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Western EuropeSeptember 3 2006

UK banks are setting a bad example

UK banks are being criticised for unfair practices, and are not good role models, says Andy Mullineux.
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The UK’s banks are not serving their public well. The EU Competition Commission and others, who regard it as the model for the banking system of, for instance, Germany and Italy, would do well to look at the evidence. An overemphasis on shareholders while ignoring a number of other stakeholders in society is not the best way forward.

Britons think that the banks are failing to provide adequate services: complaints to the Banking Codes Standards Board (BCSB) have reached record levels. The Competition Commission has found the banks to be operating a “complex monopoly” in the provision of bank account services to small and medium-sized enterprises. The banks are accused of punitive charging of people who fail to pay credit card debts on time and they are under investigation by the Office of Fair Trading (OFT) for similar charging for overdrafts.

The UK government has taken action to deal with financial exclusion of the poor. It has fostered community development financial institutions and the formation of credit unions, and banks and post offices have been urged to provide basic bank accounts. Nevertheless, many people who try to open such accounts are being turned away. There was a strong public outcry following the closure of bank branches in remote areas and poorer districts, where profitability is low. And the banks have been accused of lending irresponsibly to consumers who can gain access to credit, largely via credit cards, leading to over-indebtedness.

Profit seekers

Why should this come as a surprise? Most UK banks are profit-seeking companies owned by shareholders whose interests they should ultimately serve under the country’s prevailing corporate governance rules.

Yet basic banking is infrastructural, like transport, communication and utilities. Access to credit and to the payments system is a right for a citizen of a modern society. It is unfair that poor citizens should pay more for the use of the payments system than richer citizens. It can also be argued that the rich should not get credit cheaper than the poor, yet they do. For finance to be sound, it must be based on risk-related charging, and subsidies for the poor are required to redress the situation.

Cross-subsidisation in charging for payment sources, which underlies the punitive charging being investigated by the OFT, is a different matter. ‘Free banking’ has evolved over time. It aims to attract customers and then recoup the costs of servicing high volume users of the payments services by charging excessively those who do not, or cannot, make repayments on time, and by paying low rates of interest on bank account balances that are in credit. High-value users with low average balances (such as young professionals) are essentially cross-subsidised by low-volume users with high average balances (such as old ladies).

Fair play

Given their still dominant position in the payments system, banks should be required to set charges that reflect usage, to abandon punitive charging and to pay fair, market-related interest on credit balances. Everyone must become accustomed to paying for the payments services they are using, which in many cases will encourage them to be more economical in their usage.

The situation in many other European countries is different. In Germany, the public savings banks and the co-operative banking sector together have about two-thirds of the retail banking market, leaving the big shareholder-owned banks with about one-third. The savings and co-operative banks are full retail service banks, which charge for services supplied. The incidence of cross-subsidisation and punitive charging appears to be low and over-indebtedness is not as widespread as in the UK. No wonder the German shareholder banks are lobbying for permission to take them over.

The German public and the EU Competition Commission are advised to ask the question: Is the British banking system a good role model for Germany (or Europe)?

Andy Mullineux is professor of global finance at the Birmingham Business School and the co-author of The British banking system: A good role model for Germany?, published by the Anglo-German Foundation.

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Read more about:  Analysis & opinion , Western Europe , UK