Current Issues in Financial Services

This book takes as its focus what has become known, in the last 15 years or so, as the financial services sector. The meaning of the term ‘financial services’, as it is applied in the UK, is broadly understood to include banking, insurance, building societies, stockbroking and investment services.

Why should financial firms be regulated? Are they different from non-financial firms? A financial service cannot generally be tested at the time of purchase, and much of the rationale for financial regulation stems from the problems of market failure that exist in the financial system, particularly in relation to investors. ‘Market failure’ here refers to a variety of events that can imperil the safety of investors’ funds — fraud, misfeasance, collapse of an institution (either through fraud or mismanagement, for example).

In Chapter 2, the reader was introduced to the issues and principles of regulation of the financial system. By way of exemplification, this was illustrated by reference to the investment sector of the financial services industry. The present chapter builds on this by examining the practice of regulation in three other sectors of the financial services industry: banking, building societies and insurance.

This chapter opens with an account of developments in macroeconomic thought and policy analysis to place in context the contemporary economic environment in which financial services operate. The final section analyses the recent behaviour of banks and other financial institutions, emphasising the linkages which are evident between the financial sector and the macroeconomy. If there is perhaps some noticeable bias towards banking institutions in this chapter, this may be explained by the monetary nature of their activities and the importance of money in the economy. This, however, should not necessarily make us ‘monetarists’. The relationship between the stock of money in the economy and aggregate monetary expenditure is by no means fixed and unchanging over time because, during a boom or on the upswing of the business cycle, monetary expenditures may run ahead of the supply of money, whilst during a recession quite the opposite might happen. However, as observed by Joseph Schumpeter, this expansion and contraction of bank credit might not be the cause of the economic cycle but without banks these booms and slumps might not be what they are!¹

The financial services sector has been at the forefront of the application of information technology in business. This is hardly surprising since, in most developed economies including the UK, the financial services industry has been one of the most dynamic and rapidly growing sectors of the economy. Such a rate of growth and change has created a fertile environment for the innovation of information technology.

Taxes are used by governments to raise funds for public expenditure. However, almost all taxes produce distortions in the economy of a country and affect the behaviour of its citizens. In fact governments often legislate in order to influence individuals’ behaviour, for instance by offering tax incentives to home buyers to encourage home ownership.

One of the major changes in the UK capital market over the last quarter of a century and more has been the extent to which institutional investors have replaced individuals as the most important holders of ordinary shares. During the 1980s the Conservative government under Margaret Thatcher encouraged individual share ownership through the privatisation of nationalised industries. But although the number of adults owning ordinary shares increased from 3 million in 1979 to around 11 million in 1990, their relative importance in the stock market continued to decline. There was ‘widening’ rather than ‘deepening’ of share ownership — the number of personal shareholders rose, but their percentage of the total market continued to fall. In fact, a survey by London Stock Exchange in 1990 showed that 60% of personal shareholders held shares in only one company, and only 14% held shares in four or more companies. Between 1963 and 1992 the proportion of ordinary shares in UK listed companies held directly by individuals fell by two thirds — from almost 60% to under 20%. At the same time, the proportion held by the major institutional investors more than doubled — from 28% to 60% (see Table 7.1).

Providing finance (lending) means risk-taking by the banks. There are a multitude of things which might happen to cause both businesses and private customers to be unable to repay their debts, and so bankers will often wish to take collateral (security) to cover themselves. However this latter action is well recognised to be only for control purposes. Thus, the borrowing proposition and subsequent repayment must be considered in isolation from the security: money should not be lent unless the bank is satisfied there is good probability of the money being repaid, without recourse to security.

This chapter uses the banking sector to illustrate the problems of low profits and problems of strategic and operational profitability, together with the response made by banks towards improving their profitability relative to the new competitive environment in which they operate. The financial services industry in the UK has moved since the 1980s from a traditional domestic retailing service centred around the main High Street banks to a competitive industry where the retail credit market is dominated by a number of leading players with new entrants to the market jostling for position. This increased competition has been partly the result of the growth of the market for retail credit, but is closely connected to a complex mixture of other factors arising from political, commercial and cultural changes in the 1980s. These changes are detailed in more detail below, but in essence they arise from the increase in consumer credit, the diversity of the banking industry, a generally low industry profitability, an expensive product delivery system and a general problem of cost identification in an industry where many costs are fixed and the products sold are intangible.

This chapter will draw together some of the threads that influence corporate strategy that have been dealt with elsewhere in this book, for example the impact of deregulation, financial innovation and new legislation. Any organisation, to be successful, has to respond to the competitive environment in which it operates. This has been particularly important to the formulation of business strategy for financial institutions due to the rapid pace of change in this environment during the last decade. To discuss the formulation of corporate strategy, it is necessary to discuss these external factors, the rapid pace of change and internal influences on policy such as the aims and the aspirations of managers and the response of financial institutions to these factors. The processes that have led to change will be identified, and their consequent impact on marketing and strategy analysed, to determine strategic policy areas and the response of the financial institutions in terms of marketing strategy and techniques employed. Undoubtedly the major influence on strategy has been the rapid pace of developments in the competitive environment.

The free movement of goods, services, capital and people within the European Community was a clearly defined goal of the 1957 Treaty of Rome. The achievement of this aim is, however, dependent upon there being a financial Common Market; deregulation within banking and credit, brokerage and insurance would be insufficient to liberalise the market. It is vital that capital is free to move across the borders of the various member states.