WITH the collapse of the Co-op deal to take over 632 Lloyds branches, another attempt to extend competition into the banking sector has broken down.
Enhanced competition in banking is vital to restoring health to the sector. Existing banks face incentives to shrink lending and enhance short-term profitability, either to buy out their taxpayer owners, or be fattened up for privatisation – thereby limiting taxpayer losses. New players, however, would not face the same legacy of bad debt, and would have powerful incentives to expand lending at keen rates so as to gain market share. But although policymakers recognise the need to achieve more competition, four main blockages remain to new entry from outside the existing players.
First, establishing a foothold in the sector involves considerable upfront costs since, to be credible, firms must have very high consumer visibility and confidence. In the past, they also required extensive branch networks. Perhaps in the age of internet banking these barriers are a little less than they were, but they remain significant.
Secondly, there are extensive regulations in banking, as in financial services generally, which have the effect of driving all major banks to offer very similar services, thereby restricting new entrants from offering much that is truly novel. Reintroducing the principle of caveat emptor – “buyer beware” – into financial services would change this considerably.
Third, entry is hard because capital requirements are high, despite being reduced recently for new entrants. Capital requirements have been set so high because governments felt obliged to bail out failing banks, and wanted to make such bailouts less likely in the future. But a consequence of this is less competition.
Most fundamentally, however, competition is poor because banks have not been permitted to go bust and exit the market, creating space for new entrants. The European Commission’s new bank resolution procedure, piloted recently in Cyprus, may go some way to changing that. But competition, like capitalism more generally, can only really function if firms are permitted to go bust.
An alternative route to competition may, therefore, come not from encouraging new entrants but from breaking up the state-owned banks. Before the 2010 general election, George Osborne proposed breaking up the three state-owned banks into six new players. This week, the new archbishop of Canterbury Justin Welby has suggested (to some criticism) that such a break-up should create regional banks, instead of the current national ones.
But whichever way we go, the clock is ticking. The sooner we can get genuine competition into banking the better.
Andrew Lilico is chairman of Europe Economics.