State banking: reforming the UK infrastructure
At the beginning of March, George Osborne travelled to the English seaside town of Bournemouth to make a speech at the JP Morgan operations centre there.
It wasn’t Henry V’s St Crispin’s Day speech, but it may well go down as a watershed moment in the history of the UK financial services sector. Osborne is Chancellor of the Exchequer in the UK’s coalition government, which has embarked on the most radical changes to the sector since the Big Bang deregulation of the City of London in 1986. Perhaps longer.
“Any bunch of politicians can bash the banks, chase the headlines, court the populist streak. But what good would that do our country? The jobs, the investment, the banking system we all need would go with it,” Osborne told the JPM staff.
“Let’s take the anger we feel about the banks and turn it into change to build the banking system that works for us all. That is precisely what we are doing. And through the work we’ve done, the expert help we’ve enlisted, we can make 2013 the year of change in our banking system,” he continued. “2013 is the year when we re-set our banking system. So the banks work for their customers – and not the other way round.”
He went on to list “four concrete things” that are going to change this year.
“First, we’ve got a brand new watchdog with new powers to keep our banks safe so they don’t bring down the economy,” he said. “Second, we’ve got a new law to separate the branch on the high street from the dealing floor in the city to protect taxpayers when mistakes are made. Third, we’re going to start, with the industry, changing the whole culture and ethics of the business, so they work for you. Fourth, we’re going to give customers the most powerful weapon of all: choice.”
The first of these became concrete this month, with the replacement of the Financial Services Authority with two new regulators, The Financial Conduct Authority and the Prudential Regulation Authority, and the Bank of England taking over macro-prudential responsibility for oversight of the financial system.
The issue of choice is essentially about retail banking, where new rules about how applications for banking licences are handled, and reductions in the capital and liquidity requirements for new entrants is intended to encourage new entrants – “challenger banks” – to the market. (see panel).
Concrete plans to separate retail and investment banking are yet to be defined – Osborne’s government seems to be resisting calls to “electrify the ring-fence” from influential sources such as the Parliamentary Commission on Banking Standards, headed by Andrew Tyrie.
The current proposal would allow the regulator to split an individual bank if it was seen to be crossing the line between retail and investment actives, but Tyrie’s Commission wants to go further and create legal powers to split the operations across the entire industry.
“The government rejected a number of important recommendations. We have concluded that the government’s arguments are insubstantial,” said Tyrie.
Further into Osborne’s JPM speech, things took an interesting turn. Having gone into detail about the four concrete things, Osborne said, “today, we will go further” and turned his attention to the payments systems.
“Payments systems sit at the heart of the banking system. They are the hidden from view wirings that operate every time you get wages paid into your bank account, deposit a cheque or withdraw money from an ATM. It’s how the money flows around the system,” he said.
FSA’s swansong opens a fast track for new entrant banks
In future, the possibility of a bank failure will be accepted as a normal market process, and barriers to entry for new start-ups, including capital requirement obstacles, will be removed, the Financial Services Authority and the Bank of England have confirmed.
Potential new entrants who have “the development backing, capital and infrastructure to allow them to set the bank up at speed” – such as through subsidiarisation of branches or where they are able to use existing IT and other infrastructure – will also be able to take advantage of an improved authorisation process that should allow them to be fast-tracked through in just six months.
The Bank and the FSA have published the result of a review into barriers to new entrants in the last week of the FSA’s existence. As of the beginning of this month, it was replaced by the Financial Conduct Authority and the Prudential Regulation Authority. New entrants to the banking sector will have to be approved by the PRA for prudential issues and the FCA for conduct.
The review “sets out significant changes to regulatory requirements and authorisation processes which, taken together, will reduce some of the regulatory barriers to entry into the banking sector and, as a result, enable an increased competitive challenge to existing banks”.
The arrival of the double-headed FCA/PRA regulatory regime will see the enactment of a range of measures intended to increase competition in the UK banking sector, reflecting a “major shift in approach to prudential regulation of banking start-ups”.
The PRA’s philosophy of regulation is that “the possibility of bank failure should be accepted as a normal market process provided there are clear mechanisms in place to resolve banks smoothly without threatening financial stability”.
Specifically the changes will involve removing the additional requirements that were previously applied to reflect the uncertainties inherent in start-ups, and which often resulted in capital requirements for start-ups being higher than for existing banks. On top of that, the Basel III regime will be implemented by applying to start-ups only the 4.5% minimum Core Tier 1 capital requirement instead of the 7% to 9.5% requirement that will apply to major existing banks.
New entrants will also benefit from reduced liquidity requirements and no automatic new bank liquidity premium.
Changes to the authorisation process will see the PRA and FCA introduce “a significant level of up-front support” to firms during the pre-application stage. Where an applicant firm is able to deliver a complete application form with all supporting materials, the PRA and FCA “will work together to complete all of the assessment and decision making within six months”.
“At the moment, a new player in the industry has to go to one of the existing big banks to use the payment system. Asking your rival to provide you with the essential services you need at a reasonable price is not a recipe for success. And in other walks of life, like telecoms, we don’t operate like that,” Osborne continued. ”There are no incentives on the big banks to deliver new and better services for users – like saving the cheque or creating new services like mobile payments.”
Osborne listed a number of failings in the existing system – several of which were at odds with reality, commentators quickly pointed out – before delivering a surprise: “The system isn’t working for customers, so we will change it. I can announce today that the Government will bring forward detailed proposals to open up the payment systems. We will make sure that new players in the market can access these systems in a fair and transparent way.”
Osborne restated this in the annual budget speech later in the month, adding that the government would consult on bringing payment systems into a “competition-focused regulatory regime” where the regulator will have “strong powers to ensure that challenger banks have the opportunity to compete on a level playing field with their larger competitors by requiring that challengers can access the payments infrastructure”.
HM Treasury has duly set the wheels in motion with the publication of the consultation document Opening up UK Payments at the end of March. (The consultation period closes on 25 June.)
In a previous round of consultation in July last year, the government said that its favoured approach was the introduction of a new public body, the Payments Strategy Board, to set strategy across the UK payments industry. “Since the publication of that document, however, a number of developments have occurred that have led the Government to conclude that this option would not deliver its aims as set out in that document, and that these would be best achieved by pursuing an alternative approach of bringing payment systems under a new regime of economic regulation,” says the Treasury announcement.
“The Government is now proposing to proceed with bringing payment systems under economic regulation, and establish a new competition-focused, utility-style regulator for retail payment systems.”
Gareth Lodge, senior consultant, payments at Celent, suggests that the consultation is simply window-dressing and the government and Treasury are set to plough ahead with the new regulator – already nicknamed PayCom along the lines of other regulatory bodies like Ofcom – regardless of the responses.
He points to the fact that in the budget statement, it says that the government has shown its commitment to competition by adopting the recommendations of the Independent Commission on Banking in full.
Yes, says Lodge, up to a point. “While it did accept the recommendations in full, the Treasury also seems to be including things that weren’t recommended – the ICB report clearly states that it did not find evidence that access to the payment systems was a barrier to entry, nor did the report recommend a PayCom,” he said. “The ICB was very clear – it was the government not they who believe that the Payments Council should be brought into the scope of regulation.”
He quotes the ICB:
In its interim report, the ICB raised possible concerns about the ability of small banks to access the payment systems. It said there was some evidence to suggest that the ability of banks to access the payment systems through incumbents, and the ability of the Payments Council to maintain a level playing field in payments, were not conducive to a competitive market.
However, the evidence was not clear-cut, and this was not raised as a substantial barrier by most new entrants. Therefore, the ICB did not make recommendations in this area, beyond suggesting that the Bank of England, in collaboration with the FCA and OFT, should monitor access to the payment systems and the effectiveness of the Payments Council in providing adequate governance to ensure innovation and competition.
The review of the payments systems, and the role of the Payments Council had long been expected – even the idea of a regulator with strong powers is not a new idea, but the triple whammy of new legislation regarding competition in banking, competition in payments and an increase in capital requirements all being announced in the same week was unexpected.
“I am not suggesting a review is a bad thing, nor even that PayCom itself is a bad thing. Unless the industry reflects on what it does well and what it doesn’t well, it cannot ensure that it fixes what needs fixing and preserve what doesn’t,” said Lodge. “And that’s my fundamental issue. The Government has prescribed the medicine, ignoring the advice of the specialists it had appointed (i.e. the ICB, the Cruickshank report, the OFT and its latest consultation), and is about to forcibly administer it, yet has neither articulated the diagnosis nor listened to the symptoms. PayCom cannot ever succeed unless it is clear what it is trying to achieve, why it seeks to achieve those goals, and what the measures of success are. We can only hope that the forthcoming consultation provides some reassurance.”