A Brave New World for Britain's Banks

It is not surprising that the reforms put forth this week by Britain’s Independent Commission on Banking, led by John Vickers, have been hailed as a good deal for consumers. The ICB report clearly outlines a number of principles to create a marketplace where competition thrives and works in the consumer’s interest. But Mr. Vickers is also promoting a radical notion of what the retail banking system should look like by 2019 — namely, a liberalized market in which the government will not step in to save any of the four largest U.K. banks from failure. His commission’s report, read between the lines, implies that losing one of the big four due to stronger competitive forces may even be a good thing. In practical terms, the ICB aims to facilitate this by creating a more transparent system in which consumers can easily choose between providers. The report recommends an industry-wide account-redirection service to make switching accounts a more smooth process. Retail banks will also be required to provide clearer information allowing consumers to compare different banking products more effectively. Such measures are long overdue. With household budgets being squeezed by inflation and pay freezes, consumers are already using online aggregators to seek out the best rates and deals. The ICB’s reforms will only increase this behavior in the future. Unless the big four start making it worthwhile for their customers to remain loyal, they are going to lose them to new players who are more innovative and in tune with consumers’ needs. The Vickers Commission also aims to help get these new players going. The report recommends that the European Commission go further in forcing Lloyds Group to sell off 600 branches and divesting a fifth of the bank’s mortgage book. The aim is to help establish a new high street player with at least a 6% share of U.K. current accounts; acquiring the divested Lloyds assets under the current terms would only give the challenger bank a 4.6% share. Faced with a more competitive marketplace, we can envisage a scenario where one of the big four retail banks is driven out of business by tougher competition and will not be supported by the government. The report acknowledges the distortion that the “too big to fail” principle creates, whereby banks benefit from low funding costs when creditors assume that the government will step in in the event of failure. Minimizing this implicit subsidy is essential to achieving a competitive marketplace. At one extreme we could eventually see retail banking be treated as a sub-sector of the broader retail market, with all the attendant brutal competitive pressures. If Woolworths is allowed to fail, why not Barclays? But consumers can’t have everything their own way. At the extreme, reform implies that customers have to take more responsibility in dealing with the implications of a bank failure themselves. Consumers may benefit from some level of protection similar to the Sale of Goods Act, but in the longer term they are unlikely to be afforded the current level of protection, under which the government guarantees significant losses. Such protections do not work in the world the ICB aims to create. “Caveat emptor” will be the new maxim.

It’s “banks beware” though, too. Allowing a bank to fail would mark the emergence of a banking system that really works in the interest of the consumer. The banks may not like everything they read this week, but the scene has been set for a brave new world.

• Ipsos Blogs: The Financial Statement
• Financial Research at Ipsos

Joe Marshall is head of Industry & Services at Ipsos Marketing and wrote this article for the Wall Street Journal.