Select Committee on Treasury Appendices to the Minutes of Evidence


Annex

Letter from the Chairman of the Competition Commission

  I noted two points in the report in The Times relating to the hearing with the clearing banks on which we felt we should comment.

  Firstly, one of the banks is reported as saying that the Commission based its findings on excess profits at a particular time in the economic cycle when bad debts were low. In its report the Commission acknowledged that an adjustment should be made for a more sustainable level of bad debts than recent levels. As discussed in paragraphs 2.371 to 2.383, we did not feel it appropriate to take into account the average level of all bad debt over the past 12 year period since we believed the experience of the 1990s should be discounted to some extent to reflect what the banks had themselves told us about subsequent improvements in credit appraisal and monitoring.

  Nevertheless, we did look carefully at this longer period and made explicit adjustment for it. Specifically, we adopted an average figure of bad debt (of 1.2 per cent of lending) significantly above that of the latest year (0.48 per cent). This we noted was consistent with a four to five-fold increase in bad debt from current levels in a future recession. As we discussed in paragraph 2.381, we felt that figure of 1.2 per cent may be a high figure, but we believed it right to err on the side of caution. We also carried out detailed analysis of the extent to which, if at all, it was appropriate to adjust for the effect of current levels of economic activity (paragraph 2.384—2.387) but found the data indicated that this additional adjustment was not warranted.

  Another bank made the point that if all quoted companies in the UK were treated to the same excess profits argument put forward by ourselves, the value of pension funds would fall because share prices would tumble. We considered comparisons with other sectors in paragraph 2.409 of our report. We noted that accounting returns on the book value of assets greater than the cost of capital may indicate the factors such as presence of intangibles, inclusion of tangible asset at historical costs rather than replacement value, risks, or survivor bias. We sought to identify and quantify such factors as applied to the banks and adjusted for them as appropriate before reaching conclusions as to whether there remained any excess returns not accounted for, which could be treated as reflecting persistent excess profit, indicating excessive prices and a failure in competition. (paragraph 2.411.) The excess profits of clearing banks arose after adjusting for those factors: that may well not be the case with other sectors, but it was clearly not appropriate nor indeed practical, for us in any one enquiry to investigate the circumstances of other industries.

  The above points are taken directly from the Report and I hope you will find them helpful in correcting what, according at least to press reports, was said to the Committee.

17 May 2002



 
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