Why competition could add up to bad news at the ATM

It might surprise you to learn that the familiar LINK system we all use at ATMs is owned and run by the four largest UK banks: RBS, HSBC,...

It might surprise you to learn that the familiar LINK system we all use at ATMs is owned and run by the four largest UK banks: RBS, HSBC, Barclays and Lloyds.

And they don’t just control the ATM network. They also own and run the BACS system, which makes direct debit payments and is used by employers to pay wages, and the Faster Payments system, which we use to make online payments.

These three systems all use the same payments infrastructure provider, VocaLink. And the four large banks own that, too. So a large part of the UK’s payments system is effectively run by its biggest banks.

The three payments systems and their VocaLink infrastructure grew out of collaboration. The BACS network was formed in 1968 by the (then) Big Five clearing banks as the Interbank Clearing Bureau: it was renamed BACS in 1971, but remained a joint venture. The LINK network grew out of collaboration between small banks and mutuals to enable customers to draw money more easily. It was so successful that larger mutuals and banks quickly joined and effectively took it over. LINK and BACS (now renamed Voca) merged in 2007 to create VocaLink, mutually owned by 18 banks and building societies, with the four largest banks by far the largest shareholders. Faster Payments was added to VocaLink in 2008.

This success has led to the almost complete absence of competition. The largest banks have established a near-complete monopoly over the provision of ATM and payments services to much of the UK. We could say they are operating a cartel.

The Payments Systems Regulator has proposed that this be broken up. The banks should be forced to sell part of their stakes in VocaLink, and the barriers they have created to the entry of competitors eliminated.

Bank of England
Bank of England

There is nothing new about large UK banks operating as a cartel. For much of the 20th century, the so-called “Big Five” clearing banks (Midland, National Provincial, Westminster, Barclays and Lloyds) operated the Committee of London Clearing Banks, which set interest rates and opening times. This cartel was backed by the Bank of England and the Treasury, not least because it was believed to keep interest rates low on lending to government and to key industries. Its members had a gentlemen’s agreement not to merge – an agreement broken in 1968 with the merger of National Provincial and Westminster banks.

But the cartel was under pressure. Memories of the financial instability before World War I were fading, weakening the desire for central control of the banking system. And the belief was growing, underpinned by economic research particularly from the University of Chicago, that lack of competition was harmful to the economy, causing price distortions and inefficiencies. Voices from academia and the financial industry criticised the banking cartel for “restrictive practices” and argued for clearing banking to be opened up to the same level of competition as other parts of the financial system.

In 1967, the Prices and Incomes Board recommended that collective pricing agreements between banks be abolished. This was followed in 1970 by the Institute for Economic Affairs’ paper “Competition in Banking”, which recommended that “all obstacles to potential new entrants to the industry” be abolished, including rate-fixing, clearing house membership and entry to retail banking. The Competition and Credit Control Act of 1971 ratified many of these ideas.

But cartels are not so easily broken. The now “Big Four” banks were used to collaborating and continued to do so. Price-fixing in capital markets (Libor, ISDA, gold and FX fixes) continued long after interest rate fixing was ended by legislation. And the big banks found other ways of effectively controlling the UK banking landscape. BACS was the first of many bank collaborations which were ostensibly meant to benefit customers but in fact aimed at squeezing out competitors.

From customers’ point of view, it is not clear that the big banks’ dominance of the UK payments network is necessarily a bad thing. Their collective investment in the network makes it fast and efficient, while their collaborative approach ensures that customers experience no barriers. For example, only when the big banks bought in did the LINK network cover every bank and building society: the big banks “sponsor” smaller banks and building societies to enable them to gain access to VocaLink.

Simply requiring banks to sell shares creates the possibility that they will be bought by companies that don’t necessarily have the interests of the UK retail customer at heart – like hedge funds

This is a clear customer benefit that has come about through collaboration, not competition. But it could be improved. After all, why shouldn’t smaller banks and building societies have direct access to VocaLink? The large bank “sponsorship” is a relic of the clearing-house model that was supposedly ended in 1971. Restrictive practices still live on.

vocalink_logoOn the face of it, therefore, the regulator’s recommendation that the big banks be forced to sell part of their stake in VocaLink looks attractive. Smaller banks, building societies and credit unions could buy in, widening ownership and creating pressure for reform.

But I fear this is not the aim. If the goal was a collaborative system delivering real benefit to customers, it would be better to make VocaLink a true mutual, open to any financial services provider that needs access to UK payments systems, with equal voting rights for large and small providers. Simply requiring banks to sell shares creates the possibility that they will be bought by companies that don’t necessarily have the interests of the UK retail customer at heart – like hedge funds.

And it is hard to see how turning VocaLink into a for-profit organisation is in the best interests of customers. The report’s assertion that not-for-profits have no incentive to innovate or drive down costs is not supported by evidence. In fact, not-for-profits often have a focus on customer outcome that motivates them to introduce innovative and cost-efficient practices in which for- profits have no interest. Shareholder value is not the only driver of innovation.

It seems that this report, like so many others concerned with the regulation of financial services, is driven by a competitive market ideology – the same ideology that has proven so flawed in practice. There is ample evidence that unfettered competition and unregulated markets do not create stable financial systems.

On the contrary: the break-up of the interest rate cartel in 1971 led directly to the Secondary Banking Crisis of 1973-5, which forced the Bank of England to step in and re-regulate (the famous “corset”). I cannot see how deliberately introducing instability into the payments system that is the lifeblood of the UK economy is in customers’ best interests. Better a stable but inefficient system than an “efficient” one prone to crashes.

There has been heavy lobbying by large payment service providers such as Visa and Mastercard to open up UK payment services to competition, not only by forcing UK banks to sell their stakes but also by introducing common standards for messages and a more rigorous competitive tendering process for payment services contracts. But opening up utility providers to international competition seldom creates the thriving ecosystem of small, medium-size and large players, providing diverse and cost-effective solutions, in which competitive market ideologues like to believe.

From a business perspective, the aim of competition is to eliminate competition: unbridled competition therefore tends to end in market concentration, oligopoly and abuse of power. Strong anti-trust regulation such as exists in the US can prevent this, but the UK’s anti- trust regulation leaves much to be desired. So if the recommendations of the Payments Systems Regulator are adopted, I expect to see the UK payments network eventually swallowed up by the giant international providers.

The ideological bias of the Payment Systems Regulator has resulted in a fundamentally flawed report. It should think again.

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