Conduct and competition in SME lending report published

Some of the key conclusions and recommendations contained in the report include:

Quotes are  from Andrew Tyrie MP, Chairman of the Treasury Committee.
A full list of the conclusions and recommendations can be found on pages 96-102.

1. Mis-sale of Hedging Products and the FCA’s IRHP review

- The FCA’s IRHP redress process is guided by the principle that “redress must be fair and reasonable”, and that “redress should aim to put customers back in the position they would have been in had the breach of regulatory requirements not occurred.” This is a statement of principles, and is open to interpretation by banks conducting the review. The outcome in each customer’s review therefore relies primarily on the judgement of the bank, on a case by case basis, subject to approval from an independent reviewer. In addition different banks came to different conclusions with inconsistency between different independent reviewers. (paragraph 91)

- The arbitrary sophistication test may have been necessary to obtain agreement to a voluntary scheme from banks, but it is clear that not all non-sophisticated customers have been included in the review. (paragraph 92)

- The FCA has acknowledged that the introduction of a £10 million cap on the size of an IRHP has excluded approximately one third of the largest IRHP review participants. The FCA should write to the Committee to explain its decision-making on this cap. This explanation must state whether, in its view, it represented a concession to bank lobbying, and if not, why not. (paragraph 99)

- The FCA has consistently maintained that the redress process has worked as intended. But there have been complaints that the process of the IRHP review falls short of delivering fair and reasonable redress. It has been difficult for this Committee to determine, however, whether these complaints are examples of isolated exceptions to an adequate process, or are signs of a wider, systemic problem with the review (paragraph 114)

- This in itself is indicative of a flaw in the process which the FCA should address. In particular, the FCA should collect the information necessary to establish whether there are systemic failures in the review. The FCA should publish its findings, a summary of the complaints it has examined, and take any action it decides is appropriate to ensure that all customers receive fair and reasonable redress. (paragraph 115)

“Many small businesses have been badly hit by the complex terms of the IRHPs offered by their bank. A significant number of those firms who were mis-sold these hedging products feel that, having been ripped off in the first place, they have now been treated unfairly again by the FCA’s IRHP redress scheme.

“It is far from clear that the FCA’s scheme has delivered fair and reasonable redress to all the businesses affected. The FCA needs to do much more to demonstrate that this process is credible and has not unduly favoured the banks.

“As part of this work, the FCA should collect the information necessary to establish whether there are systemic failures in the review. This would benefit from independent oversight. It should publish its findings. Greater transparency is crucial in order to ensure that those SMEs mis-sold these products receive – and are seen to receive – appropriate redress. The Financial Services Act provides for the Treasury to require for this type of work to be done. But hopefully this won’t be necessary.”

2. Tailored Business Loans and Clydesdale Bank

- We have received evidence suggesting that Clydesdale Bank mis-sold Tailored Business Loans. Clydesdale has itself admitted that its terms and conditions letters would not pass a plain English test, and that its TBL customers could not reasonably have anticipated the high levels of potential break costs to which they had exposed themselves. Many small businesses indeed did not grasp their exposure to such high break costs, nor could they reasonably have been expected to do so. (paragraph 147)

- It appears that the bank did not explain the potential scale of break costs in a low interest rate environment because the bank itself had not taken into account this potential risk. Banks, however, should be the experts in assessing the potential risk of products they sell, and explain those risks to their customers. The sale of TBLs has led to considerable consumer detriment. The bank’s failure adequately to assess the potential risk of its product may explain the detriment that the bank has caused to its customers, but does not excuse it. (paragraph 148)

- From the point of view of the customer, the services provided by the hedging element of a loan with an embedded interest rate hedging facility—such as a Tailored Business Loan—and a stand-alone IRHP are extremely similar, if not identical. But stand-alone IRHPs are regulated, while loans with embedded interest rate hedging facilities are not. It is a logically inconsistent result of the perimeter of regulation that products whose effects may be identical fall on both sides of the perimeter. (paragraph 149)

- Clydesdale understood that TBLs were unregulated. It created TBLs to avoid requirements imposed by the regulator on the sale of a regulated product, IRHPs. It claims that this was to simplify the associated documentation, and to make the product easier for customers to understand. The use of TBLs has left regulators powerless to enforce compensation for customers to whom products were mis-sold, as they have done with IRHPs. Clydesdale created a product that retained the risks and complexities of the regulated product, but had none of the safeguards. (paragraph 150)

- The Treasury should publish an assessment of the feasibility, benefits and costs of adjusting the perimeter of regulation to cover loans with features of interest rate hedging products. This assessment will need to take into account the possibility that other products may inadvertently be included in the perimeter as a by-product, and the negative consequences that this could entail. (paragraph 151)

- The lack of public oversight, minimal transparency and limited coverage of the scheme mean that the Committee cannot be confident that Clydesdale’s separate internal review will deliver outcomes equivalent to the FCA review upon which it is intended to be based. If Clydesdale’s aim is to build public trust in its actions, it should address all three of these problems. (paragraph 161)

“The hedging element of Tailored Business Loans fell outside the scope of regulation, despite sharing – for all practical purposes – the features of regulated products.

“This gap in the regulatory perimeter meant that the product created by Clydesdale Bank was not covered by the usual safeguards. Many of its customers did not understand the product and could not reasonably have been expected to do so. Some were probably unaware that the product fell outside the scope of FSMA. Regulators have been powerless to provide redress to those affected by wrongdoing.

“Furthermore, Clydesdale’s own internal review of potential mis-selling appears to have serious shortcomings. It lacks public oversight, transparency and is limited in scope. All three of these problems need to be addressed by Clydesdale.

“The Treasury should, for the future, undertake a thorough analysis to consider the merits of bringing these products within the scope of regulation.”

3. Competition

- Inadequate competition in banking is a long-standing problem. Many of the problems identified by the Parliamentary Commission on Banking Standards, the Independent Commission on Banking and the 2002 Competition Commission market investigation persist. The UK SME banking sector remains dominated by four major banking groups, who among them have a market share in England and Wales of 85 per cent. The largest firms have the lowest satisfaction scores. (paragraph 212)

- Challenger banks and the growth in alternative lending have scope to increase competition. However, gross peer-to-peer lending to businesses in H1 2014 was £300m, only about 1% of the £24.8 billion lent by banks to SMEs over the same period, and the CMA found that the SME banking market share of banks outside the top 5 in England and Wales was less than 5%. Challenger banks and alternative lenders are therefore not yet at a scale sufficient to challenge incumbents. There is currently little evidence to suggest that new entrants in the SME finance market and existing measures to improve competition will deliver the transformation in competition that the industry needs. This lends weight to the importance of the CMA’s market investigation into SME banking. (paragraph 213)

- The presence of multiple credit searches in a business’s credit history can damage their credit score. Multiple credit searches may indicate that a customer’s applications for credit have been repeatedly declined, and therefore suggest to a lender that they are a higher risk. But they may simply be evidence that the customer is shopping around. Borrowers are often deterred by the banks themselves from comparing providers by the negative impact that making applications to multiple banks could have on their credit score. As part of its market investigation, the CMA should, in consultation with the industry and the Information Commissioner’s Office, examine how this disincentive can be addressed. (paragraph 219)

- Price comparison tools are prevalent in retail banking and insurance markets, but less so in business banking. This may be due to the relative complexity of products in the SME banking market. It may also be a symptom of a lack of competitive pressure in the industry. As part of its market investigation, the CMA should examine, in consultation with the industry, why the provision of price comparison tools for SME banking has so far been limited, and the scope for increasing it. (paragraph 225)

- The Current Account Switch Service has been geared primarily towards retail customers, not businesses. Changes announced by the Government at the 2014 Autumn Statement to improve the CASS for SMEs are therefore welcome. As part of its market investigation, the CMA should examine how the scheme could further benefit SMEs, and what steps can be taken to improve SME awareness of the scheme. (paragraph 231)

- Measures taken so far by the competition authorities and the Government have not resulted in a transformational improvement in the competitive environment. The CMA has concluded that concentration in banking is part of the problem. It must now also decide whether reducing concentration would help to address it. This has been examined more than once before. In 2002, the Competition Commission concluded that the forced break-up of large banking groups would not be "proportionate". The Parliamentary Commission on Banking Standards examined the possible benefits to banking from breaking up RBS into a ‘good’ and ‘bad’ bank. It stopped short of recommending an immediate breakup of the bank, but recommended that the Government commission a detailed analysis of the case for such a split. This study concluded against such a split. But the question of concentration will not go away. The Chancellor is now reported as having said that he made a mistake in not radically restructuring RBS in 2010. The Committee recommends that the CMA’s market investigation should include a detailed examination of whether the conclusions of both the Competition Commission and the Parliamentary Commission on Banking Standards remain relevant, and whether structural reforms may remain essential to secure a reduction in concentration in the market. (paragraph 238)

“Millions of consumers and small businesses have been getting a poor deal for decades because of a lack of effective competition and genuine choice in banking. This problem is particularly acute in the SME banking market.

“The Government and regulators have both been trying to improve competition, not least by implementing the recommendations of the Treasury Committee, the Vickers Commission and the Parliamentary Commission on Banking Standards. Nonetheless, greater competition remains crucial to raising standards across banking.

“The CMA’s market investigation, announced in November 2014, is the latest in a series of studies of inadequate competition in banking, and recommendations for remedy. Most previous efforts ended up in the long grass. It is crucial that the CMA’s work does not suffer the same fate. It should, among other things, look at the case for structural reform of the banking sector.”

4. The role of the regulators

- Regulation can be an impediment to effective competition in banking. Regulators appear to have an instinctive resistance to new entrants: in the recent past, prudential requirements had been applied in a way that unnecessarily hindered new entrants, the authorisation process had been difficult for new entrants, and small banks had to reach an agreement with a larger one to have access to the payments system. The FCA now has a statutory objective to promote competition in the interests of consumers. The FCA must continue to transform its regulatory approach in order to fulfil this new objective. It is essential that the FCA’s approach to meeting this objective is not siloed within an individual department of the regulator, but instead permeates through the entire culture and approach of the organisation. (paragraph 250)

- The FCA’s competition objective is new. The regulator is in the process of learning a new set of skills. The evidence suggests that this is a work in progress. The Committee recommends that the FCA, with oversight from the CMA, produce an annual report on the implementation of its pro-competition activities. In particular, the CMA should be invited to form a judgement on the effectiveness of the FCA’s competition regime. The FCA and CMA have concurrent competition objectives. They both remain active in the competition field. The danger is that the CMA retreats, and the FCA does not vigorously fill in the space left. The CMA should report publicly if it believes the FCA is not fulfilling its competition duties. (paragraph 251)

“Regulation alone is not the answer. After persistent pressure from the Treasury Committee, the FCA is now required by law to promote competition in the interests of consumers.

“The FCA’s efforts to fulfil this objective and transform its culture are still work in progress. Much more needs to be done to put competition at the core of decision-making across the organisation. The CMA should assume responsibility for reaching an annual judgement as to whether the FCA is fulfilling its statutory duty to promote competition in the interests of consumers. It should ensure that its findings are published.”

5. RBS and GRG

- In his report on RBS, Sir Andrew Large said that GRG was run as an “internal profit centre”. However, in written and oral evidence to the Committee, RBS disputed that description—even though it had had the opportunity to contest that point when it saw Sir Andrew’s report in draft. Mr Sullivan and Mr Sach told the Committee, on behalf of RBS, that GRG was not a profit centre. The Committee, having received further written evidence from Sir Andrew Large, the Chairman of RBS, Mr Sach and Mr Sullivan, has concluded that Mr Sullivan and Mr Sach’s original statements to the Committee on this point were wrong. It is now agreed by all that Sir Andrew was correct in his description of GRG as an internal profit centre. (paragraph 80)

- The evidence that Mr Sach and Mr Sullivan gave was incorrect and therefore misleading, whether intentionally or not. RBS has apologised to the Committee and corrected its evidence. However, given the seniority of the original RBS witnesses, it should not have required intervention by this Committee with the Chairman of RBS to obtain that apology and a full statement of RBS’s position. (paragraph 81)

- This misunderstanding of the bank’s position by two senior executives is indicative of a systemic weakness of standards and culture. It is understandable, indeed right, that banks should seek to support businesses in difficulty with special measures but how that is done and whether the institution or the customer is the main beneficiary needs much greater clarity. (paragraph 82)

- The Clifford Chance review of RBS’s treatment of distressed customers, principally by the Global Restructuring Group, was welcomed by RBS as finding “no evidence of systematic defrauding of business customers”. However, the review—overseen by a bank executive rather than an non-executive director—was not independent, was based on narrow terms of reference, and left a number of questions unanswered, such as why GRG could not explain the size of fees it had charged, and the accuracy of its asset valuations. (paragraph 68)

- The FCA is conducting its own review into GRG. It is important that this review comprehensively address the allegations against GRG, so that the public can be confident that any wrongdoing is identified and resolved. (paragraph 69)

“Two senior RBS managers gave evidence to the Committee that was materially incorrect on a key point. RBS has subsequently but belatedly apologised.

“The Clifford Chance review of RBS’s treatment of distressed customers should not be considered a clean bill of health. A thorough investigation by the FCA already underway is crucial to the restoration of confidence in RBS as a bank. This investigation needs to demonstrate that RBS serves its customers’ interests rather than its own.”