British banks

Cracking the oligopoly

A new competitor offers hope of a shake-up in British banking

Sep 14th 2013

FOR more than a decade competition regulators have fretted that Britains banking oligopoly is ripping off customers,
mainly by stinging them with high fees for overdrafts or late payments. Yet the resurrection on September 9th of TSB
bank, which traces its roots back to a lender set up in 1810, promises to inject competition into a market that is among
the rich worlds most concentrated.

The new TSB bank is being created through a spin-off of 631 branches from Lloyds Banking Group, Britains biggest
lender when measured by domestic market share. Although TSB is still wholly owned by Lloyds it plans to issue a
prospectus early in 2014 with an initial public offering (IPO) to follow in the summer.

The divestment by Lloyds was forced on it by the European Commission after it was bailed out by the British
government five years ago in the midst of the financial crisis. Even the IPO was a reluctant choice. Lloyds had hoped
to sell the branches, along with their 4.5m customers. Several potential buyers came forward before it accepted a bid
from the Co-operative bank, a small not-for-profit firm. But the deal was scuppered when banking regulators noticed
that the Co-op was pursuing its not-for-profit ambitions a little too diligently and was dangerously short of capital.

Despite these hiccups an IPO of TSB holds out some promise of making Britains banking market more competitive
after more than a decade of false starts. In 2000 a government-appointed review headed by Don Cruikshank, a former
telecommunications regulator, found evidence of excessive prices and profits in British banking because of
insufficient competition. A succession of investigations over the following 12 years by British and European
Commission investigators have served mainly to fill vaults with reams of evidence detailing failures in the market.
Promises by the government and industry to improve matters have yielded little. A study earlier this year into personal
accounts by the Office of Fair Trading, a competition watchdog, concluded that long-standing competition concerns
remain.

Worse still, Britains banking market has become more concentrated since the financial crisis. In mid-2008, just before
the near-collapse of the global banking system, regulators worried that Britains four biggest banks had about 65% of
the retail-banking market. Within months their slice had risen to about 75% as the government pushed through the
takeover of HBOS, an ailing mortgage bank, by Lloyds TSB. The merged bank, renamed Lloyds Banking Group, alone
had about a third of the retail-banking market. But soon after the takeover it needed its own government bail-out, while
the failure of several other small lenders led to further concentration in the market.

Any challenger to the current oligopoly needs to jump two big hurdles. The first is scale. Although TSB has enough
branches to have a national presence (it claims that most Britons live within a few miles of at least one), it may
struggle to win much new business because its branches are thinly spread. This is because of an intriguing
characteristic of scale in retail banking: in places where banks have many branches near to one another, they gain a
share of customers that is even higher than their scale suggests.
To achieve the density of branches needed to compete with bigger rivals TSB might need as many as 1,000 outlets
across the country, reckons one expert. One way to achieve that might be through mopping up some of the countrys
smaller banks which face even greater scale challenges. These could include Virgin Money or the 315 branches that
Royal Bank of Scotland is also being forced to sell after its government bail-out (see chart). But in order to buy up
smaller rivals and consolidate them it needs modern and efficient computer systems.

This is the second hurdle. When potential bidders looked at buying TSB they reckoned they would have to spend
hundreds of millions of pounds building new computer systems for the bank. This would have entailed huge risk
rivals in Britain have spent upwards of 1 billion ($1.5 billion) and taken years longer than planned in rebuilding their
IT infrastructure. But it would also have left the buyer with modern and flexible systems that could then be used to bolt
on smaller lenders. One willing bidder was NBNK, a firm backed by Wilbur Ross, an American investor who also has a
stake in Virgin Money. Before its bid for the Lloyds branches was trumped by the Co-ops it had planned to use them
as a consolidation vehicle that could grow quickly.

Instead the new TSB will use computer systems run by Lloyds. TSB reckons this is an advantage since it will enjoy
some benefits of scale and also have access to new technologies such as mobile banking that Lloyds is investing in.
Yet there would seem to be an equally pressing danger that TSBs growth and competitiveness may be hampered by
its reliance on a competitor. When they ring up the Lloyds CTO [chief technology officer] to ask for a new product, will
he turn around and say sorry guv, that could take weeks and then switch it on the day after Lloyds has launched its
own version? says a person who was involved in one of the bids.

Despite the challenges facing TSB, its spin-off is a big step towards a healthier market. It lifts some uncertainty for
shareholders of Lloyds, including the government, which hopes to start selling down its stake soon. Yet its impact on
competition will be tremulous rather than seismic.