Complicated pricing for simple products?
Adrian Coles, director-general of the Building Societies Association, calls for more simple savings products
I have written previously in Mortgage Finance Gazette (March 2012) about the initiative by Mark Hoban MP, financial secretary to the Treasury, to bring simplicity to the market for some basic financial products.
A working group, chaired by Carol Sergeant, a former senior Financial Services Authority official, has been convened to look initially at simple deposit products and simple protection products. Obviously, BSA members are most interested in deposit products.
As I explained in my previous comment there is a concern that there are too many complexities in the terms and conditions of many deposit products with consumers expected to do too much research to make an informed comparison and decision.
There is a feeling that if only we could have a suitably branded (perhaps kite-marked) product with the same name, and same terms and conditions, across all institutions, offering fair, decent, value for money characteristics (but, perhaps not necessarily, best-buy rates), this would represent a considerable advance in enabling consumers, especially those not currently well informed or confident, to understand the market better.
The overall objective is to have simpler products that people can understand better; this will lead to greater confidence and a greater likelihood of people engaging with and staying with the savings habit.
One of the issues surrounding the design of any deposit product that might be able to earn such a kite mark is the nature of the pricing. Obviously, competition legislation prevents firms agreeing that the interest rate will be say X per cent or Y per cent, but there is an issue that arises on the structure of pricing.
Should a product be deemed worthy of a kite-mark if it features bonus rates, condemned in many parts of the media because of the perceived need for consumers either to move their money after, say, a year, or to suffer a very low post-bonus rate?
Alternatively, is it better not to include a guaranteed bonus in the product specification, but to encourage institutions to offer a good-value, long-term sustainable rate, while giving the institution the ability to vary the rate over time?
The sceptical consumer might allege that too many institutions have used their ability to vary rates to reduce the return to negligible levels, arguably, without making this fully clear to the consumer.
Perhaps the compromise might be to allow a firm to vary interest rates, but only within certain parameters, and based on an external reference rate, such as Bank Base Rate?
The consumer would always know they were getting a fair deal, reassured that the bank or building society would not suddenly decide that it had to widen its margin (or create the leeway to introduce a new product) by significantly reducing the rate of interest payable on existing savings.
Customers could make their decision on the basis of the interest rate paid, and their perception of the service and the brand of the institution offering the product. They would be secure in the knowledge that they would not have to constantly worry that they had missed the date on which the bonus - and the bulk of their interest return - disappeared or that the institution would manipulate the rate downwards so that a low rate of return had replaced the previous attractive rate of return that they thought they would always receive.
However, such an arrangement might not be to the advantage of the product provider. There is a risk that if product providers lose the freedom of action to vary their rates of interest at will this could potentially be dangerous. The post-crisis world appears to most institutions to be more unpredictable and risky than the world that we thought existed pre-2007.
Firms perceive the need to maintain maximum flexibility in relation to interest rate setting. If firms have tied themselves down with rate guarantees, their ability to react, to say, a sharp increase in levies from the Financial Services Compensation Scheme or a significant increase in losses on mortgage portfolios is constrained.
Indeed, in recent years, some building societies (and banks) have suffered considerably as a result of the interest rate guarantees that they had offered on particular tranches of mortgage business, inhibiting their ability to increase mortgage rates in a way that would enable them to react to competition in the savings market. Undated, unfloored, mortgage rate trackers at 0.5 or 1 per cent above base rate are an obvious example.
It is not easy – but also not impossible – to see a way through this conundrum. Consumers want certainty, reliability and trustworthy behaviour on the part of their institution in setting rates.
On the other hand, firms want the ability to manage their balance sheet and their margins in such a way as to enable them to react successfully to conditions of unexpected or extreme stress in the market, or regulatory, environment.
Marrying together these two requirements in such a way as to offer consumers products they want, that providers can afford to provide, while keeping the products simple and straightforward, and providers prudentially sound, will not be easy.
On the other hand, the prize of contented customers depositing with safe, trustworthy, institutions is considerable and there is every incentive to work on, and solve, this problem.