Business banking - called to account
Are 'Challenger' Banks and a switching service making things easier for small businesses? Martin Morris finds out.
The market for retail and business current accounts has been undergoing significant change over the last five years, not least due to the emergence of the so-called challenger banks. Fresh impetus was provided back in September 2013 when the Payments Council launched its free-to-use Current Account Switching Service (CASS), aimed at consumers, small charities, small businesses and small trusts.
The service's selling point, then and now, is the speed with which depositors can switch their current account to another provider – including direct debits, standing orders and incoming items such as salary – within seven working days, as opposed to the 18-30 working days it used to take. Moreover, a new redirection service ensures any payments made to or requested from the old account will be redirected automatically to the new account for a period of 13 months after the switch date.
Backed by a "current account switch guarantee", detailing the key benefits of the switch and outlining what a customer is entitled to in the event of something going wrong, the service – now supported by 36 UK banks and building societies – is intended to increase competition in the high street and encourage more banks to enter the market.
Evidence suggests it is having some impact. Data from the Payments Council (January 2015) shows that, as of end- December 2014, 69 per cent of people interviewed were aware of the service, up from 59 per cent in 2013. In addition, there were 1.16m switches made in 2014, up from 1.03m in 2013.
Yet while implementation of CASS has been welcomed, there remains room for improvement. As Paul Pester, chief executive for TSB, puts it: "Anything that can be done to increase current account switching is a good thing – so we are very supportive of the Payments Council's Current Account Switching Service."
But he adds that, based on his bank's own research, improvements can be made, specifically by making it easier to switch overdrafts along with the customer's current account.
"This would mean that some of those customers who have most to gain from switching their current account, such as overdraft users, could make better use of the service," says Pester. "We think these improvements would go a long way to fixing the problem where overdraft users are only half as likely to switch as other current account customers."
Challenger banks vs. the 'Big Four'
Against this backdrop the challenger banks, which have pitted themselves against the "Big Four"– Barclays, Lloyds Banking Group, HSBC and Royal Bank of Scotland – have been making inroads, even if market share remains relatively paltry in the current account segment.
"Lloyds Bank CEO António Horta-Osório pledged up to £5m towards an industry fund to improve digital services and comparison websites to aid switching"
The British Bankers' Association, in its 2014 report Promoting Competition in the UK Banking Industry, cites research by Joseph Dickerson, banks analyst at Jefferies, that suggests there is room for the challengers to continue increasing their market share. As Dickerson puts it: "...in part reflecting the continued deleveraging of some of the large banks."
Dickerson's research assumes the larger banks will cede around four points of lending market share over the next five years so "...even if the challenger banks only maintain their current rate of growth they would double their market share by 2018."
This is against the backdrop of a £100bn market with £5bn of potential revenues available for the challengers over five years, as the major players continue shrinking their loan books. Overall, Dickerson calculates the challengers account for 2.1 per cent of the UK lending market and 2 per cent of the deposit market.
According to research carried out for the Cabinet Office, the four major banks currently have a market share of around 85 per cent in the small and medium-sized enterprise (SME) lending segment (77 per cent for personal current accounts). In November 2014 the UK's Competition and Markets Authority (CMA) announced its decision to launch a review into personal current accounts and small business banking. The move is aimed at broadening the market for customers seeking better rates, so the majors' market share is liable to erode over time.
The challengers include high-profile, retail- oriented operators such as the banking arms of Tesco and M&S, as well as Virgin Money (which emerged out of the old Northern Rock). Other players, however, have also been making inroads into the SME lending market, including Santander, Metro Bank, Aldermore and Sweden's Handelsbanken. Total loans for Handelsbanken, via its 178 branch network, amounted to £13,153m in 2014 (2013: £11,633) of which £4,044m was lent to households (2013: £3,252m) and £9,109m (2013: 8,381m) to companies.
Together, the incomers pose a threat to the established order on the high street. Mark Sismey-Durrant is CEO of the Hampshire Trust Bank, which received regulatory approval in 2014. He notes: "The strength of challenger banks lies with their focus on creating and maintaining long-lasting personal relationships with customers."
Sismey-Durrant argues that the challengers treat customers as individuals, rather than segments, and the key to success for new entrants is being able to differentiate themselves from the competition in the way they conduct business. This might take the form of expert and highly capable teams that create long-term relationships; an ability to respond rapidly to changing customer demand, offering consistently excellent products or providing technological innovation.
He says: "Each has the potential to deliver excellent service and great results for the customer, but a challenger's approach must be real and scalable, otherwise it will become nothing more than a mini-version of a traditional bank, with all its faults."
One success has been Aldermore, which announced in February its intention to float on the stock market. The bank witnessed a surge in lending from £76m in 2009 to total net loans of £4.8bn as of end-2014 (31 December 2013: £3.4bn), of which £2.2bn has been lent to SMEs, and £2.6bn to homeowners. The bank's underlying profit before tax, meanwhile, amounted to £56.3m.
Part of the Aldermore story is that it is a 'legacy-free' bank, employing a modern digital platform to support its customer services proposition, and it is able to provide a scalable, efficient operating model.
"CASS does cover joint accounts, but both named parties on the account will need to complete the relevant forms. It is not possible to use the service to switch a joint account to a sole account"
Meanwhile Metro Bank, which was founded in 2010 and now has 31 stores, has also benefitted from having no legacy systems. It has had the opportunity to design its services with customers in mind, taking into account their "entrepreneurial nature", says Richard Saulet, director at Metro Bank SME Finance.
According to Saulet, SMEs are consistently underserved in the UK and have been for some time. He says: "Since we launched... we have been committed to playing a role in helping SME businesses not just to survive, but also to grow. As the bank for entrepreneurs, business customers are a key focus for Metro Bank and at the end of 2014 deposits from business customers represented 64 per cent of total deposits, and... 45 per cent of total lending."
Lending to business and personal customers more than doubled during 2014, reaching £1,597m at the end of Q4, up from £754m at 31 December 2013; an increase of 112 per cent year on year. Total assets were £3,667m, up from £1,892m at 31 December 2013; an increase of 94 per cent year on year.
Face-to-face relationships are important, the bank says, and each Metro operation has a local business manager who is able to make lending decisions on a case-by-case basis.
"We are focused on offering real advantages and expertise to our SME customers. Whether they require more working capital, commercial mortgages or funding for expansion, we ensure that all SMEs have their own relationship manager who takes the time to understand their business and its needs," says Saulet.
Calls for reform
Unsurprisingly, the major high street banks have been responding. Lloyds Bank CEO António Horta-Osório, addressing the annual British Chambers of Commerce conference in February, called for a range of reforms to enhance competition in SME banking. These included more innovative ways for the industry to improve product switching through comparison websites and using technology to provide more effective banking services for small businesses. Horta-Osório pledged up to £5m towards an industry fund to improve digital services and comparison websites to aid switching.
As a Lloyds Bank spokesperson puts it: "We are committed to ensuring that the markets for small to medium-sized enterprises deliver choice and good customer outcomes through more effective competition. A seven-day switching service encourages more people to look at what their bank offers and to seek out those with the best products and service. We believe this will help create more trust and confidence in switching in the SME market."
The CMA and the regulator, the Financial Conduct Authority (FCA), noted in their July 2014 joint study, Banking services to small and medium-sized enterprises, that effective competition to provide SMEs with high-quality and responsive banking services – and at the lowest possible cost – is critical.
Even if competition ensures greater flexibility and choice for customers, however, challenges remain for customers looking to switch bank. As Alan Knowles, a partner in the banking team at law firm Brodies, observes, CASS, as its name suggests, is for current accounts only.
"CASS does cover joint accounts, but both named parties on the account will need to complete the relevant forms. It is not possible to use the service to switch a joint account to a sole account," Knowles notes.
He adds that the rules apply to payment accounts through which customers are able at least to place funds in a payment account, withdraw cash from a payment account and execute and receive payment transactions, including credit transfers, to and from third parties.
He explains: "Accounts with more limited functions are, therefore, excluded from CASS. These include, for example, savings accounts, credit card accounts where funds are usually paid in for the sole purpose of repaying a credit card debt, current account mortgages and e-money accounts, unless such accounts are used for day-to-day payment transactions and comprise the functions set out above."
Knowles further observes that current accounts may have additional features to the usual payment and deposit taking services. Overdrafts, for example, may be provided on a current account, too. If the customer is overdrawn, the new bank or building society may be able to provide facilities to help pay off any overdraft.
"The customer will, however, have to meet the new bank's lending criteria before deciding to make the switch. If the criteria are not met, the customer must make separate arrangements to repay the old bank or building society what they owe," he points out.
Meanwhile, the establishment of the Payment Systems Regulator (PSR), a subsidiary of the FCA, should also provide some comfort to SMEs. The PSR's objective is to promote competition, innovation and the interests of end-users through overseeing designated UK domestic payment systems.
Proposed legislation – currently in the consultation stage – to increase the availability of SMEs' credit information should also prove helpful to newer or smaller providers. By enabling them to make more effective lending decisions, it looks set to help them to compete more effectively with the larger banks.
As Mark Sismey-Durrant puts it: "The problem that remains for very small businesses is that they often cannot provide the detailed information that makes up much of the criteria required by larger banks before they will even consider lending. In some instances, small companies and sole traders in particular don't have the data and information readily available, which is why it is important that each individual application be assessed on the merits of the business, instead of via an automated application process that can often lead to the computer saying 'No'." In the meantime, the "challengers" look set to live up to their collective name. Watch this space.