St Gallen International Competition Forum
Session III: ‘Too big to fail, but not too big to be unbundled?’
Investigating the banks—The importance of competition
Peter Freeman QC
20 May 2010
In contributing to the St Gallen International Competition Forum session on the banking
sector, this paper draws a distinction between prudential/moral hazard issues, which are
very much the province of the financial authorities and government, and competition issues
which can be examined by independent competition authorities, working carefully within the
overall policy framework.
There have been calls in the UK for a Competition Commission (CC) market investigation
into the banking sector. The paper examines the different ways in which such a market
investigation could be approached, considering the relative advantages of a broad or a more
focused approach and examining the possible issues that could come under consideration. It
also examines possible remedies, including structural remedies, pointing out that these are
not the only measures available to improve competition.
The paper shows how a market investigation into the banking sector could include consider-
ation of competition in its full context, taking account of financial stability, regulatory and
prudential issues. The UK regime specifically allows Ministers to intervene to ensure that any
proposed remedies take specific public interest issues into account.
St Gallen International Competition Forum
Session III: ‘Too big to fail, but not too big to be unbundled?’
Investigating the banks—The importance of competition
Peter Freeman QC 1
20 May 2010
Introduction: three quotations
There has been much talk of ‘breaking up the banks’ as an answer to the recent turmoil in
the financial sector. In the UK we have a new coalition government, in whose future pro-
gramme this issue is likely to have some significance. The purpose of this paper is to separ-
ate some of the entangled strands of the debate and to identify what are the competition
issues to be examined, as opposed to the prudential or moral hazard issues that also loom
The following three quotations illustrate different viewpoints. They are chosen from a wide
variety of authoritative comment:
The massive support extended to the banking sector around the world, while
necessary to avert economic disaster, has created possibly the biggest moral
hazard in history. The ‘too important to fail’ problem is too important to ignore.
Mervyn King; Governor of the Bank of England
Lecture to Scottish business organizations, 20 October 2009
To fix the system we must break up the banks.
Philip Auger and John McFall 2
Financial Times, 11 September 2009
A pre-requisite … is a Competition Commission investigation into the current
banking sector because one of the consequences of all the events of the past
years has been a huge amount of consolidation and a removal of certain
George Osborne 3
Financial Times, 27 October 2009
Whilst it might be thought these comments show a degree of unanimity, they also reveal the
multi-faceted nature of the problem; starting with the problem of large-scale state support
leaving major banks in effect rewarded for their own failings; moving through a concern for
the scale and excessive profitability of banks; and then to the intuitive observation that
competition has probably suffered from the recent wave of banking collapse and
Chairman, CC. All views expressed are personal to the author and should not be taken to represent the views of the CC.
Until recently, Chair of the House of Commons Treasury Select Committee.
At the time shadow Chancellor of the Exchequer, now Chancellor of the Exchequer in the newly formed coalition government.
consolidation. It is the last issue on which I want to concentrate, but we should first look
briefly at prudential aspects.
The so-called moral hazard issue is that, through organic growth, merger and extension of
activities into numerous different fields, some banks achieved such a position in terms of
importance to the economy and the financial system that, because they knew government
would ultimately stand behind them, they had less incentive to guard against incurring
excessive risk. This problem has, as we have all seen, posed a major threat to financial
stability, has caused and prolonged the economic downturn and has exposed taxpayers in
the UK and elsewhere to the consequences of the risks that have been taken.
One possible solution to this moral hazard is increased regulation, particularly in relation to
capital requirements. But increased capital alone may not be sufficient. Any increased
capital ratio is arbitrary to some extent and may not be sufficient to cover the risk incurred or
to deter banks from taking excessive risks in the first place.
‘Break up the banks’?
Various influential commentators 4 have therefore argued that it may be necessary to con-
sider whether banks should be split up, either by separating conglomerate businesses—
banking from insurance, for example—or by the separation of narrow or utility banking
activities from more speculative trading or ‘casino’ operations. 5 These proposals are not
directed primarily at increasing competition in banking markets, but rather at preventing a
second banking crisis. Their implementation would be, of necessity, a matter for govern-
ments, and they are not the subject of my talk today, which is about competition. 6
Competition is, however, also a major concern following the financial crisis. Initially the focus
was on preserving fair competition as state support for banks ballooned in 2008–2009; but
latterly the agenda has shifted to restoring or even increasing competition in banking
markets. The issue of ‘splitting up’ or ‘unbundling’ banks arises in this context as well, either
as part of state aid restructuring and recovery packages or to counter the effect of bank
mergers and bank failures leading to greater concentration. The former is the preserve of the
European Commission in the operation of the state aid rules. The divestments of businesses
and assets required of RBS and Lloyds Banking Group as a condition of further state aid
approval are examples. The latter is more problematic—generally speaking, absent illegal
conduct, the splitting up of companies to promote competition is difficult territory for com-
petition authorities, although it is routine for competition authorities to require structural
remedies such as divestitures in merger cases. In the UK, perhaps unusually by comparison
with other jurisdictions, the market investigation regime does allow such interventions.
In addition to the Governor of the Bank of England, and the former Chair of the House of Commons Treasury Select
Committee already mentioned, these have included Dr Vincent Cable, the Liberal Democrat former spokesperson on Treasury
Affairs (now the Secretary of State for Business, Innovation and Skills in the newly formed coalition government).
For proposals and developments in the USA, see for example: US Senate debates finance reform bill, The Financial Times
Online, 30 April 2010; The case for a Glass-Steagall Lite, The Financial Times Online, 11 March 2010.
It appears that in the UK an independent commission will be established to consider this question: See The Guardian, 13 May
2010; The Independent, 13 May 2010.
It is not as if competition concerns have been absent from the banking sector. There has
been a wide range of competition and consumer issues arising in banking markets in recent
years. These include cases where competition law has been applied, consideration of state
intervention, merger control, and more wide-ranging examination of structural or consumer
• The possible investigation of investment bank fees. 7
• Price collusion between RBS and Barclays in relation to pricing of loan products to large
professional services firms. 8
• Various cases involving payment systems including antitrust enforcement actions in the
UK and by the European Commission against Visa and MasterCard (including Maestro)
interchange fees 9 as well as the report from the Payments Council referring to the likely
demise of cheque payments by 2018. 10
• Office of Fair Trading (OFT) report on Northern Rock and the impact of public support on
• OFT report and ultimate approval by the Secretary of State of the Lloyds/HBoS merger. 12
A variety of cases involving specific consumer-facing markets:
• the CC inquiries into Personal Banking in Northern Ireland 13 and Payment Protection
Insurance 14 (PPI) (ongoing);
• OFT activity against ‘unfair’ bank 15 and credit card default charges; 16
• OFT review of barriers to entry, exit and expansion in the retail banking market; 17 and
See, for example, comments by then Minister Lord Myners (The Independent, 4 April 2010).
RBS agreed to pay a fine of £28.5 million imposed by the OFT for sharing confidential future pricing information with Barclays.
Barclays secured 100 per cent leniency from fines (OFT news release 30 March 2010).
For a handy summary of the various UK and EU enforcement actions, please go to www.oft.gov.uk/oft_at_work/markets/
See news release by the Payments Council, 14 April 2010.
OFT press release and report, 10 March 2009.
OFT report on proposed merger, 31 October 2008; Decision of Secretary of State dated 31 October 2008 not to refer the
merger to the CC. On 10 December 2008, the Competition Appeal Tribunal dismissed the application of the Merger Action
Group for review of the Secretary of State’s decision to approve the merger.
Personal current account banking services in Northern Ireland market investigation, 15 May 2007.
Market investigation into payment protection insurance, 29 January 2009.
Investigation opened by the OFT in March 2007 under the Unfair Terms in Consumer Contracts Regulations to review the
fairness of personal current account contract terms providing for unarranged overdraft charges. The investigation led to a test
case as to whether the OFT had the power to review those terms in full for fairness. The Supreme Court ultimately decided
against the OFT, which abandoned the investigation. The OFT obtained undertakings from the banks for improvements in the
next two years (OFT press release 7 October 2009; OFT follow-up report and press release 16 March 2010).
See OFT press release 5 April 2006. Also OFT press release 1 April 2008 regarding enforcement action against Clydesdale
Financial Services Limited to reduce store card default charges.
See article by Philip Collins, OFT Chairman, The Daily Telegraph, 30 March 2010.
• super-complaint by Consumer Focus on low ISA interest rates. 18
• OFT strategy/plan for Financial Services. 19
• EU sector inquiry into aspects of financial services. 20
A possible market investigation?
These cases have either tended to focus on individual sub-sectors of the financial services
industry or they have stopped short of being a comprehensive overall investigation, leading
to definite measures. It may therefore be useful to consider what would happen if a CC mar-
ket investigation of the banking sector were to be proposed. How would it be scoped? Would
it be general or specific in nature? What ‘theory of harm’ would be involved? I emphasize of
course this is all entirely hypothetical at this stage.
The potential scope is extremely large. The CC’s investigations are subject to a statutory
time limit of two years, and it would be necessary to be realistic. The flexibility and ability to
see the bigger picture that comes from a broad field of investigation would need to be
balanced against the risk of being overwhelmed with data and losing the necessary focus.
• the CC’s PPI investigation covered one specific set of products and involved 20 main
parties and very large amounts of data; and
• the CC’s Northern Ireland Personal Banking case involved one sector in one small part of
the UK, and nevertheless generated much data and evidence, even with fewer main
Nevertheless, tackling large and complex sectors has not daunted the CC in the past and
there are plenty of examples of wide-ranging investigations into many-faceted industries.
Depending on the terms of reference, such an investigation could potentially cover the
supply of banking services provided to personal and business customers (for example
SMEs) and to services provided between banks as well as the nature and extent of compe-
tition and cooperation between banks. Activities other than lending, liquidity and deposit
taking might also be involved (eg advisory and capital-raising services by investment banks).
Assessment of market power
Whatever the scope, the essential task would be to assess whether one or more banks
enjoyed market power, either individually or collectively, in a defined market, which they
were able to exploit to the detriment of customers and the consumer.
Such an investigation would follow the statutory framework and would explore the core
competition issues in the sector including market definition and structural features of the
market, unilateral effects, coordinated effects and customer behaviour. Nevertheless, this
The Daily Mail and The Times, 31 March 2010; OFT press release (36/10), 31 March 2010.
Financial Services Plan, OFT (OFT1106), July 2009; OFT news release 7 April 2009, OFT launches consultation on its
proposed Financial Services Strategy.
Report of the European Commission following its sector inquiry into retail banking, 31 January 2007.
would be no ordinary investigation and it would be necessary to consider a number of wider
The effect of government intervention
It would first have to consider whether the participation of the Government in the ownership
of particular banks, as a result of emergency intervention to ensure financial stability, was
having a distorting effect on competition. That effect might be seen, for example, in a bank’s
enhanced ability to attract depositors, or in the products/services/terms which a bank offers
and which (under the Government’s direction) may not wholly reflect normal competitive
pressures. This is a topic already examined by the OFT in the UK context 21 but there may be
more to say on the subject.
The Lloyds/HBoS legacy
Such an investigation could also cover the legacy of the Lloyds/HBoS merger (which was
cleared by the Secretary of State to preserve financial stability, although the OFT had
identified competition issues in some markets). There is a continuing need to assess the
competitive effects of this merger.
Possible additional public interest considerations
Finally, it is very important that any competition investigation should not ‘go off on its own’.
Particularly if there is ongoing consideration of wider prudential or moral hazard measures in
progress, coordination between these strands and competition is highly advisable. It is, of
course, both possible and desirable to take account of wider issues such as the need to
maintain financial stability in the context of a market investigation conducted on competition
grounds, both in the analysis and in any remedies. 22
In this context, it should be noted that the UK’s market investigation regime, 23 just as with
the merger regime, 24 provides for Ministers to be able to intervene on specific public interest
grounds, as they did in the Lloyds/HBoS merger. This mechanism would enable Ministers to
take wider issues, such as financial stability, into account when considering the CC’s
findings on competition and could help to counter any criticism that any CC investigation
would be too narrowly focused and assist in coordinating it with other measures in train,
including, for example, the separate examination of prudential issues currently planned by
the new UK Government.
Focusing the analysis
Accepting that the investigation would have this significant, wider context, there would still
need to be a competition analysis. In thinking about the most appropriate level at which to
conduct this, it would be necessary to consider whether it was appropriate to focus on
particular products and services (eg mortgages and current accounts) on particular types of
customer (personal, SMEs, large companies) or particular geographic areas (eg Scotland).
See OFT press release (109/09) and Guide Government in Markets: Why competition matters—a guide for policy makers
(OFT113), 8 September 2009.
See the CC Report The supply of banking services by clearing banks to small and medium-sized enterprises: A report on the
supply of banking services by clearing banks to small and medium-sized enterprises within the UK, Cm 5319 (2002) particularly
in the consideration of bank profitability.
Section 139 Enterprise Act 2002.
Section 42 Enterprise Act 2002.
In looking at the structure of individual banking markets, concentration ratios alone are
usually a poor guide to proper analysis of levels of competition; similarly with market shares.
But these can provide a helpful starting point and provide the trigger for further investigation.
Any investigation would need to pay much attention to entry barriers—physical (eg bank
branches), reputation and brands—and regulation. These are more reliable indicators of the
state of competition. A detailed consideration of the regulatory framework would be needed
Inter-bank supply and cooperation
While detailed analysis of individual markets would be an important part of any such review,
it would be unwise to neglect the overall picture of how banks compete with each other, and
where they need to cooperate. The UK’s Cruickshank Review (2000) (an informal but wide-
ranging review) examined the relationships of UK banks with each other and numerous
aspects of cooperation between banks (including in areas such as payment systems where
some degree of cooperation is clearly unavoidable and desirable), and the banks’ relation-
ship with government. The overall picture was not entirely a favourable one, even in the
kinder economic climate of the times, and its findings may need to be re-examined in the
light of recent events. Considering what areas of cooperation between banks are essential
leads, of course, back to the issue of financial stability and the contribution of banks to the
functioning of the economy as a whole.
However it were scoped and specified, if serious problems were found, such a market
investigation would probably involve among many other things consideration of structural
remedies and possible break up of businesses. The CC’s SME Banking inquiry 25 considered
carefully the possible divestment or opening up of retail branch networks. In the event
divestment was not recommended. The European Commission’s RBS and Lloyds state aid
measures included requirements to divest businesses and retail branches. The objective of
such structural measures is to make new entry to the market easier and help the growth of
new competitors, so that there is more rivalry in the market. There are many other remedies
available, however, and it may be that other measures to improve competition and
encourage new entry and expansion would be better.
It should be asked whether a market investigation by one member state alone is appropriate
when similar issues may arise across other parts of the EU. There may be scope for parallel
and coordinated activity by the authorities, although there are considerable differences
between the powers available to authorities across the EU. There may also be calls for a
renewal or update of the earlier EU sector inquiry.
The need for caution
I must emphasize that this discussion of issues is purely hypothetical and any actual
investigation should be approached with great care. The memories of financial crisis are all
too recent. It is also not the task of the competition authorities to take steps to enhance
See footnote 22.
competition which may damage prospects for economic recovery. But we have learned a
number of lessons from recent events:
• financial markets are not necessarily self-correcting; and the rescue measures and
accompanying regulation can, themselves, stifle competition;
• banks are of central importance to economic activity but they are also commercial
organizations selling products and services to customers and can enjoy market power
which can be exploited in a harmful way; and
• while, in extreme cases, it may be necessary to override competition law to preserve
financial stability, there is no logic in a permanent exemption for banks from competition
The question of ‘unbundling’ as posed by this session therefore has two faces. One is as a
further measure to tackle prudential/moral hazard issues, in particular to prevent the mis-
allocation of risk and excessive leverage on the basis of inadequate capital. That is very
much a matter for the Government and the financial authorities and I have alluded to it only
briefly. The other face of the issue is the need to ensure that banking markets are competi-
tive in the interest of consumers and an efficient economy. That is more, but not exclusively,
a matter for the competition authorities, which in the UK can initiate an investigation,
although it is open to the Government to intervene to ensure that wider issues are taken into
account in any measures to be taken.
Such an investigation would not be straightforward, either in scope or in execution. Whilst it
is always easier to focus on particular issues or sectors, the bigger picture needs to be
looked at also. And the investigation would have to be realistic, fair and concluded in a
reasonable time, to avoid placing further, unacceptable, burdens on an already stressed
sector. But there is no reason to think that such concerns could not successfully be over-
come as the market investigation regime is flexible and comprehensive.
My purpose today is not to advocate any particular investigation, but instead to outline what
could be done, and how the competition authorities’ contribution to such a major issue of
public interest could be made. Nor should one think that the outcome of a market investi-
gation would inevitably be structural measures or divestments. ‘Breaking up the banks’ for
prudential purposes is a different issue, which should, and in the UK will be, considered
separately. But, equally, no sensible competition investigation would fail to take into account
the need to maintain financial stability and the impact of systemic risk both on the analysis
and any remedies. Let me conclude by again quoting the Governor of the Bank of England:
As in the English Premier League, getting into the top four will not be easy for
those outside it … I hope greater competition will produce less rigidity in the
composition of the top four.26
The Governor has been proved right in terms of the 2010 football results, with the ascend-
ance of a new club to the top four (though sadly for the Governor, not his beloved Aston
Villa). Let us hope his foresight extends to competition in banking.
See earlier reference to the speech.