Retail banks have changed – but don’t blame investment banking

Frances Coppola
AT A recent debate, the Bank of England’s Andy Haldane called for a culture change in retail banking. He claimed that a structural separation of retail banking from investment banking would end damaging cross-contamination. Retail banking could return to its roots in relationship management and judgement, based on local knowledge.

But Haldane’s comments were based on a misconception. There is a widespread belief that any changes that took place in retail banking in the 1980s and 1990s were the consequence of the liberalisation of investment banking in the Big Bang of 1986.

But this is wrong. By the time of the Big Bang, retail was already a low-margin, cut-throat business and the weaker players already found it hard to make significant profits. Changes in retail banking arose from the introduction of American-style marketing and retail sales techniques, allowing economies of scale in back-office processing. This change was identical to contemporary movements in retail shopping – the crowding out of small high street shops by out-of-town shopping malls, and investment in IT for efficient, low-cost manufacture and delivery of products. Investment banking had very little to do with it.

In 1986, I started working at Midland – the first bank to transform its retail operations into the now familiar sales-driven model. Midland was dismally short of money and was going into a period of retrenchment. It consolidated its merchant and wholesale banking activities with its international businesses to create the Midland Montagu subsidiary. It thus functionally and legally separated its core retail business from its investment banking activities.

Driven by the head of domestic banking Gene Lockhart, the retail part of Midland embarked on a programme of automation and centralisation of its back-office operations. It created huge dedicated processing centres, highly automated and thinly staffed. Back-office functions like cheque processing and payments were removed from branches and consolidated in these centres. Branches were redesigned to be like retail shops, staffed with sales staff whose job was to sell products. They were given challenging sales targets and their pay became partly commission-based. Some branch staff were made redundant – especially the older, more experienced and more expensive ones. The rest were retrained.

Midland did manage to improve the performance of its core retail business. But inevitably, other retail banks like NatWest were quick on its heels and its competitive advantage was short-lived.

In 1992, Midland was taken over by HSBC, which was looking for an escape route from Hong Kong in anticipation of the handover to China in 1997. And HSBC didn’t reverse the changes in retail banking that Lockhart had driven. The sales model in retail banking remained.

The final nail in the coffin of traditional retail banking was the conversion of building societies into banks, starting with Abbey National. This led to significant consolidation of retail banking and the creation of the super-banks we have today.

The cultural issues that Haldane sees in retail banking are therefore nothing to do with “cross-contamination” from investment banking. They came from the retail sector itself.

And the model for the future of retail banking was not investment banking: it was shopping. Banks created “one-stop shops” where retail customers could go to buy all the products they needed, including pensions, insurance and, for business customers, derivative products. Banks knew they could make far more money from selling these products than they could from providing core banking services.

And for retail banking the shopping model is not a bad one. Efficient, low-cost banking services do require centralised, automated operations. With the advent of internet banking, the need for local provision in ordinary banking activities is reducing fast.

There is space for diversity in the retail banking sector, however. Haldane was right to endorse the small local branches operated by Svenska Handelsbanken. But there is also still a place for supermarket banking, just as there is a central role for supermarkets. Not everyone can afford the higher prices that small shops tend to charge. Banking is the same: small scale and personal service comes at a price.

Frances Coppola is a financial writer and former banker.