David Prosser: The long wait for better competition in British banking

Outlook Tesco is not the first company to which one would automatically turn when looking for a shot in the arm for market competition. But for those who hope the banking sector might one day become a little more competitive, the grocer has long been regarded as the great hope. It already has a hugely successful financial services business, owns a ready-made branch network courtesy of its supermarkets and, of course, has deep pockets. So, in 2008, when Tesco announced the appointment of Benny Higgins, a former retail banking executive at Royal Bank of Scotland and HBOS, as chief executive of Tesco's personal finance business, people started to get excited. And when Tesco was subsequently granted a full banking license, it seemed that a full-scale launch into the current account market from a player with the ability to take on the biggest banks was finally going to happen.

Almost three years later, we are still waiting for that launch. Tesco insists it will happen in 2012, but a growing number of banking experts are nervous. This week it emerged that Tesco has pulled back from several pilot schemes that saw it install bank branches in a handful of its shops, raising further doubts.

What explains the delay? Well, the financial crisis has slowed reform of the banking market, of course, and Tesco naturally wants to learn from its trials. But there is also the puzzle of how to make the economics of getting into current accounts stack up.

It is certainly true that no one, anywhere in the world, has been able to make supermarket banking work. It seems shoppers simply do not wish to combine their weekly food shop with a visit to the bank.

There is an even bigger problem, however. It is that the economic model on which the UK's current account market is built means new entrants of scale have to be prepared to put up with years of hefty losses. Customers of banks in this country have grown accustomed to paying nothing for their current accounts. They do so because the 20 per cent or so of customers who go overdrawn regularly – and particularly those who breach agreed limits or bounce cheques – incur fees and interest charges that subsidise the 80 per cent who don't.

A new entrant faces two challenges. First, it has to pay through the nose to acquire new customers – banks work on the basis that a current account customer costs £100 to get through the door – and then it has to sit back and wait until the 80/20 profile develops. It may be years before it breaks even – and the larger the operation, the bigger the losses incurred. For the likes of Tesco, there may be better opportunities for growth.

This is one of many dilemmas faced by Sir John Vickers' Commission on Banking, which iscurrently investigating how to improve competition in the sector. If Tesco feels obliged to take so long to make a move into current accounts, what about others, at least on any meaningful scale?

One option for Sir John would be to recommend the end of the free banking model. A new provider could not charge for accounts if existing players were not doing so, but if everyone had to scrap free banking, the barriers to entry might come down. Still, it would be remarkable if a commission set up to improve the outcomes for consumers from the banking experience were to conclude that the only way to do so is to make 80 per cent of customers pay for services they currently get for free.