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: banking, competition, IT, Paul Crowe, Vickers commision

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