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Why is competition important in banking?

Chapters

    We aim to keep banks safe, but of a bit of healthy competition can be a good thing for consumers.

    Why do we care about competition?

    If banks are competing against one another, they have to provide great services for their customers – otherwise people will switch to another, better, bank.

    This makes banks more efficient and productive, which is good for the economy.

    Creativity and cost

    An obvious way for a bank to keep their customers and attract new ones, is to keep their prices low.

    It’s a bit like if there were two restaurants next door to each other with exactly the same menu. If you had to choose which to eat in you’d probably go for the cheapest right?

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    It’s the same with banks; when they lower their prices, you’re more likely to make use of their products, such as a mortgage.

    However, there is a limit to how cheap banks can make their prices because they still have to cover the costs of their own activity. Instead, banks have to think creatively about what else they could offer to make you want to bank with them.

    Think again about the two restaurants with the same menu. This time, the more expensive one offers you a free cinema ticket with your meal if you choose them. Which would you pick now? The additional offer now makes the decision harder.

    Often banks offer additional products with services (anything from contactless payments, to free rail cards) to make you want to join or stick with them. This works well for both banks and customers because they increase their business and people get more for their money.

    Stability

    We also support competition because before the financial crisis, there wasn’t enough and some banks were ‘too big to fail’.

    ‘Big’ refers to how interconnected they were to the economy. Measures had to be taken if these banks were ever in trouble, to make sure they could continue to provide services.

    However, during the financial crisis, the biggest banks realised they would be bailed out… which made them take more risks.

    An example of this is the collapse of the investment bank Lehman Brothers in 2008. Extreme risk-taking led to bankruptcy. This increased the impact of the financial crisis on the economy and so huge bail-outs were made to prevent more harm being done.

    Competition is one way to help avoid this happening again.  If there are lots of smaller banks offering great services, its unlikely people will only bank with major firms. Banks will then take fewer risks as they know they won’t be bailed out in a crisis because their failure would only have a minor impact on the economy.

    How do we help support competition?

    New banks

    We help new banks enter the market by making sure our policies are fair to both big and small banks.

    We also regulate banks to make sure their failure wouldn’t have a huge effect on the economy and to enable banks and customers to have a good relationship, meeting each other’s needs.

    This framework enables competition and we soon see the benefits – lower prices, better quality, and greater innovation across banks.

    Find out more:

    • Read the Quarterly Bulletin article, ‘The Prudential Regulation Authority’s secondary competition objective

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