Banking Competition

Mark Garnier Excerpts

Thursday 12th July 2012 Westminster Hall

[Mark Garnier (Wyre Forest) (Con)]

Let me apologise to the Minister at the start, because I will miss his winding-up speech. Unfortunately, I have to rush back to Kidderminster for an important meeting about Kidderminster hospital. Members who remember the 2001 general election will know that any Member of Parliament who does not pay attention to Kidderminster hospital when called upon can suffer dire consequences.

I am grateful to my hon. Friend the Member for South Northamptonshire (Andrea Leadsom) for securing this debate and for gathering such enthusiasm for it. It is an incredibly important issue in the regeneration of our economy.

I specifically want to turn the focus of attention to the problem that arises when a regulator is still reeling from the fall-out of the banking crisis. Here we are, nearly half a decade on from the crisis, and we have just started a new round of scandal as the results of the FSA investigation into LIBOR fixing hit the headlines. The story will no doubt run and run for some time as other banks are brought into the mire. The Government’s response—the so-called Tyrie commission—is as good a start at understanding the problems as I can imagine, and, I hope, a significant step in the direction of truth and reconciliation between the banks and the taxpaying consumers.

The FSA’s response to the banking crisis has been reactive, and it is in its reaction that significant barriers have been established that limit competition in banking. Over the past few months, my hon. Friend the Member for South Northamptonshire and I have been meeting a number of smaller, existing banks as well as potential challenger banks to the banking marketplace. In nearly every case, their experience of the FSA has been problematic. All parties concerned were either small banks—banks with balance sheets under £2.5 billion—or individuals representing organisations that had experienced the FSA’s application process. Those interested parties came forward with points about the FSA’s process of issuing banking licences, and the regulator’s attitude to, and regulation of, smaller banking institutions.

It is significant that just one of the organisations we met detailed a positive experience of the FSA and its practices. It is also worth noting that banking licences are very rare commodities. There has been just one ab initio banking licence granted in the past 100 years and that was to Metro Bank. All other new entrants to the market, such as Virgin Money and Tesco, have done so as a result of buying existing licences and transferring their use to the new operation, or from overseas banks passporting in their expertise. That in itself says a great deal about banking competition in this country.

I want to concentrate on two specific areas of concern: the FSA’s application process for banking licences, and the FSA’s regulation of smaller banks.

[Mr Thomas]

I share the hon. Gentleman’s concern about the regulators and his understanding of the potential for new players in the financial markets. The all-party group on building societies and financial mutuals held an inquiry into the work of the regulator in relation to building societies, friendly societies and credit unions. It was far from clear that regulators had any real experience of working for and in those organisations. Will he support a call to encourage the new regulatory bodies to ensure that among their senior staff they have people with real practical, hands-on experience of working for a financial mutual?

[Mark Garnier]

Yes, I will. One of the problems is that, with the potential move of the FSA into the new regulatory regime, there has been an exodus of staff. As the hon. Gentleman suggests, that is of course something to do with the employment process within the new regulators, but it is absolutely right that any regulator should draw on people’s extensive experience. As we look forward, it is important that we provide leadership and that mutuals and other models of banking should be encouraged. The regulator should accordingly take account of that when employing staff. I wholeheartedly agree with the hon. Gentleman on that point.

The second problem is the FSA’s regulation of small banks, starting with the application process for banking licences and significant changes. That process has two tiers. It starts with an initial inquiry, and if an applicant is given the nod, the process continues with a formal application. The initial inquiry can be likened to a conversation on the doorstep of the FSA, with the aspirant bank seeking permission to come through the door simply to start the application process formally.

However, that initial inquiry—it should be remembered that it is not a formal inquiry but just an opening conversation—can cost the applicant more than £1 million to process. That is because the applicant requires a corporate body to make the application, which is not unreasonable, but also needs evidence of capital committed, advisors, auditors and, it seems, evidence of system design and building, which can be very expensive as there are no off-the-peg systems available.

So far we have found just two organisations that have proceeded past the initial stage from an ab initio enquiry. Trying to establish the reasons for that, we found that the cost and delay involved in the application process appear to be disproportionate. New applicants are effectively required to create a functioning, fully staffed banking operation before any type of licence is granted. We found that one applicant was forced to resubmit their application because the application process was stretched beyond the 12-month time limit and consequently a second application fee of £25,000 was demanded. One individual spent £1.3 million just to get to the formal stage of the application process. The application was then denied by the FSA.

The applicants we met had many complaints about the FSA process, and I will go through some of them. All applicants felt that the FSA had an arbitrary power to grant or refuse applications. They felt that the FSA should provide a publicly available checklist of criteria that, if satisfied, will result in the award of a licence. Such a change would lead to a more transparent application process. Apparently there is no requirement for the FSA to apply the same criteria to all applications in its internal processes or to explain its reasons for advising that applications should be withdrawn. Representatives of one small licensed bank said that they were given the “impression” that their application was progressing but “never a green light”. A representative of an individual who tried to buy a failing bank said that, although the FSA might appear to favour an applicant, they were capable of

“changing their opinion with no prior warning”.

One applicant was encouraged by an FSA official to proceed with an application for a change of control. However, a few months later, and after incurring considerable cost, they were advised by a different FSA official that their application would not succeed and should therefore be withdrawn. Worryingly, in one case the absence of objective criteria allowed the FSA to engineer the withdrawal of the application by putting the applicant in a cleft stick. The FSA imposed a very high tier 1 capital requirement, which had the effect of suppressing the profitability of the applicant’s business plan. The applicant was then told that the proposed venture was not sustainable because it was insufficiently profitable, and they were advised to withdraw.

In short, applicants felt that the individuals concerned within the FSA feared the prospect of having their name associated with any bank that might possibly fail in the future, and so they felt that the FSA staff regressed to having a bias of ultimate safety, and that bias meant that they favoured rejection of applications.

Let me turn to the regulation of existing smaller banks, of which there are 50 or so. Those banks are penalised for being small. It is quite interesting that the department within the FSA that looks after smaller banks is called “Smaller banks, smaller building societies and spread betters”. It seems curious that banks that are so important to this country can be regulated alongside spread betters, which are perhaps less important to the financial system.

The first and most basic problem that the smaller banks face comes in the form of the capital ratios that they must have. Small start-up banks are required to have a capital ratio that is potentially three times larger than that of a big, systemic bank. Although it can be argued that that is to ensure the bank is stable as it builds up its lending book, it restricts the opportunity to become a new entrant to the market to those who have very deep pockets indeed. Even if a new bank grows, its capital ratios are frequently twice that of the big banks’ capital ratios. Moreover, risk-weighted valuations of property lending, with regard to items such as a property lending book, are skewed against small banks, which may lack the database and breadth of client type available to the big banks to justify a similar risk-weighting. That means that a small bank will need a third more capital for its property books than its bigger competitors.

Small banks are also likely to have a more limited loan book. For example, a small bank’s loan book might be restricted to the UK. That incurs a 1% increase in capital ratios. That is quite an interesting proposition because it implies that big banks lending to Greece and Spain face a lower risk than those banks that are just lending in the UK. That so-called “concentration of risk” has further implications, as small banks are likely to seek niche markets. Doing so means that a bank incurs a further 2% increase in its capital ratio.

Meanwhile, liquidity reporting has resulted in small banks seeing the cost of their compliance increase tenfold. Representatives of a small private retail bank whom we met said the bank used to charge its customers £25 a month for the privilege of banking with it. Those customers are now being charged £65 a month, just to cover the increased cost of compliance. Another small bank that has only a £50 million balance sheet is required to submit 160 liquidity reports every year.

In addition, it has been suggested that for a small bank the staff to accountant ratio, which is obviously an overhead cost, is 17 members of staff for each accountant who is examining what is going on. In a recent survey, chief executives of small banks complained that 40% of their time was spent on compliance. And non-executive directors, far from contributing a wide range of skills to the bank’s board, must now demonstrate extensive banking experience and sign up to what amounts to a full-time job. Is it right that banks’ boards should be so monochrome?

There are many reasons why businesses might face problems in getting started, but in an environment in which we expect banks to lend more and to contribute to our economic recovery is it right that the regulator is apparently creating a blockade for new entrants and increased competition? Including me, there are three members of the Treasury Committee still in Westminster Hall—the other two are my hon. Friend the Member for South Northamptonshire and the hon. Member for Erith and Thamesmead (Teresa Pearce); and there was another member here earlier, the hon. Member for Edmonton (Mr Love). I hope that the Treasury Committee will proceed with a forensic investigation of banking competition and seek to separate myth from fact as regards this problem. However, as we progress with the Financial Services Bill and the soon-to-come banking reform Bill, it is crucial that we consider competition as part of the mandate of the regulators.

This is a very difficult time for our financial services industry, including banking, and we must ensure that we strike the right balance between regulation that is effective and easy to apply and regulation that ensures international confidence in our financial system. Striking that balance is too important for us to get wrong, but we must ensure that in achieving it we allow, and indeed encourage, healthy competition within the banking community. That must be the approach taken by the regulator.