Supermarkets branch out into banking

Do Britain's biggest retailers have the know-how to cash in on our lack of trust in high street banks?

by Sarah Butler
Last Updated: 09 Oct 2013

Milk, teabags, loaf of bread, newspaper, home insurance and a five-year fixed-rate mortgage - all these could be on your supermarket shopping list soon. With the retail market struggling after years of strong growth, the UK's big store groups are looking for new opportunities to keep the money rolling in, and they are being drawn to the world of financial services.

And no wonder. Not only does banking offer retailers the prospect of increasing revenues without all that tiresome capital outlay on new stores, there's also a one-off chance to cash in on the fallout from the credit crunch.

Public anger towards and distrust of traditional high street banks have reached unprecedented levels as a result of Northern Rock, the RBS crisis, rewards for failure, government bailouts and so on, ad nauseam. The time could well be ripe for some untainted names to clean up in the retail banking business.

No prizes for guessing which of our leading stores is in the vanguard. With its usual impeccable timing, the unstoppable force of nature that is Tesco bought out its partner in a long-term financial services joint venture, the aforementioned Royal Bank of Scotland, for a bargain £950m in July last year. It is now intent on adding current accounts and mortgages to its already broad range of customer services.

Its ambition is to more than double the profits of its retail services division - to which financial services already contributes more than half - to £1bn in the next few years.

While Tesco's goals, as usual, outstrip those of its smaller rivals, retailers of many a different stripe are thinking hard about following its lead. Sainsbury's, Asda, Marks & Spencer, John Lewis and even Boots have expressed a desire to boost their activities in every financial activity from insurance to savings accounts.

Although many of these firms have been in financial services in a smallish way for years, altogether more serious operations are now being considered. Andy Higginson, former group FD and now chief executive of Tesco's retailing services division - which includes Tesco Bank - says he wants Tesco to become a full retail bank, and that he intends to have at least 100 branches open in supermarkets within the next few years.

To that end, the chain now has its own banking licence, a dedicated regulatory team at the Financial Services Authority and a pile of capital likely to be the envy of the high street banks. Its all-important 'tier one' capital ratio is close to 11% - compared to 7%-10% for a typical mainstream banking rival.

Consumers certainly seem ready to give retailers a shot. More than a million former bank customers have switched to Tesco's savings or credit-card accounts in the past year, raising deposit levels by £2.5bn between October and February. Says Higginson: 'If people trust you with their savings, that's a good sign. It's different with a loan - you would borrow from anyone. It's more telling that people do trust us.'

One of the key weapons in the war for this business is the level of engagement that supermarkets enjoy with their customers - something high street banks have tried to emulate over the years, without success. Other stores are also winning business as a result of strong relationships with shoppers, including John Lewis, through its Greenbee financial services arm, and Sainsbury's, which has been attracting 1,000 customers a week to its internet saver account since February.

Says Darren Shapland, finance director of J Sainsbury, which also wants to expand its existing savings, credit card and insurance businesses: 'We are a challenger. We're not big yet but the potential is significant, and we don't need to win customers from elsewhere: 18 million people come into our shops every week.'

Like Tesco, Sainsbury's sees its biggest opportunity in linking its financial services offer to its loyalty-card scheme, to market tailored services to particular groups and reward them for buying into new financial products.

Tesco is looking at how it can use Clubcard data to give its best customers cheaper deals - credit-rating them, in effect. Explains Higginson: 'We're trying to bring our values to financial services, a greater sense of looking after customers so that they reward us by coming back again and again. We ought to be able to reflect in risk analysis that you're a loyal Tesco shopper rather than say: "Because you shop at Tesco, we'll give you 10% off."'

Sainsbury's is also working on this with its Nectar card scheme. Of course, there may be questions over how consumers will feel about shopping habits affecting their creditworthiness - particularly for Tesco, which already has to dodge frequent brickbats over the pervasiveness of its brand.

It's a tricky balancing act, as damage to the core brand is a sensitive issue for retailers. Although Tesco, Sainsbury's and M&S have all managed to avoid reputational damage from bad loans and unpaid credit card bills, the emergence of Tesco-branded home repossessions could potentially be much more harmful.

It's easy to see why tapping into the existing customer base, rather than trying to attract lots of random punters, is the key to most retailers' strategies - it's a double whammy of dramatically lower marketing costs and lower risk.

And customers seem to respond better to supermarket financial services than to those offered by conventional rivals. John Lewis boasts an 88% renewal rate on its home insurance, while Tesco's credit card has lower levels of non-payment than 'almost any other card we have compared it to', according to Higginson - not least because customers are incentivised to keep paying their bills.

Says Higginson: 'We have no interest in having 20% of the credit card market per se. It's much more important to have a bigger proportion of loyal Tesco customers. They want to use the card because of the benefit of points and so are more likely to pay it off and keep the relationship going. We'll probably make a thinner margin, but it will be better quality.'

Phil Jones, personal finance campaigner at Which?, the consumer rights group, says retailers are an attractive proposition for consumers because they can offer accessible, convenient banking and, crucially - in Tesco's case, where it has broken free from its traditional banking partner - more choice. 'We think the banking market is uncompetitive at the moment. People tend to stay with their bank. But new people coming could stimulate competition and give more choice.'

With that in mind, one analyst, Lafferty Group, has estimated that half of all British adults will have some kind of financial services relationship with a retailer within the next five years. Market research firm Verdict, meanwhile, predicts that Tesco could build its loan and asset book to £196bn from £6.2bn, and increase its deposits from £4.4bn to £114bn in 10 years. It goes on to suggest that retailers as a whole could control close to £200bn of deposits within the same timescale, putting them on a par with Barclays' UK business.

Says Sandy Chen, banks analyst at Panmure Gordon: 'I think the retailers could take significant market share. The food retailers in particular are very well positioned.'

Some market observers are more cautious. Given that the treasury select committee inquiry into the mishaps of Britain's banking industry criticised the lack of technical banking expertise in the boardrooms of the major banks, are retailers really best placed to take on such complex financial products?

Sainsbury's bank reported its first solid profit only this year, after embarking on an over-enthusiastic expansion that landed it with bad debts. Shapland admits that the business was too keen to drive short-term profits from the bank at a time when its retail business was suffering. And, of course, HBOS's attempt to harness the experience of former Asda director Andy Hornby as CEO didn't work out for the best. The bank had first to be rescued by Lloyds TSB and then by the Government as its failings threatened to drown even its saviour, too.

It can't be a coincidence, though, that Alliance Boots - which also wants to get into financial services - has hired Hornby as it new boss. He hasn't turned his back on banking after all.

Higginson believes the sales tendency can be tackled by setting the right key performance indicators (KPIs) for the business. 'A lot of the problems in the financial services industry came from having the wrong KPIs - size of the mortgage book, share of new mortgage business,' he says. 'If you do that, you are always going to be a slave to getting numbers.'

Adds Higginson: 'I don't think there's any generic reason that a retailer is not able to transfer to banking. I've got the self-confidence to be able to say: "If I don't really understand something, we are not going to do it."

'That's why we didn't go into mortgages before. It was a positive decision, not an accident. We couldn't see a way of making money and didn't know how the banks were doing so. We were happy to leave it alone.' He adds that, as a result of the global financial shake-up, margins on mortgages have improved, making them a more attractive commercial proposition.

Despite such assurances, there is a question over whether consumers are prepared to entrust their serious banking business - beyond the search for a tasty headline savings rate or added-value insurance - to a retailer.

Swapping credit cards or savings accounts is one thing, but the unwillingness of punters to change their current accounts is quite another. This inertia makes the break into banking a real challenge. Says Alex Potter, an analyst at financial consultancy Collins Stewart: 'Retailers have been in financial services for years and they haven't taken material market share so far. The old adage that people change their current account less often than their wives or husbands demonstrates that it's pretty tough.'

Potter adds that the normal route to attract new customers - low savings rates - is trickier, because the base rates are so low at present. 'At the margin, we will see Tesco having some success, but will it have the same market share as in retail? Almost certainly not.'

Meanwhile, Neil Saunders, consulting director at Verdict Research, says Tesco's smaller rivals are only likely to gain a quarter or less of its share of financial services. Apart from financial restrictions, some retailers will find it tough to stretch their brand into more than a handful of niche products. 'M&S has the advantage of the trust in the brand partly because of its longevity; it also has good reach, with lots of stores.'

Boots also certainly has that trust, yet it has no tradition of offering financial services beyond travel insurance, and may take years to become a serious player. Even Tesco, M&S and Sainsbury's, the big three retail players in the financial services market, have taken a decade or more to get where they are now.

Potter says the need to take on additional technical expertise and to find sufficient sources of capital to back loans and mortgages will limit what retailers can achieve, especially as their shareholders and the market in general will be wary of raising money via the wholesale markets. This is the model that led to the downfall of Northern Rock, after all.

Shapland admits Sainsbury's is not likely to start offering mortgages in the near future, because of the potential pressure on its finances and the risk that this could bring to the business as a whole. 'Our savings book is well over double the value of our lending book, but if we went down the mortgage route, we would have to set our balance sheet up very differently.'

Tesco has told the market that it will fund most its lending via savings deposits in the traditional way. However funding will have to evolve as the bank grows, admits Higginson. 'Our primary goal is to have lending funded through good, solid deposit business. If we do start to have a big mortgage book, we'll have to look at the wholesale market as well, but there is no pressure to do that. Over time, there will be medium and long-term funding put into the business to help grow it. It will be more balanced funding, but we will not be depending on the three-month wholesale market, as Northern Rock did.'

Still, it's likely that any move to borrow from wholesale markets would worry shareholders. Already, as even Higginson admits with a wry smile: 'The plc is worried that banking is going to bring Tesco down and the FSA is worried that Tesco is going to bring the bank down.'

But perhaps the biggest straitjacket on Tesco will be its own processes. Before it can launch any new products, it has to transfer six million customers from the databases of its former partner RBS to its own IT platform. This is expected to take at least 18 months, and no plans can really be implemented until that point. The banking branches opening now will be selling the 28 products already available by picking up a leaflet in Tesco, and the retailer has told the market not to expect significant progress at the bank for two or three years.

Given the cataclysmic changes that have happened in the financial system over the past 18 months, who knows what might be happening by then? Perhaps the banks will have started selling milk, bread and cheap flat-screen tellies in a bid to pull the punters in.

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