Competition and choice in retail banking - Treasury Contents


3  The current account market and switching

62. As we discussed previously, some segments of the market appear to be more concentrated than others. The current account market appears to be the most concentrated, and concentration has increased significantly. Lord Turner considered the importance of the personal current account market derives in large part from its perceived role as a gateway product—that is, as an avenue through which consumers access, and firms sell, other potentially more profitable financial products. He described the personal current account as "essentially a loss leader, [...] a classic loss leader, or at least a low return leader", which banks provide in order to get hold of a relationship on which they can then sell other products." He argued this acted as a catalyst for "aggressive selling" because providers were "trying to make up for the low profitability of the core product."[65]

63. In its recent market study Barriers to entry, expansion and exit the OFT concluded that "the PCA continues to remain an important gateway product in retail banking", although their research showed that cross-selling rates varied considerably with respect to different retail financial products (see Table 8 below).[66] Jayne-Anne Gadhia, CEO of Virgin Money, concurred with the OFT's conclusions stating that "the reason that banks want to attract current account customers—and big banks do—[...] and want to talk about free banking is because a lot of profitability comes off the analysis that is subsequently undertaken to enable big banks to sell different products to customers".[67] As Benny Higgins said:

    What the current account acts as a fulcrum for all of the other products that banks sell. So for example, 88% of savings products will be sold by the bank that has the current account.[68]

Table 8: Current account cross-selling conversion rates, by product type, Sept 2009
Retail banking product Proportion of PCA customers who hold this product with their PCA provider (%)
Savings account88%
Credit card53%
Cash ISA42%
Unsecured personal loan 42%
Mortgage27%

Source: OFT, Review of barriers to entry, expansion and exit in retail banking (Table 7.1)

64. Many of the incumbent banks took a more nuanced position on the extent to which the personal current account continued to act as a gateway product. The two arguments they used were that cross-selling rates had declined over time and that cross-selling rates were low in the UK compared to other countries. Eric Daniels told us "the cross-over between them [the different market segments] is very, very small" adding that it would be "very normal" for "a typical consumer" to "have a mortgage with one bank, a credit card with yet another and a current account with a third institution. That's very normal behaviour."[69] When quizzed on the discrepancy between the OFT's figures which showed an 88% cross-selling rate on savings accounts and his earlier answer that "cross-over is very, very small" Ms Weir said that the OFT "numbers sound very high to me".[70] Mr Daniels also argued that international comparisons showed cross-selling was far higher elsewhere—"If we look at the comparisons, if you look at Europe and other international comparisons, the concentration of a customer's wallet—in other words the number of products they buy from an individual institution—is much higher in Europe than it is in the UK because customers shop around for different banks, different products."[71] However, Brian Hartzer acknowledged cross-selling "was an important part of what we are trying to do because in the end [...] our strategy is to be a full service provider." Indeed, Mr Hartzer's key regret was that RBS needed to get "better at cross-selling". He explained that "at the moment just under 40% of our customers only have one product with us, and so we think that's a pretty big opportunity, and about one-third of customers have two products with us."[72]

65. We are concerned by the significant increase in concentration in the personal current account market in particular and the dominance of a handful of large banks. Despite the larger banks' protestations, we consider the current account remains a "gateway" product which means dominance in this market by the large banks has competition implications elsewhere in the sector. This means that barriers to competition in the personal current account market need to be scrutinised particularly carefully.

'Free banking'

66. The UK's 'free banking' model may be a significant barrier to competition. The features of the 'free banking' model are a free-in-credit charging structure, where regular fees for operating the account are not charged but credit interest tends to be low and explicit charges are levied for certain types of transaction or service, which have been historically related to overdrafts.[73] Before 1985 the transaction-based model, under which consumers were charged per transaction or per block of transactions was predominant in the UK. Free-if-in-credit banking was introduced by Midland Bank in 1984. Its introduction led Midland to gain approximately 450,000 customers in the following year. As a result, other large current account providers moved towards this model with the end result that the free-if-in-credit personal current account model came to dominant the market.[74]

67. Recently some banks have introduced packaged accounts in which customers pay a monthly fee for the package which can include a mixture of banking services, insurance policies, and unregulated services. The FSA estimated that over 14 million customers hold such accounts and noted that such accounts "now provide a significant source of fee income for banks."[75]

Costs, revenues and profitability of current account provision

68. One of the problems with the 'free banking' model is that costs and profitability become extremely obscure, as does the price paid by the consumer. We spent some time in our inquiry trying to establish how much it costs to provide current account banking services, what the customer 'paid' and how profitable such services were.

REVENUES

69. In its 2008 market study on personal current accounts in the UK the OFT estimated that the banks earned £8.3 billion in revenues from personal current accounts in 2006 and that average bank revenue from a current account was £152 per customer per annum. The £8.3 billion came primarily from the following sources:

  • Net credit interest, defined as the difference between the interest paid on credit balances to consumers and the income derived from the bank from these funds
  • Net authorised overdraft interest charges
  • Net unauthorised overdraft interest charges
  • Insufficient funds charges
  • Packaged fees, and
  • Ancillary sources.[76]

John Fingleton told us that the OFT had not subsequently updated the £8.3 billion figure.[77]

Figure 1: Composition of industry PCA revenue in millions, total 8.3 billion, 2006



Source: OFT, Personal current accounts in the UK: An OFT market study, 2008, p 18,

70. The above chart shows the breakdown of revenues from these six sources. As can be seen net credit interest alone amounts to almost half the revenues earned by the banks from current accounts. Helen Weir, Group Executive Director, Lloyds Banking Group, told us that this 50:50 split held for Lloyds and that "foregone credit interest would be approximately half of the total income on personal current accounts". She went on to explain that the total net credit interest figure for Lloyds would be "approximate to our broad market share", which would be around 25-30% of £4.1 billion or between £1-1.25 billion.[78]

PROFITABILITY OF CURRENT ACCOUNTS

71. The OFT has previously tried to establish whether current account provision is profitable on a stand-alone basis. It concluded that banks typically assess profitability at the wider retail banking level rather than for individual product lines and that they had "judged that it would have been disproportionate for the purposes of this market study [OFT's 2008 market study on the personal current account market] to require the banks to collect cost data at a product level purely in order to enable us to assess profitability of accounts."[79] When John Fingleton was asked whether current accounts were profitable on a stand-alone basis he explained that the banks did not attribute their costs by product line, going on to tell us that consequently it was not possible to make that assessment.[80]

72. When questioned about the cost of current account provision to the bank itself Helen Weir told us that:

    The cost of a current account is quite significant, as you'll appreciate [...] Typically the cost of the branch network, the cost of providing ATMs, cheque facilities, the debit cards, so there are a number of services that go along with the current account.[81]

HSBC gave a similar answer, Joe Garner arguing that it was "pretty much impossible to isolate the cost of providing a current account to an individual customer". This was because:

    The reason for that is that you would have to make an assumption over how much of your branch network, your ATM network, your purchasing system, your internet usage, et cetera each customer used; all of those things you would have to factor in to make an individual calculation. I don't think that either it is really practical to do or very useful.[82]

Mr Garner said that it was possible to produce an average figure for the cost of products by taking "the total cost of running a bank and dividing it by the number of customers which gives you a number." However he warned that such a figure would produce an average and would not "be representative of a large number of customers"[83] In contrast, Co-operative Financial Services were more forthcoming about the cost of current account provision, informing us that "each individual current account customer [...] costs us £85 per year" on average.[84]

73. We asked bank executives whether the provision of current accounts was profitable on a stand-alone basis. Helen Weir told us that their "current accounts are profitable but not excessively so" and that Lloyds were "getting a hurdle benchmark rate of return on the capital that's employed in that business".[85] Later she described overall current account provision as "not significantly profitable".[86] Brian Hartzer described the overall RBS retail customer business as "profitable", but explained that "profitability tends to slosh around in a bank from one thing to another, depending on where interest rates are and how people behave." He explained that:

    At the moment, as interest rates have fallen, what has happened is that the profitability of deposits has become probably break-even at best and in some cases a loss, and the margins on mortgages and some loan products are wider, so in a sense are contributing to a larger portion of our profitability. If rates rise that situation could very easily reverse [...] which is that profit dynamics are constantly in flux.

74. Peter Vicary-Smith had little sympathy for banks who complained about the limited profitability of operating current accounts, telling us that in their position he would be "quite happy to have personal current accounts as a loss leader" given "the enormous amount of data they can use" and "all the other things it enables me [the banks] to do."[87]

COSTS TO CONSUMERS AND CLARITY OF OVERDRAFT CHARGES

75. We also asked about the cost to consumers of current account provision, including net interest foregone, which is the increased return consumers could earn by placing their current account deposits in, for example, higher interest savings accounts. Ms Weir told us that for a typical customer with an average current account balance of less than £1,000 the net interest foregone would be £5 a year. When pressed on what the cost of net interest foregone would be in a more typical year, i.e. with base rate higher than 0.5%, she replied that a base rate of 3.5% would imply net interest foregone of £35 per annum.[88] She went on to compare the cost of a current account to consumers with the price of coffee, telling us that:

    The typical amount a customer pays for their current account, including foregone interest, is approximately the same as a cup of coffee a week[89]

76. Ms Weir seemed confident that consumers would know the cost to them of operating a current account, telling us that "most consumers would have a pretty good idea of what they are paying for their current [account] banking. However, when we pressed her to say how much she paid in terms of interest foregone herself, she was unable to answer.[90] Ms Weir was not the only witness who was unable to tell us the cost of their current account. Lord Turner explained that he did not know, although unlike Ms Weir he did not argue that most consumers would know.[91] Adam Phillips was similarly unable to tell us how much he was paying for his current account.[92] Benny Higgins stated "very few people" would be able to quantify the cost of their current account and concluded that the inability of most consumers to calculate such costs "strikes at the heart of the issues around competition within current accounts."[93]

77. The distinguished list of financial services experts unable to tell us the cost to them of their current account indicates a serious problem. If they cannot estimate the cost of their accounts, we hold little hope that members of the public are able to do so. Greater disclosure of information on cost is a pre-condition to greater competition in this market.

WINNERS, LOSERS AND CROSS-SUBSIDY UNDER THE FREE-IN-CREDIT MODEL

78. We also examined who were the winners and losers from the free-in-credit banking model. Helen Weir considered that for the "average" customer, current account provision represented "good value":

    the average customer pays—and that's including foregone interest—less than a cup of coffee per week for their banking. For that they get access with our group to over 3,000 branches, a wide ATM network, money transmission service, use of debit card and so forth. If you compare that with things like mobile, with Sky and a number of other things that's good value.[94]

She revealed that approximately 30% of Lloyds customers would pay fees associated with an overdraft whilst the remaining 70% of customers did not go into overdraft and had [positive] credit balances in their account.[95] When Joe Garner, HSBC's Deputy Chief Executive in the UK, was asked what proportion of HSBC customers ended up paying for their current account, he told us that it was "a very difficult question", but that "the vast majority pay additionally no or very low overdraft charges" whilst "a small minority" did pay more in overdraft charges and that these customers did "need particular care and attention."[96]

79. Adam Phillips was keen to expose the fact that whilst free banking was "notionally free [...] it's not actually free". He said the effect of this was "to favour certain kinds of people against others."[97] John Fingleton explained that beneficiaries under the current model were "people who have average balances that don't go into overdraft and who manage their accounts very well. People with average balances of less than the £1,000 a year are far more likely to go into overdraft. As that number comes down, you get numbers that go into overdraft, say, six times a year. If you go into overdraft six times a year, the chances are you are paying way above the average cost of a bank account."[98] Mr Fingleton described the model as "truly a cross-subsidy, because people who don't pay anything over the year for their current account clearly have cost something to the supplier".[99] He described this cross-subsidy as having an "important distributional impact":

    Some of the people at the lower end of the income distribution are cross-subsiding people perhaps in the middle. Perhaps some people at the higher end of the distribution with high average balances, on the foregone interest, are also cross-subsiding some of the people in the middle.[100]

When questioned as to whether he believed such cross-subsidy was bad per se or was bad because of the lack of transparency, Mr Fingleton replied that "cross-subsidy is not in itself something that would concern us" [the OFT] and used the example of airline pricing to illustrate his point:

    If you think about airline pricing, people who book late cross-subsidise people who book early, and that happens in quite a competitive market. So we don't necessarily think that cross-subsidies are inconsistent with the competitive market situation.[101]

80. So-called free banking is not free. The term free-in-credit banking is a misnomer, given that consumers with positive balances pay through interest foregone. It misleads the consumer. It is also clear that so-called free banking has important distributional consequences. A minority of consumers, often those on lower incomes, pay explicit charges associated with overdrafts. This results in high prices and poor outcomes for a sub-set of consumers. Meanwhile, other consumers, often on higher-incomes do not pay explicitly for their current account provision, in spite of the fact that their PCA provision clearly does incur a cost to the provider. Whilst it is undesirable from the perspective of 'fairness', cross-subsidy is not always wrong. For example, cross-subsidy exists in the airline industry where customers who book early are cross-subsidised by those who book later. However, pricing is far more transparent and customers can easily switch airline provider. These conditions are not currently present in the personal current account where cross-subsidy is opaque and switching costs are high.

PRICE TRANSPARENCY

81. John Fingleton argued that his key concern was "the inability of people to know what they pay for their bank account and, as a result of that, the inability to make any meaningful comparison between them.[102] The bulk of current account revenues come from foregone interest and overdraft charges, which Mr Fingleton said were "probably two of the areas the consumer had the least information on which to make an assessment of what they were paying their existing bank, or to compare prices between banks". He concluded that it was "very difficult for consumers to choose between competing suppliers if they can't see the prices of the aspects where the most revenue is earned".[103] Jayne-Anne Gadhia argued that "free banking is a fallacy" and that:

    customers are being misled to stay with the big banks who claim to offer free banking when actually these non-transparent charges are really what's making them money.[104]

82. Consumer groups were also critical of the opacity of charges, which they said had two consequences. It made it difficult for many consumers to understand the true cost of their current account and made it difficult for consumers to compare costs across providers. For example, Consumer Focus said that:

    Under the prevailing model of so called free banking, charges are hidden and punitive and present barriers to comparison. A consumer will not make decisions and cannot make comparisons on the basis that they are likely to encounter financial difficulties. Penalty charging is not a fair business model and is difficult for a consumer to predict or manage.[105]

The Financial Services Consumer Panel said that the "hidden" nature of charges presented a barrier to comparison. They told us that charges were often not disclosed in advance, telling us that information about overdraft charges did not have to be specifically disclosed to a customer opening an account, it is enough that the charges are made available via a telephone helpline, a website; or by asking staff. Finally, the Consumer Panel were also critical of charges that were labelled in different ways that prevent comparison.[106] The Consumer Financial Education Body (CFEB) expressed concerns about developments in the current account market which "have meant that products are not necessarily transparent, readily comparable or understandable". They cited packaged accounts and other products tied to current accounts which competed, by their nature, on a variety of features as well as price, noting that "the FSA has flagged that this may not be of benefit to all who use them."[107]

83. John Fingleton explained that the OFT had focused its transparency effort on "those areas where the banks make their money—on foregone interest and overdraft charges".[108] His colleague Clive Maxwell, Executive Director at the OFT, expanded on this:

    the banks have committed to being clearer about the charges that they're applying to individual customers, and to setting them out much more clearly on their statements. That is already starting to happen. They've committed to state people's average balances [...] That is happening in some cases already; it is beginning in other cases over the course of the next year or so.[109]

Mr Fingleton considered setting out the average balance over the year was "a good step, because if you don't have your average balance, it's very difficult to have a quantity to apply the interest rate to."[110] Other initiatives currently being undertaken in conjunction with the banks on a voluntary basis include:

  • Enhanced monthly information
  • An annual summary of the cost of their PCAs; and
  • Illustrative scenarios showing unarranged overdraft costs.

A number of providers have now published illustrative charging scenarios on their websites, whilst links to the charging scenarios of the major providers in Great Britain can be found on the OFT's Consumer Direct website. Furthermore, the OFT has reported that the major PCA providers in Great Britain have all confirmed that they will implement the remaining transparency initiatives by or around the end of 2011.[111]

84. When asked whether these initiatives would be sufficient to improve transparency and comparability, Mr Fingleton said "we think it needs to go further."[112] He touched on a number of areas, including foregone interest—"being clear about if one bank is offering a higher rate of interest than another bank. Given your transaction pattern, how could you compare those two prices?"[113] Jayne-Anne Gadhia agreed that this was an area to focus on, arguing that "it's possible to show—certainly against, let's say, base rate—how much interest is foregone" but cautioned that "a lot of work [needs to be] done to understand how best to communicate that in a simple, clear, straightforward way. Joe Garner from HSBC, however, told us his firm did not show interest foregone because their "view is that a current account is for daily purchases" and that HSBC had "savings accounts for those who want to accrue interest". When pressed on whether this represented a cost to the consumer, he replied "no more than the cost of keeping money in a wallet."[114]

85. Another area where Mr Fingleton felt more needed to be done was the tendency to "simply to flood consumers with information and say then, 'Everything is transparent.'". Instead, "maximum transparency—giving consumers lots and lots of information" was not:

    necessarily any better than giving them no information. You're catching a waterfall with a teacup; it's not very helpful. So, it's giving consumers the information that is relevant to them.[115]

Nationwide also noted that "a balance must be struck between achieving greater transparency and avoiding information overload that could potentially increase, rather than reduce, consumer inertia and apathy, precisely because there is too much information to digest."[116]

86. Lord Turner considered greater transparency was a necessary but not sufficient condition for greater competition, given the particular dynamics of the retail market.[117] The FSA's submission to this inquiry expanded on some of these dynamics, arguing that across the retail market there was "substantial evidence to suggest that consumers generally do not use the information provided to make decisions or shop around and that "even when they read the documents, research indicates that many find them daunting, with some terms difficult to understand." The FSA also noted that products were "becoming increasingly complex (the growth of the structured product market is one example), and as a result it was "increasingly difficult for consumers to understand descriptions of a number of mainstream retail products." They concluded by "acknowledging the limitations of disclosure, by itself, to facilitate effective consumer choice and to secure good outcomes for consumers."[118]

87. Sir Donald Cruickshank identified problems with price transparency and the difficulty of comparing products in his 2000 report on competition in the banking sector. Over a decade on those problems remain acute. The OFT is working with the banks to try to ensure greater transparency. It is vitally important to ensure information is provided in a way which enables meaningful comparability. We believe that, as a matter of priority, the OFT and the banks must examine how best to present information to consumers on net interest foregone. 'Information overload'—the tendency to simply 'flood' consumers with information, acting to increase consumer inertia must be avoided.

A BARRIER TO COMPETITION?

88. A number of witnesses to this inquiry argued that so-called free banking discouraged and hindered competition in the current account market. Lord Turner argued that it "probably is the case that free-if-in-credit banking does create a bit of a barrier to new entrants." This was because, as discussed previously, the current account was "loss making" or only marginally profitable for providers, which Lord Turner explained "makes it more difficult for new entrants to come in, because they cannot make profit just out of the core product" with the consequence that "they had to immediately be able to cross-sell other products as well."[119] Lord Turner also made the point that there were "other important barriers to new entrants".

89. One aspiring new entrant to the personal current account market—Virgin Money—argued that the widespread availability of 'free banking' meant that all banks seemed the same to consumers, and there was no obvious financial incentive for customers to switch their current accounts. They believed that even where customers were considering switching between current account providers, 'free banking' meant that it was not easy to assess likely charges, and it was not possible to compare the levels of service offered by different banks, except by hearsay. Virgin Money concluded that 'Free banking' makes it very difficult for new entrants to the PCA market" and that "new entrants are not able to compete by offering lower prices (than zero) or by innovating with simpler, lower-cost products."[120]

90. For many consumers there may be little financial incentive to switch. Mr Rhodes from Nationwide discussed how "customers actually believe that a current account, with the exception of interest foregone on any balance, is free" adding that "for 80% of the population that is correct". He considered that in consequence it was "incredibly difficult" to "create [...] pull demand in a market where 80% believe it [PCA banking] is free." He dismissed the possibility that competition would take place on interest foregone saying that was "a very few pounds."[121] When pressed on this point Mr Rhodes said that "the average in credit balance in a UK current account is about £1,500, so if you put base rate as an anchor rate to do a calculation, you get £7.50 a year."[122] When quizzed on the unusually low current base rate, Mr Rhodes redid the calculation: "If you put your best instant access rate that you could get from a high street provider, about £30 a year. That is your foregone interest cost." He argued that this simply was:

    not a lot in terms of convincing you to move your account even if you put an in credit interest—even if you disclosed that number, worked out the price, it is not a significant driver to cause you to switch your current account [...] Whereas the charges are more significant but most people believe they will never pay them, and 80% in reality never do.[123]

He told us the result was it was difficult to attract new consumers by saying "come to Nationwide because you have your free account", so "a whole range of other incentives" had to be added, which made "it very expensive to recruit new personal current account customers" and "then your earnings only occur at the back end of the process when customers start to incur the overdraft structures that we know so much about. So, unless you have a back book of current account customers, day one you have no income".[124] Tesco Bank told us that new entrants were "placed at a further disadvantage by the ability of incumbent banks to offer attractive rates to new customers, which they pay for by giving very low rates to their existing customers". This they said was also a common practice in the savings market.[125]

91. But price is not the only driver of competition as Metro Bank told us. Representatives from Metro Bank, whilst saying competition could take place within the free-banking model, did not believe such competition was primarily driven by price. Anthony Thompson, Chairman, noted a recent OFT report which:

    said that only 7% of people move their current account because of rate, for 93% it's around service and convenience. So the banks, I think, seem to have persuaded everyone that this is a rate driven environment. The reality is it is not rate driven. People want value, they want fairness, they want transparency and value is an amalgam of many, many different things, not just rate.[126]

The future of free banking?

92. There has been a growing debate around the future of so-called free banking. For example, former Barclays Chief Executive, John Varley, has publicly stated that "it is possible that free-in-credit banking is a structure that has outlived its time", adding that the concept was "idiosyncratic by the standards of the world" and "worth re-examining".[127] When John Fingleton was asked about the future of so-called free banking, he said that he "wouldn't favour saying that you should regulate to have fixed fees for banking" adding that "seem to be heavy-handed". Mr Fingleton believed that greater transparency—discussed earlier in this chapter—and "paring away at hidden charges, so that you are forcing the banks to put more and more of it up front" could lead to the emergence of "more products with up-front fees". In such a scenario, "you might still have some free-if-in-credit banking, but cross-subsidised in a more transparent way that enables better switching between consumers". He argued "that type of diversity in the consumer offering might be better than trying to impose a standardised approach".[128] Ms Ana Botin argued the key issue was "choice" and spoke of packaged products which Santander was introducing in the UK as evidence that the market was evolving to provide greater choice for consumers:

    We have brought out a number of products of packaged accounts. I believe it's a very interesting product. We did a lot of that in Banesto in Spain[129], so we would have a flat fee account and you would pay anything from €5 a month to €15 and would get a different value for that. This is not a very big market right now in the UK, but some customers like it and we have brought out different models of it. What's important is choice.[130]

Joe Garner spoke of how HSBC was trying to increase choice for its customers. He explained that HSBC had introduced "a £15 a month current account with no charges whatsoever" which it was "impossible to incur charges on." He said the account had "not taken off to a great degree".[131]

93. RBS argued that "there is a widespread perception amongst the UK public that core banking services such as current accounts and credit cards should be provided for free". The consequence of this, they argued, was "that it would be commercially difficult for a bank, as a first mover, to start charging for fees."[132] Ms Ana Botin concurred saying that the free banking seemed "an ingrained model for the UK banking consumer" and it was something "people value and it seems to work".[133] This viewpoint was echoed by Which? whose research showed "that consumers would be very price sensitive if faced with an explicit charge, such as monthly or annual charges for operation of their current account, and would switch to a non-fee account."[134]

94. Which? considered that the only direct measure to change current account charging models would be a form of price-control: regulating banks' charging structures to ensure explicit regular charges for holding a bank account. This they concluded would be "a complex and significant intervention in the market." They warned of the "serious risk of unintended consequences" unless "regulation to impose an explicit fee also then set controls on any other charging options or price structures that may also be adopted", claiming that failure to this would risk creation of both an upfront fee and continuation of hidden or opaque charging models.[135] This would be an extremely intrusive level of regulation.

SUPREME COURT DECISION ON ASSESSING FAIRNESS OF UNAUTHORISED OVERDRAFT CHARGES

95. £3.6 billion, almost 50% of total bank revenues from current account provision derive from overdraft, insufficient funds and other charges. In March 2007 the OFT opened an investigation into the 'fairness' of certain charging terms relating to unarranged overdrafts under the Unfair Terms in Consumer Contracts Regulations 1999 (UTCCRs). Subsequently, in July 2007 the OFT entered into a litigation agreement with eight PCA providers and commenced a test case to assist in securing a clear and orderly resolution of the fairness of these charges. The test case ultimately led to a Supreme Court judgment, dated 25 November 2009, which overturned previous High Court and Court of Appeal rulings that unarranged overdraft charging terms could be assessed in full for fairness. The United Kingdom regulations transposed a European Directive, which specified that an assessment of unfairness could not relate to the definition of the main subject matter of the contract or the adequacy of price or remuneration as against the goods supplied in exchange.[136] The Supreme Court considered that overdraft charges were provided as part of a package of terms and conditions and that individual aspects of that package could not be considered for unfairness as ancillary items. John Fingleton told us that the OFT was "surprised" to lose the Supreme Court case on unauthorised overdraft charges but said the OFT had "to accept the Supreme Court's interpretation of the law."[137]

96. After detailed consideration of the judgment and of the various options available to it, the OFT concluded that any investigation it were to continue into the fairness of current unarranged overdraft charging terms under the UTCCRs would have a very limited scope and low prospects of success. Given this, it decided against taking forward such an investigation. Instead, the OFT decided to work together "with the major PCA providers in Great Britain to voluntarily agree to implement a number of initiatives that will make the costs of PCAs more transparent.[138]

97. Lord Turner emphasised that "there was a clear legal decision [...] that the banks were justified in doing this", but he stressed that "the appropriate regulatory authority should be directly looking at both the transparency and indeed the level of unauthorised overdraft charges."[139] Which? told us that they did not believe "that the current voluntary, market driven initiatives to address concerns about unauthorised overdraft charges" were "delivering sufficient improvements for consumers" adding that they did not believe "sufficient improvements will be delivered without the Government taking legislative action." They pointed to "developments in the market since the Supreme Court handed down its decision last year. While banks are becoming more transparent about their unauthorised overdraft charges, the fees are still extremely high and, for some consumers, are now higher than prior to the Supreme Court decision." Consumer Focus considered that unauthorised charges had been creeping up again and authorised overdraft charges had increased significantly to ensure profit margins are retained.[140]

98. The predominance of so-called free banking in the UK appears to suggest a clear consumer preference for this particular model. However, consumers are not provided with sufficient information about charges to make an informed choice. The predominance of this model prejudices competition in the personal current account market by obscuring those costs, and probably also by increasing the advantages enjoyed by existing banks. Greater transparency will alter consumer behaviour not least by revealing the hidden charges inherent in the free-in-credit model. Complex regulatory interventions in the market to constrain free banking could well be counterproductive to competition and are likely to increase costs to business and the consumer. However measures to increase transparency do not carry these disadvantages. We strongly support the OFT's efforts to improve the information that banks give on costs and charges. We recommend that the Independent Commission on Banking should examine the impact of free-in-credit banking on competition in the personal current account market, and, in particular, what is appropriate action to ensure the provision of adequate information to consumers to enable them to make meaningful choices.

Switching

99. Even if changes were made to improve price transparency, competition would not be efficient if customers found it difficult to change provider. The ease of 'switching' from one current account provider to another was identified as a problem in the Cruickshank report and remains a barrier to competition. The switching process has a number of stages.

  • Awareness: Consumers are prompted to switch by becoming aware that they may not be getting the best deal.
  • Information gathering/obtaining advice: Consumers gather information about alternative products and/or obtain advice from a third party.
  • Choose/buy: Consumers weigh up the different options and make a decision as to which to buy.
  • Execute: Consumers execute the switch and/or contact their provider / providers who executes the switch for them.
  • Post mortem: Consumers reflect on the costs and benefits of their decision and decide whether to switch products again.

100. The OFT in Review of barriers to entry, expansion and exit in retail banking concluded that "new entrants face significant challenges in attracting personal and SME customers", specifically referring to "low levels of switching" as a key barrier.[141] Tesco Bank said the effect of such "inertia" was "most seriously and negatively felt by new entrants seeking to establish themselves in the current account market."[142]

101. Benny Higgins stressed the importance of switching to competition, saying that "the freedom to switch between suppliers was 'a necessary component of competitive markets'", and that "disclosure, full information" and "a minimum number of barriers to switching" were prerequisites for "a competitive market".[143]

102. Our inquiry explored how long it typically took to switch current account providers. The estimates we were given ranged from two weeks to two months; transferring direct debits was identified as the part of the process most likely to cause delay." [144]

103. We tried to establish how many people were switching personal current accounts. Eric Daniels told us that at Lloyds Banking Group it was "somewhere between 7% to 11% of the customer base every year". He described this figure as both "very high" and "about the international norm."[145] Brian Hartzer gave the comparable figures at RBS as "about 9% of accounts" which he described as 50% higher than in Australia.[146] Benny Higgins was dismissive of these figures, claiming that if you take out secondary accounts, the real underlying switching rate was "probably more like 3%. It's very, very low."[147] Jayne-Anne Gadhia was similarly dismissive of the 7% to 11% figure, telling us "that the underlying rate of switching is probably less than 5%."[148] She believed that the level of switching had fallen since the financial crisis began because "people have been less ready to take the risk of switching accounts", describing this as "unfortunate."[149] Of the five largest current account providers only Ana Botin of Santander acknowledged that "the level of switching is low."[150]

104. Some of the banks suggested that the switching statistics under-estimated the number of people changing accounts, because as Antony Jenkins pointed out most consumers have 2.4 personal current accounts. He said "many of those [accounts] are with different institutions, so people try before they buy".[151] Nevertheless, the OFT—using research from the EC Consumer Market Scoreboard—identified an annual switching rate in the "PCA market of 9.2% in 2009 compared to around 6% in 2006." They concluded that "overall, switching rates for both PCAs and business current accounts remain low" when compared to other sectors.[152]

105. The OFT's view that switching rates in current accounts was low in comparison with other sectors was shared by Consumer Focus. That organisation contrasted switching rates for current accounts, described as having "lagged at around 7% for the last 10 years", with utilities such as energy and phones which showed "switching rates well in excess of this, starting at 26%". Benny Higgins contrasted the current account with the credit card market where "in the last twelve months no less than 27% of customers have either taken a new card or a first card and [...] 14% closed the card they had. The lesson was that, in a market with "transparency around what you get charged" and "where there is an ease of switching", "customers will be more active."[153]

106. There are a number of possible explanations for the relatively low level of switching in the personal current account market—namely, difficulties whether real or perceived with the switching process, the fact that the majority of consumers are satisfied with their current account provider or consumer inertia.

PROBLEMS WITH SWITCHING

107. The industry has removed the need for customers to write a new Direct Debit mandate to each service provider with new bank account details. Instead, the new bank takes care of informing the customer's service providers of the new account details. This is a major improvement for the customer but they can still have a problem with a Direct Debit payment if:

  • The new bank is slow to request the customers direct debit and standing order details from the original bank
  • The original bank is slow to send the information to the new bank, and
  • The service providers are slow to update their records in a timely fashion to avoid charges being requested from the old account; and finally
  • The remitter—frequently the customer's employer—is slow to change their records.

A further and growing problem with switching is that the 'remitter' (for Direct Credits) is not just a customer's employer, but increasingly a large number of other people. With the growth of internet banking (and rapid decline in cheques), consumers increasingly use bank account details to make payments for goods and services (and for person to person payments). Switching bank accounts therefore creates the significant risk of such payments going astray—and this is a further deterrent to switching. Moreover, there is currently no system or simple solution to address this problem.

108. Cut Loose[154] confirmed that "the vast majority of accounts are switched without any problems for the customer", but said that "for every customer who is inconvenienced there will be many who hear about the problems and decide not to switch":

    The personal risk that bills won't be paid or salaries won't go to the correct account is at the heart of customer concern when switching. The inconvenience and embarrassment to the customer when payments going 'wrong' is high and customers run the risk of such an error negatively impacting their credit reference score. Correcting these problems is time consuming and frustrating for the customer. These potential issues undoubtedly contribute to the low level of account switching experienced in the UK, with customers preferring to open multiple current accounts or simply stay with their existing bank.[155]

This viewpoint was shared by Vernon Hill, who said "customers are scared to death that something is going to go wrong. The story we hear all the time is, "Oh, my God, the Sky TV payment is not going to get moved over, my Sky is going off."[156] He argued direct debits were at the heart of the problem:

    What makes it structurally harder in Britain than in America is the direct debit system you have or standing orders. That doesn't exist in America so it's easier to move accounts. When people move to us—and they're moving every day to us—we have to line up their direct debits and their direct credits to make it happen. It takes more effort and it takes more time. We do it by doing it for the customer but your system of direct debits does inhibit accounts moving.[157]

Jayne-Anne Gadhia referred to the perceptions that the switching process might go wrong —"the trouble is that so many people think it might not happen perfectly, and, "I need it to happen perfectly and my life's too busy to worry about my direct debit."[158] Benny Higgins told us that OFT data showed that "a quarter of customers who switched said they wouldn't do it again" whilst "a third of customers who switched said they wouldn't recommend it to a friend or member of their family."[159]

FRAUD AND FEAR OF SWITCHING

109. We were keen to understand if the fear of fraud, in particular regarding online banking, was discouraging customer from switching and using internet only accounts. Mike Bowron, Commissioner of the City of London Police told us that:

    I can understand why some people would be reluctant to switch, but I suppose it is incumbent on us to help to educate people to have the confidence of knowing what to look for in terms of crime.[160]

When we pressed him about whether a customer is at higher risk of fraud with internet banking he conceded:

    I suppose, logically, you are when you switch to internet banking because you're transferring your personal details over the ether.[161]

Although he did explain that he was personally very comfortable with using internet banking: "I use it, and I'm confident when I use the internet to do my own personal banking."[162]

John Fingleton responded in a letter to our concerns about internet fraud and the possible impact on customer inertia:

    [...] there is a common perception that the internet is susceptible to fraud... however, this concern is often uncorrelated with the number of fraud cases occurring. For example, in 2009, reported internet fraud in the UK decreased by 15% from 2008, whilst internet transactions increased by 14% during the same period.[163]

He said that the OFT had, as part of their work on retail banking explored the reasons why consumers were reluctant to switch. Mr Fingleton's conclusion was that their research had "not identified the fear of fraud as a key factor—the most significant factor deterring switching was a fear that the process was too complicated and problems occurring that disrupt regular financial transactions."[164] Given that a much greater share of the market is likely to be taken in by the internet in later years it is surprising how little work has been done to improve security, and the lack of detail apparently available to the police concerned us. We recommend that the regulatory and competition authorities return to this.

110. The OFT placed a different emphasis on their research on switching with Clive Maxwell describing "significant improvements in the switching process being driven by BACs, which is the central organiser of the payment system around this". He boasted that the number of complaints around switching had "fallen from something like 30%, 32%, [...] of customers down to less than 10% of customers who have switched current accounts"—concluding jubilantly "We've seen some improvements there."[165] Nonetheless, Which? said the results of their membership survey on the switching process showed "nearly 80% found the process easy"; "10% reported "having to manage the process themselves, and consequently found it much more difficult to do so"; "40% experienced a problem with direct debits or standing orders being transferred incorrectly, a problem with the helpfulness of their old bank or with the length of the overall process."

ACCOUNT PORTABILITY

111. Sir Donald Cruickshank said that "retail banking markets lack a dynamic seen in most parts of the economy in that customers chose not to switch supplier even after having been subject to high costs and/or very poor levels of service." He attributed this to:

    the cost to the customer of time, hassle and, it is feared, the potentially costly disruption of relationships with providers of other services who rely on standing orders or direct debit payments. Despite recent improvements to the switching process, this is still a major problem.

Sir Donald Cruickshank argued that:

    a regulator, armed with independent authority over money transmission systems would make a huge difference, certainly in retail markets where the current account market is key. Why shouldn't a retail customer's bank account numbers be personal and recognised as that by the systems used to communicate between banks and to transfer value between bank accounts? Why shouldn't the hassle and cost of transferring a personal account from one bank to another be suffered by the banks and their engineers (who incidentally, if my experience of introducing number portability for telephony is anything to go by, would relish the challenge). There are other changes that an independent regulator of money transmission systems could deliver eg credit card transactions at cost, but improving the dynamic of the market for current accounts would be key. [166]

Sir Donald Cruickshank expanded on these points in oral evidence, stressing that the current account is so important to the bank because of our inertia, and their opportunities to sell on other products [...] breaking that hold, or rather making it absolutely clear that they had to serve you well, clearly and faithfully, would make a huge difference."[167]

112. When quizzed on the feasibility of account portability, Sir Donald Cruickshank referred to his time as regulator of the telecommunications sector, telling us that "number portability, which you all enjoy now in telecoms, was something that I drove through in the 1990s, first on the fixed line and then mobile."

    In each case the estimates of the cost were huge. You could get an engineer sitting in front of a body like this demonstrating how expensive it was going to be. However, if you drive it through, that same engineer is delighted to have the challenge and the costs are trivial. The engineers get at it, they are legitimised to get at the issue and in today's world they should be able to deliver it very easily. I would go further: they should be able to deliver it in ways that are cost saving for the bank, as well as service improving for us.[168]

113. We asked witnesses whether they agreed with Sir Donald Cruickshank that greater account portability could be a solution to problems around switching. Many of the so-called challenger banks, including Virgin Money were supportive. Jayne-Anne Gadhia said:

    a key issue from a transfer point of view, is, wouldn't you feel so much more confident if you could simply move your account number to me or to Metro and know that all your direct debits and standing orders moved with it? [169]

Ms Gadhia was dismissive of those who argued it was technically difficult or too expensive, telling us that "if we can give everybody a single National Insurance number, and we've been able to do that for decades—we can change everybody's telephone number whenever they want to change between phone providers—we should be able to change people's bank accounts". She concluded that such a change "would revolutionise the way in which the banking system worked".[170] Although Vernon Hill initially told us that moving accounts from bank to bank with the same account number was "a good idea", but "very unlikely to happen" due to differences in IT systems,[171] Metro Bank subsequently told us they believed account mobility was possible and was "a practical solution to providing customers more freedom of choice", adding that "we urge this option be explored."[172]

114. John Fingleton picked up on the analogy between telephone number portability and account portability raised by Sir Donald, stressing there was "an important difference":

    It is critically important with telephone numbers that everybody else knows your telephone number. Therefore, changing your telephone number is very costly: you have to change your business cards; you have to tell everybody; you risk losing contact with people you haven't seen for a while, and so on, when you change your telephone number. [...] you can function [...] without everybody you know knowing your bank account number, so the benefits of that and the costs associated with switching are slightly different.[173]

His conclusion was that "the benefits of having number portability here are probably lower than with telephone numbers." Mr Fingleton stressed that the cost of number portability also needed to be brought into the equation and that his "intuitive hunch would be that it could be very costly and not worth while doing it in the short term."[174] However, whilst saying that number portability wouldn't be his "top priority" in the "next year or two", he confessed that he was "attracted to it as a long-term vision for the market". Mr Fingleton sketched one possible way forward:

    if you said, "From 2020 or from 2025 that is what we expect", you might give the banks the time to make sure that the upgrades to IT systems that happen over the next 10 years move in that direction; so you set it as a longer term objective. That would be a much less costly way of achieving it.[175]

115. Others were less supportive of portability, arguing variously that the costs would outweigh the benefits, that it could be technically difficult, that consumers would end up picking up the tab, and that there were more cost effective ways to improve the switching process. Antony Jenkins admitted it was "possible to create a portable account number for customers", stressing "there was no doubt about that" and that "with enough time and money, the technology exists to do that". However, "the cost of doing that would be very significant—at least in the hundreds of millions, probably in the billions."[176] Mr Jenkins questioned "whether the benefit of improving the switching process outweighs the cost" and that the Barclays view "would be that it would not." Eric Daniels also acknowledged that it was "not beyond the wit of man to figure out a different system" but was also sceptical "that you would ever be able to justify that investment."[177] Stephen Hester also felt that the benefits of account portability, which he described as "the incremental ease of switching" would be "outweighed by the disbenefit", which Mr Hester said would be "massive".[178] Even Mr Higgins who thought portability "was the embryo of a very good idea" feared it would be very expensive."[179]

116. Helen Weir cautioned that such costs "would ultimately be borne by the customer".[180] Antony Jenkins also questioned whether the diversion of resources into developing a system of account portability would really be in the interests of consumers:

    in addition to the investment required to retool the whole payments infrastructure, there would be a massive opportunity cost in the deflection of technology and resources to that sort of activity, away from some of the innovations that I was referencing before in terms of branch refurbishment, mobile, internet, contact lists and so on.[181]

117. The technical way in which account portability is secondary: what matters is that switching should be simple and safe. Cut Loose considered that improvements could be made within the current system to "allow a customer to switch accounts without the potential for transactions to go wrong during the switching period." They explained how this could be done.

    As part of the existing switching mechanism, banks submit a request via BACS to the original bank to send details of the customer's Direct Debits and Standing Orders. This request could be used by BACS to set up a cross-reference holding both the old and the new Sort Code and Account Number details.

    When BACS routes transactions, they check the cross-reference and if it holds a new Sort Code and Account Number the routing is done to the new bank.[182]

Vocalink, the company jointly owned by the major UK banks and building societies which processes all BACS payments (Direct Debits and Direct Credits) told us in their written evidence said that the current system was working well.

    We believe the consumer inconvenience in switching banks has been largely removed by the ToDDaSO [Transfer of Direct Debits and Standing Orders] service, although there is potential for further innovation in this area.[183]

118. A supplementary submission from the Payments Council explained that:

    there is scope for reviewing the ToDDaSO service to see how it can be improved for customers and we will be working with Bacs, which runs the service, to consider this. Additionally, we will be proactively engaging with our members to see what further collaborative arrangements, beyond those under ToDDaSO could better facilitate the process of switching for customers.

119. The Payments Council also agreed that account portability would be considered although they pointed out that previously they had come to the conclusion that this was not the best way to facilitate switching.

    Whilst we have no reason to believe that the evidence that led the industry, as well as external commentators, to conclude that this was not the best way of facilitating switching has changed in any material respect, we will nevertheless commit to reviewing this again.[184]

120. There are other measures which could improve the switching process. Tesco Bank suggested a range of measures:

  • Penalties—the company forfeits payment for the month if they attempt to take funds from the old account;
  • incentives—league tables for the best/worst performers;
  • contractual liability to the customer—the Direct Debit payee is liable to pay damages for late transfer; or
  • enforcement through a central agency, possibly funded by Direct Debit payees, which would undertake the switching process on behalf of customers.[185]

121. Competition can only be effective if consumers feel confident in switching to new providers. Although there is evidence that the system has improved, the perception remains that there are still risks involved in switching, and levels of switching remain low. We believe it should be possible to find technical ways of making switching easier without excessive cost—one such suggestion has already been submitted by Cut Loose. We recommend an independent technical study should be done into how account portability could operate. There are also ways in which switching can be made easier without new technical infrastructure. These need to be explored more urgently by the regulator. This should include provisions that the provider, not the customer, should be penalised if things go wrong.


65   Q 48 Back

66   OFT, Review of barriers to entry, expansion and exit in retail banking,p 130-131, para 7.18, Table 7.1, November 2010 Back

67   Q 643 Back

68   Q 402 Back

69   Q 194 Back

70   Q 200 Back

71   Q 194 Back

72   Q 324 Back

73   Ev 202 Back

74   Ev 218 Back

75   Ev 228; The OFT's 2008 market study on personal current accounts estimated that banks generated revenues of £560 m from packaged accounts in 2006 Back

76   OFT, Personal current account market study, p 17-18, July 2008 Back

77   In Review of barriers to entry, expansion and exit in retail banking, the OFT cite a figure of £9 billion for 2009. This figure comes from Datamonitor  Back

78   Q 157 Back

79   OFT, Personal current accounts in the UK :An OFT market study, p21, July 2008 Back

80   Q 807 Back

81   Q 151 Back

82   Q 850 Back

83   Q 853 Back

84   Q 918 Back

85   Q 162 Back

86   Q 238 Back

87   Q 36 Back

88   Q 149 Back

89   Q 154; The figure of a price of coffee per week appears to come from adding the £35 net interest foregone figure to half of the OFT's £152 given that 50% of Lloyds revenues derive from charges, overdraft fees levied on consumers. This results in an annual figure of £111 per annum which roughly equates to a £2 cup of coffee per week. Back

90   Q 180 Back

91   Q 53 Back

92   Q 30 Back

93   Q 399 Back

94   Q 242 Back

95   Q 148 Back

96   Q 849 Back

97   Q 27 Back

98   Q 809 Back

99   Q 809 Back

100   Q 809 Back

101   Q 810 Back

102   Q 810 Back

103   Q 762 Back

104   Q 634 Back

105   Ev 177 Back

106   Ev 244 Back

107   Ev w22 Back

108   Q 810 Back

109   Q 781 Back

110   Q 763 Back

111   OFT, Review of barriers to entry, expansion and exit in retail banking, para 7.27, p 134, November 2010 Back

112   Q 762 Back

113   Q 764 Back

114   Qq 856-857 Back

115   Q 762 Back

116   Ev 188 Back

117   Q 55 Back

118   Ev 225 Back

119   Q 48 Back

120   Ev 181 Back

121   Q 988 Back

122   Q 991-994 Back

123   Q 995 Back

124   Q 988 Back

125   Ev 213 Back

126   Q 470 Back

127   Financial Times, Barclays chief calls for rethink on free banking, 3 December 2010 Back

128   Q 813 Back

129   Banesto, a Spanish bank, was Ms Botin's former employer Back

130   Q 755 Back

131   Qq 854-855 Back

132   Ev 218 Back

133   Q 755 Back

134   Ev 202 Back

135   Ev 202 Back

136   Council Directive 93/13/EEC, Article 4(2) Back

137   Q 759 Back

138   See also Q49 Back

139   Q 49 Back

140   Ev 176 Back

141   OFT, Review of barriers to entry, expansion and exit in retail banking, p 6, para 1.10, November 2010 Back

142   Ev 213 Back

143   Ev 412 Back

144   Q 223, Q623, Q452 Back

145   Q 222 Back

146   Q 322 Back

147   Q 410 Back

148   Q 635 Back

149   Q 642 Back

150   Q 752 Back

151   Q 622 Back

152   OFT, Review of barriers to entry, expansion and exit in retail banking, p6, para 1.10, November 2010 Back

153   Q 410 Back

154   Cut Loose are a niche consultancy advising potential new market entrants and helping existing banking organisations to expand their offering. Back

155   Ev w52 Back

156   Q 452 Back

157   Q 448 Back

158   Q 680 Back

159   Q 407 Back

160   HC 430 - viii, 16 November, Q 531 Back

161   Ibid. Back

162   Ibid. Back

163   Ev 255 Back

164   Ev 255 Back

165   Q 781 Back

166   Ev 237 Back

167   Q 127 Back

168   Q 130 Back

169   Q 678 Back

170   Q 680 Back

171   Qq 449-456 Back

172   Ev 248 Back

173   Q 816 Back

174   Q 816 Back

175   Q 816 Back

176   Q 624 Back

177   Q 230 Back

178   Q 329 Back

179   Q 408 Back

180   Q 172 Back

181   Q 624 Back

182   Ev w53, Ev w54  Back

183   Ev w7  Back

184   Ev w57 Back

185   Ev 213 Back


 
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Prepared 2 April 2011