Northern Rock break-up is good for competition

Stuart Fraser
Leaving the debate over who should be the first &ldquo;President of the EU&rdquo; aside, the EU Commission&rsquo;s recent decision to allow the break-up of Northern Rock into separate &ldquo;good&rdquo; and &ldquo;bad&rdquo; banks was a major step forward to restoring healthy competition in the banking sector.<br /><br />Restructuring Northern Rock and selling off its viable parts will enable the government to secure a much needed windfall for the embattled public finances. This disposal will also increase choice for consumers. <br /><br />Rules on state aid and government guarantees were relaxed at the height of the crisis to ensure the financial system across the UK and Europe did not grind to a catastrophic halt.<br /><br />However, subsequent bailouts also created an uneven playing field skewed in favour of government-backed banks. Lloyds Banking Group, for example, holds roughly a third of the current account and mortgage markets. Meanwhile, Lloyds and Royal Bank of Scotland have a combined share of the small business market of around 50 per cent.<br /><br />This has prompted one recurring criticism of the industry since the crisis broke &ndash; that banks have used the government&rsquo;s Asset Protection Scheme (APS) to rebuild their balance-sheets while failing to meet demand for credit from customers.<br /><br />The current economic and political climate makes this tension understandable: on the one hand policymakers talk about the need to increase capital requirements, while on the other they call for banks to boost lending to the real economy. Business conditions are still very difficult, more defaults are expected in the commercial property market and higher provisioning is likely to be required for mortgage and credit card default. It is not surprising banks are being cautious on lending. <br /><br />However all businesses including banks need to be kept on their toes and reinvigorating competition in the banking sector by bringing in new players should improve the supply of funds at a time when the government is pulling back.<br /><br />Therefore, the sale of Northern Rock, combined with expected divestments from Lloyds and RBS, will help to provide better deals for consumers. This will be particularly true if branches are sold to new entrants to the market.<br /><br />However we must be careful that increased competition does not lead to overly aggressive lending simply to gain market share. It has to be made clear that there is a price for having a lender of last resort in the government. Risks have to be better evaluated and priced appropriately. Constraints will remain so that mistakes we have seen in the past are not repeated. <br /><br />Stuart Fraser is chairman of the City of London&rsquo;s policy and resources committee.