Retail banking in the UK is undergoing profound changes partly as a result of regulatory interventions such as Open Banking, a remedy imposed by the Competition and Markets Authority (CMA) which came into force in January 2018 with the aim of making it easier for consumers to compare alternative offers for their personal current account (PCA). The CMA required the largest banks to adopt common, standard technological solutions, labelled ‘application programming interfaces’ (APIs) through which they will share data with third party apps, such as ‘aggregators’ that allow consumers to monitor more than one account held with different banks via a single online platform. In addition, consumers can seamlessly instruct their bank to make a payment directly from a third-party online app. The CMA’s concern was that the persistent low levels of switching are in large part caused by customer inertia due to lack of engagement, which in turn is the result of high search costs due to the difficulty consumers encounter in comparing substitutes. The ability to attract retail deposits is considered essential to compete in retail lending markets.
Another potentially impactful intervention is the Bank of England’s decision to provide access to its real-time-gross-settlement (RTGS) system to non-bank payment service providers, including e-money institutions such as PayPal. As a result, authorised operators can gain greater control over their payment activity, thanks to the fact that they will no longer have to partner with a direct competitor for access to essential payment infrastructures.
A research paper (presented at the Annual Conference of the Journal of Financial Regulation) explores the potential implications of these two reforms, in particular the extent to which the mainstream model of retail banking might be disrupted and how the regulatory community may respond to the resulting challenges.
The most immediate impact likely to arise is a squeeze on PCAs’ profitability as a result of the combined increase in the overall cost of raising retail deposits and the reduction in income from non-interest fees. Lower profitability not only entails lower ability to accumulate loss-absorbing capital, thus making banks more fragile, but also might induce more risk-taking in an attempt to recover profitability. In addition, the implementation of Open Banking might undermine retail banking by calling into question the traditional reliance on sight retail deposits as a relatively cheap and stable source of funding. Therefore, increased deposit mobility may worsen a situation of liquidity stress in both an idiosyncratic or systemic event. Finally, deposit mobility may affect the transmission of monetary policy. Specifically, whilst banks will want to promptly pass on rate increases to depositors, they might not want to pass on cuts unilaterally for fear of being subject to a sudden outflow.
In practice, though, the materiality of such an impact will depend on the rate of adoption of ‘aggregators’. Furthermore, banks might find ways to adapt to the fact that consumers become more prone to move their deposit balances in order to improve their remuneration. For example, banks may adopt bundling, a form of price discrimination adopted by a multi-product firm where the price for the bundle is lower than the sum of stand-alone prices (i.e., a bundled discount). Therefore, it would be too hasty to intervene ex-ante by changing the categorisation of insured sight retail deposit under liquidity adequacy rules. Furthermore, in case intervention was needed, in order to prevent systemic contagion due to a price war among banks worried about being subjected to an outflow of deposits, the best approach may be for the central bank to provide an alternative source of funding by setting up a lending facility scheme of the type used for monetary policy.
Allowing non-bank payment service providers to access RTGS might have the unintended consequence of enabling a potentially more disruptive competition threat to retail banking, something that could prove to be as impactful as the provision of universal access to the central bank’s balance sheet. Perhaps counterintuitively, banks’ strategic reaction aimed at fending off this threat might push non-bank payment service providers to offer a fully-fledged substitute for a bank current account. The resulting disintermediation threat might have far reaching implications not only for financial stability, but also for the supply of credit to the real economy. Ultimately, the combined result of these two reforms may be to expand the role of the central bank in the direction of financial intermediation.
Paolo Siciliani is a senior technical specialist at the Bank of England’s Prudential Regulation Authority, an independent expert in competition and economics at the Bar Standards Board for England and Wales and a visiting lecturer at UCL Faculty of Laws.