As the battle to contain the financial crisis winds down, the
eagerness to return to more normal business conditions is palpable.
But it is not just banks that yearn to put the crisis behind them.
Bank regulators, too, are eager to pick up where they left off.
For most of the past two decades, the predominant objective of
regulatory action in the UK has been to spur competition and
deliver value for bank customers. Now regulators want to refocus
their energies on that goal, partly because through bank closures,
government takeovers and forced mergers, concentration in the
banking sector has increased significantly. The six biggest banks
have increased their total holdings of retail deposits from 66 per
cent to 77 per cent, raised their share of personal current
accounts from 85 per cent to 91 per cent, and lifted the proportion
of residential mortgages they underwrite from 64 per cent to 78 per
cent. Continued consolidation, regulators worry, can disadvantage
savers and borrowers and leave taxpayers on the hook to bail out
banks that grow too big to fail. But how regulators go about
balancing stability and competition will have major implications
for banks, their customers and the broader British public.
Earlier this year, the government charged the Independent
Commission on Banking with the job of threading the needle between
minimising systemic risk and promoting competition. As the
Commission itself acknowledges in an Issues Paper it released in
late September that lays out reform options it is weighing, these
are challenging objectives to reconcile. Measures that aim to
increase stability could result in fewer large banks. Credit may
become less available to borrowers as banks shrink their assets to
reduce leverage and shore up their capital base. In the end, the
pursuit of stability could cause banks to feel less pressure to
innovate and improve the customer experience.
But policies that promote competition by encouraging new
entrants and even splitting up the big banks could compromise
stability, leading to smaller and even weaker banks. As competition
intensifies, history says that banks are more likely to misprice
risk and increase their need for wholesale funding. They will also
be disposed to rely on leverage to boost returns on equity.
In our view, simple economics dictates that regulators, to the
extent that a choice needs to be made, should focus on measures
that reinforce stability. Bain & Company calculates that the
cost borne by taxpayers from an unstable banking industry is more
than £1,000 per annum per head-mainly as a result of reduced
output and higher unemployment. By contrast, regulators inclined to
view the UK banking market as insufficiently competitive would be
hard pressed to identify the cost of this to customers as more than
£200 per annum per head. Those taxpayers and customers are,
broadly speaking, one and the same.
The good news, however, is that it is possible to have both
stability and competition without adding large numbers of players
and fragmenting the market. Analysing banking markets in 30
countries, we discovered that the most stable outcome that best
serves consumers is to foster competition among a smaller number of
diversified banks, and that the incremental benefits to consumers
from increasing the number of leading players diminish rapidly.
The experience of Australia and Canada, both countries that
weathered the global banking crisis without having to resort to
government-financed bank rescues, is relevant to the UK. Both have
concentrated banking markets that are closely monitored by
regulators to ensure that banks meet adequate capital standards,
maintain healthy reserves and steer clear of risky activity. Yet
banks in both markets earn customer loyalty scores that equal or
exceed those in the UK. In Canada particularly, banks have achieved
profit growth by focusing on customer service and improving the
customer experience.
Whichever course UK regulators choose, banks cannot afford to
relent on competing aggressively to win more business from their
customers. UK consumers are not willing to park their funds with
just one bank, but make active financial product choices across a
wide range of providers. Today the foundation for sustainable
future growth is shifting to customer loyalty, higher
customer-retention rates, relationship-based pricing and a richer
customer experience.
Key contacts in Bain's UK Financial Services
practice:
United Kingdom:
Mike Baxter in London
John Ott in London
Matt Symonds in London
