What will make banks care about their customers?

Yesterday I gave evidence to the Parliamentary Commission on Banking Standards, on competition (lack of) in retail banking – alongside two distinguished former competition regulators, John Fingleton and Clare Spottiswoode. The transcript will be published later. My message was that banks are mistaken when they say they are competing vigorously with each other – just look at the cut-throat rates on offer in the ‘best buy’ comparison tables. My experience on the Competition Commission for eight years taught me that big firms always regard their competition as intense but they can’t distinguish their intense oligopolistic rivalry from a competitive market. That intense – often loss-leading – rivalry over a narrow range of goods for a small group of customers is cross-subsidised by high margins on other extensive areas of business. (Indeed, you can tell what the banks think of the small group of mobile customers they are competing over from the fact that the industry term for them is “rate tarts”.)

Most bank customers are inert. Switching banks is a huge hassle. If it goes wrong, the consequences are an even bigger hassle, causing enormous potential disruption to bill payments and so on. The only alternatives available will be just as poor in terms of service quality or rates offered. The lack of switching and the cross-subsidies between different groups of customers are clear signs that competition in retail (and SME) banking in the UK is inadequate.

Understandably, there has been a lot of focus since the crisis on tougher regulation. But regulation alone will not improve things for customers. If you rely on regulation to improve service standards, banks will focus on their regulators. It will take competition to get them to focus on their customers. Indeed, more and more regulation will make it harder to get new competitors into the market, and the regulators are not sufficiently focused on using competition as a tool to achieve their aim of improving consumer outcomes – after all, regulators regulate. Competition works indirectly but it is a powerful force for serving consumers, and in particular for innovating and anticipating customer needs.

There is a good example in the Competition Commission’s decision to break up the BAA airport monopoly. The counter-argument was that there are economies of scale, and it’s a complex business, with break-up disruptive and uncertain. But who would have predicted that after the divestment, Gatwick Airport proved able to clear the unexpected snow off its runways quickly and efficiently in December 2010, while Heathrow, still in the hands of the old monopolist, was paralyzed for days?

I’ve not quite finished Anat Admati’s and Martin Hellwig’s The Bankers’ New Clothes. It’s absolutely excellent at skewering the bogus claims the banking lobby makes about the consequences of increasing equity requirements and limiting bonuses. It addresses regulatory issues.

What it doesn’t do is consider the competition question. Indeed, in all I’ve read about the banks in recent years, competition issues have been overlooked. There is a misperception that “too much” competition contributed to the crisis, I think, but that’s to make the same mistake of confusing a competitive market with oligopolistic feuding in some areas. The empirical evidence is mixed but leans firmly towards indicating that more competitive banking systems are more stable – the banks tend to be smaller so the “too big to fail” problem is less acute, and smaller banks are simpler so regulators (and their boards) can monitor them more easily.

The Parliamentary Commission on Banking Standards was, though, clearly well aware of the importance of increasing competition and new entry. More power to their elbow.

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5 thoughts on “What will make banks care about their customers?

  1. A question for you, given all your experience in this area:

    How many new entrants (or fragment breakups) do you think will be required to actually make a difference in the banking market?

    In electricity we have a Big Six oligopoly instead of the Big Four in banks – and service levels look very similar. Likewise, before the financial crisis, there were a number of smaller building society (some in name only, actually banks after buyouts) competitors – but that didn’t do much for overall service levels, although there was a greater level of rate competition.

    • There isn’t a particular right number. The key is the potential for new entry, and therefore customers being competed away. If there’s no dynamism, it doesn’t matter whether there are four, six or ten incumbents. However many or few there are, they need to feel vulnerable.

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  3. Hi Diane – this is a great post (and I very much appreciate this blog more generally). May I ask if there are any studies/inquiries you are aware of that substantiate this idea of cutthroat competition for the most mobile banking customers (and most easily compared product lines) but slacker pricing for inert customers? The idea seems plausible and important.

    • Thank you for the kind comment. I was drawing on my experience in writing this. The OFT and Competition Commission inquiries into aspects of retail banking highlight the prevalence of cross-subsidies between different groups of customers, always a warning indicator for a competition regulator. However, I’m not aware of any academic research into this specifically. The academic literature would cover the general issue of predatory pricing, I just can’t bring to mind any examples in the context of a retail banking oligopoly.

      At the Banking Commission hearing in Parliament, all three of us from competition regulatory backgrounds were unanimous in recommending that if the retail banking market in the UK is not significantly more competitive in a few years’ time, a full market inquiry by the authorities would be needed.

      Maybe new entry will succeed – the FT this morning has some interesting background on Handelsbanken in the UK: http://www.ft.com/cms/s/0/e695b88e-5d5a-11e2-a54d-00144feab49a.html#axzz2Hw1u9yHu