Recently appointed Tesco CEO Dave Lewis pledged to tackle the over-statement of profits and the firm’s many other problems with “integrity and transparency”.
These are not words that are associated in the popular mind with banking, and might not be viewed as priorities by experienced insiders in the world of finance either.
Integrity – or a reputation for the same – can certainly be ranked as an unimpeachable benefit in banking. Transparency is viewed with more ambivalence. High margin products are the best products of all, whether they involve the sale of food or banking services, and companies of all types are understandably slow to share the details of profit levels with their customers.
But perceptions of double dealing and overcharging in finance have created a clear opportunity for challenger banks, including those run by supermarkets such as Tesco.
Tesco has the largest and most diversified bank among the UK supermarkets, with a greater lending presence than Sainsbury’s and M&S combined. Tesco moved into banking via a 50/50 joint venture with RBS, but has run its operations independently since 2009. M&S continues to offer banking services on a profit-share basis with HSBC, while Sainsbury’s followed the Tesco template by ending its link with Lloyds Bank at the start of this year and now runs its bank independently.
Loan growth at Tesco has been substantial, helped in part by access to cheap Bank of England funding. Loans grew by around 20% year on year in 2013, and Tesco already has around 4% of the market for UK unsecured loans. It is also beginning to branch out into mortgage lending, where it has 0.05% of the UK market.
Tesco’s bank had a return on equity of around 20% last year, according to Deutsche Bank analysts, and would have a return on tangible equity of 23% if it cut its core Tier 1 capital ratio from a substantial 14% at the end of 2013 to an industry standard around 12%.
|Tesco CEO Dave Lewis|
Advice from banking industry analysts that a supermarket-owned retail bank should increase its leverage to boost returns might cause unease in some quarters, but there are other reasons to feel optimistic about prospects for Tesco and its fellow challenger banks.
One reason is that Tesco, like most supermarkets, has a strong relationship with its customers. The firm has over 3,000 branches in the UK, for example. That number is likely to fall as new CEO Lewis tries to revive returns from core food markets, and challenger banks such as Tesco are basing their appeal chiefly on electronically delivered services, not on use of stores as physical branches.
The sheer number of stores presents an opportunity to market banking services to customers, however. Stores are also used to market the customer loyalty cards that reward regular shopping, and can be tied in with provision of financial services.
This is an area where supermarkets have a chance to win financial business from the relative reputational advantage they enjoy over banks, which are still widely detested by their customers and blamed for many of the wider economic woes of recent years.
When Sainsbury’s was justifying its move to buy the portion of the banking joint venture with Lloyds that it did not already own at the start of this year, it noted that it already had 30 million customers, of whom only 1.6 million were users of its banking services. The retailer also noted that one of its own surveys found that as many as 10 million of its existing customers would consider buying financial services from a supermarket, largely because of their negative views on the banking industry.
Sainsbury’s was an early mover in providing incentives to users of its Nectar customer loyalty cards who sign on for a package of financial services products, and will now hope that this move can help it to catch up with the shift into banking by Tesco.
Current accounts linked to Tesco’s Clubcard loyalty scheme were launched in June, to add to a product range that already included personal loans, mortgages, insurance and foreign exchange.
Tesco Bank remained profitable during the 2008 credit crisis and its immediate aftermath, despite its almost overwhelming reliance at the time on unsecured loans.
With that track record and 6 million existing banking and insurance customers, Tesco Bank is already a relative success story. The question is whether it can extend its incursion into banking on a bigger scale.
The company will have to monitor its business mix closely and avoid accounting issues comparable to those that recently hit its core grocery business.
The strong performance of its insurance operations while personal lending suffered during the credit crisis provided some inbuilt balance during the last big downturn, but competition on pricing to build market share in other products could leave Tesco and other supermarkets with a less desirable financial business blend.
And senior executives at retail firms should know, like those in no other sector, how quickly a genuine price war between strong competitors can erode margins.
M&S has already retreated from an attempted move into fee-based current account banking that was based on the assumption that its affluent customers would pay for services that had related subsidies. That indicates that price competition will be the main route into banking for supermarkets.
At least Tesco, Sainsbury’s and M&S can search for data mining and product subsidy levers to try to boost their banking presence.
Standalone banking challengers such as OneSavingsBank, which became the first bank to list in London in over a decade in June, and Aldermore Bank, which has targeted an October IPO, will sink or swim purely on their ability to win profitable market share.
A revival of meaningful business model differentiation in retail banking should be welcome news for customers. Depositor safeguards and product sales rules have been tightened since the crisis and new investors should be encouraged to provide capital to banks that are small enough to fail.
A degree of dispersion is also returning to the range of investment banking business models, where there are now choices beyond flow monster or regional firm.
The role of emerging or shadow banking in the wholesale financial markets offers a less clear-cut systemic benefit, however.
If Aldermore Bank is a post-IPO flop its new investors will share the cost along with existing shareholders led by private equity firm AnaCap. Failure should be pain-free for most others.
A shadow banking firm that tries to fill the gap left by banks retreating from the derivatives and structured credit markets could pose a far greater systemic threat in the event of failure.