Topic 2: Competition in the financial services sector

• ‘Competition’ refers to the number and size of sellers supplying products to a particular market. A ‘competitive market’ is one in which there is a large number of sellers and in which no single one of these sellers is so big that it can dominate the market. A market in which competition is limited has fewer sellers, some of which can be so big and powerful that they are able to influence prices and the quality of the products supplied.
• In the retail banking sector, customers are individuals or small to medium-sized enterprises, who have little power to influence the institutions that provide them with financial services if they do not like their products or if they believe that the price is not favourable. To attempt successfully to persuade the bank to offer a better rate, individual depositors would have to band together and form a pressure group by means of which their voices could be heard.
• The main commercial banks, however, are very large corporates and even smaller providers are comparatively quite big. Each bank can have a significant influence on the market by means of its decisions; for every customer who complains about its products, there are probably many customers who do not complain, and so the bank is unlikely to be seriously concerned when consumers of its services challenge its decisions. The balance of power in the market is in favour of the suppliers rather than the customers.
• it is better for individual consumers when there is effective competition in a market because then they have more choice. ‘Effective competition’ has been defined as a situation in which ‘banks compete to serve customers well rather than exploiting lack of customer awareness or poor regulation’
• So effective competition means that banks will act with the best of motives. While the bank may indeed be keen to demonstrate an ethical approach, these motives will not be entirely altruistic: the bank will be keen to offer the best deal and thereby attract more customers. The bank will not aim to attract and keep customers based only on customers’ ignorance of better deals or their inability to assess whether its products are good or suitable; neither will the banks rely on exploiting consumers in the absence of a rule against doing so or if it believes that the regulator will not notice.
• In a situation of effective competition, customers are able to switch to a competitor if they believe that their current provider is charging too high a price or that the quality of its products is not good. The knowledge that consumers can do this imposes discipline on the firms in the market and should motivate them to give value for money, to design high-quality products that people actually want and to give good customer service. A provider that fears that it may lose business to existing competitors, or that new rivals may enter the market to take away its regular customers,.
• consumers must be well informed about different products and changes in them, and must be willing and able to switch providers – and this has not been the case historically in the UK. Measures are consequently being taken to encourage switching and to make it easier
• Good competition - In a situation of GC, there is a variety of providers on the market from which consumers can choose.

  ◆ Each firm supplies products which respond to real customer needs and long-term interests.

  ◆ All of the products are charged at interest rates and fees that are fair and reasonable.

  ◆ The provider does not try to sell a product to a customer unless the product is suitable and no undue pressure.

  ◆ There is what is known as ‘transparency’

  ◆ Not selling a customer a product that is too expensive or otherwise unsuitable for their needs and circumstances.
• Bad competition - In a situation of BC, there are few providers; these providers are large and powerful, and aim only to maximise their sales.

  ◆ Each supplies a wide range of financial products, but, because each firm is big enough to be well known, so there is little product differentiation.

  ◆ Some of the products are designed more to bring in a profit than to meet the consumers’ needs. Sales staff are given targets to achieve.

  ◆ Providers give their customers superficial information about the products.
• Bad competition in practice - Large numbers of payment protection insurance (PPI) policies were sold to customers during the 1990s and 2000s. The Financial Ombudsman Service (FOS) estimates that hundreds of financial firms, including the main providers, sold policies worth a total of around £50 billion. Millions of people have complained that they were mis-sold these policies and billions of pounds have been paid out in compensation to victims of the mis-selling – and the cost to the industry of compensating customers has been enormous.
• Because the sale of PPI policies was so profitable, few firms were not engaged in mis-selling them. All of the providers had an incentive to promote the policies as strongly as possible so as to maximise their sales and most did so; any firm that did not follow what was going on in the rest of the market was seen to be losing out. It is for this reason that the number of complaints made to the FOS is so high.
• Another situation that can arise is known as ‘wasteful competition’, in which case each provider spends huge amounts of money on designing, branding and marketing a product that differs only very slightly from those of its competitors – money that might have been better saved and used to reduce the price of the existing product.
• Some of the features that banks add to products might be wasteful if customers do not need them. The large banks provide a range of different current accounts, from a bottom-of-the-range normal current account, which is free, to various types of enhanced current account, which have added features and for which they usually make a charge. Some customers might choose the enhanced accounts, thinking that they are good value for money, but the benefits they already have.
• Royal Bank of Scotland offers a range of personal current accounts, as follows.

  ◆ The ‘Select Account’ is a normal personal current account and does not charge a monthly fee.

  ◆ The ‘Reward Account’ is a personal current account with added 'rewards’ on eligible household bills paid by direct debit. To earn rewards you must pay in £1,250 a month. The account costs £2 a month.
• Royal Bank of Scotland offers a range of personal current accounts, as follows.

  ◆ The ‘Reward Silver Account’ is a personal current account with added European travel insurance, mobile phone insurance, fee-free debit card purchases abroad and the same added ‘rewards’ as the ‘Reward Account’. It costs £10p/m - for existing RBS customers only.

  ◆ The ‘Reward Platinum Account’ is a personal current account with added worldwide family travel insurance, mobile phone insurance, UK car breakdown cover, fee-free debit card purchases abroad’. It costs £20p/m and is for existing RBS customers only.
• Another example of wasteful competition in practice might be the high levels of advertising of financial products, on television and radio, on the internet, by telephone and via mailshots.
• It might also be argued that most people simply want a normal financial product, but that the volume of different packages available on the market can be very confusing. The products offered by one provider might seem to be different from those offered by the others, yet the differences between brands may be illusory and have little substance.
• The accusation that products are too complicated for ordinary customers to understand is one commonly levelled at financial services providers.
• Financial services are not simple products that people can consume with ease; rather, they require the consumer to have a certain amount of knowledge and understanding, and often contain complicated terms and conditions. Products such as investment accounts and mortgage loans are inherently very complex.
• Long-term investment is always uncertain and, to increase the return on a pension product, providers have to take difficult decisions and actively manage the funds in which they have invested. This is expensive – and is the reason why providers apply relatively high charges to the pensions that they sell to their customers.
• the need to compete drives each provider to differentiate its products from those of others. The effect of this is to deepen the natural complexity of the financial product. In an effort to make its own specific brands different from and more attractive than those of other providers, the provider of savings, loans or pensions products will add special features and impose additional conditions – and the result will be a product that is ever more complex.
• People do not always appreciate the differences between similar brands of the same type of product, however, and may choose one particular product without being fully aware of what they have bought. A provider may even occasionally seek competitive advantage by not clearly stating in its headline advertising slogans what the product involves.
• Many providers consequently try to attract deposits by offering a higher rate of interest on a particular savings account under certain circumstances or for a limited period, such as one year – but the prospective customer may not fully appreciate the impact of these special terms.
• As well as comparing the rate of interest on offer, the potential saver needs to consider, among other things:

  ◆ whether there is any minimum deposit required to earn this rate;

  ◆ the amount of time for which this interest rate is being offered;

  ◆ whether regular deposits have to be made; and

  ◆ whether any other additional products are provided at the same time.
• The majority of customers consequently want simpler products that they can understand; they do not want to have to work hard to understand what they are buying or to do long hours of research to find out which product suits them best. At the same time, they want transparency.
• The degree of competition existing within financial markets in the UK can be considered from both sides of the market – ie the ‘demand’ side (the customers) and the ‘supply’ side (the providers).
• Consumers of retail financial products are individuals and small businesses, each of which will generally face the might of the financial services providers’ marketing efforts alone. Consumers are not organised However, there are now some pressure groups through which consumers aim to make themselves heard. Such pressure groups are necessary because the level of financial capability among some consumers is not high.
• If consumers were well informed and financially capable, however, the demand side of the market would become more powerful. They might demonstrate this in two particular ways:

  • By comparing products - consumers need to be able and willing to make comparisons between the products provided by competitor providers.
  • By switching providers - consumers need to be able and willing to switch providers, without incurring a charge or a penalty.
• Most providers offer a savings account that pays a bonus interest percentage for a limited introductory period, for example for one year; at the end of the period, the interest rate falls to the standard, very low, rate. At that point, savers need to look for an alternative account, perhaps a different one that will also pay a bonus.
• Although consumers of retail financial products are rarely organised, there are now some pressure groups that represent their views, aiming to give them a voice and to increase the power of the demand side.
• Save our Savers was a pressure group that believed that savers must be ‘supported and rewarded for saving’ (Save Our Savers, no date). The group campaigned against:

  ◆ devaluation of savings through inflation;

  ◆ artificially low interest rates;

  ◆ unfair legislation and taxation;

  ◆ exploitative financial practices.
• Save our Savers

  It wanted providers to pay higher interest rates to savers and to make their products more transparent by fully disclosing the interest rate being paid, together with the underlying conditions. It also wanted all fees charged for managing investments and pensions to be made transparent.

  Save Our Savers is no longer an active campaign group, but savers are still suffering from historically low interest rates.
• Financial Services Consumer Panel The Financial Services Consumer Panel is an independent statutory body which:

  ◆ the supervision of the consumer credit sector;

  ◆ consumers’ ability to obtain redress and compensation;

  ◆ the provision of products and services that ‘do what they say on the tin’;

  ◆ price transparency, financial advice and product accessibility;

  ◆ the FCA’s remit to deal with the issues that prevent effective competition; and

  ◆ effective consumer representation at EU level.
• The Centre for Social Justice is an independent think tank that seeks ‘to put social justice at the heart of British politics’. In November 2013, it produced a report entitled Maxed Out: Serious personal debt in Britain, which examines levels of personal debt in the UK and describes high debt levels as ‘problem debt’. The report looks at the social and medical consequences of problem debt, and calls for an improvement in financial capability and education, better debt advice and improved access to alternative finance, via credit unions, for example.
• There are two main aspects to the degree of competition that exists on the supply side of the market – the degree of concentration and barriers to entry.
• The financial services sector – and particularly the personal banking sector – is highly concentrated. This means that there are few providers, each of which is very large, and this degree of concentration has increased since the 2007–08 financial crisis, as stronger banks have taken over weaker ones.
• The ‘concentration ratio’ is defined as the percentage of a particular market accounted for by a certain number of firms. Over three-quarters of the current accounts being operated by individual customers in the UK were held with these five banks.

  Barclays

  Santander

  Halifax

  Lloyds

  Natwest
• The mortgage and personal loan markets are also concentrated, whereas there is more competition in the savings and credit card markets. These latter markets are more contestable, which means that it is easier for other smaller providers to compete and gain business.
• A market that is dominated by a small number of very large firms is called an ‘oligopoly’ (meaning ‘competition between the few’). In such a market, all firms are well known and have a large market presence, and so each knows a lot about the others. Each has good knowledge of the products being offered by its competitors and of the prices being charged; it knows immediately when its competitors make some changes or develop new products.
• firms operating in an oligopolistic market tend to compete less on price than on product differences and heavy marketing. The main banks in the UK operate in this way. A summary comparison of interest rates and fees charged on loans, and of the interest rates paid on savings accounts by each of the main competitors, shows that the differences are small. But each bank tries to make its own products seem different by using brand names, by inserting special features.