Submission from VocaLink (S047)
· VocaLink operates at the heart of the UK payments system.
· It is vital for UK competitiveness that the banking industry finds a governance structure which enables the common infrastructure to be developed more flexibly and quickly, with a view to enabling new entrants to join the market.
· A coherent blueprint for future growth and development in the banking sector needs to emerge from the various strands of regulatory review currently taking place.
· The pace of change in retail banking has been slow. This is because banks have focused more on investment banking; consumer demand has been for the improvement of existing services rather than for innovation, and retail banking appears to be commoditised; and banks themselves have placed more emphasis on cross-selling to existing customers than seeking new ones.
· In any case, customers have not found it easy to switch their account from one bank to another.
· When change is contemplated, it often takes a long time to agree and to implement.
· Proposals for reform include: the way in which the agency bank model works in relation to new services such as Faster Payments; a pre-funding model to counter the disincentive effects of the collateralised loss-sharing agreement on participation in the Faster Payments Scheme; and the introduction of different classes of membership to facilitate the involvement of new entrants.
1. VocaLink welcomes this opportunity to contribute to the deliberations of the Parliamentary Commission on Banking Standards. This submission focuses primarily on how to inject more competition into retail banking (4(a) of the Commission’s Terms of Reference).
2. VocaLink is a specialist provider of payments services to banks and the wider financial community, with unique experience and capabilities. VocaLink processes domestic and international automated payments, supports clearing and settlement, and provides ATM switching for around 60,000 ATMs. In 2006, VocaLink replaced a 30-year-old payment system with a robust, innovative platform. VocaLink’s real-time payments platform went live in 2008 and is the central infrastructure for the UK Faster Payments Service. Building on all of this, VocaLink is now poised to deliver an international Immediate Payments solution, and is working with the UK payments industry to deliver the Mobile Payments Common Infrastructure Platform.
3. VocaLink’s role, at the heart of the UK’s payments sector, is to provide the central, common platform on which banks and building societies can base their differentiated consumer propositions. This platform has proved its worth over the past forty years in terms of operational security and resilience, and it is important to consider how this infrastructure can best be leveraged to enhance the banking sector and in particular to foster growth and competition. VocaLink’s contention, broadly, is that it is vital for UK competitiveness that the banking industry finds a governance structure which enables the common infrastructure to be developed more flexibly and quickly, with a view to enabling new entrants to join the market, bringing with them innovative products and ways of working which will benefit consumers and the UK economy. Conversely, allowing the governance of the infrastructure to stagnate would render nugatory any other measures taken to promote competition in high-street banking.
4. As the provider of infrastructure, rather than being involved in providing commercial services to consumers or in the financial markets, VocaLink is not directly concerned with many aspects of this Commission’s Terms of Reference, nor with many of the other developments in financial services regulation and legislation which are currently in progress, with the exception of the Treasury Review of Future Payments, on which a consultation is currently taking place. However, from a VocaLink perspective, many of these developments – including the Financial Services Bill currently before Parliament, the Banking Reform Bill expected later this year or early next, the OFT inquiry into current accounts and the work of this Commission - are inextricably interlinked. It would benefit everyone, including the banking sector which VocaLink serves and the payments sector of which it is a significant and integral part, if the complementary nature of these different developments could be borne in mind, so that what emerges from this period of considerable (and undoubtedly necessary) change and upheaval in the UK financial services industry forms a coherent blueprint for future growth and development.
Competition in Retail Banking
5. On the face of it, customers’ experience of retail banking has changed considerably over the past thirty or forty years. Mostly this has been linked to technological change – for example, the introduction of online banking, the easy availability of cash through ATMs and the decreasing use of cheques and cash in the face of the switch to debit and credit cards. But on the other hand, comparing change in retail banking with the overall pace of change in technology, or, closer to home, with the speed of developments in the investment banking sector, it is clear that retail banking has practically stood still. Retail banking has essentially responded, often quite slowly, to change elsewhere, but its own internal development has been largely frozen.
6. It might be argued that the pace and scale of change in the investment banking sector has in part led to some of the problems which beset the industry today. But retail banking is at the other end of the spectrum. The Big Four may (just about) have become the Big Five, but they continue between them to control around 90% of the volume of transactions.
7. In VocaLink’s view, the slowness of the sector to embrace new entrants and accordingly to innovate in product development has come about not through any deliberate intent but for four main reasons. First, the attention of the banking sector in the world of unified investment and retail banks has been on the more glamorous and (potentially) profitable arena of investment banking; retail banking has to some extent become the poor cousin. Secondly, in a sense, consumers have not known what they might be missing and therefore consumer pressure has tended to focus on elements of the existing set-up which are felt not to be working in consumers’ best interests: account charges are one obvious example, the availability of free-to-use ATMs has been another. In this context, it is also worth bearing in mind that as an industry retail banking has to serve a very large customer base, many of whom have a small ‘c’ conservative view of how banks and banking should operate. The furore over the proposal to phase out cheques was one graphic illustration of this. Thirdly, the lack of innovation in banking has become self-reinforcing: as all bank accounts seem pretty similar, there is a view that retail banking services have become commoditised, and differentiation has tended therefore to focus on relatively minor aspects of service rather than offering anything fundamentally different or innovative. Finally, banks have focused strongly on selling other products and services beyond traditional current accounts to their account-holders, rather than competing for new business.
8. This sense of inertia in the marketplace has been reinforced by the perceived difficulty for consumers of changing their bank. With the introduction of easier account switching next year, this situation should improve. But in VocaLink’s view, there will not be really significant change in the retail banking market unless the governance structures of the industry are seriously overhauled. For the reasons set out above, the market has been slow to change and innovate. This has meant that the structures in place forty or more years ago, when the Big Four emerged from the period of banking consolidation, have remained largely intact. The banking sector retains some of the attributes of a gentlemen’s club: change, if it occurs, is slow; decisions are by consensus and taken at the pace of the slowest; the membership list is maintained by the existing leading members; and the committee is made up of busy people who all have other jobs to do.
9. When change is agreed, it tends to take too long to implement and to roll out to all those who might benefit from it. Faster Payments, for example, which VocaLink operates, is proving very successful and volumes are growing rapidly. But in truth it took a long time for the industry to decide to proceed with it, and even now it is not as accessible as a scheme as it should be to some of the smaller players (who have to be sponsored by an existing member in order to participate – indirectly - in it). What could have been a revolution in the payments sector has instead been replaced by incremental growth at a pace moderated by the controlling interests.
10. The introduction of a mobile interbank payments infrastructure has been another case in point. It has taken so long to get off the launch pad that individual banks are now producing their own solutions, which brings with it the risks of lower interoperability, higher industry costs and an overall disbenefit to UK plc. The specification for the mobile payments infrastructure is still not fully determined. At one level, this may appear to be an example of the banks competing with each other to innovate; but in fact it is a symptom of failure, because without a common platform only the big players will be able to compete in this market.
Recommendations for Reform
11. Access to the central payments infrastructure is one area that should be considered for reform. Whilst the agency bank model (in which a member agrees to act as an agent for a non-member) works well for Bacs, after four years operation there is still extremely limited agency access to Faster Payments services directly. This may be due in part to the technical complexity of building or purchasing a gateway and then integrating this to the bank’s back office systems, which has led to VocaLink developing a managed service access to Faster Payments. However, we believe that technical considerations are a secondary concern.
12. One disincentive to any bank considering membership of the Faster Payments Scheme is the way that banks fund their participation. The system works on the basis of "Deferred net settlement" with three settlement points a day. Between these settlement points, banks will be either in credit or debit to the system. To ensure that the system is protected from the failure of a member, each member bank is set a ‘Net Sender Cap’ (NSC), i.e. a debit position to the system that cannot be exceeded. The system is protected by a collateralised loss-sharing agreement, to be called on in the case of the failure of a member bank. The loss collateral is funded by members pro rata to the size of their own cap. Thus all members are obliged to provide security collateral, and asked for more if the largest member increases its volumes through the service. We believe a more open and equitable route would be to remove the loss-sharing agreement and require each member to pre-fund their settlement accounts. They would then only be able to operate if the sum of their settlement pre-funding, plus inbound transactions less outbound transactions, is greater than zero (i.e. in credit). Such an arrangement would be more transparent to operate and, without unnecessary contractual agreements and collateralisation, simpler to sign up to and administer.
13. Further consideration should be given to the ‘rules of the club’ that govern membership of the scheme. These rules exist for a reason but a consequence is that smaller players and new entrants find them overly onerous; we believe that additional classes of membership, conferring access rights but with fewer obligations, would encourage wider participation, promote competition and stimulate innovation.
24 August 2012