Tom Clougherty's recent Alt-M post on competition (or the lack thereof) in UK banking nicely highlights the problem posed by barriers to entry into the British banking industry. That there is indeed an entry problem should be obvious from the fact that Metro Bank, which opened in 2010, was the first new financial institution in the UK to get its own banking license in over 150 years!
What may still not be sufficiently appreciated is the extent to which entry into the British banking industry has been limited, not by the unavoidable challenges would-be entrants must face in attempting to compete head-on with established British banks, but by hurdles erected by British bank regulators.
Nothing better illustrates this fact than the story of Dave Fishwick and his struggle to establish a bank in Burnley, a run-down town in Lancashire, in the northwest of England.
Now that the Bank of Dave is up and running, Fishwick has become something of a celebrity here in the UK. A charismatic self-made businessman, Fishwick grew up in a small two-up-two-down terraced house in one of the poorer parts of the former mill town of Nelson, just outside of Burnley. He did badly at school, which he left at 16. He then began dealing in second-hand cars, eventually moving up from cars to vans and from vans to minibuses. The minibus business then grew to be the largest in the country, making Fishwick a rich man in the process.
Come the financial crisis, bank lending in Burnley dried up almost overnight. Local firms could no longer finance purchases of Fishwick's vehicles. Soon his business was in trouble. To save it, he himself started lending to his customers. When, after six months of doing so, and despite hard times, not a single customer defaulted, it struck him that running a bank wouldn't be too difficult.
So Fishwick rented and renovated the lower floor of a vacant £100-a-week shop, installed a cash machine and a safe, and (it's said) hid the key to the safe behind a bottle of cherryade. He then put a sign above the window saying "Bank on Dave!" and, September 2011, opened shop.
A little more than half a year later, Fishwick had formed some rather caustic opinions about established British banks, which he shares in this Guardian article. "The whole [banking] system," he observed, "is rotten and it's ruining the lives of good, hardworking people."
Fishwick's "bank" (to call it that, despite British regulator's insistence that he not do so), resembles a brick-and-mortar peer-to-peer crowd funding scheme. Purists might argue over whether Dave is really doing banking or not, as opposed to operating a building society or a credit union. To such arguments I would respond that Dave is doing what banks traditionally do, acting as a financial intermediary that takes in deposits and then loans them out. But what clinches it in my mind as banking and differentiates it from some mutual is that Dave guarantees lenders' returns out of his own personal wealth, i.e., Dave acts as the residual claimant or shareholder. As it happens, Dave donates his profits to charity, but that is entirely his choice. Were he interested in making personal profit from his bank like a typical bank shareholder, he would be entitled to do so. In short, for all practical purposes — although not legal or regulatory ones, and I will return to this subject presently — Dave is running a bank.
Investors in Dave's bank were offered interest of up to 5% AER (Annual Equivalent Rate) for those willing to make deposits that required a year's notice of withdrawal. Borrowers — and Dave targeted small businesses for the most part — paid between 8.9% flat (17.4% APR) and 14.9% flat (29% APR) depending on their credit assessment. Potential borrowers were assessed primarily using Dave's own judgment of their businesses' viability and their personal characters, and he then followed through with advice to help them run their businesses, all very old-fashioned. Dave's lending policy was highly successful, too: after a couple of years, 99.5% of borrowers had repaid in full.
However, Dave's bank also had a £25,000 a week lending target and additional customers were put onto a waiting list. So unlike Northern Rock in September 2007, people were queuing to put their funds in, rather than queuing to take them out — despite the fact that investors in the Bank of Dave had no protection under the Financial Services Compensation Scheme, the UK version of deposit insurance. Their only protection is their confidence in Dave and his business model, and their confidence that he would come through on his personal guarantee if it came to that. Moreover, since his bank is legally set up as a limited liability company, Dave's guarantee is not legally binding: his word is his bond. But that was good enough for those queuing up to invest in his bank.
But Dave's task to set up a "bank" was far from easy, if not downright Herculean, between the 8,000 pages of forms he had to fill in, the lawyers' bills and the £10 million minimum reserve that he was required to maintain to get his license.
According to The Guardian, as he went around the City, one expert after another poured cold water on his plans: "They told me that if I use the word deposit or say I'm a bank then I will go to prison." He was told that he had ideas "above his station" and didn't "have a chance." Someone else told him that, in the past, "if you went to the right school and had the right parents you might be considered a fit and proper person to go into the banking industry … [but] there is no evidence you are." He didn't have the right accent either.
As an aside, the "fit and proper" test is a real test. As the latest FCA handbook on the subject explains, the key criteria are "honesty, integrity and reputation," "competence and capability" and "financial soundness." Curiously, as applied by UK regulators in 2012, both James Crosby, whose aggressive risk-taking led to the collapse of HBOS, and Fred Goodwin, whose aggressive expansion led to the collapse of RBS, both easily met the test — perhaps because they had the right backgrounds and moved in the right circles — and were even awarded knighthoods (though since cancelled) for their services to the banking industry. Yet Dave, who clearly had these "fit and proper" qualities, was deemed not to have them because of his unconventional background. The "fit and proper" test is a joke.
Not to be deterred, Dave mounted a publicity campaign that got a lot of media coverage and elicited a huge amount of public sympathy. His campaign culminated in a Parliamentary hearing in the early summer of 2012, ably chaired by my friend Steve Baker MP (Con., Wycombe). The hearing room was packed and well attended by MPs. "Curious how TV cameras draw in the MPs like moths to a lamp," Steve said to me afterwards. Dave's message resonated with the audience: I am only trying to help my community but the regulators won't let me.
Dave's story also appeared in July 2012 on Channel 4's "Bank of Dave" documentary series, which chronicled the challenges he met at every turn. Reckoning he can't do any worse than the banks who lost fifty billion quid, he sets off to see expert after expert in the City, who tell him that he hasn't got a cat in hell's chance. The system is heavily regulated to protect the public, he was told — this at the time when the LIBOR scandal was in full swing and feelings were still raw from the bank bailouts. Dave isn't put off, however. "Sometimes it's far easier just to go and do something than to get permission," he says. He tries to get Richard Branson's phone number to put him right on the banking system. He tries to get the Bank of England's number by calling directory inquiries. He then gets through to the Bank switchboard. "Head of t'Bank of England," he asks. "Thanks … Threadneedle Street? And that's London?" And so on he goes from one hilarious encounter to another. By the end of the program, Dave has got nowhere.
The documentary got rave reviews, and so did a book, Bank of Dave: How I took on the banks, and another documentary, Dave: Loan Ranger, shown in January 2014, in which he successfully took on the payday lenders, which is another story in itself.
The publicity campaign put a lot of pressure on the regulators, who buckled eventually: they agreed to talk to him and, as Dave acknowledged, they couldn't have been more helpful guiding him through the regulations.
After all that effort, however, Dave never did get his banking license. Obtaining a consumer credit license to lend is not too difficult, but obtaining a deposit-taking licence is an altogether different matter. You see, deposit-taking is highly regulated in order to protect the public and is also subject to the "fit and proper" test that Dave did not meet: wrong side of the tracks, old boy.
The upshot is that he can run a bank but he may not call it one, and he can take in deposits but he is not permitted to call them deposits. His bank is formally known as Burnley Savings and Loans Ltd and is regulated as a peer-to-peer lender. The best he can then do is put "Bank on Dave!" over his shop window and invite regulators to take the V sign as read.
So has Dave's campaign prompted major deregulation to help other would-be Daves set up their own banks? Nope. As far as I can tell, the regulatory barriers to entry are just as high as they were before, so no joy there.
Can we conclude then that Dave's campaign was a failure? On the contrary. Dave has achieved not just one but three major successes.
First, his lampooning of UK banks and their regulators provides a far more effective critique of the system than any academic study could ever achieve.
Second, Dave provides those who would follow him with the perfect how-to guide. Basically, don't bother applying for a banking license, just set up your bank but watch your regulatory p's and q's so you don't land in jail: don't call your bank a bank and make sure that you call your deposits something else.
Last, the success of Dave's bank suggests a natural reform that would open up entry: allow anyone to enter the market provided that they accept personal liability toward investors and make it clear to their depositors that their deposits are not covered by the deposit insurance scheme. Such a reform would do away with all the pointless pretense — and the success of the Bank of Dave proves that the business model is viable. And if it would work in Burnley, believe me, it would work anywhere.
A review of one of Dave's documentaries says it all: "Up on a cloud somewhere, George Bailey is weeping tears of joy." (Andrew Billen, The Times)
Not bad Dave, not bad at all.