Making It Mutual: Establishing a local banking sector

18^th April 2013

Guy Opperman MP on how a local banking sector can deliver economic growth

There is much to be said for local banking. Local banks are based in the community, lend to the community, and make all of their decisions in the community. Localised banks would not only provide a proper return to investors, but make sure that profits are ploughed back into the local area.

Last July I held a debate on the future of RBS and suggested that it could be broken up into a series of County Banks, with the shares of each one given away to all those of voting age in each community. They would be truly mutual and part of a revolution of banking reform that aims to introduce all different forms and sizes of banks into a diverse and open market.

The UK banking market is concentrated in six large banks that have over 75% of the UK’s current account market. Look at Germany: their banking market is evenly spread across various sectors, none of which – whether they are savings banks, co-operatives, or commercial banks – have more than a 26.5% share of the market. But where we did once have an additional local tier of banks 70 years ago, we now have just one dominant with the number of bank branches on the high streets down by 43% in the last 20 years alone. Further, building societies and financial institutions that are in many cases based on local or regional customer bases have seen a marked decline over recent decades. In 1990 there were over 100 such institutions; now there is less than half that number – a serious blow to the local banking sector.

All of this is odd given that many other leading economies all have a much more localised banking sector. It is shocking when you consider that the stability of their local banking sectors helped offset the decline of their big banks during the recession. A recent report by Civitas found that German local banks have increased lending to local business in every year since the recession in 2008. [1] In the UK, there was no such off-set partly because there are no local banks.

Financial institutions on the continent didn’t suffer nearly as much as those in the UK – much of this can be attributed to the existence of a thriving local banking sector. According to Oliver Wyman Consultants, in the Eurozone almost 1 in 5 banking customers is a member of a banking co-operative. [2] This brings with it the obvious benefits of competition and diversification, and makes for a more stable financial sector.

Establishing a network of smaller, local banks would create a more plural and competitive market. To do this the Financial Services Authority (FSA) is working to make it easier for new entrants to access the banking market, both from a regulatory, and a capital requirements standpoint.

The City of London has long been one of the UK’s prized assets on the economic world stage. But whilst the importance of preserving the significance and clout of the City cannot be underestimated, the recent announcements on banking reform are a step in the right direction and will bring about a change in culture and attitudes.

But the main issue here is not banking culture, but a lack of banking competition. As mentioned previously, 75% of the industry is made up of a handful of banks, and most would say that there is not much discernible difference between them. Greater choice for customers would require more entrants into the market. Small and medium-sized businesses (SMEs) have struggled the most to acquire loans from the ‘big banks’ since the recession: only 7% of SMEs receive their money from outside the biggest of banks, showing starkly how over-reliant we have become on a small selection of providers.

The most striking aspect of this problem are the huge barriers to entry for new applicants to the banking market. Anthony Thompson, the co-founder of Metro Bank – the first new major entrant into the UK banking market for years – experienced the vast difficulties when putting together an application for the FSA, for example.

Putting up a huge amount of capital for an application, which is not even guaranteed to be successful, is the biggest barrier of all, as well as the biggest ‘put off’ to engaging in the process. The FSA themselves have freely admitted to me that they need to become more open and less negative.

There is a real desire to introduce more competition and consumer choice into the UK retail and commercial banking market. I have met with numerous individuals from the finance world who all agree that the barriers to entry need to be freed up. The desire is not only in the Government and across both Houses in Parliament, but from within the banking industry. All concerned agree that additional competition will introduce more commercial credit as well as reduce the cost of credit, which in turn will boost small business.

There are many groups wanting to create new banks: local communities, municipal authorities, regional businesses, individual businessmen (wanting to back local lending in their county), universities, and even pension funds. Local banking tailored to local need would be an effective means of tackling the on-going slump in business credit. Creating the right framework for prospective investors to finance local banking initiatives is crucial to achieving this.

Diversifying the banking sector: next steps

For diversification to happen, there are several steps that need to be taken. The first has already been addressed by the Government: passing the legislation, in the form of the Financial Services Act, to introduce the requirement for competition and innovation in banking.

The second is to relax the regulatory approach for smaller entrants. The FSA accept that they need to have an easier, cheaper and less onerous regulatory approach when smaller banks are being created. Hector Sants said in March 2012: “We are conscious of the balance to be struck between ensuring high standards at the gateway, and the importance of allowing innovation and appropriate levels of access for new firms…” – quite rightly there is a need to ensure entrants are bona fide – “…there has been public debate about the potential advantages of new entrants in the area of small, regional banks focused on servicing the SME sector. In such cases we will be proportionate in our approach and would invite all firms with a viable business model and appropriate levels of resources to a pre-application meeting to help guide them through the application process”.

Since then, the process of authorisation has been reviewed by the FSA in consultation with the Treasury and will be simplified in spring 2013.
The third key need is to reduce the amount of capital required. It has been a critical barrier to many, but can be simply solved as the capital requirements for new banks have now been revised downward, subject to a few caveats which are being worked upon by the Treasury and the FSA.

Fourthly, the process of building a robust and compliant infrastructure is both lengthy and costly. This could be solved by an outline of a FSA agreed basic universal model, with the creation of a UK based ‘common infrastructure platform’ that would provide a simple, quick and low cost solution for new bank entrants – thus removing the final barrier to entry. This would provide a ‘just add water’ solution for new entrants; no capital cost (payment ‘per customer per month’ instead of major capex), reduced time to market (and therefore cost), reduced infrastructural cost to entrants and the creation of a FSA compliant infrastructure, which would offer a simplified process for resolution. They do it in the US, which has a more competitive banking market than the UK (over 7000 banks), and it works well.

In simple terms, this means faster market entry, lower costs, easier access to the infrastructure needed and a lower break-even point: this translates into a more viable business case. This would in turn lead to more competition and more consumer choice, creating more credit for SMEs, and a greater number of new and bona fide entrants.

The FSA suggest that it would welcome a move in that direction as it will provide a low cost, quick and scalable option for new entrants that could also assist in a more efficient resolution process should a new bank fail. Whether it is an agreed pathway, or a universal ‘off the shelf’ model, the Government and the FSA need to be committed to putting in place the new process and infrastructure for use by new entrants in 2013.

When local, and more co-operatively owned, banks are set up, it will be good for the economy, good for choice and very good for SME lending. It needs to be made clear to those considering such a step – local communities, municipal authorities, business groups, universities and pension funds – that going forward their applications will be welcomed by the FSA. Just look at the likes of Metro Bank and Handelsbanken: they are leading the charge for a better banking relationship for customers, and ideally on a local basis. A mutually owned Bank of Hexham, Bank of Newcastle or Bank of The North East are all possibilities. Larger banks may not like this, but the competition will make them up their game in areas that they have taken for granted: namely their customers.

Local banks, owned by individuals or wider community groups, will not only offer a wider choice of banking – key to maintaining and encouraging wide and open markets in one of Britain’s most valuable industries – but they will also encourage a greater sense of responsibility to serving the local community and the local economy. A culture change will take time, but these are positive first steps which will send the good vibes to the banking sector, would be entrants, SMEs and the public as a whole. The strategy for banking reform is evolving and community-owned and mutually run local banks are a part of that evolution. Ensuring a local banking sector fit-for-purpose can help deliver the economic growth we dearly need.

This article was originally published in ResPublica’s Making it Mutual: The ownership revolution that Britain needs, a collection of essays covering all areas of policy – energy, financial services, education, infrastructure, welfare, public services, competition – proposing entrepreneurial and innovative policy proposals for structural reform.