Future Prospects of British Banking - Essay Example

24-10-2006 Future of British banking The origin of the modern banking in Britain can be traced back across four centuries, but the last centuryhas seen more changes in financial services arena than the preceding three centuries combined. British banking has been transformed since the Victorian era, from an industry comprising many small bankers offering a limited range of paper based services to a wealthy minority to one characterized by the growing pre-eminence of a few global players providing a varied range of financial services to all based on the most up-to-date technology. The U.K. market is one of the most competitive banking markets in the world and international research shows that U.K. banks provide extremely good value for customers unlike in other countries where customers pay both to have bank account and for the services they use whereas in U.K. banks, they provide free banking including access to free debit card, free access to ATM’S, free use of cheques, internet banking etc. Their charges are transparent and are advised to customers when they open the account. Banks generally publish their tariff charges also. London is both home to the world headquarters of the major British banks, and the host to major trading activities of both US and Continental European banks. London today is with 264 foreign banks and has 20 % of international bank lending. So it becomes the largest center for cross border banking. British banks account for 5 of the worlds top 20 by market capitalization, while there are 7 in the rest of Europe, 6 in America, and the remaining 2 are Japanese (Smallwood, 2005). The development of a number of world-class British-based banks successes is based on their own competitiveness, and not on any degree of government subvention or protection. A consequence of this is that London is, and is likely to remain for at least some appreciable time, the most international of capital market centers. The UK accounts for 60 per cent of primary international bond trading, and 70 per cent of secondary. There are more companies listed on the London Stock Exchange than on either the New York or Tokyo exchanges. In the OTC derivatives market, the UK accounts for over 40 per cent of global trade, compared with 24 per cent for the US, 10 per cent for France, and 3 per cent for Germany. Our fund management and insurance industries are both the third largest in the world, behind those of the US and Japan. The good news is the present strength of banks: a high level of profitability, strong levels of capital, and risk management, which has clearly been substantially improved over the last decade. For many years now there have been pressures on the UK banking industry from increasing competition, from ever more demanding customers and from the natural, but sometimes unwarranted attention of politicians and regulators (Bristol 2003). Today, these pressures are as strong as ever. At the same time, technology is opening up new opportunities to serve our customers better and manage our businesses more efficiently than ever before. The banking markets in U.K. could be divided into three major groups: • Money transmission. This is the flow of money between firms, individuals and Government through the payment systems. The main methods of money transmission, including cash machines, credit and debit cards, cheques, direct debits and standing orders as well as high value payments; • Services to personal customers. The main services investigated were current accounts, savings products, personal loans, mortgages and credit cards; • Services to small and medium sized businesses (SMEs). The main services considered here were current accounts and external finance. Money transmission. The big four banks dominant UK payment schemes. They own 74 per cent of shares in the UK’s low value clearing scheme, BACS, calculated according to transaction volumes. The market for merchant acquiring – recruiting retailers to credit and debit card schemes, processing transactions and paying retailers is even more concentrated. Here, just three merchant acquirers accounted for over 85 per cent of credit and debit card transactions in 1998. No other acquirers had more than 5 per cent of the market. Personal consumer markets. The most concentrated market is in current accounts. In1998, the big four banks had 68 per cent of personal current accounts in Great Britain. Established banks also dominated the supply of credit cards, with a 78 per cent share of all cards issued. Mortgage supply showed greater diversity. Here, the big four had a market share of only 17 per cent and converted building societies a share of 48 per cent (Gooding, 2006). Small business markets. These markets are even more concentrated. In 1998, the big four banks had an 86 per cent share of SME current accounts; while Barclays and Natwest alone accounted for 49 per cent of the total. In the relevant economic markets - which are local -concentration levels are higher still. In order to understand the dynamics of the banking sector and whether its markets are competitive, we first needed to examine what makes banks different from other firms in the economy. While we accepts the need for government intervention to protect retail depositors’ funds and ensure that banks are not at risk from the failure of another bank, the old regulatory contract goes wider than that. It has produced a raft of regulations and special arrangements. Under the old regulatory contract firms found it hard to enter the market and when they entered, just as hard to persuade consumers to switch to their services. They also encountered a range of barriers to innovation and efficiency. This is bad for competition, leading directly to concentrated market structures, high levels of profitability and high prices. UK banking services to small business and personal customers are currently overpriced. Because of the cyclical nature of profits from these customers, and the inability of firms to provide disaggregated data through the cycle, it is not possible to measure the level of excessive prices with any degree of accuracy. A modest 10 per cent improvement in efficiency would mean a £1 billion fall in prices. Most banks acknowledge many of these problems but claim they are only temporary and will right themselves without intervention. Clearly it is important to examine these claims, and the wider impact of the market environment. The global uncertainties and rapid pace of change, which we are all experiencing, provide a particularly turbulent environment in which to operate. They also mean that the opportunities and threats facing UK banks are more than ever closely affected by developments all over the world. Therefore we examines the likely impact on competition from: • New technology; • Developing regulatory trends; • New competitors in banking. There is no doubt that technology is reshaping the economics of traditional banking across a whole range of activities. It has allowed banks to: • Cut the costs of back office processing; • Introduce new lower cost access and distribution channels such as ATMs and telephone banking; • Introduce innovative products such as flexible mortgages. The highest expected growth rates are for debit cards and for remote banking via the telephone, Internet and digital TV.E-commerce the pressure for cheap, real time payment schemes will only increase; there are no developments yet on the horizon, which are likely to enhance competition in the money transmission markets to any significant degree. Looking to the future, the internet and digital TV are now expected to spark a revolution in banking: cutting costs, allowing consumers to change bank accounts at the click of a mouse or remote control button, and potentially opening the market to a flood of new entrants. But the reality is rather different, at least for the moment. While the UK has been very successful in promoting the take up of telephone banking with penetration of around 10 per cent of customers, the take up of PC and internet banking in the UK lags behind a number of European countries. Figures for both telephone and Internet banking suggest that there is still a long way to go before remote banking takes over from more traditional forms of banking. Growth rates may be spectacular but absolute transaction levels are still low (Cronin, 94). There is real concern that the UK banks are trailing behind their international competitors in taking advantage of new technologies. UK Firms’ profit maximizing strategy is able to focus on short term cost cutting at the expense of the longer term customer benefits that would flow from investing in new technologies. This lack of investment is a sign that the banks think that they can dictate the pace of change, shielded from consumer and competitive pressures. The best consumers can expect is relatively gentle innovation, characteristic of firms with market power that rely too much on outdated computer systems and lack significant competitive incentives to innovate. The market in which the UK banks operate will still continue to allow for some growth in revenues. Combined with very tight control of costs and investment spending this should allow for some further increases in operating profits. Another development, which could have a significant impact on the value for money for consumers, is Customer Value Management (CVM) and Customer Relationship Management (CRM) tools. Not all UK banks appear to be developing these tools and even among those who are, some are apparently doing so without much conviction. The introduction of better risk management tools by banks is welcome. For small business customers they produce better lending decisions and prices more accurately attuned to risk and therefore cost. For retail customers, more sophisticated credit scoring techniques may bring credit within reach of some customers previously refused loans or subjected to penal rates of interest. Taking a wider perspective, better risk management should allow banks to allocate their capital according to real economic risk rather than to meet regulatory standards, which are often a poor proxy for actual risk. This better allocation of capital should give banks a clearer view of the costs associated with different activities. Both Basel and the European Commission, the proposals for regulation are based on an incremental approach. Neither body proposes any fundamental deregulation or measures to encourage competition. So while limited regulatory reform is welcome, it will do little on its own to foster competition. The Commission identified a number of areas for action including: • Information and transparency; • Redress procedures; • A balanced application of consumer protection rules; • Laying the foundations for e-commerce based retail financial services. A decision by the UK to join EMU could have more significant implications for UK banking markets, however it would accelerate the development of the single market by encouraging greater cross border price transparency, eliminating currency risk on cross border transactions, eliminating foreign currency commission charges and eliminating the need for separate, non Euro payment schemes. A more effective single market would mean greater entry and competition in UK markets and better portfolio diversification for banks. The World Trade Organization (WTO) also has a role in setting international rules for financial services. The Fifth Financial Services Agreement was agreed in December 1997. It contained a total of 56 schedules of commitments representing 70 WTO member governments. Most of the new commitments dealt with foreign banks by eliminating or relaxing restrictions on ownership and operations. The Agreement explicitly excluded prudential issues, however, with the result that regulations imposed for prudential reasons will not be construed as trade barriers. Negotiations for a further agreement are currently underway. One of the proposals on the table, advocated by the European Union, is for a transparent and predictable regulatory environment. This would provide legal certainty and raise confidence among service suppliers, investors, users and consumers. There is already an open attitude towards foreign bank entry into the UK, which means that the current Agreement will have few if any implications for the development of competition in UK retail banking markets. The scope for new entry under the current regulatory framework has been overstated. Many of the barriers to entry are likely to remain for some time to come. Branches will still be essential for certain forms of banking. This is particularly true for small businesses needing to deposit cash and cheques regularly since it is unlikely that cash will be replaced by new payment mechanisms for at least the next 10 years. Similarly, remote access technologies like the Internet will not remove the need for branches. Although growth rates are very high, only minorities of consumers are likely to want to bank exclusively on the Internet for a number of years to come. It is often argued that the UK has one of the most competitive markets in the world, in which retailers, new and foreign banks all compete against established high street players. On closer examination, not all the entrants are as new as they might appear and there is anyway a danger that future consolidation could remove them from the market. However, there are some encouraging signs of increasing competition and new entry in some product groups, for example mortgages, personal loans and credit cards. As yet, however, entry has only had a limited impact on the prices charged by the established banks. Many of the arguments put forward in favour of further mergers and consolidation, such as reaping economies of scale, require skeptical challenge. Indeed there is evidence to suggest that there would be no efficiency gains - and possibly efficiency losses - from further consolidation. Mergers may prove to be a costly route for getting rid of poor management. Future developments are, of themselves, unlikely to lead to an immediate and significant improvement in competitive conditions. While some consumers may see benefits in the near future, such benefits are unlikely to filter through to the majority of consumers for some time to come. In essence, a pro competitive approach set within a more transparent, non-negotiable policy framework that is clear to all market participants. Any regulations and their enforcement should follow the principles of: • Competitive neutrality; • Proportionality and cost effectiveness; • Transparency; • Flexibility; • Accountability. A clear policy framework fundamentally depends on greater transparency. The Government should encourage the FSA in its efforts to make the regulatory process more transparent in the UK. It should also work with the FSA internationally to promote the importance of information disclosure in prudential regulation, for example through the European Union, and the Basel Committee on Banking Supervision. The inclusion of market discipline is in the Basel proposals. These proposals are still at the formative stage and it will be some time before any new requirements are implemented. Current disclosure requirements in the UK are significantly less than in countries such as the United States, where the Securities and Exchanges Commission imposes detailed disclosure requirements so there would be real benefits in firms publishing risk disclosure statements setting out their risk strategies and any significant individual risks or exposures. The Government should examine the costs and benefits of requiring authorized firms to publish disclosure statements of their risk exposures and risk strategies, across all activities, in advance of the implementation of the new Basel Capital Adequacy framework. The statements should also include details of regulatory requirements such as capital asset ratios. The Government has brought greater clarity to financial services by introducing a single regulator, the Financial Services Authority (FSA). The FSMB gives the FSA clear objectives in the following areas: • Market confidence - maintaining confidence in the financial system; • Public awareness - promoting public understanding of the financial system; • Consumer protection - securing the appropriate degree of protection for consumers; • Financial crime reduction - reducing the extent to which a business carried on by a regulated person can to be used in connection with financial crime. It is essential that the market structure maximize the potential for competition in the long term. As markets are likely to remain concentrated for some time, changes are needed to the way government considers mergers between firms operating in these markets. Currently, the UK has no special legislative rules concerning mergers in the financial services sector. The long-term healthy development of a competitive financial sector demands careful consideration of any mergers between firms. The competition and regulatory problems encountered are not unique to the UK. Special regulatory contracts cause just as many problems at the European level, if not more. The markets to supply banking services to SMEs are much less competitive than those, which face personal customers. The problems associated with switching, information, representation and redress are more significant there. Furthermore the markets to supply these services are extremely concentrated, and barriers to entry are high. In the absence of government intervention, the prospects for effective competition in these markets are remote. Personal customer and SME banking markets: However, there are some encouraging signs of increasing competition and new entry in some product groups, for example mortgages, personal loans and credit cards. As yet, however, entry has only had a limited impact on the prices charged by the established banks. The markets to supply banking services to SMEs are much less competitive than those, which face personal customers. The problems associated with switching, information, representation and redress are more significant there. Furthermore the markets to supply these services are extremely concentrated, and barriers to entry are high. In the absence of government intervention, the prospects for effective competition in these markets are remote. The following principles apply with equal force to both personal customer and SME banking markets: • Avoid over regulation; • Ensure adequate redress and customer representation; • Empower consumers through information. British banking and insurance sector employ almost 4% of the total workforce in U.K. Now responses by financial and business services to increase globalization and competition include new products, new forms of selling, process reorganization, merger and acquisition, which are all likely to impact upon the number of type of jobs on offer in the sector (Hasluck, 1999). In the financial service industry the key issues based on the current economic projections include globalization and competition, forcing companies to change and adapt to the situations. The sector will increase in size requires 1 million new entrant having technically correct and competent selling skills to deliver in financial services. Possible entry of U.K. in E.M.U. , Terrorist attack and focus on suspicious transactions and to regulate it, have effects on the U.K. banking sector. Some of the threats faced by banks in Britain are financial scammers due to laziness in checking of regular transactions (BBA, 2006). The password security is also one of the main concerns of banks transactions. Safety for online banking is being to be major concern for the banks in the near future. Almost 6,00,000 persons has been ditched out of 15 million customers of online banking in last one year. So it will be major concerns, which banks have to deal. Financial frauds for unsecured credit card advances are on the rise and banks have to face the burdens. Banks are realizing the threats of high-tech frauds and to manage it through data sharing has been proposed to mitigate risk. Though banks are trying to improve the services and to reduce transaction time but delay in transfer of funds between account holders of the same group by upto a day in order to introduce new security checks. The move is designed to help thwart phishing attacks that costs British banks estimated about 12 million pounds last year. Banks are taking the route of U.K. intermediaries to transfer money for oversees. This cause delay in transfer of funds and banks are under heavy pressure to speedup the process. The banks have not followed findings of security audits Therefore if banks have to survive the onslaught of change globally as well as domestically govt. and banks has to follow the required steps such as (Cruickshank 2000): 1. Increase transparency in banking supervision, 2. Does not give preferential treatment to any bank, 3. Improve competition, scrutiny and eliminate regulatory distortions, 4. Prevent anti competitive mergers in banking industry, 5. FSA must be empowered, 6. Price transparency, 7. Good governance, 8. Non discrematory access, 9. Efficient wholesale pricing, 10. Don’t regulate products, 11. Provide customers particularly more information about complaint against firms, 12. Establish more objective criteria, 13. Give access to basic banking services to those who do not have access till now, 14. For SME customers, make monopoly reference, 15. Give SME better information to compare products, 16. Publish more information about complaints against firms, 17. Provide wider criteria for giving SME access to ombudsman. So banks in Britain earning record profits currently but to maintain that profit level they have to improve their efficiency, services, transparency, competitive advantage, long term prudent policies, better liquidity, risk management skills, better trained and skilled employees, better product range, better fraud controlling mechanisms, improved technology to reduce transaction costs, tight cost control etc. ******************************************************************** References: 1. Banking Business- The Annual Abstract of Banking Statistics. Vol.23 (2006) 2. Banking Review Competition and Regulation in Financial Services: Striking the right balance. (July, 1999) 3. Banking Technology (1995, March 25). The next generation - Internet. 4. 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