Undertake a background study for the creation of a new community bank in the UK
Contents
1. Executive Summary
2. Business Analysis
2.1 Why more diversity might be needed in UK banking
2.2 The role of community/regional banks in other countries e.g Germany, United States etc.
2.3 Analysing background economic data in East of England that may need to be addressed by a community bank e.g poverty levels, wealth inequality,
2.4 Section discussing some of the services that a community bank might offer to customers and how it might differentiate itself from other banks
2.5 discussing potential barriers to entry that might prevent the establishment of a community bank and some of the risks it might face
3. Conclusion
1. Executive Summary
Our objective
This report will analyse the region of East England and look closely at the economy to discuss whether setting up a community bank in this region would be a good option. We will look closely at the banking system and some of their limitations. Banks are regulated heavily by rules which some members of the community won’t be able to benefit from in terms of the economy scale that banks provides to start up business. We will also outline the kind of diversity that the sector of banking needs and how they can enhance the economy. In addition to this we will also explain how the introduction of community banks could be a good initiative for businesses and the growing market labour in the East England.
This report will analyse useful background economic data in the East of England and the specific issues that may need to be addressed by a community bank e.g poverty levels, wealth inequality. Also, we will refer to some of the services that a community bank might offer to customers and how it might differentiate itself from other banks. We will further talk about the barriers to entry that community banks may face to establish and give some recommendations on whether setting up community banks in this region would be a good option. This report will give a thorough analysis of community banks and undertake a background study to help it decide whether or not to create a new community bank in East England and will follow with a recommendation to the consultancy firm on whether they should establish a community bank in this region.
2.1 Why more diversity might be needed in UK banking.
Diversity can be described as a range of different things. One example would be the creation of community banks serving the needs of local customers. These banks do exist in countries such as Germany and the USA. This report will exam the region of East of England and find out whether it might be feasible to create a community bank in this area.
With the continuous development of economic globalization, more and more people begin to pay attention to global financial diversification. On the one hand, diversified banking business improves the income of commercial banks, expands the channels of capital absorption, and accumulates more customers. Specifically, the diversification of banking business has the following effects: Firstly, it can improve the market competitiveness of banks. Diversification of business can promote rapid expansion of banks and increase market share. At the same time, commercial banks with diversified operations can improve their market competitiveness and comprehensive strength by relying on their competitive advantages in different business regions. They can establish their own markets whereas single operation enterprises have no competitive advantages. Secondly, it can reduce transaction costs. Business diversification can promote market internalisation and reduce transaction costs. Relevant personnel of the bank can make appropriate resource allocation according to the operating status and business needs. For example, resources can be placed in businesses that can increase cash flow, and slow-growing businesses can be transferred to regions with large business prospects to improve the efficiency of resource allocation. Thirdly, it can diversify the operational risks of banks. In order to improve business performance and reduce business risks, banks can combine businesses with smaller connections, which is not only an effective way to disperse business risks, but also a way to promote business performance. On the other hand, although business diversification may not promote the improvement of profit margins of commercial banks, it can reduce the fluctuation of profit margins, which is very important for listed companies. If the average rate of return is the same, the reduced fluctuation of profit margins will promote the improvement of stock value of the company and attract more investors.（Fan Fang 2018）
The independent commission on banking in the UK believes that the highly centralised banking sector limits competition between banks and is not conducive to commercial banks serving customers better, especially retail banking customers. Therefore, the report on its reform proposals proposes a number of measures to promote competition among commercial Banks. Firstly, it is suggested that Lloyds bank should consider selling more branches on the basis of the 600 branches already on the agenda, so as to reduce its share of the UK retail banking market and improve the market competition of retail banking. Secondly, in order to greatly improve the convenience of customer service in the process of bank transfer, special attention should be paid to the confidentiality of customers in the process of transferring accounts. Customers' free choice of service institutions can promote commercial banks to improve service level and meet customers' diversified needs. Thirdly, whether effective competition among financial institutions can be promoted should be one of the important factors to be considered in the future reform of British financial regulatory institutions. It is suggested that in terms of bank access, sharing management experience with other banks, providing necessary support for new entrants.
Pushing higher competition in banking system is the reason why British banking reform compared with other countries and international financial regulatory reform is more unique. It has a direct relationship that is why the British banking industry structure is different from other countries and also reflects the basic starting point of the bank of England independent committee to protect the interests of the consumers. (Ming Yi 2016)
2.2 The role of community/regional banks in other countries e.g Germany, United States etc.
‘A community bank is a depository institution that is typically locally owned and operated’ (Critchfield, T etc., 2005), these banks tend to focus on the needs of the small and medium-sized companies and families, and because the service object is relatively smaller than some banks, they can have more diversity to different kinds of customers. In general, community banks will choose the place where near uptown, so that people who need to handle the business can conveniently find them. In different countries community banks play different roles.
In the UK, some big banks could not take into consideration the small companies and individuals. Individuals or small companies are short of money to conduct a transaction. So they worry about where they can accept such a small transaction, so, they have different kinds of demands as single service cannot satisfy them. Low levels of trust, the failure to serve the poor and small and medium-sized enterprises, big banks become unpopular in small companies and individuals. To the contrary, community banks, the small banks, have diversity services and aim to serve the everyday financial needs of ordinary citizens, local community groups, and small and medium sized companies, become more and more popular (Business West, 2018). At the same time, they have advantages such as high credit, attentive service and satisfy the small companies and families.
In the United States, community banks are not so clearly defined. In general, they differentiate it with assets size. For example, Office of the Comptroller of the Currency is less than $1 billion, or like Federal Reserve Board and Government Accountability Office, up to less than $10 billion (Critchfield, T etc., 2005). In the United States, community banks are a common institution. The US tends to follow a more traditional money-lending model in this way, but still incorporates collective ideals in that the community banks are locally owned (Hoenig, Thomas M. 2003). This bifurcated banking system in the United States has served the economy well. Similar to the UK, large banks have become complex organizations engaged in a wide range of activities, and small banks have focused more on ‘relationship banking,’ which make decisions based on an individual's understanding of customer credibility and have a keen understanding of the business conditions of the communities they serve( Keeton, William etc., 2003).
In Germany, community banks can be called public banks. They are financial institutes, typically held directly or indirectly by the public sector. Not all companies are fully publicly owned. They can also be defined as public by providing services out of a public interest (Hüfner, F 2011). The German banking system is structured in three different pillars, totally separated from each other, and the public banks are the third tier of it. It is not always a good thing with such many banks in a country, though these three different pillars system has worked well in the past. Because there are too many banks in Germany, this system will be eliminated in the future, and some weak banks will close down.
In conclusion, in different countries different banks systems exist and they play different roles. Although, they have similar features, for example, they are small, and they tend to service small companies and individuals. Community banks occupy an important place in a county’s economy, which are more convenient than some large banks.
2.3 Background economic data in the East of England region identifying specific issues that may need to be addressed by a community bank e.g. poverty levels, wealth inequality
The East England region is characterised by a market town. The East England economy is driven by the manufacturing industry (Europa,na). This region has the second highest levels of investment in the United Kingdom. The expenditure on research and development sector contribute to 3.36 of the GDP. It has the highest proportion of active business. Overall of 165,700 accounted for technology, which is in the intensive sector in the UK. Due to this dynamic, it has attracted multiple big international brands such as Nokia and large firms. (Europa,na)
Poverty is measured on household income. The level of relative low income have been steady over the past few years. The proportion of children and pensioners in relative low incomes is getting higher than it was five years ago due to the increase in prices.(Cambridge new,na).In the East of England more than a fifth of people of working age are living in relative poverty. The region has inflated property prices. New homes are too expensive for 83 per cent of ordinary families which mean that an average of 1.1 million people can’t afford an average standard of living. Child poverty levels are increasing as well because ordinary families are stuck on low pay while living cost rises and family benefits are reduced. These issues needs to be addressed by community banks by offering financial products that will not usually be available usually for these families, that encourage them to save and take out loans.
Smaller businesses are crucial for the British economy and more of them are rising with the increase of immigration. Their ability to access finance is critical because of their size, banks are not willing to provide them funding. There is also new start up small enterprises which have difficulties to be financed by banks for it to start up. It is also stated that British entrepreneurs do not consider other sources finance other than banks although there are other financial options such as credit card and overdraft. (british business,na) With all the data that we collected, community banks should take measures which will be beneficial for the economy. Community banks should try to investing more in new small business and try to diversify. It should invest in different sectors which would create more jobs for the labour force arising from the immigration.
With reference to the graph we can see that regional employment is quite volatile. This region has a growing employment rate which means that they are productive. The region with the largest increase in the economic inactivity rate on the previous period (September to November 2017) was the South East at 1.2 percentage points, followed by the East of England at 0.6 percentage points which explains the low rate of unemployment. There were approximately 6.2 million people with non-British nationality living in the UK and 9.4 million people who were born abroad.(ons,na)
2.4Services that a community bank might offer to customers and how it might differentiate itself from other banks.
The regional bank must offer services that will grant it a competitive edge over commercial institutions such as large existing banks which includes banks such as HSBC, Lloyds and Barclays. These services could be services that are already offered by other institutions but the difference being that they are offered at a higher level or the regional bank could offer services that cannot be found anywhere else and are easily accessible for everyone.
Like commercial banks, regional banks offer the basic services required by customers for banking services such as deposits, loans, mortgages, savings, debit/credit cards and more. The difference between the larger banks and regional banks is the number of customers they deal with. Larger banks deal with a large volume of the market share and in order to meet the demand, they are not able to invest into a personal relationship with their customers however regional banks are. Community banks may know your whole family, since they’re more relationship-based, Fellhauer says. Branches are smaller and more intimate. When you visit a community bank the personalised service they offer helps small banks attain high personal satisfaction scores and repeat custom. If a regional bank has an individual client who requires wealth management services, the regional might intermediate an agreement between that client and a local business. If the bank has a business client that is seeking for a loan to start up their business, the regional bank might be able to offer the client a loan based on the business’ performance once it is operational. This can be the case for the wide variety of services the bank will offer. In addition, they also have more lending flexibility as they can offer more l loans than the big banks. Also they can offer cheaper rates and have lower minimum requirements compared to commercial banks so they are able to give out more loans.
Aside from services based on the products they provide, since regional banks know their clients, regional banks can also offer services that practically help their customers. For their business clients, the regional bank could hold an East Midlands networking event for business that will allow business to meet their counterparts. For individuals, they could host conferences that deal with topics such as mortgage planning, debt management, investing and topics alike.
2.5 Potential barriers to entry that might prevent the establishment of a community bank and some of the risks it might face
There are many potential barriers to entry that might prevent the establishment of a community bank in the region of East of England. Barriers to entry are factors that prevent or make it difficult for new firms to enter a market. An oligopoly is when a market is dominated by relatively few large firms. An example of an oligopolistic market structure is commercial banking. Barriers to entry as a result of this market structure may include brand loyalty or economies of scale. This means that when setting up a community bank other firms will be able to benefit from economies of scale where there are able to generate lower costs per unit from expanding. In addition, brand loyalty would mean that customers have positive feelings towards a brand which leads to repeat custom. This would make it difficult for firms to enter the market because they would struggle to attract new customers.
There are many barriers to entry and risks in setting up a bank. One barrier to entry in setting up a community bank is regulatory barriers. These barriers to entry result from acts issued or acts performed by governmental executive authorities. The capital and liquidity requirements issued by the government could be an issue for banks when setting up. As the initial application to the Bank of England costs £25,000 and the CSBA estimate that £1million is needed to be available for the initial set up process. In addition to this, the CSBA estimate that £20 million pounds of start-up capital is needed in the first 5 years to underwrite the investment and to get the bank up and running. This makes capital and liquidity requirements a barrier to entry as well as access to funding. As setting up a bank is high to finance and hard to reach the minimum requirements in order to set up which could deter people in setting up a community bank. Another potential barrier to entry is bank authorisation. This is part of the regulatory barriers to entry and involves obtaining a banking licence. This can be a barrier to entry as it is difficult to obtain and can prevent the establishment of a community bank. For instance, the Burnley Savings and Loan (or Bank of Dave23) began in 2011 and one of the problems encountered by the owner, Dave Fishwick, was getting a banking licence from the City banking establishment. He said: ‘Britain is crying out for community banks but it’s not as easy to get a banking licence as people make it out to be'. This shows us that bank authorisation is a huge barrier to entry as it prevents many people such as Dave Fishwick from obtaining a banking licence which means him and many others are not able to set up community banks.
Furthermore, a community bank may face the risk that new technology means that many of the functions traditionally provided by branches e.g account opening, can now be done through digital channels (internet and mobile), which is a risk when setting because there may not actually be a market in setting up a community bank.
Conclusion
To conclude, there is a need to improve diversity in the supply of banking services through the introduction of community banks. As this improves the income of commercial Banks, expands the channels of capital absorption, and accumulates more customers. Community banks are depository institutions that is typically locally owned and operated and plays different roles in different countries. Community banks may need to address the issues of poverty levels and wealth inequality that exist in the East of England region. This makes community banks important because of their role in helping to solve these issues by being available to the local needs of the community rather than commercial banks who wouldn’t cater to these issues. Community banks offer services such as deposits, loans, mortgages and savings. The criteria to use these services and its fees will differ considerably compared to commercial banks with community banks offering low fees and more of a perosnalised service. The establishment of community banks is very hard to set up and many barriers to entry exist which prevent or make it very difficult to set up a community bank. With one major barrier being the high costs to finance. As mentioned earlier in the report, the CSBA estimate that £20 million pounds of start-up capital is needed in the first 5 years to underwrite the investment and to get the bank up and running. This huge amount of capital is not readily available for many of these start-ups and as three community banks are in the process of being established this will be very expensive. In light of the results and findings we have discovered we would recommend to the consultancy firm to not create a new community bank in region of East England. A huge number of bank closures has meant that there is a steep decline in bank branches that operate this region. This is due to the fact that many of the functions traditionally provided by branches e.g. account opening, can now be done through digital channels which means there may not be a demand to set up community banks. In addition, with low unemployment rate in East England, they should consider that this region may not need a community bank to support the local needs compared to other regions. Therefore, I would urge the firm to take note of the improvement in technology and other factors previously mentioned and decide not to set up a community bank in the East of England.