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 LloydsTSB. 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 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 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 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 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 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.
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.
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.
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