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Item 2 is our banking and financial services inquiry. We have two panels today. Later we will talk to Clydesdale Bank, but I now welcome Benny Higgins from Tesco Bank.
Good morning. I thought that I would open by giving the committee a brief history of how we find ourselves where we are today.
Thank you for those opening remarks, Mr Higgins. Can you tell us a bit more about where you see Tesco Bank going? Will you continue to focus on personal banking, or will you expand into other areas including the mortgage markets and business banking for SMEs in particular?
We will focus on the loyal Tesco customer base, but that does not mean that all our customers will be Tesco customers. For example, although three quarters of our credit card customers are loyal Tesco customers, a quarter are not. Our focus initially will be to serve our existing customers and sell more of the products that we already sell. Our next priority, however, is to broaden our offering to a fuller service. That will require our offering current accounts and mortgages. We have not set any dates for offering either of those, but they are the next priorities in personal products. We also have a large body of small business customers who are Tesco customers, particularly among sole proprietors. Although we do not have any definite plans yet, I see further opportunities to serve Tesco customers down the line.
You have indicated that you are not particularly interested in developing a branch network. Is that likely to continue to be the case? If so, you are not likely to have an interest in any of the branch divestments that are coming from some other banks as a result of the EU rulings—is that correct?
You are asking two questions. We never comment on speculation, but I will give you enough information to reach a conclusion.
Good morning. You have made public commitments to organic growth, but there has been considerable speculation about a potential purchase of the good part of Northern Rock. Do you want to comment on that?
I refer you to my previous answer: we do not comment on speculation as a matter of course. I have already articulated what we have and what we need. We have a relationship with a large customer base—the Tesco customer base consists of 15 million households in the UK. We have a large physical network that customers visit, we do 65 per cent of our business online, and we have a strong brand. That is what we have; we are well on with building infrastructure.
Although Tesco has primarily offered insurance products and credit cards, has it been exposed to any bad debt?
Yes. I am afraid that that is the nature of the market: by definition, companies that lend money will have bad debts. However, when it comes to arrears and bad debts, our experience with credit cards and personal lending has been extremely good, relative to the rest of the market.
My final question is about remuneration, which is a controversial issue at the moment. How important an issue has remuneration been in attracting well-qualified staff to Tesco Bank? How have the remuneration practices at Tesco been agreed? Do you have a remuneration committee, for example?
Yes. Within Tesco Bank, we have a remuneration committee, in line with the guidance from the Financial Services Authority, and it links with the remuneration committee at group level.
So you have had no recruitment problems at all.
We have recruited extremely able people. I am delighted with the quality of the people we have hired.
My first question is about the new facility in Glasgow, for which Tesco received some regional selective assistance moneys. Given the profits that Tesco makes and the size of the company, why did you need RSA funding to help set up that facility?
The answer to that is quite simple. We could have based our big service centre anywhere in the country and, when we looked around at where to base it, many parts of the country expressed a great desire for us to do so there. The same was true when we chose to set up a customer service centre in Newcastle.
I do not decry creating new jobs or safeguarding employment, which is certainly not a bad thing. Everyone in the room welcomes that and I am sure that we all want to give Tesco credit for going to Glasgow. However, on the day that the announcement was made, I got a text message from a friend—a Scot who has been in London for about 14 years—asking why the Scottish Government is subsidising Tesco when the company has so much money.
The Scottish Government was supporting a decision that would create a lot of jobs in Scotland. I am delighted that it did.
When I was growing up, I was always told not to put all my eggs in one basket. I have a Tesco club card and unfortunately—shopping is not my thing—I visit the local stores regularly. Whether in finance or its stores, Tesco appears to have a strategy of getting people in the door and, once they are there, hooking them to as many Tesco products as it possibly can. From a business point of view, that is an ideal strategy to follow, but I am concerned that, if something went wrong that caused stores to close in local communities—such as a double dip in the recession—while Tesco was trying to extend its loyal customer base and the products and services that it offered, there would be a negative effect on the customers as well as on Tesco itself.
Tesco sets out to listen carefully to customers and understand what they want. The business is run cautiously and sensibly and is very customer led. It has come through a number of economic conditions and, over the past few years—even this year—proven that it can continue to serve its customers well in different and changing environments. When Tesco's customers say that they want to spend less in a shopping trip, the focus of the business is enabling them to do that. It is a fine example, if not the best one that I know, of a business that knows how to look after customers in different conditions. In offering financial services as well, we are simply setting out to do for customers what they want us to do for them: to reward their loyalty and to be there, be stable and be cautious. In difficult conditions, that is important rather than a concern.
Are there any models in the EU that compare to what Tesco is trying to do in Scotland and the UK?
There are other supermarket banks in the world—I can think of one and I am sure that you can too—but none is highly successful, although a number have made pretty good progress. We are not trying to emulate anybody else; we are trying to do in financial services exactly what Tesco has done for its core business in retail, which is follow the customer.
You may have heard that my attitudes to Tesco are not exactly uncritical. I spent 28 years teaching at the University of Tübingen in Germany, where there is what could be called a Mittelstandskultur—a culture of small businesses. We have no big supermarkets in our part of Germany, because they cannot rise above a certain size. Instead, in Tübingen we have street markets four days a week, small businesses, public transport, cycling and co-operative banks. Also, 35 per cent of our output is in high-technology, environmentally oriented manufacture. It seems to me that all those things hold together.
I remind you that our inquiry concerns the banking crisis.
Yes, but banking in Baden-Württemberg is based on small, locally and mutually owned banks—that is part of the network that I have described. I see Tesco as threatening to subvert that structure.
As the convener said, the purpose of today's session is to discuss banking. I refer you to some of my earlier comments. Tesco is about serving customers well—that is its focus. If we can bring that focus to financial services, we will make incredible progress. As I said, more than 1,000 small Express stores are on the high street around the UK to serve customers who want the convenience of a convenience store.
I offer a couple of observations. When my pupils in Germany go into work, they will get apprenticeships at local firms, be highly skilled and come out as engineers working in a dynamic local manufacturing economy. In various areas of Fife, the only possibilities for people are shelf stacking, call centre work or fighting out in Afghanistan. The difference is vivid. I find Tesco's structure oversimplistic for a sophisticated society. We must emerge from that if we are to have an effective and diffuse small business sector. What will happen if small grocery businesses come to you for finance in an area that you have monopolised?
There are 20 million visits to Tesco stores every week, and the customers in question are well served. Fifteen million households in the UK are loyal Tesco customer households. It is about serving customers well—that is what we seek to do.
I am sure that you look often at the competitive environment. What is your perspective on the duopoly against which you are ranged, which has a staggeringly large share of the market and receives Government support? Will you reflect on the fairness or otherwise of the playing field on which you find yourself?
We do not view it as unfair. We believe that, because of the relationship that we have with our customers, we can serve them well in financial services. Clearly, these are atypical times in the financial services marketplace. Things are not likely to settle down very quickly, but no one should think that the market is not competitive. Some of the most competitive saving rates that have been around in my time in banking are available today. The market is competitive, but we believe that we can thrive in it if we stick to our strengths and serve customers well.
How far do you think that you can go in terms of market penetration?
We do not think in terms of market share or market penetration—we are focused on doing the right thing. We have 8 per cent of the credit card market, but we still have relatively modest penetration of our loyal clubcard customer base. There are opportunities for us to make progress, but our approach will be centred on doing the right thing for customers in an environment in which they think that, too often, that has not been done for them.
I get the impression from what you have said that you regard your customer base as made up substantially of people who shop at Tesco. I generally do not shop at Tesco, because I live more or less next door to one of your competitors and have only to walk across the road to get there. I get the impression that, if I was a Tesco Bank customer and I could not do something online, I would have to find a branch, which would be a store. Is that a fair impression?
It is not far wrong, but it is misleading. We are open to all—there is no question about that—but as a business we are focusing on serving Tesco customers. We principally serve customers online; we have only six bank branches around the country, although we have some in-store deposit-taking facilities. I hope that you become a Tesco customer, but as a non-Tesco customer you can still become a customer of our Tesco bank or insurance products, and our online facilities will serve you well.
Lots of things cannot be done online. I think that you said that 50 per cent of customers go to a branch for some reason or other, which makes sense to most of us. How will you facilitate the face-to-face contact that will be necessary? What model do you envisage?
As I said, we are focused on Tesco customers, and we are here to serve them primarily. Currently, between 55 and 65 per cent of consumers of most of our financial products are Tesco customers—the proportion is a bit higher for credit card customers. If someone is not a Tesco customer they can still use us, but we are focusing our energies on serving Tesco customers.
Forgive me, but you evaded my question about how you will facilitate face-to-face contact. Will that be in store?
It will be in store—I am sorry; I was not trying to evade the question. A person would need to go to a Tesco store, and there would be nothing to prevent them from doing so. However, it is right that we are focusing our energies and efforts on serving Tesco customers.
Part of what the committee is doing in its inquiry is to consider how we got here and what banks are doing; we must also consider the regulatory environment, which has changed. Do you have thoughts on the regulatory environment in which you find yourself and on what the Financial Services Authority is up to?
There is no doubt that regulators worldwide are emboldened by recent events. They have acknowledged that they had a part to play in how events unfolded, as did many other people.
Will Tesco Bank, or whatever you call it, be on the same balance sheet as Tesco supermarkets?
Tesco Bank has its own banking licence and its own balance sheet. We are regulated by the FSA as a stand-alone entity. We have a cautious balance sheet, because we are entirely funded by retail deposits, as of now. We are setting out to be a stable, cautious bank that stands on its own two feet and is regulated as such.
In effect, although Tesco Bank is part of the Tesco empire and wears the Tesco badge, it is a wholly separate and distinct banking entity.
It is a wholly owned subsidiary of Tesco, but it is regulated and it stands on its own two feet in relation to its balance sheet.
Are you comfortable with the recommendations on how banks should be governed in future, in relation to the setting up of boards and to risk management, remuneration and audit committees? Is Tesco Bank as it is currently set up well placed to deal with the recommendations?
I am entirely satisfied that Tesco Bank's governance and the relationship between Tesco Bank and Tesco plc are satisfactory and fit for purpose.
The Building Societies Association feels that, although building societies and mutuals are essentially low-risk, deposit-taking and lending-from-deposits retail operations—which is similar to what Tesco Bank does—in a sense they are being unfairly charged to cover the bad banking practices of some of the larger banks. Are the charges that you have to put up with for guarantees and so on fair for the type of banking that Tesco is involved in?
We have not complained, and we do not propose to.
You have mentioned the headquarters operation that has been established in Edinburgh and the 800 full-time equivalent jobs in Glasgow. Do you envisage any further expansion of jobs in Scotland as you develop the bank in future?
I am certainly hopeful that the bank will continue to grow. As it grows and we launch new products, we will require additional resources. We will make sensible and measured choices about where we base additional activities, and Scotland would certainly be a strong candidate in every instance.
I have one final question; I do not think members have anything to add. As you move into the current account and perhaps mortgage markets, do you envisage more of a presence of banking staff in some or all Tesco branches so that people who want to have a face-to-face meeting will know where to go?
That is something that we are working through. There is definitely a latent demand from customers for physical presence, but what that physical presence looks like must be given a great deal of thought. Increasingly various levels of automation are available for banking; you will see other high street banks using high levels of automation. We are going back to first principles, asking customers what they want and what they would like us to do for them, and we are starting to establish what we should do. Physical presence is certainly very high on our agenda, but it does not always mean people; it can mean a mixture of automation and people.
That concludes our questions. Thank you very much for coming along and giving us one of the better news stories for Scotland from the banking sector. I certainly hope that that continues, certainly in terms of jobs expansion.
Thank you.
We will suspend until 11.30 to allow the panel to change over.
Meeting suspended.
On resuming—
Colleagues, we resume to hear from our second panel to give evidence today as part of our banking and financial services inquiry. It is my pleasure to welcome David Thorburn, who is executive director and chief operating officer at Clydesdale Bank. I will allow him to make some opening comments before we move to questions.
Good morning, ladies and gentlemen. I will be brief.
How have Clydesdale Bank and National Australia Bank Group in the UK managed to withstand the financial crisis in better shape than some of our other banking institutions?
There are probably three main differences between Clydesdale Bank as a UK bank and those organisations that have ended up in difficulties.
It is clear that your organisation has adopted a different risk management culture from that in other organisations, particularly HBOS I suspect. How does that come through in your corporate structure, governance arrangements and risk management committees?
It is worth pointing out that we have not really had to change anything as a result of the recommendations that have come out of the crisis. For example, one was to establish risk committees, but we have had a board risk committee and an executive risk committee for as long as I can remember. I do not have much to add to that. Our approach is conventional and traditional. I am not sure how the risk functions operated in those other banks, but they clearly did not operate in the way in which banks used to operate.
Can you give an indication of your current market share in the markets for personal current accounts, mortgages and business banking, particularly SME lending?
Do you mean the Scottish market share?
Yes.
Our market share for personal current accounts is of the order of 12 per cent. For mortgages it is about 4 per cent and for business banking it is 18 to 20 per cent. That is as far as we can gather from the published Bank of England statistics. It is not always easy to gauge the precise market share, but the Bank of England statistics are probably the most reliable way to do so.
Has your share in those markets changed significantly in the past few years or have you been running at roughly the same level for a period?
Clydesdale Bank changed its strategy significantly in 2004. I will not go off the agenda too much, but to answer that question effectively it is probably important for the committee to understand that, at that point, we entered into a pretty deep-rooted three-year turnaround of the organisation. In 2003-04, Clydesdale Bank's business was suffering from several shortcomings for reasons that included underinvestment for the best part of a decade. That had to be attended to. One decision that we made at that time was to change the mix of our business, because the bank was fairly skewed towards unsecured consumer credit. Credit cards and personal loans were about 14 per cent of our business and our loss rate in the area was really poor.
Will there be any enduring impacts of the financial crisis? How will it affect Scotland's financial services industry?
It is difficult to be precise at this point, so I can give only a personal sense based on where we are and what we know today.
When are we likely to see the impacts?
None of us has previously been through precisely what has happened over the past 12 months. When we go through things of this nature, we cannot form a clear view about what has happened such that some dramatic announcement can be made about it. It is a progressive process, which takes place over years.
How has the restructuring in your organisation already affected jobs? What will the future hold?
No major reorganisation or restructuring is planned; we never know what is around the corner in business, but we have nothing planned at this point. Over the past four financial years—for eight half-year periods in a row—the cost base of Clydesdale Bank, which is the net cost of running the business, has been flat or fallen. That is a necessary element of staying competitive in financial services nowadays. Whatever people might write or think, it is a very competitive industry and we simply cannot afford to let our costs drift up by the rate of inflation every year.
Are there any areas of significant growth, in Scotland in particular?
Strangely enough, there is an opportunity in this crisis for Clydesdale Bank. We are already taking advantage of it and I imagine that we will continue to have that opportunity for some years to come. It applies particularly to business banking, to services for SMEs and to the corporate space. Clydesdale has been able to stay open for business—basically, it has not changed its lending policies through this whole crisis. At the end of it all, it now finds itself the only medium-sized bank left in the UK. We are the only medium-sized, full-service commercial bank in the UK with a UK footprint. We offer choice in the market. There are the big banks, Clydesdale and a few niche players—although not many of those are left. We have an opportunity to gain market share, we are taking advantage of that and we intend to continue to do so.
The other side of the coin is that there has been a lot of controversy about remuneration packages and what is necessary to attract well-qualified staff. What is your view on remuneration? How necessary have remuneration packages been to your bank to recruit well-qualified staff? What are Clydesdale Bank's remuneration practices? How do they work? Is there a remunerations committee, for example?
Yes, we have a remuneration committee, which links in with our parent company's remuneration committee. Our framework already essentially fits in with the FSA's recommendations about remuneration; we need to make some minor tweaks at the edges to align with them completely, but no major changes in Clydesdale Bank's remuneration practices are required for us to meet the new paradigm.
In your written evidence to the committee in September, you mention
I can update those numbers because we have since published our year-end results and made further commitments to continue lending. I will share that information with the committee in case you are not familiar with it.
Can you provide the committee with further written information on the conversion of overdrafts into loans for small businesses?
I am happy to look at that and write to the committee as quickly as I can. I am not sure how easy it would be to track that through our systems—it might involve an element of examining manual returns from our people.
Has that practice increased in your company during the past two years, specifically throughout the recession?
Only to the extent that, in a recession, many more customers and businesses get into financial difficulties so you end up with a lot of people facing hard-core overdrafts that no longer fluctuate into credit and have no repayment plan attached to them. They will often sit down with the bank manager and try to work out how they repay the money in an affordable way over a period of time. You reorganise it and turn the hard-core element of the overdraft into a term loan and repay it over whatever period can be managed; you sometimes create a new overdraft at a smaller level that will fluctuate into credit. Converting overdrafts to loans tends to happen more during a downturn because more hard-core borrowing tends to develop, but it is not anything that is unhelpful to customers. They often find it helpful because it helps them to deal with an issue that has arisen in their business.
In the Clydesdale Bank, would you seek a face-to-face meeting with a business customer before converting an overdraft into a loan, or would you write to a customer saying, "This is what will happen and these are the new terms and conditions and the new rates that you will have to adhere to."?
It is possible that we could write to a customer about it, because you cannot always meet your customers. I cannot guarantee that there would be a face-to-face meeting on every occasion, although whenever possible we try to have face-to-face meetings. Our business managers are based in branches or in business centres around the country. We have a branch manager in almost all our branches who is available to conduct such meetings, but sometimes the customer cannot get in during opening hours and it is sometimes necessary to communicate in writing. Occasionally, there will be a bit of a breakdown in the relationship, so you might need to write to a customer and say, "In the absence of alternative proposals, we need to take this approach." That could have happened in the Clydesdale Bank in some areas, but it is not the norm and it is not the preferred option.
I look forward to reading the further information that you provide.
That question addresses two points. The first is the support that was provided to the two Scottish banks about a year ago. It seemed to us that that was necessary at the time, in the interests of financial stability. Money markets were effectively frozen globally and, as a result, some organisations were left vulnerable. We now see, with the benefit of hindsight, that the steps the Government took at that time were sufficient to stabilise the situation. In the fullness of time we will see all the benefits and downsides of that, but at this point it seems to me that it was the right thing to do and that it had the desired effect.
Some would say that we are in a global marketplace and that the Adam Smith approach to markets, rather than what the UK Government did in respect of the other two banking institutions, should have been adopted. What would have happened if the Government had not stepped in and provided the funds, but instead let one or potentially both of the banks go to the wall in accordance with a true capitalist marketplace?
We are speculating to some extent, but probably the nearest proxy—on a much smaller scale—is what happened with Northern Rock. Stories started running on the "Ten O'Clock News" that Northern Rock was in difficulties and the next day there were queues outside all its branches. I imagine that we would have seen that on a much larger scale, because the two Scottish banks are very substantial organisations in their own right. That would have been terrible, so I am glad it did not happen.
You said earlier that you fundamentally re-examined your business model about five years ago. You also said that, in essence, your approach to business lending has not changed. Have there been changes either in your approach to dealing with existing customers or in your operation in the marketplace as a direct result of the financial crisis over the past couple of years?
One of the most important changes was the establishment of specialist units to help people in financial difficulties. I can give you an example, which again is based on some of our management's experience of previous recessions. We can have personal customers with borrowings, particularly mortgages, who find themselves in a difficult situation because of short-time working or losing their job. A centre of expertise is needed to help such people; we cannot rely on the branch network for that, because a branch might receive only one or two such requests a year. We therefore established a specialist unit, staffed by experienced mortgage advisers, to help customers to reschedule their borrowing in a way that prevents a crisis turning into a personal drama for them. One of our principal aims in doing that was to prevent the number of repossessions from mounting. We have therefore had only a very small number of repossessions over the past year or so.
We have heard evidence in the past two weeks about changes in practice by the banking sector in general. For example, in dealing with business customers, we have heard about practices such as converting overdrafts to loans and calling in and withdrawing overdraft facilities when there appeared to be little substantial evidence that a business was in trouble and when the business operated with an overdraft as part of its normal financing mechanism—for example, where a large capital investment was required to get the payback over time. Have you changed your practice in that regard in any way?
There has been no policy change. One difficultly in that regard is that you hear stories from constituents, but the assessment of viability in business lending is not a precise science, which can sometimes make it difficult to be clear about what is going on.
If you converted an overdraft customer into a loan customer, would that count as new lending business?
If borrowing did not increase, that would not be new lending.
Even though the customer previously had an overdraft facility rather than a loan.
Yes, because that would just be a straight swap. Of the numbers that I cited earlier, the net increase in our business lending is the best proxy of what has happened overall. That showed double-digit growth of 10 per cent in the year that ended in September, which is pretty sizeable. In the British Bankers Association figures that have been issued periodically through the year, the absolute market size has fallen for much of the time and has just stabilised more recently. It is clear that we are lending more than the average.
We have heard from small businesses that deal with the range of banks that the relationship managers with whom they work daily have no power or authority in practice. Do you recognise that in your business? Do you enable relationship managers to make significant local lending decisions?
We do—I am generalising across our business. SMEs and mid-corporates are managed from our business centres. As part of the three-year turnaround, we took the key decision in 2004 that we would decentralise much of our credit decision making to local centres. On average, about 90 per cent by number of our lending decisions are made in local centres. We have credit managers based in Inverness, Aberdeen, East Kilbride and elsewhere who are empowered to make most of the decisions there. Managers can make many decisions; they do not all have to be made by one person in a centre. Beyond managers' immediate approval authority, the next step up is the credit manager in the centre.
In broad terms, on how large an amount can a credit manager in a centre make a decision?
The sum varies according to the credit manager's expertise and whether the facility is secured or unsecured, but it can be seven figures. Decisions on most SME requirements should be capable of being made in the centres, which is the reason for the 90 per cent figure.
That is helpful.
We plan no material changes. We have developed a winning model. In retail, we put branch managers back in branches. We handle small businesses through business managers who are based in branches, and for larger businesses we have business centres that are based in communities with as much decentralised decision making as we feel comfortable with. Nothing has happened in the past 18 months to prove that that is wrong. Our bad debt experience has been much less than that of most other institutions.
One suggestion for the sector is that cheques might be phased out by 2018. What is Clydesdale Bank's view on that proposal?
The Payments Council is meeting today to start to consider that proposal. We have not reached a view on that. We understand that the use and acceptance of cheques continue to fall year in, year out, but we are in no rush to decide to phase them out. We are participating in the discussions. As the proposed timescale suggests, the phasing out of cheques is probably a long way off, but discussing it now might be good to allow us to consider what else the financial services sector needs to do because of the migration to electronic forms of payment settlement.
You do not see the proposal disadvantaging customers.
That argument needs to be heard. The discussions have just started. Our board, for example, has had no discussions whatsoever on the issue, and it does not have a view on it. There are consultation processes on such issues. If something will disadvantage many customers, one must think long and hard before doing it.
Bouncing electronic transfers does not have the same ring to it, does it?
No.
You were here when the representative from Tesco Bank gave evidence. Will you contrast your model with its model? The business models seem to be a long way apart. Are you confident that your model will be robust for a sizeable fraction of the population? Tesco certainly thinks that its model will work for its customers.
I would like to say a couple of things about that. First, the UK market for financial services is large and mature, and our view is that several different business models are capable of succeeding in it. Another way of saying that is that there is not only one way to be successful in the marketplace. We have chosen not to go down the route that you mention and to carry on essentially as we are, with the branch at the centre of our interaction with the retail customer.
That is my point in many ways. You do not need me to tell you that you have bricks, mortar and space overheads on the high street, but Mr Tesco and possibly others who will follow the Tesco model do not; they have very different overheads for very large selling spaces. Will your service necessarily be more expensive? If retail banking does not make you much money anyway—
It is profitable for us and is a significant business line, but the difficulty that I am highlighting is income growth in that space. I do not think that Tesco Bank's model will be for everyone any more than our model will be for everyone. Our model is poles apart from its model in some ways. As a medium-sized organisation, Clydesdale has chosen to focus on tailoring financial solutions for customers on an individual basis; by and large, we do not follow the off-the-shelf philosophy. Our mortgage business provides an example. If someone wants a face-to-face meeting, a sophisticated service and sophisticated advice, they will get that from us, but they will not get it from many of the direct players. That is attractive to many people, and we can provide it at a rate that works for us and is competitive in the marketplace. I do not think that that will change. The competition keeps us on our toes, but it is not a major concern. In Clydesdale, it is all about the individual tailoring of solutions to customers' needs, not trying to shoehorn them into our product range. That is even more true on the business banking side.
One common comment from small businesses for the past while is that, although their overdraft facility still exists, it costs them a lot more than it used to. In other words, the margin above base rate has risen dramatically. Is that your perception of what has happened? Will that ever reverse? Are we now in more cautious times, such that the margins above base rate will stay?
That has definitely happened throughout the industry. It is probably worth while for me to try to explain in simple terms what has driven that. If we think of the simple balance sheets of banks such as mine and Tesco Bank, from which you heard evidence earlier, they need to bring in £1 of deposits to make £1 of lending. That is a simplistic explanation, but that is broadly how it works.
Thank you for that admittedly simplistic analysis of where your money comes from, but if neither the customer deposit rate nor your capital costs have anything to do with the base rate—in other words, if the base rate only affects what you take in from the market—why on earth would you correlate customers' interest rates with the base rate at all?
In an ideal world, we would not. We are not talking about a huge proportion of our business. Overdrafts related to the base rate total £1 billion or so in our organisation. That business exists because it is the only way in which to provide customers with a facility that fluctuates in and out of credit. We cannot do that against the three month London interbank offered rate because, by definition, that is fixed for a three-month period. The customer need is for a fluctuating facility, and the custom and practice over the decades has been to peg that to the base rate. That is as close a proxy to the actual cost as we can get, but it has not been much of a proxy in the past 12 months.
That is genuinely news to me. The base rate correlation is largely irrelevant. It just happens to be the best thing that you have that mirrors something that might be relevant.
It is important to bear in mind how extreme the situation has been in the past 12 months. If we consider the average in the 10 years up to 2007, before the crisis started, the difference between the base rate and LIBOR was about 0.17 per cent. That is not a precise figure, but it is not far off. The two rates were very close, therefore the base rate was a good proxy, but when the global money markets froze the correlation fell apart and organisations were forced to flex their customers' pricing accordingly.
Another issue that has been raised with us—in addition to the increased margin on loans—is that arrangement fees have increased excessively in a number of banks. What is your bank's position on arrangement fees? For example, if someone renews their overdraft, they are charged £1,000 just for going through the door. People are being charged a lot more than they were. We have heard of someone who went from paying £1,000 to paying a £10,000 arrangement fee. It was not your bank, but that is an example of the increases in arrangement fees for businesses. Is your bank involved in that as well?
We charge arrangement fees. As we discussed earlier, our pricing is negotiated individually at customer level by the relationship manager, so we do not have one standard charge. We have a broad range of charges that depend on, for example, the risk score of the customer, the term of the facility and the security that is available. Relationship managers have discretion to operate within a matrix, and that has not changed materially during the past 12 months.
Is risk not priced in the interest rates that you charge? Are banks not just using arrangement fees to cash in, because they are able to say, "We are in a crisis, so we are going to charge more"?
I can speak only for our bank; I do not know precisely how others calculate their pricing. Our pricing is based on a return on equity percentage for the relationship. Our business managers use a fairly sophisticated model, the inputs into which are the costs of handling the relationship and all the different forms of the customer's business, the customer's preferences for what they want and how they pay for things, and the margins and fees that they pay. We try to arrive at an overall risk-based return on equity that is within a range that makes sense for us as a business. For example, sometimes customers prefer higher fees and lower margins, and sometimes higher margins and lower fees—obviously, they always prefer lower both, but they have to be reasonable about that. Some have preferences, and our model provides the flexibility to tailor pricing to get the return on equity. To really understand the nature of risk-based pricing for a relationship, we need to be able to look at all the income and costs associated with the relationship, which is why we do what we do.
Essentially, you are saying that the matrix is pretty much the same, but where customers sit within it might have changed significantly in the past year.
We do a risk assessment of the lending in the relationship with the customer, and where they sit within the matrix changes only if the assessment shows a deterioration, for example because the business is making losses or one of its large customers has got into difficulty. The customer's position changes only if there is a deterioration in a risk assessment.
I want to ask about your relationship with your Australian owners. The experience of the other two big Scottish banks has shown that ownership ultimately has a considerable impact on the interface with customers. What degree of intervention did you experience from Australia pre-crash, for example in 2004? To what extent did that influence your reconstruction of the bank at that point? Have there been any developments in light of the crisis?
In 2004, our parent company made a conscious decision to change its approach to how the business was managed. A new team came together during 2002-03, and it came up with a plan to turn the business around, a key part of which was the group's agreeing to adopt a regional business model, as it was called. That meant more autonomy and more of a hands-off approach to the running of the business than it had taken previously. We needed to agree annual performance targets and the broad thrust of our strategy with the parent company, but beyond that there was local autonomy for the board and executive committee to pursue that agreed strategy and then be judged on the results. That was an important factor, although not the only one, in successfully concluding the turnaround.
You say that you were burned in that earlier crisis. Deutsche Bank also went through an upsetting time after the Vodafone Mannesmann takeover. Did that experience inspire a greater degree of prudence in the later period?
I do not think so. I have been with the group since the early 1990s, and Clydesdale Bank has been owned by National Australia Bank since 1997. One of the consistent aspects of its culture throughout that period has been a conservative approach to risk.
People from Scottish Enterprise gave evidence last week and talked about the number of firms that they account manage. If an SME account is managed by a body such as Scottish Enterprise, does that alter your relationship?
I am not hugely aware of that. Although Scottish Enterprise does a great deal of good work, in my experience it does not tend to get too involved in negotiations with the banks. Its advice seems to be more about opening up new markets, new product development and finding a suitable location for expansion—things of that nature that the bank does not do and which I am sure is helpful for the management team. That work is complementary to but not particularly involved in the raising of finance.
Scottish Enterprise would not come to you on behalf of an SME client to make financial arrangements for, say, an export.
It does occasionally, and that can be helpful. I have had the odd phone call from Scottish Enterprise to say, "We're particularly excited about this business. We'd like to introduce you to the management team. We're introducing them to all the banks. We think they're very good. It's worth your spending some time with them." It is always helpful to get that insight, and we put some store by that judgment.
Much of the crisis concerned the expansion of the mortgage market. The people who are examining carbon footprints have sketched out for us the need to increase the efficiency of our housing stock, particularly its heating and carbon efficiency. I imagine that that will require the provision of considerable and sophisticated mortgages in future to enable expensive expenditure on housing to be recouped. It seems to me that quite a degree of co-operation between Government bodies, house owners and the sources of finance will also be required. Are you providing for the impact of such complex financial arrangements on the householder market over the next five or six years?
Not directly. Providing finance to support the purchase and extension of houses is a core product for Clydesdale Bank and will be for the foreseeable future. Helping our customers to finance such work, to the extent to which we can play a part in that, sounds like an opportunity for us rather than anything else, but it is not one in which we have been particularly engaged. We will certainly make a note of that and follow up on it after the meeting.
My final point is on the approaching demise of the cheque, the survival of which has always amazed me. In Germany, where I have banked, it is simply a case of doing a giro transaction, either on a terminal or in a bank branch. Why has that extremely rapid and cheap way of settling up accounts never appealed to bankers in Britain?
Cheques have probably survived because our customers still use them. Their use has been in long-term decline for as long as I can remember. At one level, a cheque facility is quite an expensive service to provide to customers, but for as long as a significant proportion of customers continue to need it, it is one that anyone who wants to be in the current account marketplace will need to provide. We will see. The considerations on the future of the cheque have just started. What happens will depend on how the consultation with customers goes.
It is important to give you the opportunity to respond to the wider debate on regulatory reform and the proposed changes in corporate governance and to tell us how they would affect you. Do you agree with what we have been told in evidence about the changes that are required in the banking sector? How do you propose to respond to some of those issues?
In simple terms, we agree with the changes and intend to comply with them; in most cases, we already do so. As I mentioned, we already have a remuneration policy, which requires only minor tweaks, and risk committees. The proposals will not have a huge effect on us. We have noticeably more interaction with regulators than we used to, but we have no complaints about that, as they are doing an important job. It seems to us that a lot of important lessons have been learned as a result of the crisis. The governance structure is being strengthened and we will fall into line behind that.
Do you think that, fundamentally, the existing tripartite structure that is subject to reform works and can continue to work?
We do not have a position on it; we certainly do not have any complaints about it.
Thank you very much.
I have a final question about the divestments that are being required of RBS and Lloyds TSB, which I should have put to a number of the other organisations that have appeared before us. I am not necessarily asking you to say whether you are interested in bidding, but are you aware of any reason why you would not be able to do so, particularly in relation to the Lloyds TSB branch network in Scotland? Would you be able to bid if you wished to do so or would the European Union's rules bar you from doing so?
In general, our publicly stated position, certainly since 2004, has been to pursue an organic growth strategy. Doing that successfully does not require us to make any acquisitions. The position is still the same. Equally, we have said that we will look at anything that becomes available that might allow us to accelerate that organic growth strategy. To an extent, the events that are playing out in the market at the moment fall into that category. It is still early days. It is clear that there would be no competition barrier at a UK level, because our market share in the UK is small in any product line. I cannot answer your question about the branch network in Scotland because we have not examined the situation.
Thank you. In that answer and all the others that you have given, you have been extremely frank and open with the committee, for which we are grateful. Thank you for your evidence.
Meeting suspended.
On resuming—