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The Unhealthy Dynamic Between UK Banks

 4 min read / 

The landscape of the UK banking sector has raised significant concerns from regulators and policymakers with regards to the lack of competition in a sector hugely dominated by the Big Four banks (Barclays, HSBC, Lloyds & RBS). The Competition Commission states that a complex monopoly exists in the supply of banking services to SMEs, which has ultimately made customers reluctant to switch banks due to the little differentiation between service offerings.

The significant market power of the Big Four also extends into personal accounts, with the Big 4 currently holding over 75% of current accounts and raises the question, has enough been done by the Competition and Market Authority (CMA) to combat the substantial market power of the Big Four?      

Why is Banking competition important?

The economic reasoning behind competition is simple. On one hand, high levels of competition for deposits erodes per-bank profits and incentivises banks to take on additional risk in order to grow market share. On the other hand, low levels of competition do not incentivize banks to improve on their services offered and thus minimizes consumer surplus. Given the high entry barriers of the sector, the suppression of incentives to innovate leaves customers with little differentiating factors when evaluating alternatives.

The Department for Business, Enterprise and Regulatory Reform states that moderately competitive markets are the most efficient allocator of an economy’s resources by offering consumers with a wider range of services with lower prices and higher quality and encouraging firms to reduce their marginal costs through innovation and scale.

What Is Being Done?

The CMA, the Competition and Market Authority, has implemented 2 main initiatives to reduce the palpable consumer inertia seen in the sector. With almost 60% of retail customers banking with the same group for over a decade, initiatives to tackle this sluggishness are much needed, although the success of the CMA’s initiatives is hugely debatable.

The CMA has proposed the implementation of Application Programming Interface (API), a technology that promotes interbank price comparison to offer consumers better information on competing products. By increasing price transparency, customers will be able to see hidden charges applied to their accounts, thus allowing them to shop for the best deal. Although this initiative does not directly target the lack of innovation incentives of the Big 4, the increased price transparency is expected to help consumers better identify and weigh alternative opportunities.

Moreover, through regulatory efforts to reduce the barriers of entry into the sector, a number of challenger banks such as Metro Bank and Marks & Spencer have gained an increasing presence. Unfortunately, due to their size and lack of scalability, these banks tend to have a less diversified asset base relative to more established banks, leading them to consume more capital during their growth phase hereby precluding them in passing on significant price advantages to the consumer.

Although the initiatives presented by the CMA are expected to facilitate decision making of the consumer, they have not addressed the underlying high market power of the Big Four.

Why More Competition Is Needed

Recent studies indicate that 60% of UK adults are either not very likely or not at all likely to use an open API. Analysis indicates that consumers do not act as rational economists and even in the presence of perfect information symmetry do not forensically identify and secure the best value deal. The rise of non-traditional payment providers such as PayPal and ApplePay further supports the general trend towards consumer sluggishness in this sector.

Alternative studies show that just 18% of respondents stating they would consider banking with a retailer or other non-banking brand within the next two years and really calls to question the considerations behind the CMA propositions. With the consolidation of banks and building societies being so predominant in the UK, these growing challenger banks are unlikely to remain independent in the mid to long term and making the efforts to reduce the barriers to entry ineffective.

Since only 3% of customers switch banks in a given year, it is evident that further initiatives are required to foster competition in the sector. The lack of competition has led to consumer stickiness which has ultimately acted as a detriment to the consumer in the form of unsuited and overly priced services. With the Brexit vote dampening investment intentions and adding to general uncertainty, the CMA’s aims of increasing competition have made little to no impact to the long-term sustainability of the sector, highlighting the need for further action.

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