Will The Competitiveness Probe Hit Profits At Barclays PLC, HSBC Holdings plc, Lloyds Banking Group PLC And Royal Bank Of Scotland Group plc?

Piggy bankNews that markets watchdog the Competition and Markets Authority (CMA) has recommended a full competition inquiry into banks is perhaps unsurprising. That’s because the government has been pushing for increased competition for a number of years, but the ‘big four’ UK banks — Barclays (LSE: BARC), HSBC (LSE: HSBA) (NYSE: HSBC.US), Lloyds (LSE: LLOY) and RBS (LSE: RBS) – still provide 77% of all current accounts in the UK. Furthermore, only 3% of current account holders switch banks each year, which means that there appears to many people that there is a lack of competition.

A Recovering Sector

However, what is often forgotten is just how far the banking sector has come in the last few years. Indeed, Barclays, HSBC, RBS and Lloyds have experienced a hugely challenging period and are all expected to make a profit this year — in the case of RBS and Lloyds, it is the first time since the start of the credit crunch. Therefore, the focus in recent years has rightly not been on creating a more competitive landscape. It has been on helping the existing banks to recover, recapitalise and start lending to businesses across the UK so that the economy can return to growth.

This objective has been successfully met. As mentioned, the big four banks are all due to be profitable this year and the UK’s policy of focusing on recapitalising to enable banks to lend has been a sound one. Indeed, only a cursory glance at the state of the Eurozone’s banking sector is needed to see that quantitative easing has been a success thus far.

So, while competition may not be as strong in the banking sector as many people would like, that has simply not been the focus in recent years. The circumstances have dictated that we mend the banks that were, as George Osborne put it, simply too big to fail.

Looking Ahead

Certainly, the banking sector will become more competitive. However, is the key to achieving more competition a focus on new, smaller banks or on increasing competition among the incumbents? The main difficulty smaller banks have is a lack of scale. This means that they are unable to take a loss on current accounts and so must charge a fee for them, which means customers turn to free current accounts at the big four. Current accounts create vast cross-selling opportunities and so if challenger banks can’t compete on them, they are at a huge disadvantage to their larger peers.

So, do you make all banks charge for current accounts? Or, create a new regulator that theoretically ensures more competition among the incumbents, but ends up unpopular (as with utilities) and stifles profitability among banks, leading to less lending to businesses and a slower UK GDP growth rate? Neither scenario is particularly attractive and so, while there may be complaints regarding a lack of competition, ultimately it seems as though it will fall on the banks themselves to become more competitive.

Indeed, the takeaway for investors is that the banks are back. The sector is returning to profitability and, with it, a renewed focus on winning new business from rivals as they seek to grow the bottom-line rather than selling off non-core assets, writing down assets and making provisions for PPI claims. Therefore, with HSBC, RBS, Lloyds and Barclays trading on price to earnings (P/E) ratios of just 11, 13, 9 and 10 respectively, they still seem to offer great value and vast potential going forward — even if competition is, for now, not quite as strong as many people would like.

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Peter owns shares in all of the companies mentioned.