OFT publishes review of barriers to entry in retail banking

The Office of Fair Trading (OFT) has recently published a detailed report setting out its findings from its review of barriers to entry, expansion and exit in retail banking.

This review, launched in May 2010, builds on previous work in the sector, namely the 2008 market study on personal current accounts and the Competition Commission’s 2002 investigation into SME banking. The OFT received evidence from, and discussed the issues with, over fifty different parties including banks, building societies, recent and prospective entrants, industry bodies and consumer groups.

In summary, the OFT has found that although new firms have entered the sector recently and more are expected to do so, new entrants face a number of obstacles in establishing a presence on the market, recovering start-up costs and expanding their market shares in retail banking. Whilst new entrants are able to obtain the required regulatory authorisations and establish the necessary infrastructure to offer retail banking products, the OFT found that they face a number of difficulties in attracting personal and SME customers.

The OFT examined four aspects of personal and SME banking where there may be potential barriers:

Regulatory requirements and processes

The OFT found that firms do not face significant barriers in meeting the regulatory requirements to obtain authorisation to accept deposits or offer mortgages, but the OFT did find evidence of firms facing difficulties and uncertainties arising from the process involved in obtaining authorisation. This has had the effect of delaying entry and making it harder to raise capital. The OFT has welcomed the FSA’s recent revision to its authorisation procedures to increase transparency and introduce a more “modular” approach.

Existing capital requirements may disproportionately affect new entrants and smaller banks by requiring them to hold proportionally more capital than incumbents. The OFT noted that the significant changes to capital requirements which will take place over the next few years could have the potential to exacerbate these differences between incumbents and new entrants. This will need to be monitored by regulators.

Access to essential inputs

The establishment of internal IT systems was identified by the OFT as a substantial cost for any new entrant, which may not be recovered if entrants are unable to attract sufficient number of customers.

It was found that there are not significant or widespread barriers to accessing industry-wide payment schemes such as Bacs and CHAPS. Similarly access to information about personal and SME customers’ risk profiles is widely available. However, the OFT noted that there is less credit risk information readily available on the smallest SMEs which can make it difficult for new entrants to be able to offer them products, in particular loan products.

With regard to funding, the OFT recognised that the lack of interbank finance, following the financial crisis is, in the short-term, acting as a barrier to expansion for new entrants.

The ability of new entrants to attract customers and achieve scale

The OFT identified three principal barriers that may make it difficult for firms to attract a sufficient number of customers to compete successfully:

•Low levels of switching and customer inertia;
•High levels of brand loyalty;
•Consumers’ preference for providers with a branch network.

A number of initiatives have been introduced to facilitate switching following the OFT’s study into personal current accounts in 2008 and the Competition Commission’s 2002 SME banking report. However, the OFT notes that this is an area that may warrant further consideration by Government if SMEs continue to be dissuaded from switching due to a lack of confidence in the process.

Issues around exiting the market

The imposition of Government imposed mechanisms to ensure the orderly exit of banks from the sector following the financial crisis is recognised by the OFT as giving rise to the possibility of weakening competition as a result of inefficient incumbents not being allowed to exit the market, reducing the incentives, or ability, or more efficient firms to engage in intense rivalry.

The OFT considered whether the Special Resolution Regime (SRR) and the Financial Services Compensation Scheme (FSCS) may adversely impact upon competition. The evidence presented did not indicate that these acted as a barrier to exit, preventing firms from leaving the market, but the OFT encourages the relevant authorities to consider competition issues during the operation of these arrangements.

The OFT has not identified any specific actions or recommendations following its review. Instead, it has stated that it expects that the review will be used by the following bodies:

•The Independent Commission on Banking, which is to make recommendations by September 2011 on structural and non-structural measures to promote stability and competition in banking;
•The FSA in the design and operation of banking regulation and authorisation processes;
•HM Treasury and the Department for Business, Innovation and Skills, especially in the areas of improving the provision of information on SMEs; and
•The devolved governments in Scotland, Wales and Northern Ireland, with respect to ongoing work on personal and SME banking.

This article first appeared in Law-Now, CMS Cameron McKenna's free online information service, and has been reproduced with their permission. For more information about Law-Now, please go to www.law-now.com