Bank of England: Effective Competition & Financial Service Regulation

Earlier this month, the Bank of England published a staff working paper entitled, Competition and prudential regulation”. The document is the work of Paul Fisher, former Deputy Head of the Prudential Regulation Authority (PRA) and Executive Director for Supervisory Risk and Regulatory Operations, and Paul A Grout, from University of Bristol and Bank of England. The paper, as one may expect, reviews the incorporation of a competition mandate within the Prudential Regulation Authority (PRA), part of the Bank of England. This competition mandate is a recent addition to the Bank’s mission.

The position in the UK is that the PRA is charged with facilitating “effective competition” as one of its three objectives. While the effective competition mandate is a secondary one, the authors believe the competition objective for this type of institution is unique in the world. (The primary objective being achieving an appropriate safety and soundness for its firms and markets). Much of the paper’s discussion is very academic and focuses on the conflict between competition and safety and soundness or “complementarity of stability and competition in the presence of financial regulation.”

In brief, government policies are ostensibly designed to generate a high rate of sustainable economic growth and employment. Engendering this type of environment necessitates a good degree of safety and soundness. Appropriate regulations are required. But there must be a balance of sufficient competition within the financial services sector.

The paper also observes that the PRA, Financial Conduct Authority (FCA) and Competition and Markets Authority Authority (CMA) enjoy a “constructive relationship” that is not replicated by “overseas regulators”. One would surmise they are glancing west across the Atlantic. The authors believe it is important to foster the UKs regulatory communication and collaboration as “this is something which could slip away and needs to be preserved and nurtured.”

While the authors believe “there is no simple answer to the question of whether competition conflicts with stability or helps increase it,” they do note that in the UK big banks take 95.5% of the market share. Six large banks; Barclays, HSBC, Nationwide, RBS, Santander and LBG – dominate the industry.

Addressing the financial crisis of the past decade, big banks received “implicit subsidies”. They were, in fact, too big to fail. The Lehman Brothers debacle is a painful reminder as to how politics can blind policy makers to more rational decisions.

To quote the document;

“Big banks and lenders have thus received an implicit subsidy relative to small banks and this encourages too much risk taking by large banks and distorts competition in favour of those who are not paying the full costs of their actions. Policies that seek to achieve the appropriate degree of safety and soundness by making banks face the true cost of their risk taking will, simultaneously, make competition more effective. Alternatively, approaching the problem through the lens of competition and asking what can be done to make competition more effective will land in the same place, i.e. removing the TBTF [too big to fail] subsidy.”

The authors admit that a discussion regarding the appropriate amount of competition is more of an academic exercise and not very practical. Risk, on the other hand, is an important element of any market driven economy. Too little and your economy will stagnate and falter. Too much may cause a different, unfortunate outcome.

The paper asks; “What can the PRA do to advance its competition objective in this context?”

“Encouraging more entry must be part of any competition policy agenda, although allowing and encouraging very small banks, does not seem likely to generate significant competition to the UK’s big 6 in the short and medium term. The PRA has set up, jointly with the FCA, a ‘New Banks Start-up Unit’ to aid entry. In addition, new banks are often given the benefit of a lighter regulatory touch as they get themselves going – even though they may be more vulnerable than larger banks, their failure would be less systemic and so less intervention is required in order for the PRA to meet its primary objectives.”

The PRA has set up, jointly with the FCA, a ‘New Banks Start-up Unit’ to aid new bank entry #FintechClick To Tweet

The missing question is who are these new entrants in the UK banking sphere?

Of course, they are the new breed of digital only challenger banks.

Void of expensive bricks & mortar and legacy systems that greet change like highway roadkill, these mobile banking startups seek to offer superior service at a lesser cost. Think Atom, Starling, Revolut, Mondo, and more. These young online banks want to entice customers away from their geriatric brethren. Minus the teller queue.

These young online banks want to entice customers away from their geriatric brethren. Minus the teller queue #FintechClick To Tweet

Having a competition mandate compels the regulators to encourage these new-fangled mobile happy banks. That is not quite the case in some other jurisdictions. (Once again, look west, across the Atlantic.) In fact, some argue the UK’s support of competition is one of the main reasons the Fintech ecosystem remains so globally vibrant.

The paper in itself is an interesting discussion but poses more questions than answers. Real world experience has a way of veering away from theory. Hindsight is a painful reminder of this fact. The authors end with encouraging words though, perhaps indicating more financial disruption will follow;

“The Bank has implemented many policies to facilitate effective competition but there is still much for the agencies, collectively, to do.”

Other national regulators could learn much from this important UK experiment, to the benefit of all.

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