Questions and answers for SME Banking review announcement 23 August 2007

The review

1. What is 'SME banking'?
2. Why has the OFT reviewed the SME banking market?
3. What was the purpose of the review?
4. Which banks were covered by the review?
5. Did the review cover Scotland and Northern Ireland as well as England & Wales?
6. What did the OFT do?

Outcomes

7. What were the main findings of the OFT review?
8. What did the OFT recommend to the Competition Commission (CC)?
9. What has the CC decided?
10. What is OFT going to do to implement the CC's recommendations?

Wider banking issues

11. Does this mean that the OFT thinks the SME banking services market is now working effectively?
12. What does this mean for the rest of the OFT's work on banks?

 

1. What is 'SME banking'?

The SME banking market covers provision of banking services to small and medium sized enterprises (SMEs) with annual turnover of up to £25 million. SMEs in the UK hold over £100 billion in business current accounts and short-term deposit accounts.

2. Why has the OFT reviewed the SME banking market?

The CC conducted an inquiry in SME banking that reported in 2002. This found that the big four banks had a market share in excess of 90 per cent. It also found that switching banks was too difficult and that banks' offers were so similar that customers saw little incentive to switch. 

The CC put in place two sets of remedies following that inquiry. The first - and main - set (the 'behavioural undertakings') was designed to make switching easier and faster, to make prices more transparent and to stop banks from bundling SME services with other services (such as loans or personal current accounts). The CC designed these remedies to ensure that the market would become more competitive.

But it realised that this would take time, so put in place additional 'transitional' undertakings to ensure that customers were safeguarded until the main remedies took effect. These transitional undertakings required the four main banks in England & Wales to offer SME accounts that had either a minimum interest rate of no less than 2.5 percentage points below base rate or no money transmission charges (or both).

The OFT has a duty periodically to review undertakings that have been agreed by parties following a Competition Commission market investigation. The CC specifically wanted the OFT to review the transitional undertakings after a three year period.

3. What was the purpose of the review?

The OFT was reviewing whether there have been any changes in the market since 2002 that would justify a varying or releasing any of the undertakings. The OFT was also reviewing whether banks had complied with the undertakings.

The OFT only has an advisory role in respect of reviews of undertakings. The decision to release or vary undertakings is taken by the CC, following consultation with the parties.

4. Which banks were covered by the review?

The review considered the SME banking market as a whole. However, it focused particularly on the banks who had agreed undertakings following the 2002 CC report.

Transitional undertakings were agreed by the four main banks in England and Wales: Barclays plc, HSBC plc, Lloyds TSB and RBS Group.

Behavioural undertakings were agreed by the nine largest banking groups in the UK: AIB Group (UK) plc, Bank of Ireland, Barclays Bank plc, Clydesdale Bank plc, HBOS plc, HSBC Bank plc, Lloyds TSB Bank plc, Northern Bank Ltd and Royal Bank of Scotland Group plc.

5. Did the review cover Scotland and Northern Ireland as well as England and Wales?

The transitional undertakings apply only to banks in England and Wales, because in 2002 the CC found that the main four banks in England and Wales were earning excess profits. However, the OFT also considered developments in the rest of the UK as part of its wider review of the market. The behavioural undertakings apply in Scotland and Northern Ireland as well as England and Wales. 
 
6. What did the OFT do?

The OFT launched its review in January 2006. It passed advice to the Competition Commission in January 2007.

The OFT consulted a wide range of stakeholders and interested organisations during the course of the review. These included all the banks who signed the transitional and/or behavioural undertakings, consumer representative bodies (such as FSB and FPB), industry representatives (such as the BBA) as well as other Government departments and other regulators.

7. What were the main findings of the OFT review?

The OFT found that there have been some developments in competition since the CC looked at the market in 2002. These included that:

• several of the smaller banks have increased their market share in England and Wales (HBOS, Alliance & Leicester and Abbey have moved from around three per cent to nine per cent collectively) and are looking to increase this growth. The share of the four main banks has fallen
• there is evidence that SMEs are now more likely to consider a move to one of the smaller banks, and are more price sensitive than at the time of the CC report
• SMEs are increasingly banking with more than one provider. The behavioural undertakings appear to have had a positive impact in reducing the bundling of business current accounts with other banking services.

The OFT also found that the transitional undertakings have been successful in shifting prices towards more competitive levels. As a result of the transitional undertakings, the majority of SME customers of the four main banks have received either interest on their credit balances or free core money transmission services. The OFT estimates the direct benefit to SMEs has been that more than £1 billion since 2002. This has affected SME's expectations about what constitutes a competitive price.

However, the OFT continued to have concerns about the market, particularly continuing low levels of switching and lack of price transparency. In particular, although a greater proportion of customers are considering switching, customers still appear reluctant to carry out an actual switch to another bank, and in some cases appear not to be fully aware of either their current banking costs or the potential benefits of moving to another bank.

8. What did the OFT recommend to the CC?

The OFT recommended that the four main banks be released from the price controls set out in the transitional undertakings, removing the requirement on them to pay interest on business current accounts or offer free core money transmission services. It recommended that the other behavioural undertakings be retained.

The OFT recommended releasing the transitional undertakings because market developments identified in the review suggested that competition will constrain the ability of the four main banks to charge excessive prices in future. The transitional undertakings were intended to provide short-term protection to SMEs while the other behavioural undertakings were put in place, and competition in the market developed. The transitional undertakings have now been in place for more than four and a half years.

The OFT found that banks have complied with the behavioural undertakings on them. However, the banks could do more to raise awareness of the undertakings among their SME customers.

9. What has the CC decided?

The CC needs to consult the banks, SME customers and other interested parties before it reaches a final view. The CC has therefore published its provisional decision and is seeking views by close on 28 September 2007.  

The CC has provisionally agreed with OFT's recommendation to release the banks from most of the transitional undertakings. This means that the banks will no longer be required to offer an account giving interest of at least 2.5 percentage points less than base rate or an account without money transmission fees (or an account that does both).

The CC has provisionally decided that one of the transitional undertakings should be retained – this requires the banks to publish and to notify to the OFT any increases in charges or introduction of new charges.

In addition, the CC has made some recommendations to the OFT. It has recommended that the OFT:

• raise awareness of any increases in charges, introduction of new charges or reductions in interest payments following the release of the undertakings
• take account of the banks' responses in any future review of the behavioural undertakings
• work with the banks to publicise the obligations they face under the behavioural undertakings
• explore with the British Bankers' Association whether and how to include the behavioural undertakings in the Banking Code.

10. What is OFT going to do to implement the CC's recommendations?

The OFT will discuss with banks and SME groups how best to implement the recommendations. It wants to ensure that its approach to SME banking is consistent with our wider banking work.

In the meantime, the OFT continues to have an ongoing role in monitoring the undertakings (including the transitional undertakings until such time as the CC confirms its provisional decision).

11. Does this mean that the OFT thinks the SME banking services market is now working effectively?

No. The OFT believes that competition is sufficiently strong to allow the release of the transitional undertakings. That does not mean that this is now a well functioning market, or that improvements cannot be made. 

In particular, although a greater proportion of customers are considering switching, customers still appear reluctant to carry out an actual switch to another bank, and in some cases appear not to be fully aware of either their current banking costs or the potential benefits of moving to another bank. The OFT is engaging in continuing dialogue with the banks to improve these aspects of the market and believe that, together with the continued presence of the behavioural undertakings, these issues will be resolved.

12. What does this mean for the rest of the OFT's work on banks?

This decision has no direct implications for OFT's other work on banking. The OFT will continue to keep a close eye on the entire banking market - it is a key priority area of work for the OFT.

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