Steven Thavendran
Is the UK banking system too “concentrated”?
There was an unintended consequence when the European Union brought about deregulation of the
banking industry (Logan, 2004). What at first seemed like an opportunity to try to create a ’level
playing field’ and remove entry barriers to increase competition caused consolidation of the industry
through m&a- mergers and acquisitions (Barbara Casu, 2005). Such was the hostile takeover of
NatWest by Goodwin’s Royal Bank of Scotland group who capitalised on the decreasing share price
of NatWest after their announcement of a merger.
What cannot be debated is there has been an increase in concentration since the beginning of the
financial crisis as many acquisitions were partly due to concerns of net losses by banks as firms
expanded in an attempt to spread risk and prevent dependence on their current failing division;
indeed this may have been the case for the merger of HBOS and Lloyds TSB. Many firms also used
m&A as a means to persuade existing shareholders that they should retain their confidence in the
chairmen of the bank (Ben-Zekry, 2007). Whether or not the banking system is ‘too’ concentrated
can be examined by a multitude of factors such as the effectiveness of the concentrated banks
especially since this sort of concentration can be argued by the banks to be necessary as it will allow
them to utilise economies of scale and risk bearing. With the current evidence it clearly seems that
the UK banking system is too concentrated with the ‘big four’ banking firms (HSBC Holdings,
Barclays, the Royal Bank of Scotland Group and the Lloyds Banking Group) holding majority market
share (Relbanks).
If you were to compare the assets of
the top banks in the UK it is clear that
the top four have a far more
concentrated market share and asset
value than the other banks in the UK.
With the Lloyds banking group having
143% more assets than the Standard
Chartered bank there is unmistakably
a large margin between the top four
and their smaller competitors with
the rest of the market (Parliament,
2011). This market dominance only
prospered during the financial crisis
as the market share of the big four
grew to 77% by 2010, a ten percent Figure 1- http://www.relbanks.com/europe/uk
increase since the commencement of
the financial crisis (Banking, 2011). Throughout Europe there is oligopolistic competition between
banks and it seems this is especially the case in the UK. Indeed increased concentration in the
banking industry is associated with higher prices and profit and reduced competition as Claessens
and Laeven (Barbara Casu, 2005) pointed out that there is a negative correlation between
competitiveness and concentration in the banking system (Barbara Casu, 2005).
Concentration ratios are ‘the percentage of a market taken up by a certain number of firms’
(Economics Help). Concentration ratios are used to determine the market structure and
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competitiveness of the market.
The
Herfindahl-Hirschman
indices (HHI) (a measure of
concentration in the market)
have also experienced an
increase since the beginning of
the depression (Banking, 2011).
With the office of fair trading
claiming a, ‘HHI exceeding
1,000 may be regarded as
concentrated and any market
with a post-merger HHI
exceeding 2,000 as highly
concentrated’
(Banking,
2011)the graph below clearly
illustrates all UK banking area
fitting under the category of
‘concentrated’ and some areas Figure 2- http://www.scribd.com/doc/64664460/37/Concentration-in-UKbanking-markets
even falling close to being ‘highly
concentrated.’
Despite
concentration in the retail banking and mortgage area there are varying degrees of concentration in
the other areas. The savings and credit card market have significantly less concentration with the
latter being largely due to low entry barriers for SME-small or medium-sized enterprises (Banking,
2011).
The National Bureau of Economic research concluded that there was ‘a significant negative
correlation between bank size and banking failures.’ This meant ‘as the size of banks went up banks
would benefit from economies of scale as the amount of banking failures decreased’ (Fanu, 2004) so
some can argue that even if the UK banking system is concentrated it can only help stability and
prevent vulnerability in an economic crisis this is shown with the case of Northern Rock who were
not large enough to ensure stability. However with that point of view the UK banking system is not
concentrated enough as banks as large as the Royal Bank of Scotland were desperate for the banking
care package and would have fell into liquidation if it was not for recapitalisation the bank by the
UKFI who now own an 82% stake (BBC Radio 4, 2012). This point of view (that larger banks tend to
be more stable) is not necessarily the case for the deregulated UK banking system.
This is particularly due to the case that larger firms tend to have the ‘too big to fail’ mentality. It is
also plausible to argue that the UK banking system is too concentrated as the government would not
have gone to such extremes to bail out RBS if it did not own such a large percentage of the market
share (BBC Radio 4, 2012). The head of finance and business at the New Economics Foundation went
far enough to claim that “the markets still very much believe that the big four banks are so big that
the government would always have to rescue them with taxpayers' money.” With the top four banks
assured of bailout if they are close to liquidation it gives them an unfair advantage and will only
prompt them into taking more risks. Banks such as the Standard Chartered and Santander (who rank
sixth and seventh respectively in terms of UK bank assets) may act more cautiously and efficiently
Steven Thavendran
with them not holding such a large market share. If this is the case then it is clear that the banking
system has become both concentrated and self-destructive.
If you were to compare our banking system to the banking system of country that which the
recession had a minimal impact (such as Canada’s) there is a distinct difference in concentration.
With institutions being well diversified and risk averse (Canada's banking association, 2012) Canada
have managed to avoid the pitfalls that many other Western powers have fallen into. Instead of the
top four British Banks there is instead a top six in Canada and all have managed to get themselves on
the list of the top 25 most credit worthy banks by Global Finance Magazine (Milner, 2012). Both the
Canadian finance minister, Paul Martin and the Competition Bureau (the Canadian banking
regulator) exercise their power when a potential merger will result in a banking institution having
more than 35% of the market share. Undoubtedly Canada have been successful in maintaining this
tight regulation of banking (Martin, 1998)and preventing concentration something Europe and
especially the US have not.
You can also see the impact sustained on countries with largely concentrated banks during the
financial crisis. Iceland and Ireland are prime examples as both had extremely concentrated banking
systems. The top Icelandic banks were growing at an annual rate of 50 percent whilst the top Irish
banks were growing at a smaller but still staggering 35 percent prior to the crisis (Ben-Zekry, 2007).
However after commencement of the recession both countries were heavily dependent on
emergency funds and perhaps suffered the greatest as each countries’ banks lost approximately
two-thirds of their assets (Black, 2013). Though some can argue that it was not concentration that
caused the demise of the countries but instead regulatory capture and the increasing amount of
liabilities each bank possessed, these are clear traits of a banking system that is concentrated. Some
of the largest banks in the world have trillion dollars in liabilities and have large political influence to
influence deregulation (Black, 2013). Plainly the impact to Britain wasn’t as large or as shocking as
the impact on Ireland or Iceland but with Britain still undergoing the effects of the stock market
crash to the present it is not far off.
The argument that the British banking system is not dominant abroad is ludicrous as HSBC and
Barclays are always placed in the top ten in most lists of the largest banks in the world. Barclays have
also remained on the list of the top ten largest investment banks (Viet Nam News, 2012). What some
may conceive as a lack of dominance abroad can easily just be the case of comparing the UK banks
to the sheer dominance of the American counterparts. With J.P Morgan holding a large market share
of the investment banking industry it is understandable why many believe that the British banks are
not concentrated enough in relation to them as they have a lack of foreign presence but this is
clearly not the case. In fact the opposite is true with HSBC having a large dominating presence in
Eastern Asia and being one of the largest global banks (Viet Nam News, 2012).
In a way diversification has caused the banking system to be concentrated. The merging of the
investment banking division and the retail banking division has caused investment banks to become
too concentrated and hence this has caused the chancellor to propose a motion of ring fencing (BBC
News, 2010). The chancellor’s proposition of ring fencing should only prove that the UK banking
system has become too bloated and concentrated. The likelihood of this being effective is a different
issue but the fact remains that the banks are becoming more concentrated and more risky as it
continues. Banks carry out transactions, savings, investment and lending however with increased
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diversification come more roles and more potential market share. With the Glass-Steagall act being
repealed American banks were able to indulge themselves in blind diversification; such was the case
for Lehman Brothers (Bhid, 2009). This has similarly been the case for the UK. Further diversification
of banks would be unintelligent at the current moment instead splitting up retail banking from
investment banking (ring fencing) seems like the only option to cut the oligopolistic UK banking
system.
There are significant barriers to entry in the banking sector. With a majority of customers only
wanting to set up a bank account with firms who have a large range of branches and a good credit
history as well as a recognisable brand. As a result SME’s have struggled or deterred from the sector.
Potential barriers to entry have been the FSA authorisation process and capital and liquidity
requirements of course these barriers to entry have caused the UK banking system in particular to
become overly concentrated (Banking, 2011). As the table below suggests that the credit card
industry has diversified over the last few years and this is due to it having the smallest barriers to
entry whilst PCAs and mortgages have struggled to expand.
Figure 3- http://www.scribd.com/doc/64664460/37/Concentration-in-UK-banking-markets
It is easy to assume that the UK banking system is not concentrated in comparison as countries such
as Finland at one point had a minority of banks that controlled 85% of the market share (Ben-Zekry,
2007). In comparison the UK banking system isn’t as concentrated but still too concentrated to
benefit the economy. Increased stability is usually one of the benefit of having banks that have a
majority of the market share but with the current economic crisis this has not been shown and
instead the exact opposite occurs (Ben-Zekry, 2007). RBS at one point was the largest bank in the UK
and yet still collapsed requiring recapitalisation by the UKFI. Barclays who seem to have narrowly
survived were heavily dependent on the Qatar Investment Group. In fact the only British banks
which were able to withstand the subprime mortgage crisis were HSBC- partly due to their strong
foreign presence. Indeed HSBC is a British bank with a large market share and can be used as a prime
example as why concentration in the banking system may be successful however it is overly
optimistic to say all banks will behave in a similar way. It is no surprise that banks have taken
advantage of their dominance in the market and selfishly been enthralled by the ‘too big to fail’
mentality (BBC Radio 4, 2012). Banks that benefit from economies of scale do not need that large a
market share to benefit, indeed being that large serves no additional purpose than increasing the
bonuses of a bank’s senior management.
Steven Thavendran
Tighter regulation may be the only way to reduce the concentration of the banking system but with
the large political presence banks have it is unlikely laws similar to the US Glass-Steagall will be
introduced in the UK. Ring fencing may be introduced, splitting up the risk adverse retail banking
which deals with creating credit from the back of deposits with the higher risk investment banking
which undergoes proprietary trading but in practical terms it is impossible to split two areas of a
bank (BBC News, 2010). Whether or not it makes a bank less risky is also questionable.
Works Cited
Banking, I. C. (2011). Final Report. Domarn Group.
Barbara Casu, C. G. (2005). Bank Competition, Concentration and Efficiency . University of Essex.
BBC News. (2010, September 24). Banking inquiry to consider break-ups. Retrieved from BBC News:
http://www.bbc.co.uk/news/business-11400280
BBC Radio 4. (2012, December 19). UK's 'big four' banks 'too big to fail'. Retrieved from BBC News:
http://news.bbc.co.uk/today/hi/today/newsid_9779000/9779870.stm
Ben-Zekry, B. (2007, September). Concentration in the Banking Industry. berkeley, USA.
Bhid, A. (2009, January 28). How Banking Diversification Steered Us Wrong. Retrieved from Business Week:
http://www.businessweek.com/stories/2009-01-28/how-banking-diversification-steered-us-wrong
Black, W. K. (2013, February 11). Worse Than You Think. Retrieved from The New York Times:
http://www.nytimes.com/roomfordebate/2010/12/07/should-megabanks-be-broken-apart/big-banks-are-worse-thanyou-think
Canada's banking association . (2012, November 16). Canada’s Strong Banking System. Retrieved from Canada's banking
association : http://www.cba.ca/en/media-room/50-backgrounders-on-banking-issues/469-canadas-strong-bankingsystem-benefiting-canadians
Concentration Ratios . (n.d.). Retrieved from Economics Help : http://www.economicshelp.org/dictionary/c/concentrationratios.html
Fanu, J. L. (2004). The UK banking market: Consolidation, competition and the Cruickshank Report. TransGlobe.
Logan, A. (2004). Banking concentration in the UK. Bank of England.
Martin, P. (1998). Royal wedding. The Economist .
Milner, B. (2012, May 6). Six Canadian banks among world's safest. Retrieved from The Globe and Mail:
http://www.theglobeandmail.com/report-on-business/economy/economy-lab/six-canadian-banks-among-worldssafest/article551615/
Parliament. (2011). The landscape of retail banking in the UK. Parliament.
Relbanks. (n.d.). Banks in UK. Retrieved March 2013, from Relbanks: http://www.relbanks.com/europe/uk
Viet Nam News. (2012, September 14). HSBC named best foreign bank in Viet Nam by Hong Kong magazine. Retrieved from
Viet Nam News: http://vietnamnews.vn/Economy/230095/hsbc-named-best-foreign-bank-in-viet-nam-by-hong-kongmagazine.html
Steven Thavendran