CREDIT RISK, COMPETITION AND CONSUMER BANKS

A recent Bank of England working paper highlights the link between banking market competition and financial system stability. Consistent with earlier work, it highlights that as competition increases, the banking system overall responds typically by moving to higher risk lending.  However, in addition, it describes how individual banks tend to converge with the most-risky becoming more secure as competition increases.

The paper shows that in the period between 1995 and 2014 the level of competition has secularly decreased (a high value of Boone indicator suggests less competition).

 (From De Ramon, Francis and Straugham, Aug 2018, Bank of England Working Paper)

(From De Ramon, Francis and Straugham, Aug 2018, Bank of England Working Paper)

This lack of competition is linked, but not synonymous, with a limited choice of banking providers (typically measured by HHI) which also shows concentration across UK consumer banking markets. Other studies (SMF paper 2017 – “Concentration not competition: the state of UK consumer markets”) have pointed out that low competition has negative connotations – specifically poor service for consumers and the risk that for banking in particular the largest market participants become “too big to fail”.

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To address this the regulatory authorities have introduced a whole series of remedies to encourage new market entrants to grow their market share. Based on the more recent data above it seems that since 2013 these are starting to take effect and we are beginning to see an increase in banking market competition once more. Drivers of a potential reversal in UK market concentration/competition include:

  • Forced separation of TSB from Lloyds

  • Creation of Williams and Glyn funding to drive SME market competition

  • Open Banking which reduces information asymmetry of current account banks for other products

  • CCDS (Commercial Credit Data Sharing)

  • Capital add-ons for systemically important banks 

  • Support for smaller banks to attain improved capital efficiency via IRB

  • Aggregator/comparison sites to reduce friction for consumer choice

  • Fintech / Peer to Peer / AI based lenders with potentially different cost models

If competition increases this will bring a new dynamic for market participants. Finding opportunities for differentiation and efficiency in consumer banking will become core. Key tools in this new dynamic will include:

  • A clear and accurate model to estimate risk adjusted return at a highly segmented level. This becomes essential to navigate where the bank pricing power and should specialise.

  • Investment in the newly available data sources and subsequent analysis to ensure marginal assessment of risk is accurate.

  • Innovation to find new ways to help support customer’s financial needs and minimise process complexity/effort for the consumer. This is often in direct conflict with the bank’s duty to consider consumers interests and avoid conduct risks.

For further information please contact Mark Somers, COO at mark.somers@4-most.co.uk