Thursday, 1 November 2012

Supermarket banking

At the recent Occupy debate on "Socially Useful Banking", Andy Haldane argued strongly for culture change in banking, and particularly in retail banking - the sort of banking that ordinary people rely on for their payments, their short-term savings and their loans. And he claimed that structural separation of retail banking from what are viewed as "higher-risk" activities such as investment banking and trading would end cross-contamination of culture and enable retail banking to return to its roots in relationship management and judgement based on local knowledge. He said that the ring-fencing of retail banking as proposed in the Vickers report on reform of banking may not be enough and full separation would be considered if necessary.

The roots of his remarks lie in the prevalent belief that the changes in retail banking in the 1980s/90s were a consequence of the liberalisation of investment banking in the so-called "Big Bang" of 1986. He comments that:

".....financial and human resources were diverted away from retail banking services and non-bank activities towards investment banking.  At the same time, the culture and practices of investment banking infiltrated retail banking - a sales culture which culminated in harmful cross-selling and unlawful mis-selling."

I don't agree. I think the changes in retail banking arose from introduction of American marketing and retail sales techniques, and from technological change that enabled economies of scale in back-office processing. Investment banking had very little to do with it: by the time of Big Bang, retail was already a low-margin, cut-throat business in which the weaker players found it very hard to make significant profits. I would suggest, rather than investment banking draining retail, that the significant move towards investment banking throughout the 1980s was driven to a considerable extent by the poor returns in retail banking. Nor is it true to say that investment banking drained resources from retail: yes, the people working in retail were reduced in number and de-skilled, but there was enormous investment in IT at the same time. The change in retail banking was exactly the same as the change happening in retail shopping at the time - the crowding-out of small high street shops with huge out-of-town shopping malls: the replacement of personal service with glitzy product displays and sales staff paid on commission; investment in IT for highly efficient, low-cost manufacture and delivery of "products" using largely automated "production line" technology.

I have reason for saying this. In the late 1980s and 90s I worked at Midland Bank, which was the first bank to transform its retail operations into the sales-driven model with which we are now so familiar. Midland was dreadfully short of money: it had been (as we now know, fatally) weakened by its purchase and subsequent sale to Wells Fargo of the highly-indebted American bank Crocker, the last in a long line of aggressive domestic and overseas acquisitions, many of them merchant and wholesale banks. To those of you familiar with the causes of the downfall of RBS, this should sound horribly familiar.....but Midland was not bailed out by taxpayers. Its future was different.

In 1986, when I joined the bank, Midland was already going into a period of retrenchment. It consolidated its merchant and wholesale banking activities with its international businesses to create its Midland Montagu subsidiary, which was both functionally and legally separate from the rest of Midland Bank. In other words, it created structural separation between its core retail business and its investment banking activities. I worked for Overseas Systems Support at the time, and I remember the transfer of my department to Midland Montagu about a year after I joined: we all had to sign new employment contracts that differed significantly from our Midland Bank employment contracts.

Driven by the American Gene Lockhart, head of Domestic Banking, Midland embarked on a massive programme of automation and centralisation of its retail back-office operations. It created huge dedicated processing centres, highly automated and thinly staffed. Back-office functions such as cheque processing and payments were removed from branches and consolidated in these processing centres. Branches were redesigned to be like retail shops, staffed with sales staff whose job was not to provide a service but to sell "products": they were given challenging sales targets and their pay became partly commission-based. Some branch staff were made redundant - especially the older, more experienced (and more expensive ones): the rest were retrained as sales staff. Branch managers were redesignated as sales team leaders and the job became less senior: their authority was severely curtailed as Midland created specialist credit officers, not based in branches, whose job was to make lending decisions on the basis of credit scoring and customer history.

The changes made by Midland did improve the performance of its core retail business and probably enabled it to stay afloat longer than it otherwise would have done. But inevitably, other retail banks such as Nat West soon followed suit, and the competitive advantage that Midland had gained proved short-term. Midland also suffered losses in its investment, wholesale and overseas banking activities, including a completely ridiculous loss of £20m caused by "wrong positioning" on money market trading (traders had taken an open punt on the direction of interest rates and were caught out when the Bank of England raised interest rates), and was heavily exposed to Latin American bad debt. Provisioning against this virtually wiped out its profits, so it embarked on a programme of cost-cutting and redundancies, which it  euphemistically called the Profits Improvement Programme (PIP). No-one was fooled. A new word joined the lexicon: anyone made redundant had been PIPped.

But at the same time that it was cutting costs all over the place, Midland also embarked on a large (and expensive) project to improve its financial and management information-gathering and reporting so that it could make better use of its capital and manage funding and risk more effectively. I worked on that project: its budget was more than Midland's entire profits in 1991. Something had to give.

In 1992 Midland was taken over by HSBC, which was looking for an escape route from Hong Kong in anticipation of the return of Hong Kong to China in 1997. This takeover was  presented to the world as a friendly merger - and indeed it was the only realistic solution to Midland's problems: chronic shortage of money can only be solved by marrying money...... But internally it was nothing of the kind. The financial information project that I was working on was cancelled (after all, HSBC had pots of money, so it didn't need to use advanced capital, risk and liquidity management techniques to glean a few more basis points on RoE). All Midland's systems were migrated to HSBC's platform. Hundreds of staff at all levels, but especially in middle management, lost their jobs. But HSBC didn't reverse the changes in retail banking that Lockhart had driven. The sales model in retail banking remained, and indeed remains to this day at HSBC.

The final nail in the coffin of "traditional" retail banking was the conversion of building societies into banks, starting with Abbey National, which led to significant consolidation of retail banking and the creation of the "super-banks" we now have. The age of "supermarket banking" had arrived.

The purpose of this extended tale is to show that the cultural issues in retail banking are not because of "cross-contamination" from investment banking. They came from the retail sector itself. The model for the future of retail banking was not investment banking: it was shopping. Banks created "one-stop shops" where retail customers could go to buy all the products they needed, including pensions,  insurance and, for business customers, derivative products: banks knew they could make far more money from selling these products than they could from providing core banking services, so branch staff were given aggressive sales targets for selling non-banking products. The mis-selling that Haldane refers to stems from this cause, not investment banking. And despite all the scandals, NOTHING has changed. Branch staff still have sales targets, still exist to flog you "products" rather than provide banking services. My local branch recently started opening on Saturdays - but not to do boring banking things like depositing money. No, all you can do is discuss your financial product requirements with sales staff.  The cash desk is closed.

Haldane cited Svenska Handelsbanken as a current example of a retail bank that was "doing it right" - creating small local branches that served their local communities and rewarding its employees on a "pool" basis rather than individual sales targets. I absolutely endorse this: just as we are beginning to rediscover the benefits of small high-street shops providing a personal service, so we also need to rediscover the benefits of small bank branches providing a personal service.

But I would issue a word of caution here. Actually, for retail banking the shopping model is not a bad one: the problem with "supermarket banking" was the aggressive selling, the drive for short-term profit at the expense of long-term customer relationships, and the lack of effective regulation. Providing efficient, low-cost banking services does require centralised, automated operations, and with the advent of telephone and internet banking the need for local provision in ordinary banking activities is reducing fast. In my view there is still a place for supermarket banking, just as there is still a role for supermarkets: not everyone has the time to visit lots of little shops to get their weekly shopping, and not everyone can afford the higher prices that small shops tend to charge. Banking is the same: small scale and personal service comes at a price.

The abuses in retail banking must end. But to do that we need to understand what caused them, because otherwise we will not know what to change. Separating retail and investment banking made no difference at Midland Bank. I strongly suspect it will make no difference to retail bank culture this time round, either. The changes must come from within.

23 comments:

  1. Very interesting - I worked at HSBC with a lot of ex-Midland staff for a while. Your post explains some of what I saw.

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  2. I agree we need to know what to change in order to make the correct changes in banking. Having had a career in the financial services industry myself I endorse your observation that separating investment banking from the retail banking sector will not solve the problem of the gross miss-selling of financial products which has made so many banking customers victims.I wrote this post in an effort to add my voice to those who champion change. http://lifeafterdebts.blogspot.co.uk/2012/10/placation-and-platitude.html

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  3. My small local branch of HSBC is now a cheese shop. They tried to sell me some pet insurance....

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  4. just as we are beginning to rediscover the benefits of small high-street shops providing a personal service, so we also need to rediscover the benefits of small bank branches providing a personal service.

    I'd question nowadays why you need small bank branches providing a personal service when you can do pretty much everything, apart from deal with large amounts of cash, online. I don't want to have to deal with bank staff as I've better things to do with my time. Others may want a more personal service and I'm happy for them to pay for it.

    One important thing about the internet and financial services is that it is easier to shop around for the best savings or loan rate, annuity, insurance policy or whatever. The "supermarket bank" is unlikely to give me the best deal for everything.

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    1. The shopping model these days is a mix of small artisan shops charging relatively high prices for premium products and services, huge supermarkets indulging in vicious price wars, "Poundland" shops providing basic products at rock-bottom prices, charity shops, internet shopping, television shopping and online auction houses. There has never been such diversity. This level of diversity is I think what we should be looking for in retail banking, as well.

      In my view turning back the clock to traditional banking isn't any more possible - or desirable - than restoring the high streets of the 1950s. The shopping paradigm still holds for retail banking - but shopping is changing radically, and so must banking.

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    2. I'm more than happy to have diversity in the world of banking - more choice can only be good for the consumer. As long as everything is transparent in terms of charges and interest rates then I don't see a problem. However, people need to be aware that there is a trade-off between getting the best value and the service provided. My personal and business banking is done with the Co-op and when I need to speak to them, it's with a call centre in the UK with staff who are empowered to make decisions. Because of this, the rates on their products are not at the top of the best buy table. On the rare occasions that I've ventured into a branch, I've been bombarded with offers of loans and insurance so even the bank that prides itself as being ethical is still out to make money.

      I'd put it that if you want a truly personal service from a bank but without the hard sell, then you have to accept the premium that goes with it.

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    3. I'd agree with that. The only way to make profits in retail banking is by adding value - either cross-selling higher-margin products to core banking customers or providing fee-bearing services. Core banking services themselves are unprofitable and have been so for at least 40 years. THAT's what people aren't talking about. It isn't an elephant in the room, it's a bloody mammoth.

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  5. "The changes must come from within" is the single most important point about this topic, I dare say. Funds should be accumulated & deployed to install & pay 1 CEO who's expected to perform exceedingly well in terms of morality, and also smart enterprising. Then, if he or she fails, it should be built into the contract that at any point in time the supervisory board can cancel the contract. Repeat process until one good CEO is found. Then advertise that CEO.

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  6. I agree with this analysis, the separation of retail from investment banking is not the point, and was not the cause of Northern Rock having problems. I went into my local HBOS branch in Keighley, Yorkshire a few years ago to get some advice about investments and ISAs. The sales person went through various options, including what sort of level of risk I would like. I then asked him if he invested in any of the products provided by his bank. He confided in me that he made a lot of money doing on line poker, and was going large on buy to let, and did not use any of the bank's products.

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    1. Isn't the point of Vickers ringfence to prevent bailouts of investment banks?

      Isn't the idea that high-risk gambling by investment banks should risk bankruptcy, not risk getting a tax-payer bailout.

      Retail banks should be protected by the government. Investment banking should not be. Isn't this the issue?

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    2. No, that's not the point of Vickers. The aim of Vickers is to allow ALL types of bank to fail safely and end bailouts. That's why retail divisions are being required to have separate capital. I wrote about this when I looked at the draft Vickers report (the final version sadly didn't make the aim quite so clear, I suspect for political reasons):

      http://coppolacomment.blogspot.co.uk/2011/08/setting-up-banks-to-fail-retail-ring.html

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  7. 1) Absolutely correct that culture contamination is a smaller part of the picture - the main purpose of separating retail/small business banking is that it can then be bailed out in an emergency and the investment bank either allowed to fail, or bailed out on different terms.

    2) However, having said that culture contamination is a smaller part of the picture, I'd argue that at Barclays at least there is evidence that investment banking distorted the strategic direction of the bank. Automation was used in retail to move towards an "electricity company" model of providing a commodity service and basically competing on oligopoly churn. The key element is that in Barclays there was an assumption that the extra profits available by more thoughtful/flexible retail/SME saving and lending were smaller than those available in investment banking - so we'll put the infrastructure investment into investment banking.

    Further of course, new models of retail banking will only come into being when there is a reason for the companies involved to invest in it. That they will only do if it is their main line of business.

    Now will some of them go out of business? My view is probably - because the reality is that ordinary banking that many people need is basically electronic transaction capability and probably belongs in the public sector in the long term. (e.g. I need an account with a debit card and bill paying interface. There's no reason I should get my savings or loans from the same institution. There's no meaningful money to be made from an account with a debit card and bill paying interface - at the same time it's pretty much a basic for functioning in society - odds are it will end up a regulated monopoly like water supply.)

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    1. I did say in the post that banks moved towards investment banking and away from core retail banking because they perceived far better profit opportunities in investment banking. But I think the distortionary effect of investment banking at Barclays happened later than the period I'm talking about. As far as I know Barclays only became a major player in investment banking in the last decade.

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  8. Water supplies are beginning to compete now more than ever before...hardly are they being centralised into a monopoly. States, however, are trying to do so, to control without competition the rule over water supplies, but the markets are breaking these attempts. It is nature. Water is too important to society to remain in the hands of a monopolist who cannot compete.

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  9. This makes a lot of sense. I live in upstate New York and have heard terrible tales about Chase branches being completely sales focused and just just trying to shove completely inappropriate products down people's throats. They're always keen for you to use more/get a new credit card. Thinking about it, the make second hand car salesmen look good....

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  10. What do you expect when a Retail Bank wants to be a "Growth Company" and grow revenue at a multiple of the economic growth rate.

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  11. Excellent article. Supermarket banks provide obvious advantages to markets, clients and banks. Customers mostly attracted to the supermarket banks because customers can bank at a branch that's open seven days a week until 9 pm, and do their purchasing at the same time. But the trend is mainly driven by what the banks get out of it. If Comparing the traditional branch network then a supermarket network has well thought-out incredible economics. One essential thing about the internet and economical solutions is that it is quicker to store around for the best advantages or loan amount, premium, insurance coverage or whatever. The "supermarket bank" is always better for everything. Market Research Reports

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  12. Frances, an excellent commentary. Thank you. But culture is a subject not so well understood by almost everyone. It essentially boils down to "monkey see, monkey do". That sounds simple but it is actually hellishly complex. Why are pilots, doctors and engineers (generally) very competent? And why do so many crises caused by incompetence occur in banking? Here is a list http://en.wikipedia.org/wiki/List_of_banking_crises

    I have thought a lot about how to create ethical, prudent bankers -- this involves some serious behavior modification. There many are ethical, prudent professionals in our midst e.g. pilots, doctors, engineers. We need to replicate their cultural ethos into the financial sector. It can be done and it must be done. This short video gives some ideas for everyone to think about (Hammurabi's Code). There MUST be severe consequences for the affected parties (plural) when fraud or professional incompetence occurs. http://www.youtube.com/watch?v=QKdH_mhJP-E

    "Miss selling" is fraud or incompetence -- plain and simple.


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  13. In my view turning back the clock to traditional banking isn't any more possible - or desirable - than restoring the high streets of the 1950s. The shopping paradigm still holds for retail banking - but shopping is changing radically, and so must banking.

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  14. your most is more technological as well as more informative,Thanks for sharing with us.

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  15. Let's agree that even those great consumer-oriented supermarkets don't do everything well. Here are some of the most stupid & smart things that might make supermarket banking great:

    http://www.slideshare.net/HansEysinkSmeets/supermarket-banking-10-dos-and-donts

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