The Open Banking / PSD2 ripple effect: FCA clarifies purpose and scope of retail banking business models review

The FCA has published a Purpose and Scope paper for its strategic review of retail banking business models, announced in May this year.  While it stresses in the paper that the review is 'discovery work' only and it does not have specific regulatory interventions in mind, it appears that the FCA is looking to get ahead of the regulatory game in this rapidly changing market.  With PSD2 and Open Banking at the forefront of market transformations, the FCA's areas of specific focus paint a challenging picture of what the future might hold - especially for the bigger players.

The shifting sands of retail banking and payments

The FCA takes the view that the 'future is uncertain' but the 'pace of change will continue.'  It believes that existing competitive pressures brought about by:

  • new regulatory interventions such as PSD2, the UK Open Banking initiative and the EU Interchange Fee Regulation; and
  • the impact of new technology on consumer behaviour and the costs of providing services,

are only going to increase as the changes introduced by the CMA's Open Banking remedy and PSD2 take full effect.

So where will the FCA focus its attention in its review?


Anchors away: the changing role of personal current accounts

The paper suggests that the importance of personal current accounts (PCAs) as 'anchor products' and the ability to bundle or cross-sell products could erode over time due to increased digitalisation and Open Banking.  Reduced customer "stickiness" might in turn impact the larger banks' traditional role of converting short-term deposits into longer-term lending and lead to a re-think of the related business models.  Likewise increased fee transparency could lead to new fee types or more reliance on net interest margins in both PCAs and other retail banking products.  SME banking may also need to change as a result of declining relationship banking and customer loyalty as the effects of Open Banking and increased digitalisation take hold.

The potential distributional issues surrounding the free-if-in-credit PCA model will also be under scrutiny.  Do long-standing PCA customers who also hold other core retail banking and insurance products with the same bank provide a disproportionate amount of bank profit?  What about vulnerable consumers' use of overdrafts to meet regular borrowing needs?


Back book customers searching and switching

The current significant competitive advantage and profitability provided by large banks' back books could gradually reduce due to the effects of remedies to increase price transparency, increased digitalisation and Open Banking, as back book savings and mortgage customers may be more likely to search and switch to new deals.  Again, the FCA wants to understand how this might change business models.


Interest rate (and profitability) trouble ahead?

The FCA wants to investigate the extent to which large banks may have taken on significant 'sub-prime' or non-standard credit risks, driven by a 'benign credit risk environment' and increased competition from challenger banks.  This could have implications on profitability in the face of future interest rate rises, when customers may struggle to service their debts.


What about vulnerable consumers?

The FCA expresses concern about the risk of vulnerable consumers being left behind by growing use of intermediation (eg in the mortgages market) and banks' moves to offer increased access to services via online channels and reduce the number of high street branches.  It is also keen to find out whether vulnerable PCA consumers are particularly profitable for banks, eg through use of unarranged overdrafts as regular loans.  The FCA points out that, in line with its Mission, it will prioritise the interests of vulnerable consumers in its analysis of these issues.


Assessing the new players

The competitive pros and cons of the new market players will be another focus for the review.  With an eye to preserving the increased competition introduced by these challenger entities, the FCA wants to dig down into what elements of their business models are essential to the success of their current strategies.  In this way, it can better grasp the potential impact of incumbent firms' changing business models and charging structures on the new players' revenue streams.


Progress update

The FCA still intends to publish a progress update on its strategic review in Q2 2018.

Take a look at our blog post 'No breathing space for retail banks: business models go under the FCA microscope' for more information on the phases of the review.

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