Aplicación pentesting

6.54 If new entrants and existing smaller firms in retail banking are unable to secure funding to finance expansion this may hamper their ability to respond to increased consumer demand and finance innovation. This barrier may, in turn, reduce their ability to impose a competitive constraint on larger incumbents.

6.55 In general, providers of retail banking services have five main sources of funds to finance expansion:

• retail deposits, which come from customers' savings

• interbank loans where banks lend money to each other

• issuing equity which can involve direct or public selling of new shares to investors

• retained earnings, which involve a share of profits that is not distributed to shareholders as dividends, and

• debt securities such as covered bonds, which include loans with basic terms and maturity date, which can be bought or sold to third parties.

6.56 Not all of these sources are available to all types of retail banking providers and demand for them differs according to the provider's growth strategy. For example, not all retail banking providers in the UK are authorised to accept deposits and cannot access this funding source.

6.57 The relative attractiveness of different sources of funds varies over time, depending on changes in investor confidence and credit ratings, on the costs of running a retail deposit business, on changes to consumers' propensity to save and also on regulatory requirements.

6.58 Since the financial crisis, the availability of wholesale funding such as interbank loans has been severely reduced so that currently there is renewed emphasis on retail deposits. Many respondents reported that, in

the short-term, they are seeking to maximise the proportion of their funding that comes from customer deposits.

6.59 This drying up of wholesale funding has had the effect of reducing the availability of finance for those providers whose business models

depended on it, such as monoline providers of residential and commercial mortgages. If firms' access to different funding sources is restricted or curtailed, this may act as a barrier to expansion.

6.60 While some of these providers may be able to switch to using retained earnings or issuing equity, this may not be a viable option for many.¹⁶⁷ Similarly, the option of applying for and obtaining a banking licence to attract retail deposits may not be viable in the short-term and there is no guarantee they will be able to raise sufficient deposits. Taken together, these factors have led to a reduction in such providers' ability to finance new business, and in some cases, have led to their exit from the market.

6.61 We have also heard concerns that, as a result of Government support, some incumbents have received higher credit ratings than would otherwise have been justified in the absence of such support. This in turn, it is argued, led to these incumbents being able to access cheaper funds, allowing them to maintain or enhance existing levels of lending.

The difference in the cost of borrowing between smaller providers and new entrants compared to incumbents was therefore even greater than it would be in normal market conditions.¹⁶⁸

6.62 In both cases, these appear to be short-term developments related to the financial crisis. It might be expected that as wholesale markets recover the significance of these barriers to expansion will decline. We also understand that any credit rating uplift granted to large incumbents has

167 We have also been informed that smaller institutions lack the expertise and are potentially unable to bear the costs of creating a covered bond vehicle, even if the market were open.

168 One would expect that smaller institutions and new entrants will typically face a higher cost of capital compared to incumbents as they do not have a track record and scale.

been, or is in the process of being, phased out, which should mean that their cost of capital is a more accurate reflection of their financial

position.¹⁶⁹

Summary

6.63 IT systems are the backbone of retail banking activities and are essential to the safety and resilience of financial systems. There are a number of options available to new entrants to meet their IT system needs and we have not received any evidence to suggest that the cost of such

systems, in and of itself, is deterring entry. However, the sunk costs associated with establishing IT systems may deter entry if entrants then face difficulties in attracting sufficient numbers of customers to recover this outlay.

6.64 Access to industry-wide payment schemes has been under scrutiny for the last decade and there have been significant changes during that time. Firms can access payment schemes either by becoming a full member of the scheme or through an agency agreement with a scheme member. While in some instances new entrants with unconventional business models have experienced difficulties in initially accessing industry-wide payment schemes, the OFT has not received evidence to suggest that there are significant or widespread barriers to achieving access to these systems.

6.65 Access to accurate information to assess customers' creditworthiness is essential for providers to be able to accurately identify and manage business risks and offer customers products. Providers can access information on personal and SME customers from a range of third-party sources, as well as their own records. New entrants or smaller providers do not appear to face any impediments in accessing this information.

However, in the case of the smallest SMEs, there appears to be less information available to providers. This can have the effect of making it

169 See for example Phasing Out Extraordinary Support Assumptions from UK Bank Ratings, March 2010, available at www.moodys.com .

harder for new retail banking providers to be able to offer products, such as lending, to these SMEs due to a lack of reliable information on their risk profile. SMEs themselves appear willing to provide much information and there are a number of private sector initiatives which, in time, may remedy this information gap.

6.66 Financing expansion has become more challenging after the financial crisis, which caused interbank funding to dry up, affecting the viability of certain business models. We have also heard suggestions that due to Government support, incumbents have received higher credit ratings, leading to lower borrowing costs than new entrants and smaller firms. In both cases, these appear to be short-term developments related to the financial crisis. It might be expected that as wholesale markets recover the significance of these barriers will decline.

7 BARRIERS TO EXPANSION

7.1 Attracting new customers and growing market share is crucial for the long term viability and success of entrants in retail banking. This relies upon providers being able to offer value-for-money products with the features that they want. Equally, customers must have the confidence and ability to switch between rival providers. In a sector such as retail banking, where there are well established incumbents which already have a large established customer base, high brand recognition and an extensive branch network, new entrants may face significant difficulties in attracting customers.

7.2 This chapter considers features of retail banking markets that can create difficulties for new entrants and smaller providers in attracting

customers. Previous research has suggested the presence of barriers to expansion for such firms. For example, the Cruickshank Report found that new entrants had made little impact on retail banking.¹⁷⁰ The CC also found that it was difficult for new entrants to build market share quickly in the provision of accounts in Northern Ireland¹⁷¹ and similar findings were made in the OFT's PCA market study.¹⁷² If providers face difficulties in building up a customer base they will struggle to recover the sunk costs of entry, which in turn may dissuade them from entering in the first place.

7.3 The chapter begins by examining whether personal and SME customers have the confidence and ability to switch between providers in different retail banking product markets and whether there are any barriers to them doing so. It explores the consequences that low levels of switching may have on the ability of firms to attract customers. The chapter then

170 Cruickshank, Competition in UK Banking: a report to the Chancellor of the Exchequer, March 2000.

171 See CC NI banking report, pages 72-75.

172 See OFT PCA market study, pages 28-37.

examines the role played by brand and the branch network, and the extent to which they constitute potential barriers to expansion.