2.4 Structure of the financial services industry
Although the global financial crisis which began in 2007 wrought havoc with the UK financial services industry, the sector has continued to be dominated by banks. This domination had been reinforced by the conversion of most of the large building societies to banks in the 1980s and 1990s – although all those that did convert were subsequently either acquired by other banks or, in the case of Northern Rock Bank and parts of Bradford & Bingley Bank, taken into public ownership during the financial crisis.
Banks and other types of lending institutions are described in Box 2. In 2010, banks accounted for 59 per cent of personal lending, building societies accounted for 13 per cent, and other specialist lenders accounted for 28 per cent (Bank of England, 2010a).
Box 2 The UK Lending Industry
- Banks are mostly public limited companies (plcs) that are owned by their shareholders. These include the major ‘high-street’ names, such as Barclays, Lloyds Banking Group, HSBC, the Royal Bank of Scotland (RBS) and Banco Santander – the Spanish bank that has made a number of acquisitions of UK banks including Abbey National Bank and Alliance & Leicester Bank. Additionally, there are a number of smaller banks including Metro Bank, which commenced business in 2010, and Church House Trust Bank, which is owned by Virgin Money. The UK Government currently has majority shareholdings in RBS and Lloyds Banking Group as a result of the support that both needed at the height of the global financial crisis.
- Building societies are ‘mutual’ organisations. This means that they are owned by their retail savers and borrowers (that is, their personal customers). When they were originally founded – mostly in the nineteenth century – building societies were organisations formed by groups of people who saved together to buy land on which to build their homes. Subsequently, ‘permanent’ building societies emerged with whom people could save even if they did not need to acquire a home themselves. The Nationwide Building Society is, by some distance, the largest of the remaining societies in the UK, although in 2010 there were still forty-nine others, such as the Yorkshire, the Coventry and the Skipton Building Societies.
- Finance companies are in many cases subsidiaries of banks and building societies. These specialise in personal loans, and motor and retail finance (e.g. Carselect – a subsidiary of Lloyds Banking Group).
- Direct lenders are also often subsidiaries of banks, building societies and insurance companies. The chief distinction between these and other lenders is that they do not have a branch network; they deal with customers via the internet, telephone and the post, e.g. Direct Line.
- Credit unions are cooperative organisations, often small in size and run on a localised basis. There are two main types: community-based, whose members tend to come from low-income groups; and work-based, whose members are employed with an affiliated organisation. One of the largest is The Open University’s credit union.
- The Student Loans Company (SLC) is owned by the UK Government, and lends to students in higher education to enable them to meet their expenses. With the cost of higher education increasing in recent years, the SLC has become a major lender.
- The alternative credit market consists of ‘sub-prime lenders’ aimed primarily at people on low incomes. Such lenders include some loans companies, door-to-door money lenders, rental purchase shops, ‘sell and buy back’ outlets, and pawnbrokers. In addition, this market includes unlicensed lenders who provide loans in an emergency at extremely high rates of interest.
- Budgeting loans are available for people on some state benefits. These are interest-free loans which have to be paid back, and in 2010 they had a borrowing limit of £1500.
The UK’s lending industry has been affected by the diversification into financial services of many retailing companies, particularly the supermarkets. Initially, these moves into financial services were undertaken as joint ventures with established banks. For example, the financial services activities of Tesco were originally a fifty-fifty joint venture with First Active – part of the Royal Bank of Scotland (RBS). In 2008, however, Tesco bought out the RBS share and established its finance operations on its own as Tesco Bank. By contrast the financial services diversification of Sainsbury (Sainsbury Finance) remains a joint venture with Halifax Bank of Scotland (HBOS), which itself is now a subsidiary of Lloyds Banking Group. The financial arm of Marks & Spencer, M&S Money, is a 100 per cent subsidiary of HSBC Bank. The retailing names of these relatively new financial entities clearly help in marketing their services to the public.
The basic business of all lenders is really the same. It involves borrowing money from the public and institutions, and lending the money (at a profit in most cases) to the public, companies, local authorities and even governments.
Which of the categories of lender in Box 2 have you borrowed from? Why was this? If you haven’t borrowed any money, which kinds of institutions might you borrow from in the future?
Thinking through the reasons why you build and maintain relationships with different categories of lender is important. Do you shop around for the best deal or do you accept the first offer? Do you deal with building societies because of their mutual status, or do you turn to the alternative credit markets? Sections 3 and 5 of this course will provide information about and examples of the kind of issues someone might work through in order to come to an informed decision about categories of lender and types of loan products. It’s important to remember that not everyone has such a choice: low-income households may have to use money lenders or mail-order companies because of a lack of access to mainstream lenders.
One key difference between the different types of lenders lies in their differential need to make profits. For example, a major objective of incorporated companies like banks and finance companies is to maximise profits. Banks have in recent years been very successful in doing this – and the huge losses several made during the global financial crisis that began in 2007 only proved to be a temporary deviation from their ability to operate profitably. Most banks were back in profit in 2010.
It is this issue about profitability that regularly raises concerns about whether the banks are extracting too high a profit margin on their business with households through their charges and interest rates on debt products, especially credit cards. In 2003, the Parliamentary Treasury Select Committee was among those that had voiced concerns about the interest rates charged on credit cards (UK Parliament, 2003). This pressure led to some changes, such as the industry’s introduction of an ‘Honesty Box’, in which lenders provide a range of basic information about a credit deal, and the use of existing statutory powers to improve the means by which early repayment charges are calculated. Subsequently, a protracted legal dispute between the lending institutions and the OFT, on the issue of bank charges in the late 2000s, ended in defeat for the OFT in 2009. In 2010, however, the incoming Conservative/Liberal Democrat coalition Government announced its intention to end ‘unfair’ bank and other financial transaction charges, with plans to ban ‘excessive’ interest rates on credit and store cards (BBC, 2010).
Additionally, with the acquisition of several UK lenders by other banks and building societies – combined with the withdrawal of some foreign banks from their operations in the UK as a result of the financial crisis – fears started to be expressed in the late 2000s that less competition among lenders might allow them to secure larger profits.
In contrast to banks and other incorporated companies, building societies have no shareholders since their customers in effect own them, and so they do not have to make dividend payments. With the financial leeway this gives them, these mutual organisations may charge lower rates of interest to borrowers.
For credit unions, the maximum interest rate that can be charged is set by law, and the interest rate charged by the Student Loans Company (SLC) has, to date, been linked to the rate of price inflation by law. However, changes to the arrangements for fees for higher education in England, and to student loans to finance fee payments, presaged by the Browne Report (Browne, 2010), mean that this linkage may not apply in the future.