Business hates competition. And it makes products complex hoping we will make the wrong and more expensive choice.
Banks make money because they are better at arithmetic than their customers. They know that if they fix monthly repayments on a credit card at 2 per cent of the outstanding amount with a minimum of £5 it will take 25 years to clear a £2,000 debt and they will have been paid £3,500 in interest.
They know that after 43 years of charging 1.5 per cent a year on a pension pot with 4 per cent growth they will have taken the equivalent of a third of the pot. Even for the section of the population that is not functionally innumerate those are difficult sums.
And where the arithmetic could be simple the banks devise ways to make them complex. A theme that has run through my working life is explaining complex things to people in a simple way. Over the years I have come to believe that this process of making things complicated — complexification, as I call it — is deliberate. And it is anti-competitive.
Imagine if you went to fill up your car. The local garage is Esso and the price is 136.9p a litre. But Sainsbury’s sells it for 132.9p a litre. So you drive the extra mile to Sainsbury and save yourself a couple of quid.
Suppose instead that your garage charges 129.9p a litre plus £5 to enter the forecourt. That would be dearer. But if you agree to make it your petrol station for the next 10 visits it waives the forecourt charge. Is that still cheaper than Sainsbury’s at 132.9p, which charges you £2 to visit and then gives you back £1 if you fill up for two consecutive times?
Such an approach would be retail madness. But it is often the way you are charged for personal finance products.
There are nearly 5,000 different residential mortgage products on the market. Far too many to choose from rationally. Fixed rates, discounted rates, variable trackers, extended tie-ins, cashback, discount on legal fees, high lending charge, and nearly always a fixed upfront fee of between £495 and £1,995. Which mortgage is best should be a simple question — who charges the least? But these complex deals are a mixture of bets on the future of interest rates — which even professionals get wrong — and simultaneous equations.
On a loan of £200,000, is 1.09 per cent for three years with a £999 fee better than 1.56 per cent over 5 years with a £1,995 fee? And what if grandma comes through and you only need borrow £185,000? Without knowing how to use a spreadsheet it is impossible to calculate.
But what the lender and the broker do know is that at the end of two, three or five years on a fixed rate you will be back to borrow it all over again. If you stay in your home for a typical 20 years you could take out anything from four to 10 different mortgages on it. Ker-ching!
Instead of businesses competing fairly on price — that can of beans is 55p, this one is 62p — they make the sums so difficult that no one can solve them, hoping that many customers will make the wrong choice and pay more than they need.
"complexification destroys competition
by rendering rational choice impossible"
A population that is better educated in financial matters could become a challenge to the industry which is why I support the FT initiative to promote financial literacy at all ages. But unless the banks are forced to make things simple, progress will be very slow.
Business has always hated competition. Elizabeth I made the Crown's fortune by selling monopolies to individuals and organsiations. The City of London, home to our banking sector, was founded on the trade guilds which policed quality but whose hidden agenda was to fix prices.
Nowadays we tend to think competition is good. The Financial Conduct Authority has a vision of a world where “firms are competing vigorously in the interests of consumers”. We even have the Competition and Markets Authority to police it all, though if businesses liked competition we would not need one!
The CMA’s predecessor, the Office of Fair Trading, ruled in April 2006 that credit card providers could not penalise customers who missed a payment. Any fee they charged could not be more than the late payment actually cost them. But then the OFT added this fateful statement: “We do not propose at present to consider legal action where charges are set below £12.” Within days all card providers had cut their charge to — guess what — £12. I am not, of course, accusing the banks of illegal price fixing. It was just a happy coincidence. And an unhappy one for competition on late payment fees.
Firms look for ways to defeat competition rather than embrace it. The only way to force them to be fair and competitive is through rules
The Financial Conduct Authority has tried to impose general overarching principles to stop the banks misleading people. Under the current rules they must show that “fair treatment of customers is at the heart of their business model”. Despite the FCA’s £600m a year budget it is clearly not working because now it wants to introduce a Consumer, Duty where firms will put themselves in their customers’ shoes and ask “would I be happy to be treated in the way my firm treats its customers”. It is not clear from the consultation paper how that will be enforced or how its outcomes will be reported to the public.
My experience in 40 years of writing about personal finance is that firms look for ways to defeat competition rather than embrace it. The only way to force them to be fair and competitive is through rules. When you make a part payment off your credit card the bank must now take it off the balance on which it is charging the highest interest rate.
In the past, payments were taken first from the debt with the lowest interest rate — sometimes as little as 0 per cent — leaving the expensive debt ticking away at 29.9 per cent. That was not treating customers fairly but that principle did not stop the practice. It took a specific rule change in 2014 to do that.
Decomplexifying financial services means banning the factors that make things complex. Ban upfront mortgage fees so that interest rates are comparable. Ban small percentage minimum repayments off credit card balances. Root out all the clever ideas that complexify our finances. Because complexification destroys competition by rendering rational choice impossible.
This article first appears in the Financial Times 5 October 2021
