As we are entering a whole new decade, we took the opportunity to reflect on some of the biggest changes the retail banking industry has observed in the last 10 years…
Authors: Keith Church and Alex Apps
The rise of the challenger bank
At the start of the decade, five banks dominated the UK banking horizon. Technological developments have lowered the cost to entry for new banks and the challengers have arrived. In 2014, the Competition and Markets Authority launched an investigation into provision of credit to personal current account customers and Small and Medium sized enterprises (SMEs). This is the gap the challengers have stepped into, with some helped by development funding that RBS has been forced to provide as a condition for receiving state aid. Additionally, a streamlined account switching service should help the challengers. Yet old habits die hard – and the promises of Open Banking – largely remain just that. The traditional banks are starting to fight back – NatWest recently launched ‘Bó’, their own app-based bank account. It appears that disrupting the established-market players will not be getting any easier.
Intense competition in a smaller mortgage market
The last decade has seen homeownership pushed out of reach for many as house prices soared. The average price of a UK house has risen by 38% over the decade and average weekly earnings have grown by just 23% over the same period. This has reverberated into much lower activity in the mortgage market. At the same time, competition has intensified, thanks to a surge in new lenders. The increased competition combined with an excess of cheap funding due to ringfencing, has been compressed but customers have benefited from low mortgage rates.
The policy response has been to underpin the property market through schemes like Help-to-Buy, which has kept activity ticking over by allowing First Time Buyers access to high Loan-to-Value borrowing. Lenders have benefited from this, but the big winners have been executives and shareholders of the large property builders. The new government is unlikely to try to wean the market off this stimulant anytime soon. The reason for higher prices, but not the blame, can be laid at the door of Buy-to-Let (BTL) investors. Consistently low interest rates have kept the yield on BTL attractive, although the government has clearly succeeded in its aim to dampen the activity in the market through a larger tax burden.
A new way of buying cars
While the regulator has intervened in the housing market to limit high Loan-to-Income loans, much of its recent concern has been over the rise of unsecured credit. Annual growth rates of consumer credit exceeded 12% in 2016 and 2017. The ‘culprit’ came from outside the traditional banking sector and reflected innovation in auto financing. In 2017, the Bank of England issued a warning, noting that the number of cars bought with a Personal Contract Purchase plan had risen from 20% to 80% over the course of a decade. The concern at the time was that lenders were overly exposed to a drop in used car prices. But earlier this year, the Financial Conduct Authority reported that the growth in credit was highest among those with the best credit scores, while arrears and default rates, although rising, were still generally low.
The conduct of firms continues to keep the regulator busy
Although the regulator’s worries regarding auto finance have abated, the way these loans are sold, and the possibility the commission structure is delivering a poor outcome for borrowers, is high on their agenda. Meanwhile, the legacy of Payment Protection Insurance (PPI) mis-selling has hung over some of the larger banks for much of the last decade.
After the crisis, a gap opened in the market for ‘high risk-high reward’, short term lending to customers who were desperate for credit. With few alternatives, borrowers paid eye-watering interest rates, especially where loans were continually rolled over. This was often combined with an aggressive collections strategy. Regulators reacted by introducing a cap on interest and charges in 2015. This kept charges below the amount borrowed and gave borrowers back control of when they made repayments. Many payday loan lenders, including Wonga, were forced to exit the market.
The transition to the IFRS 9 accounting standard
Huge amounts of energy in the banking sector have been expended on the move to accounting for losses under IFRS 9. The need to assess losses under different economic scenarios has been costly, but in time this should help firms understand and assess risk more accurately. Firms are starting to exploit the additional insight created, in areas such as product proposition and pricing. It’s still early days for IFRS 9 and the true test will of course be in periods of economic stress when firms will need to be nimble and alert when it comes to reacting to a changed economic outlook. Recently, the regulator has pushed firms towards using at least two downside scenarios, to ensure coverage of expected losses is adequate. The choice of scenarios and the weightings applied vary widely across the industry. One criticism of the standard is that this makes it difficult to make like-for-like assessments of risk between organisations.
The end of ‘too big to fail’?
After the unedifying sight of the government bailing out the UK banking system during the Global Financial Crisis, much of the regulatory energy since has been spent on making sure this must never be necessary again. Retail banking has been ring-fenced away from riskier activities. Capital positions have been strengthened. And with regulation centralised with the Bank of England, there is more focus on stress testing than ever before. This focus is now filtering down to the so-called ‘fast-growing firms’, who have been put on notice by the regulator to ensure their models and governance are up to scratch.
The global financial system is safer but not immune. The last decade saw a crisis in Greece that started in the government sector and propagated a wave of anxiety through the Eurozone banking sector as exposure to that country’s 179% of GDP debt ratio was assessed. Greece wasn’t allowed to fail – paying a massive economic price for its rescue – but the episode reinforces the view that if push comes to shove, the banking system will always be rescued. It has to be hoped that in the coming decade, the higher capital buffers ensure that the ‘too-big-to-fail’ theory is not again disproven.
For further information, please get in touch with Keith at keith.church@4-most.co.uk
