Treasury Committee

Oral evidence: SME Lending, HC 204
Monday 21 July 2014

Ordered by the House of Commons to be published on 21 July 2014.

Watch the meeting

Members present: Mr Andrew Tyrie (Chair), Mark Garner, Teresa Pearce, John Thurso.

Questions 969-1004

Witnesses: Alex Chisholm, Chief Executive, Competition and Markets Authority; Dr Andrea Coscelli, Executive Director, Markets and Mergers, Competition and Markets Authority; and Dan Moore, Project Director, SME Banking Market Study, Competition and Markets Authority, gave evidence.

Q969   Chair: Thank you very much for coming to see us this afternoon. Can I begin by pointing out that it is somewhat regrettable that your publication has come out just before the hearing, so we have not had time to absorb it as much as we would have liked? Having said that, we are very pleased you are operating in this field. As a Committee, we have been vigorous for over four years, as was the Parliamentary Commission on Banking Standards, three of whose members are here today, in trying to get much more emphasis on the need to improve the consumer choice and to deal with consumer detriment through greater competition in banking. We are very glad you are operating, even if we did not have a chance to look in as much detail as we would like at your publication. To start, would you like to introduce your colleagues?

Alex Chisholm: Thank you very much, Chairman. We welcome very much the chance to appear before this Committee, the first parliamentary appearance of the Competition and Markets Authority, and also our first appearance, therefore, obviously before this Committee. As you say, the timing, which is a coincidence, is a little unfortunate in that we have published several hundred pages of a report on Friday, but hopefully the short note we sent you, which I hope you saw earlier today, will help a little bit. I will try to bring out some of the evidence in the report in giving answers to the questions you might have for us. Just to introduce my colleagues, on my left is Andrea Coscelli, who is our Executive Director for Markets and Mergers, overall responsibility for this as a market investigation among others; and Dan Moore, who is the project director particularly for the SMEs part of the study that we have been doing. He has been working in the sector for quite a period.

Q970   Chair: May I will read you out a recommendation of the Parliamentary Commission on Banking Standards, or a conclusion?  “The discipline of the market can and should be an important mechanism for raising standards as well as increasing innovation and choice and improving consumer outcomes. Effective market discipline, geared to the needs of consumers, can be a better mechanism for improving standards and preventing consumer detriment than regulation, which risks ever more detailed product prescription.” Is that an approach that the CMA recognises, accepts or supports?

Alex Chisholm: In a word, yes. We do agree with that statement and that would, indeed, describe quite well our own philosophy about the role that competition has to play in these markets. If it is helpful I can expand a little bit on that, Chairman.

Q971   Chair: You come from a telecoms background. You have been both sides of the fence. You have been a regulator in the telecoms field, haven’t you?

Alex Chisholm: Exactly, as well as doing this more broad competition role.

Q972   Chair: Has that given you anything you want to draw on in this job?

Alex Chisholm: Yes, I think it is useful to see the way in which competition and regulation can work hand in hand. One way to look at the problem is that regulation deals with the worst types of behaviours. It tries to rule out or protect us from the worst and also provides a framework within which market participants can operate, but it is competition that provides the pressure to provide the most excellent type of customer service, including from innovation as your previous statement said.

From my experience in telecoms, you can see how regulation can be either in place of competition or regulating for competition and, in our view, regulating for competition is the way to go. If you reflect, again from telecoms experience, how you move from a market of initially one and then two and a small number of players to a very diverse market with real emphasis on the need for the firms to compete with each other, most of what happens in the market is by the ordinary healthy interactions between firms trying to do the best possible job for their customers, not because they are being required to do it by regulation. That is one broad lesson.

There are some other very useful ones. One is that, when you are trying to get the market to work better, you can have some entry occurring, but until it reaches a real level of scale it does not provide the right kind of competitive pressure to change the behaviour of the most established firms. That was certainly the experience in the UK or Ireland where I was working before and in a number of other European countries. In mobile comms, for example, it was only after a number of years where the third or the fourth player got up to a level of scale and put so much pressure on the market leaders that they had to change their way of working. That points to the need for scale of competition.

There are also ways in which you can see how the regulator can facilitate the competitive process. Switching was obviously enormously important in opening up the mobile communications market. Again, something we might bring out here is the importance of switching between current accounts and potentially around account number portability. Also, we should consider the importance for consumers of being able to make meaningful comparisons between both the cost of provision, but also the service level you will get for that, and working with the grain of technology to try to get the most out of the market potential to try to help solve consumers’ problems, make it easier for them to manage their lives but also to delight them, if you like, with the falling cost of service and with new innovations, which have been such a feature. We would like to see some of those tendencies be more visible in the retail banking sector, a more positive impact from technology, and regulation or interventions from the market to help the market work better rather than in place of the market.

Q973   Chair: If you go back to the Cruickshank Report of well over a decade ago, as we did in 2010-2011 when we were looking at this, we came to the conclusion there had not been much progress. Would you agree with me it is something of a scandal that we have made so little progress, bearing it in mind that the problems you have just been describing and identifying have been around so long?

Alex Chisholm: I think there has been progress, but clearly not enough. It is also fair to say, when you look back over that decade, things were moving towards a better place from a competition point of view and then took a number of steps back because of the financial crisis. Certainly, that is very evident in the levels of consolidation.

Q974   Chair: What we are talking about here is millions of people paying more than they need for services, millions of people not having much effective choice because they do not even know how much they are being charged, millions of people trapped because of problems with switching or fear of problems with switching, and a level of concentration in the market that in many areas, particularly in the SME market, leaves many people beholden either to an effective local monopoly or duopoly situation. Have I said anything you disagree with?

Alex Chisholm: No, essentially not. I think you are right that both in the SME market and, as we cover in our report, in the personal current account market you clearly have low levels of satisfaction by comparison with some other sectors. In SMEs particularly, we were very struck by the research from Mintel in 2013 showing that only around about 13% of SMEs trusted their bank to act in their interests.

Q975   Chair: Bearing in mind the importance of a relationship between those two for the economy as a whole, it is a scandal in itself, isn’t it?

Alex Chisholm: Exactly. It seemed a very low level to us, absolutely. What you would expect in a healthy market is to say, “Well, if people are not satisfied with their current provider, they would be shopping around and going elsewhere”, but we have not seen that in this market, which is why we feel that these problems are quite entrenched. The switching levels that we have seen have tended to be around about 3% or 4% in both these markets.

Q976   Teresa Pearce: Twelve years ago, the Competition Commission study into SME banking markets identified a series of problems. That was 12 years ago. The CMA’s latest report raises the same problems, as has the Treasury Committee and the Parliamentary Commission on Banking Standards. Why has so little changed?

Alex Chisholm: I think there are probably a number of explanations for that. Essentially, I agree that not enough has happened and that is why we are proposing to bring about this market investigation reference, which does introduce for us the potential, if justified, to bring in new remedies that can tackle these problems, I will not say “once and for all” but hopefully very fundamentally if they are justified, and to do that with order-making powers. Some of the previous reports have only been able to make recommendations or advice. They have not had the capability that we would have in a second-stage market investigation to issue orders.

Having said that, we would like to have seen more progress than there has been. I suppose, reflecting on some of the factors that have been identified in previous reports, some of them have become a little bit better I think it is fair to say. One of the issues, for example, that has been identified in these reports has been around switching. The new Current Account Switch Service introduced last September in the personal market does seem to be making some inroads. It is not yet enough. We are not satisfied that it has changed the dynamic, but it has been growing quite considerably, around a 16% increase now. It has not yet moved into the SME market, so it is not making much of an impact there. Around about 11,000 small firms have switched under this new account switching service, which is not enough at all when you consider the backdrop of 3.5 million business current accounts. Nevertheless, it is good to see an easier switching service has finally been delivered.

Another issue where we see some glimmerings of hope would be around the credit reference data. That again has been typically identified in a number of these previous reports as being an important issue because it is difficult for new entrants and other competitors to be able to determine whether they would like to service a small business without knowing some of its previous history. Making the data available through credit reference agencies, as has now been legislated for, will help to address that issue.

Another very typical combination of issues has been if you are coming into the market, you want to become a new bank, what you have to do to get authorised and what the capital requirements are. Although it has taken a while, I think it is fair to say that the quite substantial review of that process of getting authorised, undertaken by the FCA and the PRA with encouragement from this Committee and, indeed, from the Parliamentary Commission on Banking Standards and the ICB, has brought about an improved procedure, as you can see by the number of firms who have gone through that process. Some of the feedback they have had has been positive about it, so we are genuinely encouraged by that.

The capital requirements are probably more of a work in progress. Some steps have been taken by the PRA particularly to reduce the imbalance between new entrants coming into the market and established players in terms of how you comply with the capital requirements. There has been a levelling of the playing field. That might have some further way to go and I think the PRA is looking to try to do that. We do see some encouraging signs there.

I would also like to say that, from the perspective of our observations of the banks, we do recognise that the banks have been trying to take some considerable efforts to improve their own performance and some of the banks do that extremely well some of the time, but overall we do not see enough evidence of a real transformation in terms of the customer responsiveness of this as an industry.

Q977   Teresa Pearce: One of the key things you said early on in your response was that previously all you could do was recommend, whereas now you have more power than just to recommend. Apart from that, are there any other reasons why you feel confident that we will not be still raising the same problems 10 or 12 years from now?

Alex Chisholm: There are some reasons, certainly. One is that I suppose the market context is different today from where it was five years ago. I think it is very noticeable, as I mentioned before, that in the financial crisis there was both a move towards a reconsolidation of the market with some players exiting the market, some being absorbed into larger organisations, and a pullback of international firms as well. The financial stress was also so great that, within the banks themselves, the ability for some to manage a real customer focus and innovative business was greatly diminished. You get some sense of that, for example, in reading the Independent Lending Review that was done on RBS in particular, of course the market leader for SMEs. So the market context has changed.

We are also encouraged by the potentially very positive impact of new technology. You can see very considerable growth in the use of online banking, including through mobile devices. Most SMEs now are using that very regularly. As well as being very convenient for SMEs, of course, when people are in the online environment it does encourage them to compare and see what else they can get with a couple of clicks, to be able to look at what other people are charging or what their service level might be. That opens up some good possibilities there.

I also feel, from the provider point of view, if your customers are engaged with you online it is very different from the experience of their coming in through branches because the banks are aggregating huge amounts of data from this about what the actual behaviours are. It is easier to do that, so potentially then there is the scope to be able to prompt the customers to manage their own affairs in an easier and more efficient way. For example, getting a text reminder to say, “Do you realise you are near to your overdraft limit?” or saying, “Are you aware that, although you are borrowing money from us in this account, you have a credit position in this account? Would you like us to transfer some money over there?” That is the kind of way in which you can use the technology to improve customer service. We do not see enough of it at the moment, but it does make us a bit more optimistic about some of the parts for the future.

Q978   Teresa Pearce: You are optimistic. If you are successful and we do not end up in 10 years with the same problems, what would the competitive SME banking market look like? What would you expect it to look like?

Alex Chisholm: That goes back a little bit to the opening question from the Chairman. In our view, a successful competitive market is one where the main reason why banks are improving their customer services is not out of a sense that they are choosing to do so nor that they are being told to do so by regulators or public pressure, but that they have to do so because if they do not do a better job of managing their own customers then they are going to lose the business. Their customers are going to go elsewhere. Their customers, on their side of it, feel extremely well informed about what their choices are. They feel reasonably powerful in that relationship with their banks, that if they are not getting service they can go elsewhere, and they feel that they have good choices because there are very diverse choices out there.

Q979   Teresa Pearce: That is one of the problems, isn’t it? People maybe do not switch banks because all the banks look the same and all the saving rates are the same and everything.

Alex Chisholm: I think that is exactly right and I am going to turn to my colleague Dan Moore because we did some research of the SME market with focus groups at the end of last year. Dan was overseeing that, so he can talk some more about what SMEs said to us in the course of that inquiry.

Dan Moore: Thank you very much, Alex. I think your point is very well made. The strong impression that we get from SMEs is that all banks are the same; that it is impossible to differentiate. I think that is something that is consistent both with the survey evidence we have seen but also directly what we keep on hearing from SMEs. There is absolutely a challenge of ensuring that SMEs have the right sort of information and can make effective comparisons. In our assessment, there are some differences between service levels and, in some cases, some significant differences between service levels and, in some cases, prices. At the moment, it is quite difficult for the average SME to be able to make an effective comparison so they can see those differentials. We think an important thing that needs to occur in this industry is that greater level of transparency, comparability and engagement on the part of SMEs.

Q980   John Thurso: I think my questions are probably for Mr Moore, but if anybody else wants to chip in, feel free. How big a barrier is concentration to competition?

Dan Moore: From our perspective, there is a real issue in that it is very difficult for any new or smaller provider to obtain substantial market share. It is very difficult to get customers to grow and then, because the large banks effectively have a large-scale business, the important issue is: can I grow as a new or smaller provider to try to be in a position to effectively compete with those providers? Concentration certainly gives the larger banks an advantage, which just makes it very difficult for the smaller providers to be able to compete on scale.

Alex Chisholm: Just to add to that, concentration in itself is not necessarily a problem. It is the combination in this market between it being very concentrated, particularly in Scotland and Northern Ireland but in England and Wales as well, with the fact that there are significant barriers to entry and to expansion. Then on the demand side there is quite a lot of inertia and a lack of shopping around.

Q981   John Thurso: The question I was going to was: is concentration the source of the lack of competition or is it merely a symptom? How should we be looking at it?

Alex Chisholm: We see them as reinforcing each other. One of the reasons why the market is concentrated is that there are high entry barriers and also, when you get into it, there are high barriers to expansion. It is hard for other people to grow to significant market share.

Dr Coscelli: In a sense, some of the satisfaction data we have showed that Handelsbanken, for instance, has performed much better than a number of other competitors, but they are growing quite slowly because they need to have branches and there is an issue about geography and density.

Q982   John Thurso: They are also quite picky, aren’t they?

Dan Moore: They are certainly pickier than the average provider. Sometimes we hear that Handelsbanken is an exception, that its satisfaction ratings are much higher. I know you had Shawbrook before you. There is the Co-operative Bank, which may have some difficulties, but certainly if you look at its satisfaction ratings among small businesses, it is very, very high. This is a more generalised pattern where those who have the highest satisfaction levels do not seem to be making that much progress.

Q983   John Thurso: I had to look this up because I can never remember what HHI stands for: Herfindahl-Hirschman Index, where something over 1,000 is reckoned to be quite bad and something over 2,000 is reckoned to be pretty bad. If we look at banking in Scotland, according to the chart on page 51, it is 3,216. I was about to say it was off the Richter Scale, but it is not; it is off the HHI scale. What you see there between 1999 and 2013 is that the third main provider, which is Clydesdale, which used to be 31%, has dropped to 14%. Lloyds Banking Group has dropped slightly because it used to be Bank of Scotland plus Lloyds, which would be 29%, and now the whole group has gone down to 26%. The Royal Bank of Scotland has gone up to 48%. You have half the market in Scotland in the hands of one provider. Can there be a circumstance when that is good for competition or not bad?

Dr Coscelli: The other interesting point we note in the report is HSBC and Barclays are very small in Scotland. Again, I think it is quite indicative of the barriers to expansion because obviously you have banks that have all the other assets they need to supply SMEs but they do not have the physical presence. They have played a limited role in Scotland.

Q984   John Thurso: For example, if you look at TSB being created—and, of course, we all remember the old TSB had quite a big presence in Scotland—it is going to have quite an impact. In the county of Caithness there will be two branches, which is quite something. Presumably, they have not yet started to get in much of the SME market, but as they develop current accounts they will start to develop SME accounts. Have you done any study on what that might do and what impact that will have?

Dan Moore: At this stage, we have not done a study on the particular position of TSB. In the SME sector in particular, I think you are absolutely right that their role is very limited. Even in Scotland where it does have more of a market share, we think it is going to be very limited indeed. In 2013, at the Chancellor’s request, we did provide advice on the overall impact of the state aid divestments and came to the conclusion at that point that the changes to market structure arising from the state aid divestments would be relatively limited. It was not going to change the market structure fundamentally, but then trying to feed that through into, “Does it ultimately result in better outcomes for customers?” we are not at that stage because it is just too early to tell. For example, we have not seen the initial indications as to how satisfied customers are with TSB, whether it is shaking up the market.

Q985   John Thurso: In a way, what you are saying is we have to just accept a concentration in the market for SMEs.

Alex Chisholm: I would not say that is our position. We see the concentration levels as being part of the problem. This is a complex, multidimensional problem. We want to work on all aspects of it and one of those is to make it easier for people to come into the market; one is to make it easy for people to expand in the market; on the other side of it, to make it easier for firms to make their choices, to make comparisons, to switch, or to lose their fear of switching. All these things should be reinforcing to each other to bring about a better dynamic, which I expect would be associated with reductions in the concentration levels.

Q986   John Thurso: What I am driving at is what you can do about it. I chaired the sub-panel on the Banking Commission that looked at Scotland and we had a very interesting day in Inverness. The Business Development Manager for Highlands and Islands for the Federation of Small Businesses told us that the banks take a “like it or lump it” approach to small businesses because the customers have no choice or very little choice and for me, your box on page 51 completely made that clear. Certainly, for my constituents coming to see me, it is not about, “Who do I choose as the best?” It is, “Can I get any of them to do what I want? Can I get any of them to give me service?” How can we, through you, tackle that feeling of what the banks are doing, that concentration?

Alex Chisholm: First of all, to recognise that the banks themselves recognise they have a problem with this. I know you have been hearing evidence from a number of them, but they have also come in to tell us as well separately about their own internal reform efforts and how they are going through a lot of change in the way in which they try to approach the SME market. Those who are already big in that market are trying to do a better job of looking after their customers.

You also have people coming into the market trying to expand their presence in relation to SMEs, both the people focusing on that as a particular area but also people who historically have been more in the personal current account market, such as Santander, are trying to use that to expand into particularly the smaller end of the SME market.

Then, of course, there are the alternative sources of finance and that opens up the market a bit more again because, whether it be equity finance or crowd financing or peer to peer, these extend the choices that are open. Of course, the Government has made some initiatives as well with the British Business Bank and other such things to give people choice from that source as well. These are all ways to try to tackle the problem.

We have been asked many times about whether the only solution to concentration levels is a break-up of the banks or so-called structural reforms. In our view, one of the merits of having a full market investigation reference is that you look at all the analysis of the issues. You decide, “That is where we think the biggest problems are,” and you decide which are the most justified remedies and those remedies are among the options that could be used.

Q987   John Thurso: Let me ask you about another area of perhaps problem in terms of competition, which is the ability to compare in a reasonable way. Again, on the Commission we found that, frankly, customers are often very ill-placed to make an informed judgment as to what is a real comparison between different products. Is this something you have found in the SME banking market as well?

Alex Chisholm: Yes, I think that has been a big feature. There have been some efforts again by the industry, with encouragement from Government and regulators, to try to improve the comparability there. The most recent example of that would be the Business Banking Insight initiative, which we think is very positive as far as it goes, particularly enabling people to compare the different service levels that are available now for SMEs from banks. It does not make it easier to compare prices. That is not really part of that particular proposition.

You may have seen, as part of our report, some of the banks said perhaps that is the next step. I think HSBC and others in evidence to you said that perhaps an enhanced price comparison website would help because there are quite a number of different dimensions to be able to compare. It is not just one figure, as you know. There are per item charges. There are sometimes standing charges per month. There are different levels of interest according to whether you have been authorised or not or how much you are borrowing. It is quite hard to be able to make a straight comparison between A, B and C.

We do think that electronic tools like price comparison websites can assist there, but it also does require the SMEs themselves to exercise their choice where it exists and to sometimes invest some time and effort in that. I know how difficult that is. I have been in business myself, particularly running small businesses. You are typically very busy and the amount of time and effort that you can put into analysing a choice like that is probably quite limited and you may not feel that you have a great deal of bargaining power with the bank that you are with.

Dr Coscelli: Just to add to that, we are doing quite a lot of work on pricing comparison websites in other areas as well. Our view is that price matters for comparisons, quality matters, and also some of the softer, more TripAdvisor-type comments are also important. Our view is Business Banking Insight is doing quite well on the service and has been very helpful on price. More can be done. It is quite complicated in this area, but certainly more can be done. There is also this third area, more TripAdvisor, more local, more comments, which can be very helpful for SMEs as well. That is another area we could work on.

Q988   John Thurso: It seems to me that part of the problem is that banking is not simply a commodity where one purchases. It is not like, “I am going to stay in this location. What is the best hotel or the best value or the cheapest?” or whatever and, “What bus will get me there?” and so forth. It is in part a utility and it is in part a relationship. The transactional side is you want fairness, which might be a little more expensive than somebody else, but if the relationships work, the utility is working. So it is a much more three-dimensional product than a straightforward box of chocolates or something.

Alex Chisholm: That is absolutely right, yes. Again, my impression is that the banking industry is having a bit of a self-inquiry about whether or not the current service model is as good as it could be. We were very struck by how some of them work on these very centralised models, which is very much the decisions are taken at the centre, which is good for efficiency and cost control and, no doubt, perhaps consistency and maybe concentrating expertise. Others are working very much to a, “Let us stay close to the customers. Let us devolve power to local branch managers to have the discretion to do that”. There is a degree of diversity in approach at the moment and they are obviously trying to recalibrate. They are seeing the same research that we are all seeing, which is that a lot of their customers are not very pleased with what they are getting.

Q989   John Thurso: Yes. One of the interesting things is virtually all the work we did in the Treasury Select and the Banking Commission put relationship rather than transaction, human contact rather than mechanisation, as the heart of the relationship, following which everybody wanted to do it themselves online, which is the conundrum. The BBA has just produced a report in which they said, “We are giving the customers what they want, taking the human out and we are making everything happen online”. Now, the cynic might say it is just a nice way of getting rid of costs. It does seem to me that, in getting to the heart of what is good competition, just being able to get it done more cheaply online than somewhere else without the human element in it is to miss the essential heart of the relationship that virtually everybody is looking to have with a bank, particularly an SME.

Alex Chisholm: I think that is exactly right, particularly in SMEs, because people feel that the banks should be there to support them. They should understand something about their business and should understand, even at a geographical level as a set of relationships, there is a community dimension to most small businesses and they would hope to have that from their bank. You mentioned the BBA has been giving evidence on that and I think, in their latest research just in June of this year, only 14% of SMEs do not use the branch at all.

Although the very same people are using the online thing in a very transactional, neat, convenient way, often in the evenings when the office or the factory is closed or you are not driving around, that does not mean to say they do not want to have the chance to go in every so often to a branch, either because you are handling cash or because you want some advice and someone who might have some idea about what your business is about and some relationship to draw on. Trying to find some way to be able to offer a complementary service for both the relationship aspect and the online aspect needs to be there.

Although First Direct obviously is in the personal current account market rather than SMEs, they have always had very high customer satisfaction levels and, of course, they have never had any branches at all. I think it is possible to offer a relationship if you invest very much in the training of your customer service representatives in the systems they have available and in the nature of the offer that you make.

Q990   Mark Garnier: I think it was you, Mr Moore, who mentioned about Handelsbanken being fairly picky. I want to pick up on that before I go into my main question. Isn’t it fair to say that, where you do have competition coming into the market spaces, competition is being directed at the area where there is good opportunity? If you are going to be an IFA, you want to go for rich family offices rather than people saving £50 a month. It is exactly the same in the SME banking market. Do you want to discuss a bit more about that? Is there good competition with the good customers and just bad competition with the bad customers? Is it as simple as that?

Dan Moore: It is certainly the case and, in fact, one of our big problems with the operation of this sector is that it is very niche based. We have seen new entry.  We have seen some new providers coming in, but they tend to focus on very narrow product groups, very narrow groups of customers, such that their overall wider effect is very limited on the market. When you look at some of the internal documents, for example, that we have seen from the big banks it is pretty clear that those smaller providers are “having a limited impact”. We think there is a genuine issue that competition where it occurs is limited. It is niche. It does not have a wider and broader benefit.

What we want to see is the ability for those smaller providers to more effectively acquire customers at reasonable cost so they can expand their offer if they wish to do so. One of the things that we have heard from a number of parties during the SME banking market study is, “Yes, we would be interested in expanding our customer base. We are competing where we have to compete at the moment. There are barriers. We want to expand out. We need to reduce some of those barriers if we are going to exercise an effective constraint”.

Q991   Mark Garnier: Again, do you want to expand on the barriers? Are you talking about the broad spectrum banks that are being restricted from going into certain areas or are you talking about the niche banks who are looking to expand?

Dan Moore: It is a mixture of both. There are smaller banks with a broader surface offering, and I am thinking of banks like Metro, for example. I am also thinking of banks such as even Santander, which in many respects is a very large bank but in some cases it is quite a narrow bank. Those providers are telling us that they have difficulties in expanding their offer to have more customers and to exercise—

Q992   Mark Garnier: Why is it difficult? Is it regulation or they just cannot find the customers?

Dan Moore: I think it is predominantly that they cannot find the customers. Switching levels are relatively low. For example, I know Metro has made a number of representations publicly about issues to do with the payment systems infrastructure, which now the payment systems regulator is there to address. There are issues about having an effective branch network, as Alex has already mentioned. Those sorts of things combined, perhaps not one is significant but you put all of them together and it is very difficult to grow beyond the niche.

Q993   Mark Garnier: The main bulk of the questions I wanted to cover was about the behaviour of the customers as opposed to the behaviour of the banks. I think you hit on something that perhaps is the other side of the story, and John Thurso has covered this a little bit, which is the reluctance of customers to switch. It strikes me that there are a number of different issues. Having been a small business consultant for a short period before I was elected, one of the things that struck me about it was the relationship between an SME and its bank is a very complex one. Chances are you have half a dozen different products. You have invoice financing. You have asset-based financing. You have an overdraft. You have a loan. You obviously have a current account. You have positive payroll services. You have lots and lots and lots of different services and, in trying to switch an account from one bank to another, you are not switching one service. You are switching huge amounts of services and if it does not go right, it undermines the whole of your business.

Alex Chisholm: I think that is, indeed, one of the anxieties that small businesses have. From that it follows for us that we need to address that anxiety by looking at the extent to which there is a dependence on all those different services. For example, if you are able to change your business current account but feel that you can continue with some of the other arrangements that you have in place with the bank, that would make it easier perhaps for you to switch. Indeed, we think it is important that when people are choosing, for example if they want to get asset-backed finance, they should feel free to do that from another bank than the one they perhaps have their business current account with.

At the moment the business current account seems to be very much a gateway product to other loans. One way to see more competition, more choice and more diversity in the lending market as a whole is to try to weaken the link between the business current account and some of the other types of financial services that people are getting.

Q994   Mark Garnier: In the case of the personal bank account market, of course, we have this “free in credit” banking model, which completely distorts the picture. I know that business accounts are not free or, generally speaking, not free but, none the less, I am sure they are deeply discounted from the true cost of running them in order to secure that business. I am not trying to be an apologist for the banks. I am trying to turn the argument slightly around the other way to open it up. Of course, a bank, having a relationship with an SME, in order for it to be able to effectively maximise what it can offer that SME, needs to know as much as it possibly can about the SME. If you have a situation where a business is looking for six different products and goes and picks a current bank account with one, an overdraft with another, asset-based finance with a third, invoice financing with a fourth, it goes around and comes up with a package, that SME will be worse off because no individual bank will be able to understand fully what is going on within the business because they are not seeing all the cash flow movement. Therefore, the SME will be disadvantaged as a whole.

Alex Chisholm: From our point of view, we would say, if there are indeed very strong economies of scope like that, then the evidence would be if people shop around, they look at the choices, and they find they are better off getting all six different services from one bank, but they should not have to do that because there is a tie there or it is bundled or the bank says, “You have to take this line and this line and this line in order to have the opportunity of me providing that service for you”. If there are, as you say, the efficiencies that come from having that range of different things then they would be evidenced in the market rather than by a bank insisting on it as an obligation for the SME customer.

Q995   Mark Garnier: Coming back to the level of understanding of the SME customer, I think it was the CBI that wrote to this Committee saying that just 25% of SMEs have a formally qualified financial manager and that 84% of small and medium-sized businesses did not consult external advisers before making a decision.

Alex Chisholm: That is right, yes.

Q996   Mark Garnier: Now, if you are the proverbial widget manufacturer, what you do not necessarily understand is the machinations of banking relationships. It comes back to this point again. What can be a separate selection of different products can individually be worth XYZ, but two together from one provider might be worth considerably more than the one and another from a third provider. By the time you start battening down to that type of thing, you need somebody who is pretty good at numbers and money to be able to understand exactly what is going on. How do we get to the situation where the SMEs are going to be in a position where they do understand what is happening and, therefore, make informed choices?

Alex Chisholm: We are not opposed to bundling. Bundling can give great efficiencies and also convenience to SMEs, but it is tying that we object to. It is not always easy, undoubtedly, to make these choices and I think you are right that, from our perspective, one of the reasons why we see retail banking as being personal current accounts and SMEs is that, from the customer point of view, they behave in very similar ways in that a lot of small businesses are, as you say, very small. They do not have staff to do a lot of financial analysis. They do not have much time. We have to make it much easier for them to try to make those choices.

Things we have mentioned before like price comparison websites and service comparison websites are part of that, but the other way, of course, is the customer engagement comes from much more competitive intensity on the supply side. If you have a lot more rivalry between firms then they find ways to make it easier for people to make those choices and to take an interest in the alternatives that they offer. You do not see enough of that intensity at the moment.

Q997   Mark Garnier: Possibly because they are competing among each other for the sexy customers and the mass market, which possibly has more cyclical businesses that may become problematic over a cycle and are less attractive. So they are quite happy to not compete for that area, whereas they are competing elsewhere.

Alex Chisholm: I think there are strong linkages between the markets as well. For business current accounts, we see well over 50% of them are with the bank that the SME previously had a personal current account with. So they have just carried straight across that relationship. They have not considered the alternatives very widely. With the business current account then you are very likely to take out your term loan or your overdraft with that same one. A lot of the decision points that could be within a wide, competitive environment you just carry straight on with where you started without a great deal of thought in selection. We do not want to run too far ahead of ourselves because we are consulting on a possible reference, but I am sure if it gets to the stage of an independent panel group looking at it, if they looked at that factual scheme of reference and said, “How do you deal with that?” you could introduce various prompts or reminders or ways to introduce more competition at those decision points.

Q998   Mark Garnier: Briefly, as part of this and trying to help switching, obviously the payments regulator is looking at doing this investigation into account number portability in whatever form it may or may not take. There seems to be a bit of confusion as to people understanding necessarily what it is. The debate about this is not just about moving accounts, something better than the Current Account Switch Service, the seven-day switching service, to something that would be overnight, but now the debate is widening to having Know Your Customer, money-laundering reporting data and that kind of stuff being transferred across as well and possibly even having a standing orders and direct debit mandate database centrally so you do not have to worry about where your money is arriving or being taken out of. Do you think there is a case that the payments regulator should widen this to start looking at this type of account portability that could work with SMEs so that if you are going to look at this switching, it can take into account things like overdrafts and other sorts of arrangements? It could be where you have a central database where that could be transferred relatively easily in order to make the whole process of switching a lot easier.

Alex Chisholm: It is right to look at ways to improve switching to make it easier to build people’s confidence in it. If people are not switching because they are not aware of it then you can make them aware of it. Obviously, there is more that could be done there. The CASS, the Current Account Switch Service, was mainly marketed on the personal market. I think they could push that much more strongly to SMEs. If the awareness issue is then addressed and people are still not doing it, it is likely to be either it is difficult to do or there is anxiety about it. You can build people’s confidence by saying things like, “Why don’t we allow a parallel running period between the two accounts of three months or so? If you are worried that you might be getting some payments in and you have not managed to communicate effectively to every one of the people paying into you”, which obviously would be a concern for an SME, “then you could have a period to say, ‘All right, I can see that I have had three months and nothing is coming in. We have obviously captured the whole thing’”. One could take some steps like that.

Whether you need to be able to port the entire account number I think is something to be weighed up. We note that it was a recommendation of this Committee before and we think it is good that the FCA has committed to weigh up the costs and the benefits of that. They said they would do that from September, so I think it is excellent it is being addressed. We have a pretty open mind as to whether or not the costs would be justified by the benefits at this stage.

Q999   Chair: If you look at this sector as a whole, and we have been looking at it on and off for four years, taking everything in the round, we have just had a litany of terrible stories told to us by our constituents and they just keep coming and in the wholesale markets, too. We had the forex investigation announced only today. One of the problems, particularly in the retail side, has been that there is not enough competition to drive up standards and provide greater choice for consumers and that means millions of people out there are getting a raw deal as a result. This has been evident for years, decades, and we have finally had enough and we want to see some action. You are a new body and we want you to deliver some action. I realise that it is very early days, but you are beginning to see, as is evident from your report, the scale of some of these challenges. Are you able to say anything that can give us any comfort or confidence that you are going to be able to make progress where others have failed? Teresa was asking a similar question only half an hour ago.

Alex Chisholm: From the CMA’s perspective, we started in existence with our full powers on 1 April but we had a little transition period before. In approaching what our role and priorities should be one of the first things we did decide was to prioritise the banking sector. We took the work that the OFT had been doing in relation to SMEs. We looked at that and we said, “That is promising. That is clear and we need to bring that to a head to a point of decision in a very timely way”. We did that within three and a half months of launching. Furthermore, we said, “How about the personal current accounts? Those seem to be very similar types of issues, both on the supply side and on the demand side”.

Q1000   Chair: That is what we said in our report in 2011.

Alex Chisholm: Absolutely. We essentially agreed with the analysis of that. We needed to look at retail banking in the round. We said, “What is happening on that?” They said, “We are reviewing the PCA market in September”, which would be one year after the full introduction of this Current Account Switch Service. We described this in March, in the statement we put out at the time. We brought that forward to make sure that we were able to look at retail banking in its entirety, both SMEs and PCAs, because we saw big similarities and big linkages between the two. That is why we have been able to make the recommendation that we put out on Friday to say we want to do a market investigation reference of the entire retail banking sector. It is a two-month consultation. We obviously need to test the quality of our thinking and our analysis and hear from all sides. Indeed, that is also a requirement of the statute, but we said we will decide in autumn to reach a final decision and we have put out what our proposal is to do that.

Dr Coscelli: The other important thing we say in the report is that there are a number of the existing initiatives done by Government and by industry that we think are helpful and are going to make a difference. We think things are going to improve and our view is that these are unlikely to be enough, which is why we think we should do a phase 2 investigation. The phase 2 investigation is going to build on a number of things that are going to happen. It is not going to be a case of no action between now and the end of our investigation.

Alex Chisholm: Yes. Indeed one of the benefits we envisage in that second stage market investigation reference is looking at a number of these schemes to improve the way credit reference data are available, to make it easier to come into the market through the authorisation process, the changes to the capital requirements, some of the improvements that might be made to switching, to the payment systems, plus the industry’s own self-help innovations and improvements to make it easier for people to compare the prices, to compare the service levels and to improve their own customer service.

A whole raft of things need to be looked at in their entirety with an assessment about are they delivering, are they getting to where we want to be, which, as you said at the outset and which we entirely agree with, is a competitive and vibrant market and one in which it is the competitive dynamic that is driving the further improvement rather than the efforts of a parliamentary committee or a public body like ourselves.

Q1001   Chair: In various capacities, Parliament has empowered regulators to be much more vigorous in dealing with some of these malpractices and the concentration in the market and the lack of a good consumer offer as a consequence. The regulators tell us that they have the powers that they need now, but the regulators themselves are also a vested interest in all this, aren’t they? The prudential regulator has his eye primarily, understandably enough, not on competition but on a different objective, which is the overall safety and security of the banking market. The conduct regulator inevitably is likely to find it easier to introduce rules that may ultimately restrict competition and reduce the number of players because that market then will be easier to regulate and supervise at a conduct level. Therefore, there is a tension, not to say a conflict of interest, operating there. You are one of the very few people who can hold the ring in all this. Can you give us any comfort today that if you encounter any problems dealing with this you are going to come to Parliament immediately and explain the difficulties that you are encountering?

Alex Chisholm: Thank you very much. First of all, I think it is tremendously important that the FCA and the PRA now have a competition duty. I know that this Committee played a big part in that and we entirely support that.

Q1002   Chair: It was not easy securing it. There was a good deal of opposition to both.

Alex Chisholm: I think that makes a huge difference because these are big, powerful, sophisticated institutions.

Chair: Not least from the regulators.

Alex Chisholm: I would not know about that. Most importantly, if they feel that it is their own statutory duty to do this, and one of the top three objectives now for the FCA is to promote competition, they are going to take that very seriously and they are doing it because they need to themselves, not just because of external pressure from a body like ourselves. We are very much in favour of that.

It also means when you encounter a situation where you can see customer interests are being harmed or something is not working out well, rather than always reaching for the regulatory hammer, so to speak, and saying, “What I need is a new rule here”, then with the competition duty they can say, “Perhaps this is a problem that the market can take care of. What can I do to get the market working better here?” To be able to weigh up those two different options to decide which instrument to use is an essential thing for both of those regulators and mirrors the good practice that has been introduced in other sectorial regulators. Where is our role within that? Well, first of all, this is new for them. We have to recognise that they are on a journey. Competition thinking is not traditionally drummed into a financial regulator.

Q1003   Chair: It is not in their bloodstream.

Alex Chisholm: It is not in their DNA, so they are learning a new set of skills. Our strong impression from a lot of dialogue is that they are taking it very seriously. They are both hiring people and training people internally. They have made changes right across the organisation, including bringing competition expertise on to their board. They have also engaged very much with us through the UK Competition Network, which the Financial Conduct Authority is a member of. Even though they have not yet got their full competition powers, they are a full member of that. We are making sure that we both share what is good practice in the competition space, whether it be a market study or an enforcement action, but also, yes, ultimately, as you suggest in the way you framed your question, we are a pressure on them as well to say, “Look, is this the best you can do?” That is a necessary and desirable force because there is always a risk for the regulator to feel that they like the rule they have made and it is justified. In a way, to have somebody externally as well as internally challenging that sometimes and saying, “It may be good in itself, but what is the effect on competition? Is there another better way to achieve your objective?” is a very productive and necessary dialogue.

Dr Coscelli: Our predecessor body, the Competition Commission, who were doing the phase 2 investigations in markets, has a history of essentially coming to a view on whether the balance of competition and regulation was the appropriate one in the market. You might remember the case of the disposal of the London and Scottish airports, which was in the face of an initial view from the CAA that regulation would have been sufficient. There is a history of independence in the phase 2 assessment in trying to work out what the right balance is. As Alex says, I think that both the FCA and the PRA are working hard to get the right balance in these areas, but if we ended up with a market investigation reference this would be one of the issues that we would be looking at, whether the balance is right.

Q1004   Chair: Thank you very much for coming in this afternoon. Treat it as a preliminary hearing and also an opportunity for you to put your case forward. We have spent most of our time talking about the banking market. We are in the market for ideas in how to get a better deal for millions of bank customers out there and SMEs who feel, often with justification, that they have had a raw deal. We are hoping you can do something to help.

Alex Chisholm: We share your sense of mission very much.

Chair: Thank you very much indeed.

              Oral evidence: SME Lending, HC 204                            2