Labour’s policy on banks shows how little politicians (and economists) understand the business

by Paul Crowe

The summer break is over, the kids are headed back to school and in the business pages it’s as if nothing has changed: there’s another investigation into Barclays, this time over dubious “consultancy” payments to the Qatar fund that bailed them out in the crash; RBS is under fire over pay, this time a £3.2m golden hello to their new head of retail banking and Libor investigations continue to cast a shadow over all of our banks.

The banks need to be taught a lesson. It’s almost a self-evident truth in the current political debate. The Tories are too hamstrung by their donors and innate conservatism to take the radical action needed and Labour seems to have grasped the nettle.

In July, the two Ed’s launched Labour’s blueprint for banking. At the heart of the proposals for the retail market is a commitment to force our five biggest banks to divest some of their branches so that another competitor can be created.

It’s an extension of what the European Commission has forced Lloyd’s to do as the price for allowing their takeover of HBOS. In this case, 600 Lloyds’ branches have been spun off. They will be taken over by the Co-op bank to create a new institution that is large enough to compete with the big players.

This approach was also championed by the panjandrums of the Vickers commission and in theory Labour is onto something. Divesting branches in this way directly reduces the market power of the existing banks, increases competition and should improve services for customers.

Except that the real world does not quite operate by the simple rules of elementary economic theory.

If the Ed’s had looked a bit more closely at what has happened with Lloyds’ divestment, they might have arrived at a rather different conclusion.

Based on Lloyds’ experience, the real barrier to market entry for new suppliers will not be tackled by Labour’s proposal.

As the Co-op has discovered, the biggest stumbling block to competing in the big leagues is IT. Even though they are an established bank, they have found that their IT system cannot safely deal with the extra volume of customers from Lloyds’ 600 branches.

The result? They are likely to move all of their customers onto the same huge Lloyds system that is currently used by the 600 branches, a process that will cost them hundreds of millions of pounds and reflected in the low price that the tax-payer backed Lloyds received for their divested branches.

As financially strong as a potential entrant’s balance sheet might be, unless a supplier is able to build and run one of the biggest and most secure IT systems in the country, the regulator is quite rightly unlikely to allow them into the market – if this system goes down, so does the financial stability of millions of people who depend on automated direct debits, standing orders and bank transfers.

Just ask NatWest, RBS and Ulster Bank customers how they felt when an IT glitch meant their accounts were inaccessible for a few days earlier this year.

Creating a new bank by forcing branch divestment will increase the number of big banks by only one. It won’t help any other potential entrants overcome the principal barrier to entry in the future or change the structure of the market.

The question is whether six or seven big banks will really be more competitive than five? After all, there were 16 banks involved in the cosy Libor arrangement.

A more productive approach for Labour would have been to look at how space could be made available on secure, common infrastructure for smaller suppliers looking to expand in the banking market – much as space on secure servers is currently sold to businesses.

As with the experience of many business sectors over the past twenty years, pulling down the barriers of big IT has massively increased competition. Giving smaller businesses access to IT economies of scale has played a far bigger role in opening up markets than any state regulation.

This infrastructure issue would have been obvious to anyone who has worked in retail banking and is familiar with the reality of what branch divestment means.

To the outside world, banking is about finance. To those responsible for delivering banking services, it’s largely an IT business.

But the Labour leadership’s advice seems to be coming from those at the top of the policy tree, whose experience is unsullied by practical delivery, who take a helicopter view of markets and businesses; where nationally aggregated statistics and theory drive policy.

In this rarefied environment, where Westminster politics intersects with high economics, simply increasing the number of banks by one might seem to tick all the boxes to increase competition and solve the problems in retail banking.

Unfortunately, the reality is, if Labour’s current policy was actually implemented, virtually nothing would change other than yet another extremely expensive bout of internal re-structuring for all of the banks.

Paul Crowe is an entrepreneur and Labour Uncut’s business columnist.

He is a director of a business that was recently placed amongst the top 40 fastest growing British private companies in the Sunday Times Fast Track 100 and has worked across the banking industry.

Tags: , , , ,

4 Responses to “Labour’s policy on banks shows how little politicians (and economists) understand the business”

  1. Nick says:

    Meanwhile government carries on with the Bernie Maddoff (as advised by Asil Nadir) approach to government accounts.

    7,000 bn of debt when you include the debts that matter, pensions. On an income of 570 bn.

    It’s obvious that you can’t pay, yet you carry on forcing people to hand over their cash for a pension they will never get. The same money if invested would get them 19K, you give them 5K on worse terms.

    Perhaps the solution is to let the banks operate on the same prudent principles as the government.

    So, if you open a current account with a bank, the money is immediately booked as a profit, and so can go on bonuses. After all, there will be a new depositor when people want their money back. It’s even better than the government because you don’t have to offer any return.

    I can’t see what the problem is. If its legal for the government to operate the banks should operate the same way.

  2. aragon says:

    Yes: Banks may be IT companies in disguise.

    First let me distance myself from the Banking Blueprint policy.

    And yes, six or seven rather than five retail banks may stimulate competition. Libor is a particular problem of market abuse and applies to the investment rather than retail banking.

    But the problem is not the cost of IT. Or buying a bigger mainframe to increase capacity at the co-op.

    The problem is migrating from one banks systems to another.

    It is almost impossible to move an account (automatically) between banks disparate computer systems.

    Standardising a data exchange format may help, easing the general transfer of accounts (like telephone numbers are transfered).

    If you are starting from scratch the IT systems for Banking are unremarkable i.e High Availability (five nines), Resilience and Security.
    They are still running simple batch transactions. The IT glitch at RBS was bad management in Offshoring IT support.

    The real problems are not with Retail banks but with Investment banks and their unacceptable (legal and illegal) practices. (Quants, High frequency trading etc are another issues).

    Nick we should let the Government operate in the same way as the banks, if Banks weren’t so crooked.

    I for one was aware of the infrastructure issues, but it is not a reason to abandon the ambition of having more retail banks.

  3. Alex says:

    As Aragon highlights, banking systems are not expensive IT per se. Where new licenses are issued (such as to Metro Bank in the UK, but also countless international examples) the IT delivery platform cost is significantly smaller (as a proportion of total cost) than legacy banking organisations. And it is legacy that is the key word here (couched in the context, as Aaron highlights, of migration). Legacy brings with it a number of challenges:-
    1. Legacy applications – bad design means the data is trapped in bespoke or customised COTS products (eg using STORED procedure, close coupling services, not using BASE etc)
    2. Scare of scale – why did SAP manage to sell Nationwide on the biggest banking system re-design in the UK, because of scare of scale!

    So the solution, as Paul highlights, is in delivering a banking system that nurtures the greenfield bank that does not have this monster legacy. So back to a policy fixed on local banking with maybe a development bank in the wings acting as finacial guarantoor to foster these new entrants. Or more radical – why can’t such a body provide cloud enabled banking services – a B-cloud? Or is that just B***?

  4. How can they possibly understand something in the business when all they do is fighting with each other over some unnecessary things. I can totaly agree with Nick ( he really as a point) Bank should be operating the same way as goverment does.
    ‘Creating a new bank by forcing branch divestment will increase the number of big banks by only one. It won’t help any other potential entrants overcome the principal barrier to entry in the future or change the structure of the market.’ – Would be a complete waste of time an money

Leave a Reply