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BANKING ON INNOVATION: UNCOVERING THE POLITICAL BARRIERS TO INNOVATIVE FINANCIAL SERVICES
John Fearn
Interel Financial Services
June 2014

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Contents
Introduction ........................................................................................................ 3
Scope and methodology ................................................................................. 3
A vision for future financial services .................................................................... 4
Why now? ....................................................................................................... 5
Political risk ..................................................................................................... 8
Sector analysis ................................................................................................. 10
Alternative finance ........................................................................................ 10
Payments and commerce ............................................................................. 18
High street financial services ........................................................................ 22
Conclusions ...................................................................................................... 26
About Interel ..................................................................................................... 27
Contacts ....................................................................................................... 27

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Introduction
Radical change in any sector of the economy poses challenges to politicians and regulators but nowhere is this more apparent than in financial services.
The pace of innovation and the emergence of disruptive new models is leaving policy-makers behind. In an age when consumer protection is an overriding priority for authorities, it is not easy to craft policies and regulations that do not overly inhibit diversity and competition.
In such an environment, the dominant perception of a product, service or business can be critical to influencing the rules under which firms have to operate. This is why Interel has conducted its own research to benchmark the attitudes of political stakeholders towards some of the newer services against more traditional providers.
By doing so, we have been able to determine the political reputations of different providers and identify the challenges that these firms face in influencing their own regulatory environment.
Scope and methodology
Our political audit covers a wide range of retail services including alternative finance providers, payments services, and the high street bank and mutual sectors. We believe that such a broad scope is necessary if we are to understand the political views of the future industry as a whole.
The findings in this paper are based on two main forms of primary research: Parliamentary opinion polling conducted in partnership with Populus, and first- hand interviews with various stakeholders.

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A vision for future financial services
What does the future hold for financial services? Will we tell our driverless cars to take us to our local bank branch? And when we plug in and recharge our car on the way to the bank, how will we pay? Will cash still be king? Where will we get the loan for our intelligent automobile?
It is tempting either to make hyperbolic suggestions about the future of financial services, or to dismiss radical thinking on the basis that change is always slower and more incremental than the blue-sky thinkers would like. It is the accepted wisdom that consumers are inherently cautious, particularly where finance is concerned and there is a historic record of consumer satisfaction/apathy (delete as appropriate depending on your point of view) to support this stance. However, it is possible to envisage in the near future a retail financial services market that is radically different to that in operation over the past 30 years.
Here are some predictions for the UK market:
 Banks and building societies won’t disappear from our high streets but branch networks will be pared back drastically and the average customer will only visit for major transactions such as mortgages.
 Partnerships between banks and supermarkets or other retail chains in order to address financial exclusion will increase but are not here to stay.
 The overwhelming majority of everyday transactions will be conducted digitally. Physical debit and credit cards become almost entirely redundant but not extinct, in the same way that cheques remain popular among certain consumer groups.
 Mobile payments take off significantly – coffee houses, retail chains and public transport in the forefront. Mobile and ‘wearables’ add another layer of security to overcome trust issues.
 The provision of banking services will become fragmented:
o Providers, products and services in traditional areas like current accounts, overdrafts and personal loans diversifies.
o Customers create bespoke accounts with third-parties providing smart money management services, simple but powerful

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comparison tools, and reward-based retail relationship management.
o Tech, retail and other service firms merge into the finance industry to meet consumer demand for seamless transaction experiences in their everyday life.
 20% of consumer and SME lending will be through alternative lenders.
 Financial advice effectively becomes crowd sourced as social media use brings a return to ‘word-of-mouth’ endorsements (despite the best intentions of the regulator).
Why now?
Many leading FinTech firms that are attracting headlines and major investment are not start-ups, they are established firms; Zopa, for example, was set up back in 2005. Equally, it has been apparent for some time that competition in the traditional retail markets had not yet delivered genuine alternatives to satisfy consumer demand. There have been four separate official reviews of the personal current account market since 2000, all of which have come to the same basic conclusions. In the savings market, price comparison websites have led to a plethora of providers competing hard against each other but essentially offering the same products. As a Bank of England official recently commented, for too long diversification has been mistaken for diversity.
Throughout this paper we will talk about the role of technology in creating a new financial services landscape but if innovation is a constant process what is different now that enables radical change?
It is a combination of two factors: take up of mobile technology and the impact of the 2007-09 financial crisis.
Firstly, consumer habits have been irreversibly changed with the widespread adoption of smart mobile devices and the exponential growth in accompanying services. Customers are no longer tied to a physical entity chosen because of its convenient location so they are choosing the services that best meet their needs. This change is affecting financial services but the big financial brands are mostly responding to it rather than shaping it because this shift in consumer demand is being driven by others. Some of the large banks have responded better than others – Barclay’s mobile banking app and Pingit services have won awards and

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customers – but as Paul Purcell, a leading US investor in consumer FinTech, says everyday commerce has been influential:
“The nature of commerce is fundamentally changing. Online has deconstructed the whole retail process, empowering customers by giving them choice and changing their expectations across all sectors. Commercial success becomes about how you deal with consumers now, how well to you meet their exact need, and how easy you make it. Customers now expect great service and frictionless transactions at a minimum – areas in which traditional financial services providers have not typically excelled.”
Mobile commerce continues to grow and the emergence of the app both as retail portal and revenue generator through in-app micro transactions clearly has consequences for the payments industry and the need for physical bank networks but it is also symptomatic of a consumer base that is increasingly comfortable trusting alternative providers offering diversity through novel products or compelling services.
The second factor is directly related to the global financial crisis. The effects of the credit crunch on personal and SME finance are still being felt despite a range of government initiatives aimed at increasing the flow of funding to the real economy. The dichotomous nature of financial services policy – regulate to prevent a recurrence of the last crisis while promoting lending to SMEs and homebuyers – hasn’t helped, especially when the ‘stick’ for non-compliance with capital requirements is much more feared than the negative publicity received for not lending to small firms. Furthermore, authorities’ actions to stabilise the financial sector and increase liquidity has depressed yields in many classes of securities like gilts and bonds. For example, in the UK quantitative easing and the Funding for Lending scheme has given banks easy access to funding so investors searching for better returns are being forced to look elsewhere.

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Lending to UK businesses
Lending to SMEs
Lending to consumers
Source: Bank of England Trends in Lending Report
April 2014
It has often been asserted that consumers and businesses are shunning banks because of ethical concerns and residual anger for the role ‘big finance’ played in causing the financial crash and ensuing recession. This sentiment is undoubtedly in abundance among indebted individuals or small businessmen who have been denied finance as well as more activist-minded people, and a general but widespread antipathy towards to ‘banks’ still lingers. It is important to understand customers’ motivations: people who are more open to alternatives because their trust in the established sector has been damaged will be looking for a product, a service or a supplier that offers a fresh ‘non-bank-like’ experience while those who have been denied by banks might be from the riskier end of the borrower spectrum and are looking for any way to get the finance they need.
This is not the place to examine in detail banks’ lending volumes or pricing. Even though the main banks are still by far the largest lenders to consumers and SMEs the alternative finance sector received a shot in the arm when they curtailed their lending.

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Political risk
So if consumers’ needs are being met and new firms are bringing innovation to the market, creating competition and driving diversity, are there any clouds on the horizon?
Innovation is almost always used in a positive sense but just because something is innovative or new does not mean it is automatically without problems. Firms often consider risk from a commercial or legal stance, and overcoming these issues on the way to market can be a significant effort. We consider political risk to be one of the most important factors in business planning yet it is all too often overlooked until it is too late.
Political risk can manifest itself in a variety of ways from damaging publicity to regulatory enforcement action. Sources of political risk also vary: partisan attitudes towards certain industries, a lack of political and regulatory understanding of new products and services, flaws in firms’ business models, regulatory reform programmes, conduct scandals and even elections generate risk. Sometimes the very reason for a model’s success opens it up to political and regulatory censure and quite often, difficulties in one sector or one firm can affect the outlook for a whole industry.
In the UK, the Financial Conduct Authority (FCA) has recognised the importance of understanding innovative business models before they reach the market at scale. It has launched a new programme, dubbed Project Innovate, that aims to ensure positive developments in areas such as mobile banking, online investment or money transfer are supported by the regulatory environment. Under the auspices of this project the FCA will provide compliance expertise to firms developing new models or products, and provide an ‘incubator’ to “support innovative, small financial businesses getting ready for authorisation”.
The Government has also expressed its official enthusiasm for more diversity and innovation in financial services. The Treasury recently consulted on plans to force UK banks to direct customers whose loan applications they reject to alternative finance providers. In 2013 the Government agreed to lend to SMEs through FundingCircle and in February 2014 allocated £40m of funding from the

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British Business Bank to be distributed through the peer-to-peer lending platform1.
However, there are some cautionary tales showing how innovation is not without its challenges. Consider the example of ClearAccount2, a firm that offers an automatic top-up service designed to stop current account holders going into overdraft. In theory, one can see the merit in such a service, and ClearAccount was licensed by the Office of Fair Trading under the previous consumer credit regime and is now authorised by the FCA.
However, two elements of the ClearAccount model were always likely to attract attention at a time when political focus is on the short-term, high cost credit market. First, the rate of interest charged on the top-up loans puts them into the same bucket as payday lenders, and second, the firm requested customers’ online banking details in order to know when to put credit into their accounts.
ClearAccount says it is providing an attractive alternative to higher cost unauthorised overdraft charges; Stella Creasy PM, the shadow consumer affairs spokesperson and longstanding campaigner on fair finance, said “automatically topping up someone’s finances is a new low”. Media and regulatory investigations have followed.
The example shows that firms offering new services or products have to be aware of the political context in which they operate. Regulatory authorisation does not confer immunity from political risk, which in turn can have real impact on revenues.
The rest of the paper explores the reputation of financial services providers among political audiences and provides an assessment of the political risk faced by each sector as technological developments quicken the pace of change.
1 Department for Business, Innovation and Skills
2 www.clearaccount.com

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Sector analysis
Alternative finance
Scope
 Peer-to-peer lending
 Crowdfunding
 Invoice trading
 Small sum, short-term lending
Sector summary
‘Alternative finance’ is probably the hottest subject in financial services at present yet the term covers such a diverse range of products and providers that it is worth sketching out some of the core components before commenting on their role in the landscape of future financial services and their appeal to political stakeholders.
The excellent benchmarking report ‘The Rise of Future Finance’3 sets out a taxonomy of alternative finance models that includes peer-to-peer lending (P2P); debt, equity and rewards crowdfunding; microfinance and community shares; and invoice trading. The industry covers both consumer and business credit. In practice there is some blurring between the above categories because of the diversity of innovative business models employed by firms. New firms sometimes bring a novel model to market that does not sit entirely comfortably in one category or another while sometimes the choice of one label or another depends on a very technical, regulatory classification.
There is some debate over whether short-term, small sum lending, including but not exclusively so-called payday products, should be included in this category; payday lenders are an alternative to traditional credit institutions and serving a customer base that is often excluded from mainstream products and services4. As such, we have included short-term lenders in our research though we note that payday has its own unique model and does not share many of the important
3 The Rise of Future Finance: the UK Alternative Finance Benchmarking Report – December 2013 – Liam Collins (Nesta), Richard Swart (University of California, Berkeley), Bryan Zhang (University of Cambridge)
4 Note also that some payday consumer credit lenders have entered the short-term SME finance market. For example WDFC UK, best known for its Wonga subsidiary, rebranded its Wonga for Business arm as Everline in 2013.

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characteristics of the other types of alternative finance mentioned above, particularly the open or ‘democratic’ nature of P2P and crowdfunding. Therefore we clearly differentiate this sub-sector from other alternative finance providers.
Political perceptions
There is an emerging feeling among the industry that the UK Government is becoming more aware of the potential of alternative finance. Considerable investments have now been made through P2P platforms via the Business Investment Bank, a Cabinet Office working-group is to be convened to coordinate departmental positions on crowdfunding, the Bank of England has now dedicated resources to studying and liaising with the sector, and the FCA has adopted a public stance of being “on the right side of progress”.
While the Bank and the regulator are reacting to a growing part of the financial services industry, the appeal of the sector for the Government is clear. The alternative sector offers an attractive vision of socially useful finance at a time when lending to businesses by mainstream lenders is curtailed, faith in banks is only starting to recover, and it is not politically expedient to be seen to support the established order too closely.
But while understanding grows at an official level, alternative finance retains a very low profile among politicians. Perhaps unsurprisingly given the sector’s relative youth and size, no other sector reported such a low level of understanding among politicians in our exclusive polling.
Awareness and understanding
Crowdfunding, P2P and invoice trading were the only categories which reported MPs who have never heard of the providers. At 11%, this is a significant minority.
A large portion of all respondents (35%) had either never heard of, or had a fairly poor understanding of crowdfunding and peer-to-peer lending. This low level of understanding is particularly pronounced among older and less-recently elected MPs: 43% for MPs over the age of 555 and 56% for MPs elected between 1992 and 1997. Regionally, there are significant variations: 62% of
5 The average age of MPs in this Parliament is 50.

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Scottish MPs6 and 43% of MPs in south west England reported a very low level of understanding, while among the English regions respondents from the Midlands were more likely to have never heard of crowdfunding and P2P.
Putting these figures into context, 90% of MPs claimed a good or excellent understanding of the traditional high street banking business model, with 86% reporting the same for building societies.
Breaking down the results, our polling by political party shows that levels of low awareness and understanding were broadly similar across the three main parties, although a much higher percentage of Liberal Democrat MPs were well- informed about the sector7.
Predictably, younger MPs were far more likely to have better knowledge of this industry, with 57% of MPs aged between 18-44 and 46% of MPs elected in 2010 reporting a good or excellent understanding. Female MPs were also more likely to have greater knowledge of alternative finance providers.
We also used another metric to gauge the relative profiles of crowdfunding and peer-to-peer lending among parliamentary audiences versus banks and payday firms. The graph below shows the Parliamentary ‘occasions’8 in which these four terms were mentioned. One can clearly see that crowdfunding and P2P have not received much parliamentary time over the past four and a half years when compared to banks and payday lenders.
6 32% of Scottish respondents had not heard of the services
7 63% of Lib Dem respondents reported a good understanding of the sector
8 I.e. a Westminster Hall debate on crowdfunding counts as one occasion, as does a written parliamentary question.

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An analysis of social media over the last 18 months shows that alternative finance services are also not featuring strongly in political stakeholder conversations online.
Quantitative analysis does not reveal how positive or negative these mentions were but a sample study of the results mentioning crowdfunding shows the vast majority of tweets were promoting awareness of a specific project; the term crowdfunding was not the main subject matter but used instead to garner interest in the projects themselves.
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Trust
A lack of understanding influences opinions on questions of trust and regulation.
The alternative finance9 sector’s negative rating on the question of whether MPs would trust platforms to act in their customers’ interests is very low compared to all mainstream providers except building societies and credit unions. This means that fewer MPs actively distrust the firms in the sector than they do for high street banks, new entrants to retail banking and card issuers such as Visa and MasterCard. But nearly 50% of MPs are unsure about whether alternative finance providers are trustworthy and the sector still lags behind all others except payday for positive trust ratings: 43% versus 57% for new banking entrants, 63% for established high street banks, 73% for card issuers and 90% and 93% for building societies and credit unions respectively. However, from that percentage only 2% “definitely trusted”10 crowdfunding and P2P, compared to 9% for established high street banks, 5% for new entrants to banking, 11% for card issuers, 28% for building societies and 43% for credit unions.
Of MPs from the three main parties, the Liberal Democrats had the firmest views though their opinion was split. A large percentage of the respondents from the Conservative and Labour parties (42% and 41% respectively) simply didn’t yet know whether the platforms’ interests, particularly crowdfunding and P2P, were aligned with those of consumers.
Regulation
Only a quarter of respondents thought the amount of regulation for these sectors was about right, a lower number than that of any set of providers other than short-term high cost lenders (e.g. payday).
9 Excluding payday and other short-term, high cost credit providers
10 As opposed to answering “yes, I would probably trust it”

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MPs that claimed good or excellent understanding of the sector were highly likely to also give a positive response to questions about trust but attitudes among those same MPs towards regulation of the sector was much more even: 38% believed the regulatory regime achieved a good balance but 31% thought it was too light touch and the sector posed a risk. Furthermore, while younger MPs had greater knowledge of the businesses and might have been expected to be more favourable towards new innovations, over a quarter of respondents aged between 18 and 44 believed such alternative forms of finance were under- regulated. The qualitative polling results and first-hand interviews do not suggest that older MPs are more inclined to a positive view of current regulation; rather they have not yet formed an impression of the nature of the industry and the required form of regulation.
Sector outlook (political risk assessment)
The alternative finance market, as defined in the Nesta report, is in an excellent starting position: it is experiencing astonishing growth rates, funding through platforms is increasing as large mainstream institutions become more engaged as they hunt for yield in a low rate environment, partnerships between banks and peer-to-peer lenders are emerging, and Government ministers are offering enthusiastic endorsement to the sector. The role for P2P and crowdfunding in a diverse future financial services market could be very significant.
Yet there are challenges ahead, particularly when the enthusiasm at high levels within government and regulatory bodies does not translate into accommodating action at official level.
There is, for example, some concern among P2P providers about the bundling together of P2P and crowdfunding by the FCA and European Commission in recent policy statements. We have also heard anecdotal evidence that there are technical problems with the regulator’s approach that suggests it is trying to fit these alternatives into its existing paradigm rather than taking a broader and more flexible view. One example is the use of a the Financial Services and Markets Act 2000 to clamp down on ‘illegal financial promotions’ on social media platforms like Twitter and Facebook. Industry participants complain that the out- dated legislation (enacted before social media’s arrival) is hampering start-ups’ and other substitutes’ ability to promote their enterprises.
We have also heard there are problems arising in the relationship between the banks, the platforms and the borrowers. For example, some platforms are finding

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it hard to access payments systems while crowdfunded start-ups are being denied business bank accounts.
The essence of the alternative finance concept – connecting borrowers and lenders that would otherwise be locked out of a closed market dominated by big investors – is the biggest weapon the sector can deploy to stave off business and political risk, and ensure it continues to grow. Undermining or blocking that central element will not just limit the size of one particular sector of modern financial services, but inhibit entrepreneurship and hamper the move towards a more transparent, inclusive and democratic shareholder community.
In addition to the current regulatory and business issues, we see two main challenges for the sector as it continues to grow:
 Create awareness and better understanding in order to foster a constructive regulatory structure, help the sector withstand reputational shocks (such as conduct crises or the failure of a major platform), and weather political turbulence at national, European and global levels.
 Maintain the essence of alternative finance, the things that make these products different, while gaining scale and moving to the mainstream.
It is a big task but it is also a huge opportunity for the industry.
A note on the ‘payday’ sector
One could have easily anticipated that politicians would have negative feelings towards the high cost, short-term consumer finance industry. However, the scale of hostility towards the industry is striking.
MPs awareness of claimed knowledge of payday lenders is very high: three- quarters of respondents said they had a good or excellent understanding of the industry. However, great understanding does not equal a positive view of the sector: 75% of MPs (including all Labour MPs) think there is too little regulation of payday while 90% probably or definitely would not trust payday lenders to act in their customers’ interests.
However, there is a clear division on party lines: 41% of Conservative respondents felt that the regulatory regime was ‘about right’, perhaps given the Government’s role in creating the new regime, but no MPs from any other party agreed. And it was only MPs from the Conservative party that ‘would probably

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trust’ payday lenders to act in their customers’ interests, though the amount was much smaller at 16%.
Despite this minority view it is clear that there is a chronic breakdown in the short-term high cost credit industry’s relationship with parliamentarians. Given this political opposition and the media interest in the problems associated with the product, it is likely that we will continue to see the sector under pressure from MPs and the regulator for the foreseeable future, especially should Labour win the general election in 2015.

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Payments and commerce
Scope
 Mobile payments
 Card companies and new entrants
 Big Data, big rewards and the relationship with the customer
Sector summary
The payments industry may not attract as many headlines or twitter mentions as other parts of financial services but it is no less important. As the ‘rails’ of commerce and financial services, what happens in the payments space has an enormous impact on other issues, particularly diversity and competition. Much of the speculation about technology companies and other new entrants moving into banking comes directly from their presence in payments.
Payments are tightly regulated and access to the systems is not easy to achieve. Substitutes have to fit within the existing system, which for the large part favours the banks and the card issuers but the number of players in the industry is large and growing.
Online retailers and major content providers such as Apple and Google have dipped their toes into the water but it is mostly smaller firms that are creating innovative services that respond to demands for cheaper, more flexible and more value-accretive payments platforms. In the US firms like Square and LevelUp have emerged to meet specific need: Square offers small businesses and would be merchants the opportunity to take card payments via their smartphones, turning any iPhone into a point of sale. LevelUp provides merchants with a means of taking payment via mobile phone QR scans – not only is the service quicker for the customer to use and lower cost for the merchant, it allows businesses to build relationships with individual consumers by targeting them with relevant promotions, rewards, reminders or special offers. LevelUp has also recently announced it would provide support to merchants using Apple’s iBeacon, a Bluetooth-enabled device that ‘pings’ nearby customers. In an era when data is king, these types of services offer a much greater value proposition for businesses, especially small or new ones, than that delivered in the past by traditional payments providers.

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Some innovations will emerge and disappear without ever reaching the required scale. Electronic wallets, for example, are likely to have a very short life span. O2 and Square both recently withdrew wallet apps from the market because of a lack of consumer engagement. Even Google has not worked out yet how to create a compelling offer.
However, mobile payments will continue to grow in popularity and will reach mass acceptance in the (relatively) near future. It will not be banks or card issuers making this happen; it will be coffee shops and restaurants, buses and trains. In the US, 1 in 10 transactions at Starbucks are now via mobile payments. In the UK the Harris & Hoole coffee chain recently launched its own mobile payments app that you can use to order before you even reach the counter. At a local level, perhaps the biggest single step will be when Transport for London phases out the Oyster card and introduces NFC and mobile payments in its place. At a stroke the technology will be promoted to 8 million Londoners and countless other visitors.
We believe that mass adoption of new forms of payments and a sector-wide shift away from solely processing payments towards data-driven ID assurance will have far-reaching consequences for other financial services. Consider the use of the M-Pesa payments in Africa; with no historic payment system in place and no antiquated technology to update, payments in the African continent has leapfrogged the West but to the exclusion of banks altogether.
Political perceptions
Taking the political community as a whole, the most prominent issue in the UK has been encouraging faster processing of payments. There is a relatively high level of awareness of the problems posed by delays to consumers, particularly those who might be considered financially vulnerable. It is also an issue that fits within a widely-believed narrative that says the large banks serve themselves first before their customers.
If one disaggregates government and regulators from the wider political environment one can see that a great deal of attention has focused on payments recently. However, a general political audience finds other aspects of payments esoteric and there is a lack of understanding about how this sector affects other politically important subjects such as supporting SME growth and increasing competition in retail financial services.

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Trust & regulation
There is also scepticism about innovations in the market, almost solely based upon concerns about fraud, data security and ID theft. In this regard, political audiences are no different in terms of sentiment from the general public. Research by YouGov11 found that over half of people who didn’t yet possess contactless cards or NFC/mobile phones said they would not be interested in using them in the future to make payments. Some of the main reasons were ‘fear of losing’ the card/device, concerns over security, and a belief that ‘too much can go wrong’.
In this context it is unsurprising that the major card companies are widely trusted by politicians because of the role they play in everyday financial transactions.
These findings suggest that there is actually a great deal of comfort with current services; Visa and MasterCard are seen as important contributors to a stable and secure payments system12, which gives them a privileged position in public policy debates as well as in business.
We note that consumer sentiment towards payment service providers for online transactions is more positive towards alternatives. For example, according to the Future Foundation’s m-commerce13 report, PayPal is the most trusted to take payments ahead of card companies, banks, mobile telephony companies etc. Additional research could perhaps shed light on whether politicians’ attitudes towards providers shift when just considering online but on the basis of existing evidence we suspect that the established providers14 would remain in pole
11 YouGov, September 2013
12 However, just under a quarter said they would probably or definitely not trust them – like the other established sectors, there is not much of a grey area in MPs’ views on the card companies.
13 http://www.monitise.com/insights/2013/10/01/mcommerce-future-foundation-report
14 One could rightly argue that PayPal should now be considered as one of the established providers.

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position. Put simply, new entrants are just not as trusted as the established banks and traditional service providers, regardless of how much the financial crisis and conduct scandals have undermined faith in the present order.
Sector outlook
Paul Purcell of Continental Advisors, an investor in LevelUp among others, says radical change in the market is still in its early stage and the opportunities are hugely exciting but there are also obstacles:
“The power of the mobile handset in giving retailers huge amounts of data and connecting them directly to their customers, and at a lower cost, makes it a dangerous time for banks and card companies.
“Real innovation is coming from the fringe players, not even Google or Facebook can innovate like these guys, and they can make things work because they get around the competition problems. But you still have to have access to the payments system somewhere, and that has a cost attached.”
In 2015 a new payment services regulator will be set up and one of its objectives will be to foster competition and innovation. The FCA’s ‘incubator’ service should also help start-ups and new entrants. The way that the new regulatory body is implemented and its interpretation of its mandate will have a critical effect on the development of payment services here. Reforms taking place in the US and at the European level will also influence which new technologies or services make it to mass market.
It is important that the regulatory regime does not create a bias against new firms who are trying to do new things that challenge the regulator because of their unfamiliarity. Concerns about fraud and security should not overrule change by default. In fact, mobile payments can increase security – people are now far more attached to their phone than their wallet – but the firms bringing radical products to market still have a job to do in educating stakeholders about the benefits of their innovations.

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High street financial services
Scope
 Future role of high street banks, building societies and credit unions.
 Market structure
 Competition or diversity
Sector summary
The most visible parts of financial services for the average consumer are the high street banks and the building societies. 93% of UK adults have a personal current account (PCA) while 90% of borrowers taking out a mortgage obtain credit from either a bank or a building society.
Concerns about the banking market go back to before the financial crisis and have, to a large degree, focused on market structure. In the UK retail banking services are highly concentrated15: the big five banks16 have 85% of the PCA market, 67% of the mortgage market, and the biggest four have a SME lending market share of about 80%. The personal savings market more fragmented but there is no doubt that the banks are the biggest game in town. The mutual sector is often promoted as the ‘ethical alternative’ but the sector has had a mixed record in the aftermath of the crisis. Credit unions are growing in number but still make up a tiny proportion of the market when compared to other countries. The financial crisis and following conduct issues have exacerbated fears that the banking market is not working well; overdraft charges and the PPI mis-selling scandal allow critics to paint banks as actively working against their customers’ interests, while the taxpayer bail-out of Lloyds and RBS crystallised the ‘too-big- to-fail’ dilemma as the Government stepped into stabilise the market at the expense of moral hazard. There are signs that the structure of the market is starting to change with a number of new banks (Metro, Virgin Money, Aldermore, Handelsbanken, Paragon and Shawbrook among others) entering the market, retail brands such as Marks & Spencer and Tesco launching new services, and some old banking
15 The UK is far from unique as in many industrialised countries banking is a highly concentrated industry.
16 Lloyds Banking Group, Barclays, RBS, HSBC, Santander

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names such as TSB and Williams & Glyn returning as part of bigger groups’ divestments.
Political perceptions
Understanding
Unsurprisingly, MPs reported a very high level understanding of the established banking sector; 90% said they had a good or excellent understanding of these business models, the highest of any sector in the survey. Building societies were close behind.
Simple brand profile explains this familiarity and politicians, like any other average consumer, have personal interactions with these banks. It is probable that all MPs have used one or more of these firms for saving or borrowing services.
Furthermore, the banks have barely been out of the political spotlight since the global financial crisis of 2007/08 and the ensuing economic crash. First, they needed to be rescued with vast sums of taxpayer cash; then they had to be fixed, split up and simplified before being criticised for contracting lending to SMEs, paying staff huge bonuses and fixing benchmark rates. Even now in April 2014 the shareholder revolt against pay packages at Barclays and RBS is more newsworthy than companies in almost any sector.
However, there was some uncertainty about new entrants to high street banking with only 41% confident they understood these firms’ businesses (the second lowest positive rating after crowdfunding and P2P) though that figure was much higher among younger MPs.
Conservative MPs were much more likely than Labour MPs to claim a good or excellent knowledge of new entrants but nearly a quarter of female MPs surveyed across all parties ‘did not understand [this sub-sector] at all”.
Trust & regulation
Building societies and credit unions scored very highly on trust and the majority of MPs thought the regulatory regime for these two sectors was about right (83% and 76% respectively). The latter result for credit unions is somewhat surprising

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given the debate about relaxing several important rules governing credit union products to encourage them to take market share from payday lenders.
The established banking industry did not fare so well. Our research highlighted that, six years after the nationalisation of Northern Rock, political stakeholders still have very mixed attitudes towards our banks, reflecting the fact that individuals can be perfectly happy with their own bank yet view the sector as a whole with suspicion.
Over one-third of MPs still believe that banking is under-regulated and would not trust banks to act in their customers’ interests, figures that compares badly against all other sectors in the survey apart from short-term, high cost credit, and is particularly stark given the post-crisis national and international regulatory overhaul. A small minority (8% - the same as credit unions) believed the sector to be over-regulated.
The division on party lines is easily apparent: while a quarter of Conservative MPs were unlikely to trust the big banks, only 11% of them agreed that they were under-regulated, a much lower number than either of the other two parties.
Again, there was more uncertainty about trust and regulation when it came to new entrants with around a quarter of MPs undecided on these two key issues.
Party membership and age were clear dividing lines. Unsurprisingly, Conservative MPs were far more likely to think the sector was over-regulated while older MPs were more sceptical.
Sector outlook
Despite years of regulatory change, the fear for UK banks must be that there is not yet an end in sight. The next election will be closely watched after Labour leader Ed Miliband pledged to initiate a full competition inquiry and cap individual banks’ market share.

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So far this Government has been content to try to create the conditions for more competition rather than force solutions on the market. Change will inevitably be slow but that is unappealing politically, especially after both Sir John Vickers and the Andrew Tyrie-led parliamentary commission have warned that drastic action would be necessary if conditions did not improve.
The big banks have to prove that they can once again provide the social utility that is now expected of them. They will have to do so while still responding to shifts in the economic model of retail banking. For example, the rise of mobile banking means that large scale branch networks are becoming more costly and more unnecessary but there is a significant political attachment to branches, especially in rural or deprived areas and where financial exclusion is more prevalent. Similarly, Lloyds and RBS have recently reversed their decisions to limit their basic bank account customers to using proprietary cash machines after widespread opposition to the move.
For new entrants, the challenge is one of education and differentiation while pursuing growth strategies that give them a strong presence in the market. Many of the murky cross-subsidies that allow for free access to cash machines act as a barrier to entry or growth for newer firms, and while there is a growing number of banks that now charge customers who deposit less than a minimum amount per month in their current account, the widespread adoption of monthly charges seems some way off partly because of concerns about financial exclusion. The bigger institutions must fear a political backlash and/or a customer revolt if they try to change the status quo.

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Conclusions
1. Political paradigm favours the status quo
It is very encouraging that the Government and the regulators have woken up to potential of innovation but the wider political community is behind the curve of financial innovation. The prevailing paradigm remains one centred on the large high street institutions. Understanding of the alternatives, and how they can help move the UK towards a more diverse and customer-orientated market, is low and this translates into policy. For example, Labour has promised to shake up the banking market by capping a bank’s market share and forcing the big banks to divest themselves of more branches. Notwithstanding the practical difficulties of doing so, and the fact that only one bank has an individual PCA market share above 16%, one cannot help but think that the aim of the policy is wrong. Creating more institutions that operate on very similar business models and offer almost identical products does not encourage diversity.
2. Political focus should move away from ‘what are we afraid of’ towards ‘what benefits do we want to see’
Trust continues to be an issue, both for novel business models and the established players. For less-familiar brand names it is a question of building awareness and an understanding of how new services can fit into a diverse, competitive and (relatively) stable market. There is comfort in the current system and this puts some firms in a privileged position; new entrants need to make a compelling case for the benefits that innovation can bring to the wider economy.
3. The outcome of the 2015 general election will be important for the industry
Our research provides evidence that the make-up of the next Government will have a significant impact on the prospects for the financial services industry. Labour and Liberal Democrat MPs are more sceptical about the industry in general but they are strong supporters of the mutual sector. Younger MPs coming into Parliament in 2015 might be seen as natural advocates for new entrants but it is apparent from our research that youth, and the more inherent connection to new technologies, is no guarantee of a favourable attitude.

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About Interel
Interel is a leading owner-managed fully integrated international consultancy specialising in strategic communications, public affairs and association management
We are headquartered in Brussels with own offices in London, Paris, Berlin, Washington, D.C. and Delhi (coming soon: Beijing)
We are at the centre of a global partnership of independent, best-in class public affairs specialists in more than 40 countries, with a total 1000 consultants serving clients around the globe
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Contacts
George McGregor
Managing Partner UK and Group Head of Public Affairs
e: George.mcgregor@interelgroup.com t: +44 (0) 20 7592 3804
Stephen Edwards
Deputy Managing Partner and Group Head of Technology
e: Stephen.edwards@interelgroup.com t: +44 (0) 20 7592 3800
John Fearn
Director and UK Head of Financial and Business Services
e: john.fearn@interelgroup.com t: +44 (0) 20 7592 3809