Supermarket sweep: banking at Tesco

Tesco's push into banking will worry many of the sector's biggest players, but it is fraught with risk for the supermarket group too. Sean Farrell reports
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Just what the banks needed. With their reputations battered by accusations of overcharging and misleading customers, and their balance sheets stretched by the credit crunch, along comes Tesco threatening to take them on with a full-service retail bank.

Britain's biggest retailer announced on Monday that it was buying out Royal Bank of Scotland's 50 per cent stake in Tesco Personal Finance (TPF). TPF will be put together with online sales and telecommunications to form a new retail services division targeting a jump in profit from less than £400m to £1bn.

Financial services make about half of the services division's profit now and are forecast to make a similar contribution as the business grows, meaning Tesco is aiming for a £500m annual profit from financial products. That would give it profits 25 per cent bigger than Alliance & Leicester achieved last year.

A banking industry source said Tesco had the potential to be a "significant competitor if they get their act together" in simple, lower-margin products, but that for anything more complex customers would go to a broker or their bank. "Supermarkets have threatened before. Ten years ago they promised a great deal but they never delivered," the source added.

Tesco underlined its ambition by putting its finance and strategy director, Andrew Higginson, in charge of the services division and hiring Benny Higgins, the former head of retail banking at RBS and HBOS, as chief executive of TPF.

Standard & Poor's yesterday cut its rating on Tesco's debt, citing an increase in the company's indebtedness and "a more aggressive financial policy adopted by the company".

The ratings agency said the TPF acquisition was not material because its profits were small compared with group profit of about £3bn. But S&P noted that "there is good potential to grow the business, as TPF's financial products are being offered through Tesco's stores and website and could leverage off Tesco's wide presence in the UK retail market."

TPF sells general insurance, credit cards and personal loans and personal savings and has an insurance comparison website and a cash-machine network. Tesco says its only major market shares are in car insurance and credit cards and that it can get much bigger in home insurance and savings. It is also likely to launch its own current account – the core retail banking product that generates the most sales of other services.

But, though loyalty to established banks has diminished, current-account customers remain notoriously resistant to switching. HBOS, Abbey and Alliance & Leicester have been trying to lure customers from the big four lenders for years, but even with the help of the Competition Commission they have barely dented the dominance of RBS, Barclays, Lloyds TSB and HSBC.

On the day of the announcement, Mr Higginson said Tesco could offer customers clearer, better-value products than those on offer from the banks. For instance, charges on current accounts were unnecessarily "labyrinthine", he said.

Tesco has 11 million active users of its Clubcard loyalty card and believes it can draw on the trust in its brand and knowledge about its customers to expand in financial services. It could be helped by the mauling the banks have taken in recent years as consumer groups and watchdogs have attacked charges and sales practices on current accounts, credit cards and protection insurance.

Yet Tesco's reputation has had its own problems, including increasing opposition to its dominance of the grocery market and its ability to squeeze small competitors and suppliers. Customers keep shopping at its near-1,800 UK stores, but an aggressive foray into banking could heighten the perception of Tesco as an overbearing giant.

Graham Hales, executive director at Interbrand, says: "The potential storm cloud on the horizon is people's perception of the power of the multiple grocers – at what point does Tesco become too big to risk a backlash?

"What happens if a Tesco loan [to a customer] is defaulting? That will cause issues with other areas... as to how happy you are to continue to engage with it as a grocery customer."

For the time being, RBS will continue to provide and underwrite insurance products, which make up the bulk of the business, and credit cards. But TPF will take the £1.6bn of personal loans and £2.7bn of savings balances on to its books.

Banking is a "pro-cyclical" business that inevitably suffers when the economy slows down, resulting in rising bad debts and demands for repayment of loans from unhappy customers. Tesco says its credit-card and personal-loan arrears are lower than the industry average and that it has deliberately stayed out of the mortgage market but could decide to go into home loans.

A Tesco spokeswoman says: "We are aware of some of the risks that have hit the banking sector and have taken precautions to avoid entering high-risk activities in the last few years. We choose our customers carefully and it is something we will continue doing."

How the other supermarkets offer personal finance

* Most of Britain's big food retailers have had a stab at financial services. Critics say that, despite the fanfare when Tesco and Sainsbury's launched their banking services more than a decade ago, the experiment has not paid off.

* Tesco Personal Finance launched 11 years ago as a joint venture with Royal Bank of Scotland. Tesco decided that the business needed one owner and is buying RBS out.

* Sainsbury's Bank is a venture between the supermarket chain and HBOS. Its products include insurance, personal loans and credit cards. The bank ran into trouble in 2006 after costs and bad debts soared and margins were squeezed.

* Marks & Spencer Money was set up in 1985 and was bought by HSBC in 2004. The bank and the retailer agreed to share profits 50:50 for 10 years after the deal. Products include insurance, savings and commission-free foreign exchange.

* Asda Financial Services sells products including general insurance and loans and credit cards supplied by GE, the US conglomerate.

* The Co-op's grocery and financial services arms have existed largely independently of each other but the group is bringing them together under its new "The Cooperative" brand and aims to sell more of its ethical financial products to retail customers.