Just as the banking establishment was beginning to draw a line under the 2008 financial crisis, the LIBOR scandal has blown open the debate about the structure of our banking sector once more. Renewed calls for tougher regulation of the ‘casino’ banks needs to go hand in hand with encouraging innovation in retail banking.  Individual savers and small businesses are desperately in need of alternative ways to get the financial services they need, and there is still time to bring changes to the Financial Services Bill to help them.

Regardless of the resignations of Bob Diamond and Marcus Agius, Britain’s banking system is still dominated by the universal banks of HSBC, Barclays, RBS and Lloyds, all of whom have business models geared towards making their profits from the investment banking world of global deals, big transactions and speculative trading. These are a world apart from their UK customer base of individual savers and small businesses needing working capital. The market should be an encouraging place for new financial service providers to come up with better offerings for the ordinary people and businesses of Britain. The problem is that policy makers and regulators are mesmerised by the big banks and have their work cut out preventing the bad banking behaviour, meaning not enough time and resources are devoted to encouraging the good. For the system to change, we need both. As part of our work looking at disruptive finance policy, The Finance Innovation Lab is supporting amendments being put forward in the Financial Services Bill to redress this balance.

New models for financial services are coming from the market. Peer to peer finance providers like Zopa, Funding Circle, Ratesetter and others have the potential to transform the savings market by cutting out the banking ‘middle man’ and allowing savers and lenders to deal directly with each other. Savers make better returns. Small businesses and individuals can borrow at better rates than banks will offer. Currently much of this activity takes place outside of the formal regulated market. Those peer to peer providers who have sought formal regulatory approval have taken years to get licences as their business models do not fit into the definitions in the current rule book. When the industry went to government asking for some proportionate regulatory oversight so that cowboys and fraudsters couldn’t come in and undermine the reputation of the honest businesses, the Treasury turned them away saying that self-regulation would do the job. That’s worth repeating. Some new financial innovators went to the government asking to be regulated and the government said no! To their credit, the leading players have now set up a trade body, the Peer to Peer Finance Association, which sets out some principles and codes of conduct.

The fact remains, however, that for the sector to become part of the mainstream and really challenge the hegemony of the big banks, some proportionate regulation is required. Baroness Kramer is now tabling amendments in the House of Lords Committee Stage of the Financial Services Bill to this end. Drawing on work from Simon Deane Johns of Keystone Law, these will provide the necessary duties and definitions for the new Financial Conduct Authority to establish proportionate regulation of direct finance platforms. For more details read Simon’s blog here.

As well as new finance providers, there is a growing interest in bringing back the old style of locally, or sectorally based relationship banking. Behind the scenes there are dozens of potential new banks being developed to fill the growing gap in the market for simpler banking services. The think tanks Civitas, New Economics Foundation and Compass are all promoting the virtues of the German savings banks which have supported their country’s SMEs far more effectively than British High Street banks. Britain already has The Co-operative, Triodos Bank, Charity Bank and new entrant Metro Bank, but there are many barriers to entry for new banks, including the effective cartel of the UK payments system which makes it very expensive for new entrants to participate. The Finance Innovation Lab is also supporting amendments to the Financial Services Bill that would place duties on the Financial Stability Committee and Financial Conduct Authority to address and minimise the barriers to entry for new banks, in the interests of promoting greater competition with high street banks, as well as between them.

The overall lesson for policymakers and regulators is that in getting the rules right to protect us from socially useless financial innovation, they must also be open to, and positively encourage socially useful innovations. The rule changes don’t need to be dramatic, and the resources required won’t be prohibitive, but as well as stopping bad banking we have to encourage the good.

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