In what was one of the last documents to come out of the UK Financial Services Authority (FSA) before it officially split into the Prudential Regulation and Financial Conduct Authorities, the regulator set out proposals to make it easier for new entrants to obtain banking licences. This is a positive initiative to stimulate competition in the highly concentrated UK banking market. However, as the FSA acknowledged, this will not change the banking landscape overnight as the uneven regulatory playing field is but one of a number of barriers to entry for challenger banks versus the very large established players.
The regulator set out proposed changes to both the authorisation process and the capital and liquidity requirements for new bank applicants. The authorisation process will now offer a standard approach with more upfront input and a challenge to applicants from the regulator or an initial streamlined approach whereby successful applicants can be approved subject to committing to significant infrastructure spend.
The capital and liquidity proposals (which have been trailed for some time) are significant as new entrants will no longer be required to hold additional capital or liquidity resources just because they are new and have no trading history. Furthermore, applicant banks will no longer be needed to commit the full capital required for a fully ramped-up business on day one. New banks will be able to build up capital on a so-called 'glide path' as the balance sheet and risk assets grow.
In addition, there are relaxations on the additional capital conservation buffer required under Basel III and in limited circumstances applicants will be able to adopt the internal ratings-based approach, which requires lower levels of capital.
No systemic risk
The regulator does not believe that the levelling of the capital and liquidity playing field will pose a significant risk to its financial stability objectives, as new entrants are unlikely to be systemically important institutions. The new resolution regime will allow for the orderly exit of failing banks which should be the case in a well-functioning free market system where the regulator does not have the objective of a zero-failure regime. Indeed, one could argue that a lack of competition contributed to certain bank balance sheets becoming the size of some countries’ entire economies, which led to the ‘too big to fail’ problem that is still unresolved more than five years on from the beginning of the financial crisis.
On paper, the proposals mean that the application process is less of an all-or-nothing gamble, which should give more certainty to investors and mitigate some of the risk associated with attracting human capital. Time and some test cases will tell whether the regulator's apparent pragmatism translates into a new practical reality.
Other barriers
As the FSA acknowledged, these proposals will not address other barriers to entry, which include access to payment systems that are controlled by existing clearing banks, the strength of existing brand franchises, perceived and actual customer account switching difficulties, and IT and systems infrastructure challenges. These barriers will remain significant and the recent failures of the forced RBS and Lloyds branch disposals demonstrate that, even for existing players, practical issues regarding integration, systems and funding make transformational change in the bank sector a difficult business. In the retail banking and small business space, brand value combined with customer inertia and the perceived or actual difficulties of switching banks compound the issues for challengers.
However, despite the adverse conditions there are signs of change, which in market share terms may not yet be significant, but with momentum will influence the future of banking. The change is coming in three main forms. The first is the redefinition of the product or service, with Metro Bank being the most obvious proponent of a genuine customer service-led offering. The second is the emergence of niche players in regional or particular industry areas. The third is a new wave of overseas banks from emergent countries. These three trends, combined with the forced disposals of the existing banks, will shape and define the banking industry for the next generation.
The proposals of the FSA to at least attempt to level the playing field on prudential and process matters are therefore an encouraging initiative to attract new domestic and foreign capital in the banking sector. A more competitive banking industry combined with a robust yet pragmatic regulatory regime will result in positive outcomes for both the consumer and the real economy. With current funding levels at historically low rates and security requirements for loans at relatively high levels the prospects for strong, solid margins are real, particularly for a business unencumbered with legacy loan assets and past mis-selling remediation to deal with. Perhaps now is, indeed, a good time to establish a new bank in the UK.
Dan Taylor is a financial services partner at BDO Stoy Hayward in London.
