Competition and Markets Authority Retail Banking Report

The Competition and Markets Authority in the UK published a report this week on retail banking. I commented on it briefly on the Radio 4 Today programme on Tuesday morning and the purpose of this post is to provide further information. The CMA has been operating since 2013 when it replaced for most purposes the Competition Commission and Office of Fair Trading. It is basically responsible for ensuring competition and fair practices in markets in the United Kingdom. 

Since November 2014 the CMA has been investigating the market for personal current accounts (PCAs) and of banking services to small and medium size enterprises (SMEs). Details of their preliminary reports and various other resources are available on the investigation website. A useful document for those who don't have the time to read the thousands of pages on that website is the 55 page summary document available here. The core task of the investigation is summarised below.

"We are required to decide whether any feature, or combination of features, of each relevant market prevents, restricts or distorts competition in connection with the supply or acquisition of any goods or services in the UK or a part of the UK. If we decide that there is such a feature or a combination of features, then there is an adverse effect on competition (AEC). Should an AEC be found, we are also required to decide whether action should be taken by the CMA or a recommendation be made to others to take action for the purpose of remedying, mitigating or preventing the AEC or any resulting detrimental effect on customers. This final report sets out our decisions on these questions."

The PCA and SME banking services markets are large and important in the UK. As noted in the report, 97% of adults have a PCA and there are over 70 million PCAs in the UK, generating 8.7 billion in revenue for banks in 2014. As well as traditional questions of competition policy, there are clearly many potential behavioural issues in these markets that could lead to welfare consequences for consumers.

In light of these reviews and the market studies into PCAs and SME banking which led to this investigation, we investigated three broad areas in which we had concerns that retail banking may not be working well for customers:  

(a) whether there is a weak customer response due to lack of engagement and/or barriers to searching and switching reducing the incentives on banks to compete on price and/or quality and/or to innovate;(b) whether there are barriers to entry and expansion constraining the ability of banks to enter or expand; and(c) whether the level of concentration is having an adverse effect on customers.  

The findings with respect to the above questions show very low levels of consumer engagement in both PCA and SME banking markets. Half of consumers had been with the same PCA for the last 10 years. Only 3 per cent had switched within the last year.  The figures are not dramatically different for SME banking customers with many of the same issues arising.

As well as this, there is an important question as to how customers use these accounts, in particular the extent to which they incur overdraft fees. The most striking feature of the report for me from a behavioural perspective relates to the use of unarranged overdrafts. Unarranged overdrafts are a very expensive form of credit. Nearly half of the people using them were unaware they were doing so. It is one of the clearest areas I know where there is a potential behavioural market failure, as can be seen from the report's findings below.

In addition, there are particular concerns for overdraft users. Around 4.5% of active PCAs used an overdraft in 2014 with around a quarter of PCA customers using an unarranged overdraft. Despite overdraft users tending to have the most to gain from switching, we found that:
(a) Overdraft charges are particularly difficult to compare across banks, due to both the complexity and multiplicity of the charging structures and the difficulties in understanding their own usage. In particular, customers exceeding their pre-arranged credit limit can incur substantial charges but
there is no easy way for a customer to find and compare the charges or
credit limits an alternative PCA might offer them.
(b) Overdraft users generally have limited awareness of and engagement with their overdraft usage. For example, over half of overdraft users we surveyed underestimated their usage by two or more months in a year and over a third were not aware that they had gone into overdraft. Moreover, around half of unarranged overdraft users did not believe they had gone into unarranged overdraft.
(c) There are additional barriers to switching for overdraft users due to uncertainty surrounding the acceptance and timing of any overdraft approval when opening a new account. In addition, a new bank may not be willing to offer the same level of overdraft facility as a customer’s bank, for example because the new bank will not have access to the customer’s transaction data but will need to rely on information from the customer and from CRAs. 

The report outlines a range of remedies to encourage active consumption on behalf of PCA and SME banking consumers. These are nested under four broad headings, as outlined below. There are many innovative and interesting ideas contained within these remedies, many of which have been discussed in various papers and reports on behavioural regulation over the last 10 years. As such, the roll-out of these remedies offers a particularly useful case-study as to whether this approach can actively shape outcomes in markets of this nature.

Our integrated package of remedies is illustrated below, and consists of four
elements:
(a) Three cross-cutting foundation measures that will underpin increased competition in our reference markets. They have the object of increasing customer engagement and making it easier for personal and business customers to compare the prices and service quality of different providers
and of encouraging the development of new services.
(b) Additional measures to make current account switching work better, including building on and improving the existing CASS.
(c) A set of measures aimed at PCA overdraft users, a group of customers who suffer particularly from the competition failures in the PCA market.
(d) A set of measures targeted at the specific problems in SME banking, making it easier for SMEs to compare different providers and reducing the hold that incumbent banks have in the market for BCAs and SME loans

The potential remedies for the levels of low engagement and high frequency of incurring overdraft fees and unplanned overdraft fees merit a lot of debate. Several consumer groups had advocated for mandating centrally imposed caps on the amount that banks can charge customers for exceeding their overdraft limit rather than allowing banks to set this limit themselves. Instead they recommend what could be considered a Nudge approach that forces banks to provide more transparent and timely information about the likelihood of incurring different types of overdraft fees. This is one of the most contentious aspects of the report and one of the most contentious aspects of this literature and policy area more generally. To use the phrase from the well-known Bubb and Pildes paper, why should behavioural economics trim its sails in this manner? Why focus on soft intervention when a harder more mandated approach might be more effective? I have blogged about this issue before. It is one of the central issues in behavioural economics, law and regulation and will likely shape this debate long into the future.

(a) requiring banks to automatically enrol all their customers into an unarranged overdraft alert;
(b) requiring banks to offer, and alert customers to the opportunity to benefit from, grace periods during which they can take action to avoid or reduce all charges resulting from unarranged overdraft use;
(c) recommending to the FCA that it undertakes further work to identify, research, test and, as appropriate, implement measures to increase overdraft customers’ engagement with their overdraft usage and charges. This will be facilitated by an Order to require banks to cooperate with the FCA in its research programme, including RCTs; and
(d) to increase PCA customers’ engagement with overdraft features, we are recommending that the FCA looks at ways for banks to engage customers more in considering overdraft features and their potential relevance and impact, during the PCA opening process. 

There are several other issues that people have been debating on this report. The extent to which competition in these markets is constrained by the market power of the largest established banks is an ongoing debate and is not widely addressed in the report, other than to say they have largely concluded that market power itself is likely not the source of low consumer engagement. The behavioural economics approach is a key feature of British regulation across several areas over recent year (see BIT report, FCA report, CMA Chairman speech on behavioural economics, and University of East Anglia book for very useful papers; see also Bar-Gill Seduction by Contract for a recent book on the behavioural law approach). The extent to which it tends in Britain to be associated with a soft-mandatory or Nudge type approach needs to be kept under scrutiny and debate. Behavioural barriers do not necessarily imply softer interventions. It will be fascinating to see whether this comprehensive package of recommended behavioural interventions has an effect of the levels of engagement and quality of consumer outcomes in this market. If it does not, it will certainly tip the balance back in favour of those advocating harder approaches.

The report also brings home the vast numbers of small businesses and retail consumers who clearly have difficulty engaging with what are, for many, complex services. The wider effects this might be having on constraining start-up formation, impacting on family solvency, mental health, and other welfare outcomes are worth considering, and they provide a substantive area of inquiry for people who are bringing psychological and behavioural perspectives to these areas.