A radical upsurge in new business starts and SME expansion is key to turning around Britain’s economic prospects. Already, 99.9% of enterprises are SMEs who create 60% of private sector employment… and there are half a million new start ups every year. But for the radical upsurge we want to see happen, the structure of banking needs to become more competitive and responsive to customer needs in this critical segment.
One way to achieve this is by creating a more competitive environment for banks. As far back as Adam Smith in ‘Wealth of Nations’, he argued that for enterprise to flourish there needs to be free entry and free exit in the market place.
In the banking market, barriers to entry have increased significantly over the last 15 years as banks have merged and consolidated (Metro Bank is the first bank to be given a full UK banking licence in 100 years!). And as we know to our eye-watering cost, there are huge barriers to ‘exit’. Banks have been deemed ‘too big to fail’ and this implicit taxpayer guarantee has been enormously lucrative to the sector. (A Bank of England research document showed that the implicit guarantee provides a reduced cost of funds to banks amounting to £100 billion pounds a year!)
Since the financial crisis an already concentrated UK banking market has become even more so. And SMEs have felt a lot of the pain. Project Merlin will help, I’m sure, and in the last couple of months new loans to SMEs have risen slightly. But still SME lending to the ‘smaller’ end has dropped some 19% between 2009 and 2010, and only slightly less in the ‘larger’ end. Not only that, but loan spreads over base rate have risen on average by around 60 basis points between November 2008 and 2010. And it’s not just price and availability of funds that cause problems. It’s also the term of loans and the arrangement fees that have, for many, also worsened.
Of course, the financial crisis itself is to blame for much of this – banks still have big bad debt portfolios and are more risk averse than before. They also have to meet stringent new capital rules. But there can be no doubt that part of the squeeze is because SME lending is dominated by the 5 big UK banks. Not a monopoly, but also very definitely not highly competitive.
A good example of how SMEs are struggling is that of a business in my constituency of South Northants that has been going profitably for 25 years. It’s a property investment company that banks with one of the ‘bailed out’ banks. Since the crisis, they have tried to move bank to no avail; they have tried to roll over their loans with their existing bank and have been offered unacceptably expensive terms. In the end, they have decided to wind down the business. At no time have they failed to meet their loan to value ratios.
I think we have a one-off opportunity in the UK to radically change the competitive outlook in the banking sector. The taxpayer, through UKFI, owns 100% of Northern Rock and Bradford and Bingley, 83% of RBS and 41% of Lloyds/HBoS. The Government is consulting on the new UK regulatory regime that seeks to give overall responsibility for the stability of the banking system back to the Governor of the Bank of England. And we also have the Vickers International Banking Commission specifically looking into the competitive environment for banking.
There are three huge potential areas that could each make a radical difference:
1. The taxpayers’ holdings in the UK banks give us enough clout, as shareholders, to require a radical restructure of the bailed out banks. UKFI could, for example, request the break-up of the different portfolios within each bank in order to create four or five ‘New Banks’. These might be sold to, for example, Tescos, Virgin, Metro, even Marks and Spencer, giving them a significant toe hold in UK banking markets overnight. A radical suggestion, I know, and one that would in the case of Lloyds/HBoS and RBS require other shareholder agreement, but surely worth a try?
2. The new proposed regulator, the ‘Financial Conduct Authority’ (FCA) should be given a specific pro-active competition objective. Unlike OFT, whose activity in the structure of banks has been largely ‘reactive’ to the acquisitions/mergers of recent years, the FCA should establish a ‘Financial Competition Commission’ whose job it is to look proactively at the structure of the banking market, making proposals that would: i) reduce barriers to entry for new participants (to improve competition); ii) reduce barriers to exit for failed institutions (address the ‘too big to fail’ issue); and iii) investigate (as OFT does now) anti-competitive practices in particular products or markets. Recommendations should be made to, and enforceable by, the Bank of England.
3. The Vickers Commission makes its interim report next month. They have the chance to be radical. They might go for a separation of investment and retail banking activities – not sensible in my view because since the days of Glass Steagall banking has become far more complicated and such a separation would be almost impossible to enforce. They could also choose ‘subsidiarisation’ as a model for the future of banking. Banco Santander already use this approach and it has a lot of merit – separate capital in separate geographic locations. The problem with it is that it would be expensive for banks and could change their business structure in an unfavourable way. I would like to see the Vickers Commission support a more flexible regulatory approach like the one I have outlined above.
I give far more detail on my proposals for banking regulation in my CPS paper, Boost Banking Competition.