Financial deregulation and liberalisation

The deregulation of the financial sector, which increased domestic competition, took place in a particular political context that is important to understand. In the 1960s and 70s, British banks and the financial sector as a whole were subject to considerable criticism. The sector was seen as highly inefficient and secretive about its costs resulting in the over-charging of customers for banking services. Particular criticism was aimed at the banking cartels and that, as a consequence of the cartels, “the clearers were wastefully ‘duplicating’ branch offices that remained underused” (Collins, 1988, p. 415). The Pricing and Incomes Board (PIB) 1967 report into banking charges illustrates the mood well. The PIB concluded that banks made excessive profits, were overstaffed, had too many branches, were secretive and did not stay open long enough (Lascelles, 2005). A central argument in the report was that the interest rate cartel diverted competition into wasteful investment in unnecessary branches (Moran, 1986). On the back of this report, a number of initiatives were undertaken to increase competition in the banking sector. There were also signs that the view of the compartmentalised nature of British financial services was changing. The 1959 Radcliffe Report argued that the credit market should be viewed as one market, with the implication that all credit providers should compete with each other (Lascelles, 2005).

Following pressure from the Government the banks started disclosing their profits for the first time in 1970, which led to a greater emphasis on costs and an intensification of competition between banks. The year after, Competition and Credit Control (CCC) was introduced ending the banks’ interest rate cartels (Gentle, 1993; Howcroft & Lavis, 1986; Moran, 1986). Up until then, the Bank of England and the Government had allowed banks to act as a cartel in price setting in exchange for subjecting themselves to stricter controls by and closer cooperation with the Bank of England (Morgan & Sturdy, 2000). Later, in 1983, the building societies also abandoned their interest rate cartels. However, this arguably had a less profound impact as it was largely in response to than a driver of increased competition (see e.g. Howcroft & Lavis, 1986; Morgan & Sturdy, 2000). The departure from cartels for banks and

78

building societies led to the intensification of competition and, more importantly, the rise of price competition (Howcroft & Lavis, 1986; Mullineux, 1987). Up until then both banks and building societies had competed for customers on the basis of the expansion of the branch network (Howcroft & Lavis, 1986).

In the 1980s the functional compartmentalisation of the financial market started to disintegrate. The abolishing of the corset – a supplementary special deposits scheme introduced in 1973 in the wake of the secondary banking crisis7 – in the 1980s enabled banks to move into the mortgage market (Gentle, 1993). Banks rapidly gained a considerable market share forcing building societies to offer market interest for savings and mortgages to attract funding (Gentle, 1993), leading to a considerable decrease in the margin between deposit and lending rates (Drake, 1989 cf. Gentle. 1993). The banks were also facing greater competition from building societies, Trustee Savings Banks (TSBs), secondary banks and foreign banks for retail business from the 1970s onwards (Mullineux, 1987). Relaxation of government controls on the activities of the sector in the latter half of the 1970s allowed TSBs to lend to the public and to corporate customers. Consequently the TSBs diversified in the 1970s and 80s, introducing credit cards, insurance brokering services, mortgage lending, investment management and other retail financial services (Mullineux, 1987).

There were also a series of reforms enabling building societies to compete in markets traditionally preserved for banks. Building societies began to offer money transmission services in the late 1970s and interest-bearing cheque accounts in the early 1980s, areas that had traditionally been the domain of the banks. To stimulate competition between banks and building societies, and to enable the latter to cross- sell, the Government introduced the Building Society Act in 1986 (Mullineux, 1987). This enabled building societies to enter into estate agency, real estate investment, unsecured personal lending and the issuing of cheque guarantee cards. The Act also enabled building societies to access wholesale markets and convert into PLCs. The ability of building societies to demutualise and convert themselves into banks was a significant contributor to the erosion of the market position of the sector in the 1990s onwards (Stephens, 2001). Whilst in 1995 the building societies held two thirds of

7 _{Under the corset, banks had to place non-industry earning deposits with the Bank of England if} interest bearing eligible liabilities outgrew the rate set by the state (Collins, 1988)

79

residential mortgage assets and half of all short-term savings, in 1997 this had fallen to a quarter and a fifth respectively (Stephens, 2001, p. 336). This was largely caused by the conversion of five major building societies to banks after 1995 (Stephens, 2001).

Another major reform transforming British banks by leading to their greater involvement in global capital markets was the Big Bang, a series of changes to the Stock Exchange introduced in 1986. Up until the lifting of exchange controls in 1979, the Stock Exchange was prevented from participating in the international shares market in the 1960s and 1970s (Mullineux, 1987). When these were lifted, the City found itself at a competitive disadvantage vis-à-vis its foreign competitors due to the exchange-floor based, single capacity and fixed-commission system it operated with, which threatened the long-term attractiveness of London as an international investment outlet (Leyshon & Thrift, 1997; Mullineux, 1987). The UK system was more compartmentalised compared with other financial centres (Leyshon & Thrift, 1997). The Big Bang was introduced to address this and essentially involved three main changes to the Stock Exchange: the end of the single capacity system, the abolishing of fixed commissions and the opening up of the Stock Exchange membership (Mullineux, 1987). These reforms transformed the market for domestic securities and served as a catalyst for the wider reorganisation of UK financial institutions (Leyshon & Thrift, 1997) by allowing major clearing banks to enter capital markets in a major way (Lascelles, 2005; Leyshon & Thrift, 1997).