So with Rachel having set out the case for the lack of competition in UK SME banking, what can we do about it?
Broadly we have two main strands to our thinking:
Giving the private sector a push to become more dynamic
Creating a challenger bank to speed up the increase in competition
Starting with our ideas to make the private sector in SME banking more dynamic, we have four basic areas where we think options for reform should be investigated as the subject of a focused 3 month review:
Lowering barriers to entry
Lowering set-up costs for a branch network
Increasing rates of switching
Considering a referral of SME banking to the Competition Commission
Lowering barriers to entry would include looking at things like the licensing requirements for new banks, the capital they are required to hold, or their access to payment platforms or information on potential customers. Licensing and capital requirements were noted in the 2011 parliamentary inquiry on banking competition as an issue.
A branch network is important - but expensive - part of setting up a new bank. If you don't have a local branch, then chances are an SME in a given area won't open their current account with you. Current accounts are a gateway to selling SMEs other banking services. So establishing a branch network is important for a new bank's ability to compete.
There have been reviews in the past suggesting that where a given bank is the only one left in town, it should make some of its facilities available for other banks to use. Or alternatively, we could make use of the post office network. In 2002, up to 8,000 post office branches at the time were thought suitable for using as a base for providing banking services.
Options like this could be looked at again to bring down the cost of establishing a branch network.
Switching is the process of a customer changing to a new bank. In SME banking the rate of switching is low, perhaps around 8% per annum - though twice as many try to switch. Only a very small proportion of SMEs find the process of switching easy and painless (12%). But there's also considerable inertia from customers when it comes to switching - people don't seem inclined to switch.
To get a truly dynamic SME banking market switching rates need to increase. The Vickers Commission recommended the creation of a redirection service, which is being put into effect and should be online by September next year. The redirection service would aim to reassure customers that no direct debits or credits fall between the cracks when a company switches banks.
But perhaps we need to go further and introduce full account number portability. Not an easy step by any means - nowhere else does this. But think about how much easier switching cellphones is now that you can take your number with you.
We also think there's case for considering an explicit, time-limited incentive that would match any savings a company can make by switching banks. The idea here would be to simply increase the rate of switching giving competitors a look in.
The last option to consider in our recommended review would be whether the time had come to make a market referral of SME banking to the Competition Commission. Sir John Vickers recommended that the government make this assessment in 2015 once some of his reforms had started to impact. We think the government might be better to consider this now.
The other major strand to our thinking really responds to how quickly we could expect to see change in the banking sector if it was allowed to unfold organically.
Small banks (those with less than 5% of the current account market) tend to gain market share in the UK only very slowly, hardly denting the overall competitive landscape even over ten years.
While we don't think there are any very quick wins in making the SME banking sector much more competitive, we would like to start to see an impact within 5-10 years. The problem is, even with a positive outcome from our recommended review to make the private sector more dynamic, meaningful results might be measured in decades, not years.
For this reason, we think there needs to be another challenger bank created, specifically in SME banking, with big enough scale to start making an impact on competition over a shorter time frame.
Because the current financial landscape has left many banks (large and small) licking their wounds, and because the current market landscape does not look particularly appealing, we do not expect a challenger at scale to emerge from the private sector in the short term.
On the other hand, the government is talking about creating its own business bank. We think this business bank should be a retail bank for SMEs, a challenger set to take on the incumbents and make SME banking more competitive.
To be clear, this bank would not be guaranteed or subsidised by the government. It would operate on commercial terms and aim to make a profit. It would initially focus on SMEs but could in time branch out to other markets. The government's only role would be to capitalise the bank - in conjunction with other investors - then stand back.
The rationale for the government to act is because in the short term the private sector looks unlikely to fill this role - but in the long term, once competition has picked up, we would expect the government to divest its shareholding.
Becaues competition is more of an issue in some regions than others, and becaues groups of local authorities could be co-investors with the central government and private sector, the bank could be structured on a regional basis.
Here is what one possible model might look like: