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The business model of banking giants such as RBS and Barclays, which sought to be all things to all men, appears to be broken. Conglomerate banking is now being, explicitly and implicitly, strongly discouraged. And, with the demise of retail brands such as Abbey, high-street banking is as blank a canvas as it has been for over a hundred years. The sector is entering an era of great opportunity for reinvention, new entrants and innovation. The question is, what is the best model and who will provide it?
It was widely assumed that risks in the different markets addressed by the conglomerate banks would not be closely correlated. Thus the conglomerate business model should generate a steady stream of income – as one market fell back, another would experience strong growth. Unfortunately, the massive growth in borrowing brought about by interest rates that were below the rate of growth of the various world economies led to an invention of new instruments that could package and insure debt in a variety of different ways. These products crossed the traditional borders between markets such as insurance, investment products and retail. AIG stands (or rather falls) as testament to this. Different markets became infected by these new products and the ultimate result was a strong correlation of risk across all markets – thus resulting in the widespread financial meltdown.
The bailout of Northern Rock highlighted the inherent danger of relying on wholesale sources of funding for retail operations. The systemic risk carried over from the money markets and into the retail arm of the bank. The collapse was brought about through imbalances of funding and over-reliance on investment banking markets. The universal banks are now seeking to decouple their retail business from the bancassurrance and investment markets. This gives them a unique opportunity to streamline and reinvent their retail business on the high-street. Now retail banking will be the 100% source of their income. This can only mean more competition, better products and, hold your breath, better services for consumers.
In the wake of the financial collapse, there are calls for new models of financial propriety, going beyond the separation of retail from bancassurance. Consumers want personalised, cost effective and transparent banking with an ethical dimension. And, answering these calls, economists, regulators, entrepreneurs and even politicians are brimming with ideas advocating circumspection and transparency.
Chief amongst these ideas is the theory of “Limited Purpose Banking”. This demands that banks lend only against money which has been saved with them. And, that this money should be invested in return for shares. Laurence Kotlikoff, Professor of Economics at Boston University and author of Jimmy Stewart Is Dead, writing in The Times explains, “They take in funds on a 100 per cent equity basis (they sell shares) and use these proceeds either to make loans by purchasing mortgages, commercial paper (short-term IOUs from companies) and corporate and government bonds or to buy stocks. Neither LPB banks nor the individual mutual funds they operate, are allowed to borrow, full stop. Hence, they would never experience a bank run. Under LPB, households manage their own risk by choosing from safe or risky mutual funds.”
While old universal banks struggle to decouple and their retail arms refocus on a high-street business model, new players are emerging. As reported by Bank Technology News, BoringBank and BankSimple are examples of newly-formed niche operators hoping to fill the perceived gap in the market for straight-forward consumer focused banking. The recent acquisition of Church House Trust plc by Virgin Money so it could accept deposits and offer loans and mortgages is another example of the renewed interest in the possibilities and opportunities of high-street banking. With the Payments Services Directive, We at Bayberry expect more non-banks are going to join existing and new banks in the scramble for the consumer’s banking business.
Interestingly, however, there is a growing sector of financial services providers that already provide a form of Limited Purpose Banking: Credit Unions. Credit Unions are owned by their members who invest savings in return for shares and ‘collectively’ make loans to other members based on the amount of shares invested. Unfairly classified as “the poor man’s bank”, Credit Unions are offering increasingly sophisticated products to all kinds of high-street consumers. In this article, The Ecologist describes the value Credit Unions can provide beyond their banking brethren. This case-study is a classic example of the flexibility a financial provider can give when operated by, and for, its members.
In a time where new entrants are causing a stir and getting the PR headlines, it’s easy to overlook Credit Unions. Already on the high-street, they are well placed to take advantage of the coming changes in retail banking. As a direct result of Bayberry’s own work with the Association of British Credit Unions, the sector can now provide full current account banking with debit cards. Currently 26,000 accounts are open and operational with average balances of £3 million, and this is growing all the time.
Credit unions can meet the challenges of the new era for consumer banking. As organisations closely integrated into their local communities they are uniquely placed to meet the consumer needs and to deliver services which will put them at the forefront of the new landscape of high-street banking.
All they need to do now is let the world know they’re ready and available.
St. Paul’s Garda Credit Union is one of Ireland’s largest credit unions. Bayberry was appointed to deliver a solution for Electronic banking services and payment cards at St. Paul’s.