Lloyds banks on current account gamble

Britain's biggest retail bank ups the ante but will its high street rivals have to follow suit?

Lloyds TSB, Britain's biggest retail bank, has either fired the opening shot in the mother of all current account battles or it has just shot itself in the foot.

Judging by the reaction of its rival's to the bank's market-beating offer of 3.2 per cent interest for its 10 million current account holders, it could be the latter. Lloyds' high street competitors claim to be unmoved by last Wednesday's announcement. So, is Lloyds exposed and facing further erosion of its profit margin, or will the rest of the Big Four be forced in the end to follow suit?

Royal Bank of Scotland, the second-largest current account provider with 17 per cent of the market, yesterday denied reports it was about to buckle under pressure and launch its own version of Lloyds' offer.

Lloyds surprised the market last week by unveiling a current account with a new, dramatically more generous, scale of interest payments, up to 3.2 per cent for those paying £2,000 a month into their account.

RBS's sentiment was echoed by Barclays and HSBC, with all of them sticking to the line that customers are not bothered about being paid next to nothing ­ 0.1 per cent ­ in credit interest.

A spokeswoman for RBS, which also owns NatWest, said: "Independent research suggests accessibility and quality of service is twice as important as credit or overdraft interest rates for customers."

It might be fighting talk by the banks. But many in the City believe it is only a matter of time before they accept the inevitable that, after slogging it out on mortgage pricing for the past couple of years, current accounts are the sector's new battle ground.

Rob Down, an analyst at Morgan Stanley, said: "The Lloyds announcement was more significant than was suggested by the stock market's reaction. Current accounts was the area where there was still a loose agreement among the banks on pricing. This is no longer the case."

Even so, the Big Four, which together control 75 per cent of the current account market and were accused by Don Cruickshank's report on the sector of behaving like a monopoly, will not be keen to rush headfirst into a pricing war in their key territory of current accounts.

Martin Cross, an analyst at Teather & Greenwood, said: "We think the Lloyds move will cost it between £50m and £100m a year by 2004. For banks which make between £2bn and £4bn in profits, a cost of £50m is not that significant. There will be bigger issues in banking reporting season such as bad debts."

The turmoil of global stock markets and the slew of high-profile corporate collapses of last year will no doubt grab the headlines as the banks report their full-year results over the next three weeks. But the line up of chief executives now in charge of the UK's major high street lenders know that they cannot ignore their retail banking businesses.

One banking source said: "Banks are wondering where the growth is going to come from. At the moment, due to the state of the market, wholesale banking is not expanding because no one is making any money in the capital markets and investment banking is very weak. Retail banking is the only place to find growth. But how do they get it? It has to be a mixture of cutting costs and trying to attract new customers by offering them good products."

Lloyds, the fastest-growing retail bank in the late 1980s but more recently seen as a stagnant giant, appears to have put its core retail business at the top of the agenda again. Eric Daniels, currently head of retail banking, was the mastermind behind last week's announcement and has been chosen to replace Peter Ellwood as chief executive of Lloyds in May.

Abbey National, which last year shocked the market by revealing heavy losses in its wholesale division, appointed Luqman Arnold as its new head at the end of the year on a ticket of refocusing the group on its core mortgages and savings business.

Abbey and HBOS have already upped the ante in the current account market. HBOS led the way in January 2001 by being the first significant bank on the high street to introduce a strongly competitive current account, which pays 3 per cent to customers who pay in £1,000 or more a month, and Abbey followed a year ago.

The Lloyds deal is less straightforward ­ customers are only eligible if they register online and log-on twice a month to the internet. The bank will also not pay its top whack of 3.2 per cent interest on balances above £5,000.

Cynics say copying a deal with this number of caveats would not exactly cause serious distress to finance for the rest of the Big Four. But the move ­ the first breaking of ranks by a member of the Big Four ­ could lead to a cascade of price slashing.

Mr Down of Morgan Stanley said: "Two or three years ago analysts would say banks' margins would not fall because what they did in one area they could always make up for in another. That is not the case now.

"The danger from the banks' point of view on what Lloyds did is that it could be a slippery slope. Lloyds has a number of savings products which pay less than 3 per cent, which they may feel they have to reprice as well. For all the major banks, repricing the entire retail liability on their balance sheets could be very painful indeed."

Clearly, this is a scenario neither Lloyds nor its main competitors would be keen to pursue and they know they can rely on customers' inertia to save them from a bloodbath of having to slash profit margins across their retail business.

One source said: "Some of the Big Four are notorious for taking advantage of people's inertia and they have customers who are among the least sensitive to issues of value."

The assertion is hotly contested by Lloyds and its main rivals. Tony Gibbons, head of current accounts and savings at Lloyds, said: "I am always surprised when people say banking in the UK is not competitive. It is incredibly competitive and our customers are not inert ­ if we offered them poor value they would not stay with us."

The story is slightly different from the smaller players trying to crack the Big Four's vice-like grip on current accounts. Simon Chrisp, Abbey's head of banking marketing, said: "There is a lot of inertia. There are some really great products out there and I am always surprised that more people are not prepared to change."

Nevertheless, pressure from Abbey and HBOS and others clearly is having some effect on the Big Four, along with a change in the Banking Code last year which made it much simpler and quicker for disillusioned customers to switch to new current account providers.

Abbey said 60 per cent of its new current account customers last year came from Big Four rivals. HBOS said it won 25 per cent of the new current account market in the first six months of last year and First Direct, the internet and telephone bank owned by HSBC, says it adds "more than 1,000" new customers every month.

Lloyds said its move was more to do with attracting new customers than trying to stem a tide of existing ones leaving. The argument did not convince the City, which saw it primarily as an attempt to stop some of its most valuable customers, namely those who stay in the black for most of the month, from moving to more generous rivals.

One source said: "The strategy has been in UK banking to expand by acquisition, slash costs and rely on customer inertia. They cannot ignore the fact now that that strategy has reached the end of the road."