Sustainable Responsible Banking – A strategy for Scotland

Sustainable Responsible Banking – A strategy for Scotland
The Scottish Government
May 2013


A truly competitive banking market is about more than simply the number of banks. True competition and choice comes through diversity that offers consumers a real alternative to the incumbents. Diversity in the banking sector and, indeed, in the wider financial services industry, means having a range of different business ownership models and even organisational size in the market offering customers access to a variety of products and services.  In particular, this means the presence of mutuals, such as building societies, co-operatives, credit unions, which operate stakeholder ownership as a business model rather than the more conventional shareholder ownership model. While mainstream banks have a focus on creating value and returns for shareholders, mutuals are owned and run for the benefit of their members or stakeholders, usually their customers or employees. That is not to say that one model is better than another, rather that it creates choice for consumers in the kinds of organisation they choose to provide their banking services. This should in turn lead to greater innovation and efficiency in customer service and products.

Diversity in banking, as in other areas of the corporate environment, also helps to reduce over  dependence on any one operating or business model. This should mean greater stability and robustness in the financial system since different types of organisation will respond differently to any change in economic circumstances. In the event of a significant failure or shock, this can more easily be absorbed by a spread of institutions operating alternative ownership models and different risk appetites. It is worth noting that mutuals have generally demonstrated greater resilience through the financial crisis than the mainstream banks.

Diversity also extends to other aspects. Since mutuals operate for the benefit of their customers or  stakeholders, rather than for shareholders, they often adopt value systems which allow them to pursue objectives which are not solely based on profitability and shareholder return. This means they may be focused on other priorities such as ethical concerns or providing services for customer groups, which would perhaps be regarded by others as less profitable. Member ownership and the smaller scale of many mutuals also means that they tend to be located in the same geographical area as their members, in some cases even in the same regions or communities. Such proximity to customers can help to promote commitment to the localities in which they operate.

As set out in the Government Economic Strategy, the Scottish Government is focused on building resilient and adaptable communities, which have the quality of life, environment and connectivity to allow individuals and businesses to create and capitalise on opportunities. The banking sector has a vital role to play in supporting these ambitions. Retail banks form a key part of the local infrastructure that determines the resilience of communities. For example, for many local businesses one of their most important relationships is with their local bank. Therefore, ensuring an extensive retail banking network that reaches across Scotland, including our remote communities, is important to ensuring that all parts of Scotland can maximise their potential.

The banking market in Scotland is dominated by large institutions. Smaller institutions are arguably better able to provide a more personalised service to their customers largely because their scale allows more scope to become familiar with them and their needs. This can be a particular issue for SMEs, which can feel that the quality of service they receive from the banks is not based on an in-depth knowledge of their business.

The issue then is perhaps not so much one of simply scale but one of increasing centralisation. It could be argued that it is simply not possible for the large banks with thousands of customers to get to know them in any detail. For many customers, the size of a bank or its operational structure is not a particular consideration but they rightly expect a high quality of service whatever the size of the organisation.
In our discussions with the mainstream banks, they have indicated that they too would welcome increased diversity and competition in the Scottish banking market.

They recognise the benefits of operating in an environment that encourages product innovation and drives up standards of service which in turn will increase customer satisfaction levels.

The Scottish Government believes that diversity in the Scottish banking market will help to achieve more responsible, sustainable and competitive banking services that offers genuine choice to personal and business customers.

Greater diversity would mean having access to a broader range of different types of banking service providers, rather than just a greater number of mainstream banks – this is to say competition in the qualitative rather than just the quantitative sense. Banks are not the only way for people to access banking services.

Crucially, a greater proportion of mutuals would promote greater resilience and stability in the Scottish banking market, enabling it to better withstand any future financial crises and so lessen the impact on the Scottish economy. The Scottish Government wishes to encourage a Scottish banking market that encompasses different ways of providing banking products and services to as wide a range of consumers as possible. We also want to see a range of institutions headquartered here, providing employment here and committed to serving Scottish customers.

The Scottish Government believes that more accessible community banking could have an important role to play in the Scottish banking market in the future, whether this involves mainstream banks, credit unions, mutuals or new forms of institution.  Community banks could take different forms but could offer a range of banking services, within local communities to personal and business customers, that might not be currently readily available.

The Scottish Government will explore the potential for promoting further community banking options in Scotland. Studies10 have suggested that the current implementation of financial services legislation is not conducive to encouraging diversity, focused as it is on large, shareholder owned organisations.
Indeed, it is likely that it is a barrier to the entry of new, smaller organisations into the market and to the growth of mutuals whose stakeholder ownership model presents challenges to the current regulatory framework. Mutuals can feel that the regulatory framework has not been developed to reflect differences in scale or business models. Independence may offer an opportunity for Scotland to consider how regulation can take better account of the needs of mutuals.

In the ongoing development of financial services regulation in an independent Scotland, the Scottish Government will be able to consider how the regulatory architecture in Scotland might better be able to encourage diversity.

Credit unions

Credit unions are financial co-operatives, which are owned by their members and which traditionally operate under Common Bond criteria, meaning that they serve people who, for example, live in a particular area, belong to a certain organisation or work for a specific employer. Profits are distributed to members through dividends and members have a say in how their credit union is run. There are 109 credit unions currently operating in Scotland with around 280,000 members. They are becoming an increasingly significant part of the Scottish banking services market holding more than £210 million in savings and lending around £180 million. Some Scottish credit unions can offer current accounts, cash ISAs and mortgages.

As well as providing a range of financial products, credit unions are committed to encouraging their members to save, rather than just borrow, and to increasing financial capability among their members through training in budgeting and financial management. Their commitment to charging interest rates, which are capped and generally significantly lower than most mainstream lenders, means that they can offer loans to those who would not otherwise be able to access lending through conventional providers and whose only other alternative is payday loan companies or even illegal lenders. The not-for-profit ethos of credit unions enables them to make these types of loans but in order to be sustainable, credit unions also need to make higher value, longer term loans. Such higher value loans can still be offered on a highly  competitive basis, however. 

The credit union movement is particularly strong in Scotland and it is growing. However, in international terms, it is still relatively very small. Around 93 million people, or a quarter of the population in the United States are members of a credit union. In Australia, credit unions are working towards becoming a credible challenge to the dominance of the four big banks there. In Scotland, many of the credit unions have the potential to become financially sustainable. There exists potential to increase their membership and to attract a more diverse customer base, providing affordable, alternative financial products to more vulnerable individuals and families.

This is a view shared by others, including the Church of Scotland, which is looking at a number of  initiatives designed to strengthen the credit union movement in Scotland. The Scottish Government believes that Scottish credit unions have the potential to become an even greater force in offering an alternative to the mainstream banks and to helping promote diversity in the Scottish banking market.
The Scottish Government will continue to work with the Scottish credit unions and with representative organisations to explore ways to raise the profile of the credit union movement in Scotland and so  maximise the accessibility and range of services available across the country.