July 11, 2014    5 minute read

Free Banking: Is The End Near?

   July 11, 2014    5 minute read

Free Banking: Is The End Near?

Free banking is very much akin to pouring out a glass of water: no one ever thinks about it but everyone takes it for granted. As has been rumoured for a long time now, this may be about to change. Banks have offered free current accounts as they have been able to subsidise this via selling loans, mortgages, other products (hey PPI) and high overdraft payments along with the large amounts they make from investment banking. However, as many of you will know, banks are pulling back from the other products category as it comes under regulatory scrutiny and mortgages are not exactly overly profitable right now (squeezed interest margins). Investment banking has also not been as profitable as it has been in the past with some banks pulling out almost completely (RBS) and others pulling out of certain areas (Barclays & FICC). So, in essence, how does a retail bank increase its return on equity?

Well, McKinsey recommends: technical mitigation; capital-and funding-light operating models; business model alignment and repricing. Many executives are also arriving at the conclusion of some form of charge on current accounts (the repricing option) but many are scared to take the leap of faith. In fact, warnings have been fired out from the banks for some time now but nothing has happened.

That’s all changed. Tesco has just entered the current account market with one difference: it aims to charge for the use of a current account. So, the question now is, will others follow suit?

And the answer is: we don’t know but it could very well be the future. Students rest assured you are likely to be the last on the charging list should such a thing happen. Banks love offering students special deals and privileges to encourage you to bank with them in future when say; you get a mortgage or actually have some savings. So, any change is unlikely to affect anyone reading this.

However, Tesco proposes that anyone depositing less than £750 per month into their current account will face a charge of £5 per month. Now, of course, this is not necessarily a sign of the end of free banking. More likely, it is a very deeply thought-out strategic move by Tesco to make sure it attracts the right type of customers to its accounts: the ones it wants.

Given Tesco is actually a supermarket the instant reaction from most is “A supermarket with a banking arm. What could possibly go wrong?” But, of course, this is just integration by Tesco into various business areas to continue to diversify and sustain its incredible earning power by maximising more economies of scale. In essence, the more business areas it enters then the more opportunity there are for customers to pick up Clubcard points – which in turn, gives them more reason to stay loyal. At this point, it is worth bearing in mind that every £1 out of £7 now gets spent in Tesco. Furthermore, given their supermarket business has struggled for growth recently, it makes sense that Tesco will continue to try and compensate in other business areas. Perhaps banking is a bizarre choice given the fact it is not outstandingly profitable right now but it is likely Tesco can do very well under this very different model of the current account.

Tesco has, in fact, twisted charging for current accounts to its own advantage claiming it is embracing the new era of transparency. It states that since it costs money to run bank accounts that deposit under the £750 threshold, a charge should apply. In essence, it’s about bringing an end to ripping customers off with other products. Many continue to be concerned for those on low incomes as well as pensioners who are less likely to deposit that amount or be online. Perhaps, rather, it is just simply time to bite the bullet on this issue though and accept that a good service will never be free.

It is also worth noting that Britain is in the minority when it comes to having free current accounts. A number of other countries have institutions that do charge for current accounts so potentially this is something that our culture will simply have to adapt to.

So, is this the end of free banking? No – not in the short-term at least. However, if Tesco could perhaps prove this model works better for both customer service and profitability it is likely it could be adopted by other institutions in future – especially given the not so great interest margin climate at the moment. Therefore, this space is one to watch in the medium term.

It will continue to be interesting to watch how other new players who are attempting to break the stronghold on the banking sector react in due course: Metro Bank and Virgin Money.

Personally, over the longer-term as banks begin to rebuild trust (that has been so deeply lost) they will start selling the transparency argument to customers. It is likely they will convince them that this is the way forward: there will be no hidden costs and receive a better service – especially, if the model Tesco is using proves to be very successful. The question is: how will public perception change and how will customers react to losing a freebie that no one has ever given much thought to?

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