back

90   Ev 156, Appendix 15 Back

91   QQ286 - 287 Back

92   Barclays plc, Royal Bank of Scotland Group plc, HSBC Holdings plc, Lloyds TSB Group plc, Bank of Scotland, National Australia Bank, AIB Group plc, and Bank of Ireland. Back

93   Barclays plc, Royal Bank of Scotland Group plc, HSBC Holdings plc, and Lloyds TSB Group plc Back

94   Competition Commission Report, paragraph 2.550 Back

95   QQ384 - 386 Back

96   Ev 15 Back

97   .Q438. For a Lloyds TSB plc view, see Q246. See also Q283. Back

98   .Q91 & Q94 Back

99   Competition Commission Report, paragraph 2.552 Back

100   Competition Commission Report, paragraphs 2.553 - 2.559 Back

101   Competition Commission Report, paragraphs 2.560 - 2.562 Back

102   Competition Commission Report, paragraph 2.609 (b) Back

103   Competition Commission Report, paragraph 8.26 Back

104   Ev 99 Back

105   Competition Commission Report - paragraphs 2.566 to 2.597 Back

106   Q387 Back

107   QQ295 - 298 Back

108   . Official Report, 14 March 2002, Vol 38, Col 1019. "The commission suggests that all remedies be put in place within six months. We hope that the Director General of Fair Trading will be able to reach an earlier agreement on the transitional remedy. Back

109   OFT Report: Paragraph 2a Back

110   . www.oft.gov.uk/News/press+releases/statements/bank+remedies.htm Back

111   Editorial Footnote: On 18th July 2002 the Chancellor of the Exchequer and Competition Minister accepted undertakings from the four main clearing banks to pay interest on current accounts or provide free money transmission services to their SME customers in England and Wales. The Competition Minister added "Each bank has undertaken to implement the remedy no later than 1 January 2003." The Director General is also seeking undertakings from eight banks that they will implement the behavioural remedies to improve competition in the market. The DGFT has been asked to secure these undertakings by 14 September 2002. (HM Treasury Press Notice 69-02 & Official Report, 18 July 2002, Vol 389, Col 407) Back

112   See Footnote 111 above. Back

113   Editorial Footnote: On 18th July 2002 the Chancellor of the Exchequer and Competition Minister accepted undertakings from the four main clearing banks to pay interest on current accounts or provide free money transmission services to their SME customers in England and Wales. The Competition Minister added "Each bank has undertaken to implement the remedy no later than 1 January 2003." The Director General is also seeking undertakings from eight banks that they will implement the behavioural remedies to improve competition in the market. The DGFT has been asked to secure these undertakings by 14 September 2002. (HM Treasury Press Notice 69-02 & Official Report, 18 July 2002, Vol 389, Col 407) Back

 
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