The Financial Conduct Authority’s long-awaited 2022 Strategic Review of Retail Banking Business Models finds that digital innovation and changing consumer behaviour are reducing the ‘historic advantages’ of large retail banks in the UK. The FCA’s report sets out key changes to competitive dynamics in the retail banking sector, identifies areas for improvement and calls for engagement in addressing these. We have highlighted some of the main takeaways below and how the FCA’s findings are likely to impact future investigations and regulation in the financial services sector.

Background

The FCA’s report explores key trends in the retail banking sector in light of the continued advance of digitisation, a growing focus on consumer protection and Covid. While previous investigations had found that the UK retail banking sector was characterised by stable market shares, low switching and low levels of innovation (see the CMA’s 2016 retail banking market investigation, as well as the FCA’s 2018 Progress Report and Strategic Review), the FCA’s 2022 report makes clear that this is no longer the case.

Digitisation and changing consumer behaviour are increasing competition

With sustained low interest rates putting pressure on financial returns, many expected the economic turmoil of the recent years to impact smaller banks adversely and reduce their ability to compete against the traditional big banks. However, as the pace of digital innovation accelerated as a result of the pandemic, the FCA’s report confirms that digital challenger banks have in fact been bolstered by the continued influx of new ‘multi-homing’ customers, whose money had previously sat in the accounts of their larger rivals. The report estimates that the average UK adult now has approximately 1.9 personal current accounts (PCAs), with digital challengers holding 8 per cent of this newly enlarged market. Interestingly, the pandemic reversed a similar trend in micro-business lending, with large banks able to offer larger loans under Covid-related government lending programmes.

The FCA report finds that digital challenger banks have led the adoption of digital innovation in PCA banking, forcing larger banks to modernise. It confirms that this trend has improved service quality and increased innovation, improving outcomes for consumers and SMEs.

The report also finds that a rise in the use of mortgage brokers has benefited mortgage borrowers through lower interest rates. The number of consumers on standard variable rates has dropped, evidencing the value of intermediaries that enable consumers to compare different products more effectively. However, the FCA considers that there is still room for improvement of competitive conditions in mortgage and consumer lending. Big banks that were subject to the ring-fencing rules introduced in 2019 benefited from additional liquidity which can be used in mortgage lending. Digital challengers’ current accounts, on the other hand, are currently less likely to be used as main accounts, which means lower balances, fewer transactions and less overdraft usage, and therefore lower funding benefits and fee income.

Looking ahead:

  • Given these changing competitive conditions and industry developments in the retail banking sector, the CMA and FCA may need to assess whether remedies and undertakings from previous investigations remain necessary or whether certain remedies and undertakings can now be removed.
  • In any future market studies and investigations, the impact of digitisation and changing consumer behaviour are likely to be key focus areas.
  • The FCA’s report recognises the positive impact of Open Banking in increasing competition and facilitating innovation by a broad range of players. Focus will now shift to advancing Open Finance in order to enable the easier sharing of consumer data to deliver benefits through personalised products, price comparison and easier switching.

More room for consumer protection improvements

While finding that digitisation and increased competition are leading to consumer benefits such as greater choice and lower prices, the FCA also warned that changes should not come at the expense of high-quality customer care: “we know that there are a significant proportion of consumers and businesses for whom competition may not deliver the same benefits […] We have a role to play in ensuring that banks continue to have a strong focus on consumer outcomes, especially for users in vulnerable circumstances”.

The FCA sets out some key points for future consideration as policy continues to develop in this area. These include:

  • Diversity of business models: the increased focus on digitisation could mean some consumers are left worse off (for example due to branch closures). The FCA will continue to monitor firms’ conduct to ensure a strong focus on the needs of vulnerable consumers. Diversity of business models has therefore been identified as key to ensuring competition in the sector.
  • Consumer protection in microbusiness banking: innovation and new entries in microbusiness banking need to be tied to banks’ obligations to protect consumers and the economy against harm.
  • Regulation: the FCA reiterates in its report that properly designed regulatory intervention can yield concrete results. By way of example, the FCA points to the significant decline in unarranged overdraft yields following a reform of the overdraft market which came into force in August 2020.
  • The new Consumer Duty: the Consumer Duty that is being consulted on will require firms to deliver good outcomes for retail customers, and – the FCA hopes – lead to a higher level of consumer protection. As explained in an earlier blog post, the FCA is intending to implement a standard that is significantly higher than catered for by the current rules, with the aim being to finalise the new rules by July 2022.

It is likely that consumer protection issues will form a key part of future investigations and regulation in the financial services sector. With this in mind, firms should be taking steps now around designing and implementing fair value assessments, demonstrating that prices provide fair value to consumers and building processes that take into account specific categories of consumers (such as vulnerable customers).

What happens next?

Through this report, the FCA has issued a call to further action in relation to the outstanding areas of improvement, reaffirming its role in promoting competition in consumers’ interests. It is aiming to have discussions with banks about its findings and has invited views by 31 March 2022.

Please get in touch with your usual Freshfields contact if you would like to contribute to this discussion and/or would like to have a conversation about what this means for your business. You can also read more about the evolving regulatory landscape globally in our Antitrust 10 Key Themes report.