With consumer faith in the banks at all all-time low, the supermarkets are ramping up their finance arms. But can they really compete with the banking behemoths?

The banking industry has never had it so tough. From the mounting debts, bad bets and sub-prime mortgage crisis that contributed to the global economic meltdown, to the negative publicity surrounding fat cat bonuses, mis-sold PPI and rigged Libor rates - it’s been a torrid few years for these behemoths of finance. But their nightmare run of form has opened the door to challenger finance brands - and leading the charge through that door are the supermarkets.

After dabbling in financial services for a number of years, the supermarkets have massively ramped up their activity in 2012. Just this month, Tesco extended its range of product services with the long-awaited launch of mortgages.

The move followed a frenetic July in which The Co-op agreed terms to buy the Lloyds TSB estate in a move that will make it the country’s sixth biggest high street bank Asda unveiled plans to expand its range of financial products with the addition of a new credit card and Marks & Spencer opened its first M&S Bank branch at its flagship Marble Arch store, with 49 more planned by the end of next year.

“The grocers are a pimple on the backside of a financial services elephant”

Clive Black, Shore Capital

Clearly the big supermarkets smell opportunity, but can they really take on the big high street lenders?

At the moment, the only player seen as having the experience and potential critical mass to take the fight to mainstream lenders is The Co-operative Bank, which is an established provider of 140 years and will control around 7% of the personal account market if the deal goes through. Despite having beefed up their presence in the financial services market to varying degrees over the past 25 years, the supermarkets are insignificant compared with the global banking powerhouses.

“The grocers are a pimple on the backside of a financial services elephant,” is Shore Capital’s Clive Black’s eloquent assessment. “Only Tesco has a chance of meaningfully registering, but even it may not flicker especially brightly by the end of the decade in mainstream banking.”

Black’s damning assessment is backed up by the figures. In its financial report for 2011/12, Tesco announced that Tesco Bank had enjoyed revenues of £1.04bn, yielding a trading profit of £168m. Compare this with the performance of Europe’s biggest bank HSBC, which makes 90% of its profits outside the UK, yet registered UK profits of £1.5bn in 2011 - significantly higher than even the revenues generated by Tesco Bank.

The flipside of this is of course that there’s plenty of scope for growth in the financial services market, which is a bigger and faster-growing sector than the food industry. That’s one of the reasons that Tesco launched four mortgage products earlier this month.

‘Mediocre’ products
On announcing the news, Tesco Bank chief executive Benny Higgins said: “Entering the mortgage market is a significant step in broadening the products we offer to Tesco customers. With a focus on serving Tesco customers for the long-term, we will take responsible lending decisions and have developed a mortgage business to meet our customers’ needs now and into the future.”

Despite Higgins’ bold claims, the reception from many financial consultants to the announcement has been lukewarm. That’s largely because of the way the retailer has priced its products, says Ray Boulger, a mortgage expert from John Charcol who describes the initial range as “fairly mediocre”.

“Saying your products are competitive on the basis they’re in line with or better than average is irrelevant in my book”

Ray Boulger, John Charcol

“The pricing is about half a per cent dearer than most competitive products in the market and although Tesco can say that their products are competitive on the basis that they are in line with or better than average, that’s irrelevant in my book because people don’t buy the average, they buy the best product available to them,” he says.

That said, Tesco may just be testing the water - and its own systems - with a view to beefing up its offer and improving its pricing further down the line, he notes. “For a company of Tesco’s size to come into the mortgage market, it seems to me to be a bit pointless unless they have a reasonable appetite for it, because if they’re only going to play at it by lending half a billion pounds a year that’s going to have virtually no impact on their profit and loss.”

The supermarkets banking on success

Tesco is by far the biggest grocery player in the financial services market. Its banking revenue for the past financial year increased 13.6%, with baseline profits up 29.3%. The addition of mortgage products this month should see its revenues and profits increase over the next few years, although some mortgage experts have questioned the high rates it is charging on its introductory products. Another criticism is that Tesco isn’t using specialist brokers at the moment - customers can only apply for the products directly either via the internet or over the phone. The next move for Tesco looks set to be personal accounts, but it isn’t expected to offer this until late next year.

Sainsbury’s Bank launched in 1997 and today it operates as a 50/50 joint venture with the Bank of Scotland. In its latest set of figures, Sainsbury’s share of the bank’s post-tax profits was £16m - an increase of 40% on the previous year and the fourth consecutive year of profit growth. As for the future, a Sainsbury’s spokesperson says it is “continually reviewing our product suite and innovating with new products and services”. However, it “does not have any plans to open branches - our customers already have the convenience of our online banking service, a large ATM estate, in-store Travel Money Bureaux and our in-store Save Back service”.

Asda started offering financial products 10 years ago. Last month, it unveiled its new financial services brand Asda Money and in June it launched its new Energy Compare and Save service. Key to Asda’s new service offer is the Asda Money Credit Card, which offers a competitive APR of 14.9% in addition to 1% unlimited cashback on Asda shopping and fuel and 0.5% unlimited cashback on shopping outside Asda. Transparency and simplicity are key to the new credit card launch, says Kirsty Ward, head of Asda Money. Although she doesn’t rule out a move into mortgages, she concedes that it’s an area in which it’s “difficult to deliver good value to the customer”.

The M&S Money brand was founded in 1985, with 100% of the share capital of Marks & Spencer Financial Services (the trading name of M&S Money) bought out by HSBC in 2004. Today, M&S Money operates as a 50/50 joint venture between HSBC and M&S, although the Money brand will be replaced later this year by M&S Bank. The partnership opened its first M&S Bank branch last month and plans to open 50 branches by the end of 2013. M&S Bank will start offering current accounts this autumn, with mortgages introduced at a later date. According to M&S CEO Marc Bolland: “This bank will be built on M&S values: putting the customer at the heart of the proposition.”

If Tesco is serious about the mortgage market, it could easily be doing as much as £4bn worth of business a few years down the line, he adds, which would make Tesco Bank around the eighth biggest lender.

It already has the largest financial services arm of the grocers, but its rivals are coming up hard on the rails. One area that Tesco has been reluctant to move into to date is standalone or in-store bank branches, with M&S stealing a march on its rival with he launch of its first M&S Money branch in London last month.

‘Natural extension
M&S Money operates as a joint venture between HSBC and the retailer and will be rebranded ‘M&S Bank’ later this year in a move that Colin Kersley, CEO of M&S Bank, describes as a “natural extension”.

“M&S Bank has been designed specifically to meet the needs of M&S customers with the focus of bringing retail customer service to banking,” says Kersley. “It will also deliver increased convenience, with in-store banks open the same hours as M&S stores, enabling customers to bank in the evening and over the weekend, including Sundays.”

M&S is also eyeing another service with interest. “There are plans for an M&S mortgage, but this won’t be before next year,” reveals Kersley.

Asda is more circumspect about mortgages. It beefed up its financial services offer in July with the new Asda Money arm offering customers a credit card with a competitive APR and generous cashback scheme.

“A supermarket with 18 million shoppers each week has a great opportunity to provide more convenience”

Kirsty Ward, Asda Money

The ethos behind the retailer’s financial services offer is to “use the buying power that we’ve got and the expertise around what our customers want and then provide something that delivers good value for money for everybody”, says head of Asda Money, Kirsty Ward.

It may consider mortgages in the future, she adds, but there’s plenty of scope to grow in other financial service areas first - and you have to learn to walk before you can run.

“Clearly a supermarket with 18 million shoppers each week has a great opportunity to provide more convenience to shoppers by giving them more services,” she says. “We will continue to look at how we can expand what we do within Asda, but we are very conscious that we’ve got to get it absolutely right because we’ve got a big shopper base so it would be a case of ‘watch this space’.”

Tesco, which like Asda is currently going it alone rather than in joint venture with a mainstream bank, has no such qualms on the mortgage front and also intends to add lucrative current accounts to its financial products mix. However, it is one of many companies currently seeking clarity from the government on plans to make transferring accounts from one bank to another much easier, something Shore Capital does not expect the industry to get until late next year.

Only the supermarkets that offer current accounts will be in a position to really start cashing in on the public’s distrust of the established banking behemoths, suggests retail analyst Nick Bubb.

“With the reputation of the High Street banks in tatters, there is a big opportunity for trusted retail brands to capitalise on consumer discontent,” he says. “There is still a lot of ‘inertia’ to overcome, in getting people to move bank accounts, for example, but the big supermarkets have the regular footfall to do well in this market.”

Avoiding confusion
That said, retailers will need to take care that their move into banking services doesn’t backfire through “poorly executed offers or services creating negative PR”. It’s a concern that’s shared by Shore Capital’s Clive Black, who has mixed views on the grocers’ chances of success.

“Selling baked beans is one thing, selling financial products is another,” he says. “The regulatory environment is also now a minefield. Margins are not exactly fat in such markets so it would be wrong to believe this market is low risk and high margin. That said, if done right it can be a high-return market in the medium term if meaningful products and scale can be generated.”

To deliver “meaningful products” will require a significant cultural shift in how the grocers pitch their non-food offers, according to Richard Hyman, strategic advisor to Deloitte.

“They have got strong brands and strong relationships with their customers, so they do have opportunities to sell lots of other products and services, but those products and services are by definition not food and in order to truly succeed they have to truly change their spots,” he argues. “That’s not about branding, packaging or semantics. It’s a matter of actuality, of embracing these other markets, understanding what the customer wants in those areas and learning how to deliver it in the way the customer wants it - not as though it’s bread, bananas and baked beans.”

The Co-op is poised to make the leap next year into banking’s premier league and the mainstream grocers are more than capable of following suit, believes Hyman. “They can do it and they are doing it,” he says. “The question is are they really going to be able make a difference and create serious profitable scaleable and sustainable business in those areas? And the answer is that they’re not unless they can become like the kind of bank that the customer of today really wants.”

That bank needs to offer good-value products that are competitively priced and are provided by a tried and trusted high street brand - a definition of service not far removed from what the supermarkets offer in food.

If appetite really is there to do the same in banking, the supermarkets won’t be “pimples” for long. They could soon be among the elephants in the banking herd.

The Co-op’s “deal of the millennium”

When news broke that The Co-op had agreed terms to snap up 632 branches from Lloyds Banking Group for £750m, BBC business pundit Robert Peston tweeted that the retailer had secured the “deal of the millennium”.

If the deal is approved by the Financial Services Authority, which it is fully expected to be by the end of November 2013, The Co-op will have just shy of 1,000 branches and provide a genuine alternative to the major lenders, according to Rod Bulmer, managing director of retail at The Co-operative Banking Group.

“Through this deal, we would be the sixth-largest bank on the high street with around 7% of today’s personal current account market and one that is capable of being a strong challenger bank, as recommended by the Independent Commission on Banking,” he says.

When the deal completes, Lloyds Banking Group will rebrand the 632 Verde branches, including Cheltenham & Gloucester, as TSB. The TSB brand would then exist under The Co-operative Banking Group umbrella.

The exact strategy that the merged operation will take going forward is unclear at this stage, but John Charcol mortgage expert Ray Boulger predicts significant changes and challenges on the cards for the retailer.

“One of the problems that we’ve seen in the past with major banking acquisitions is integrating existing branch networks with new branches,” explains Boulger. “This will be a big problem for The Co-op. There’s quite a challenging integration process there and that will no doubt take a few years to bed in.”

Despite Boulger’s reservations, Bulmer is confident that the Lloyds deal will be a defining moment for The Co-op.

“This has helped strengthen the trust customers have in our brand at a time when the integrity of some rivals has been questioned,” says Bulmer. “We offer a compelling alternative. This deal would make us more substantial and help us in providing that compelling alternative to more customers.”