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Case study

Internationalizing financial services in the European Union

In 1985 the European Commission published a White Paper, ‘Completing the Internal Market’, which proposed a series of measures to create a single internal market among the countries of the then European Community. This was codified in the Single Europe Act of 1986, the first major amendment to the Treaty of Rome (which had initially established the European Union in 1957). This Act required that the measures outlined in the 1985 White Paper should be implemented by the end of 1992, and included provision for mutual recognition of national product standards and a range of other measures to eliminate barriers to trade within the Union. The Single European Market formally came into being in 1993, underpinned by the ‘four freedoms’ – free movement of goods, services, labour and capital.
In the case of financial services, the single European market aimed to eliminate restrictions on cross-border activity, thus encouraging greater competition, greater efficiency, lower prices and better service for customers. Given the high level of regulation in financial services and considerable differences in industry tradition, the single market relied on the principle of mutual recognition – if a financial services provider was licensed to operate in its home market, then it was effectively free to provide services to consumers throughout the European Union.
Although formal legal restrictions on cross-border activity in financial services have been largely removed as a consequence of the Single European Act, progress towards a genuine single market in retail financial services has been slow. Genuine cross-border trade in financial services failed to grow substantially, and most providers serving non-domestic markets did so by establishing a physical rather than an export presence, with that physical presence typically being via mergers and acquisition rather than greenfield developments. In principal, there is no reason why many retail financial services need to be provided locally; in practice, most are. Take the case of a mortgage; while it is technically possible for a resident of Germany to obtain a mortgage for a house in Germany from a Spanish bank, in practice many customers are nervous of non-domestic providers with no physical presence in the market. Equally, banks may be concerned about lending into a different legal environment where it may prove costly to recover the security (i.e. the house) in the event of default. Differences in tax treatment and consumer protection legislation between countries may also serve as a disincentive to the purchase of savings and investment products across borders. In business markets, progress has been rather faster and the degree of integration is much greater, although considerable effort has been required to address areas such as capital adequacy requirements and accounting standards.
Recognizing some of the particular difficulties with financial services, the European Commission developed a Financial Services Action Plan (FSAP) in 1998 which focused on eliminating barriers to cross-border trade. The Action Plan concentrated on developing a genuine single market for wholesale financial services, creating open and secure retail markets, ensuring the continued stability of EU financial markets and eliminating tax obstacles to financial market integration. Considerable progress was made in relation to the wholesale markets; progress with retail markets was slow and the scale of crossborder activity remained low.
Subsequently, in December 2005, the Commission published a White Paper, ‘Financial Services Policy 2005–2010’, to outline its policies for the rest of the decade. The White Paper focused its attention on ensuring that existing policy changes were implemented and consolidated, improving regulation, enhancing supervisory convergence, increasing competition between service providers and expanding the EU’s influence in global financial services.

 
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Case Study

Centralized mortgage lending – a salutary story

The latter part of the 1980s in the UK witnessed the rapid birth, and almost equally rapid nadir, of what were termed centralized mortgage lenders. Names such as The Mortgage Corporation, National Homeloans and Mortgage Express came from a standing start to take of the order of 25 per cent of new mortgage business by 1990. Their success was based upon a combination of opportune timing and the unresponsive nature of traditional sources of mortgages, most notably the building societies.
In terms of good timing, the centralized lenders were able to take advantage of a period of time during which the cost of funds on the wholesale money market was cheaper than retail-sourced funds. Building society mortgages were largely funded by retail-sourced funds – indeed, there were strict limits on the percentage of their mortgage funds that could be sourced on the wholesale money market. Being centralized lenders, they had no branch infrastructure costs to carry and were able to administer new mortgage applications efficiently from one central administration centre. This gave them additional cost advantages which, together with lower funding costs, gave them a clear pricing advantage over their traditional rivals.
Three other factors worked together with their pricing advantage to give the centralized lenders a tremendously strong competitive edge. First, they were able to process new mortgage applications very fast (often within 24 hours, compared with the 4–6 weeks that was typical for building societies at the time). Speed is of the essence for the typical homebuyer as, once a desirable new home has been found, there can often be a race to cement a deal with the seller of the property. Secondly, the centralized lenders appreciated the importance of intermediaries, such as estate agents, mortgage brokers and insurance company sales agents, in placing new mortgage business. In the late 1980s, in the order of 60 per cent of new mortgages were placed with lenders via intermediaries. This resulted in a very low cost of new business acquisition compared with the branch costs of the traditional lenders. Recognizing the role of intermediaries, the centralized lenders focused their own new customer acquisition activities upon them. Thus, high volumes of new business were generated at low cost, and in a short period of time the newcomers were challenging the supremacy of a well-established incumbent industry. Thirdly, the centralized lenders brought product as well as service innovation to the mortgage business. They were able to use their treasury skills to provide new forms of interest rate management, such as fixed rate and ‘cap-and-collar’ loans.
They began to use securitization as a means of putting their loan books off balance sheet and thereby enhancing the return-on-capital to their shareholders. They introduced so-called deferred rate mortgages, most notably the 3:2:1 scheme, whereby the interest rate payable in the first year of the mortgage was a full 3 per cent less than the standard variable rate (SVR), reducing to a 2 per cent discount in the second year and 1 per cent in the third year. The ‘6 per cent’ deferred interest arrived at in this way was to be added to the outstanding loan at the end of Year 3, and the new, higher amount would be repaid at the prevailing SVR from Year 4 onwards.
The meteoric rise of the centralized lenders was also assisted by three factors external to their control. First, the house-purchase market in the UK experienced a sustained boom from 1985 onwards. Secondly, interest rates were falling steadily towards the end of that decade. Thirdly, in 1999 the Thatcher government gave advance warning that it was going to remove a tax-break known as ‘multiple MIRAS’. This had the effect of lighting the blue touch paper on a firework – the housing marketing rocketed property values to stratospheric levels.
Just as propitious timing had brought about the dramatic growth of centralized lending, so too did a set of negative economic factors result in its almost equally dramatic demise. During the course of 1990 interest rates began to rise – indeed, in little over a year the base rate doubled from 7.5 per cent to 15 per cent. Unsurprisingly, the housing market went from boom to bust within just a few short months. The centralized lenders’ price-edge evaporated, causing already declining sales to fall even faster. The rapid rise in interest rates caused hardship for borrowers, and mortgage payment defaults began to grow. At the same time, falling property prices rapidly eroded the margins of security of the lenders. To make matters even worse, many borrowers on deferred-rate mortgage schemes were among the defaulters. This meant that the interest outstanding grew rapidly and added to the losses that would be incurred as security margins disappeared. It should be borne in mind that the centralized lenders’ ‘asset’ base of mortgages was accumulated when property prices were at or near their historical peak, and that loan-to-value ratios were typically 90 per cent. In other words, the lenders had a margin of security of just 10 per cent, while between 1990 and 1992 the average property value fell by the order of 30 per cent. The outcome was that the new lenders withdrew from the market by ceasing to accept new business in order to limit further potential losses for their shareholders. All operational focus was upon damage limitation by acting quickly to gain access to whatever security remained in the valuations of properties in default. Repossessions rose sharply, and so did the financial losses of the centralized lenders.
Inevitably, it was the more ‘successful’ companies which had built the largest books of business that suffered most, and the majority of the high-profile lenders went out of business. Some of the smaller ones managed to survive, and have carried on at the margins of the mainstream business.

 
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Case study

Customer acquisition at HDFC Bank

Until the 1990s, the banking sector in India was dominated by two main groups – the public-sector banks and the international banks. The former dealt with the mass market, although the quality of products and services provided was generally considered to be poor. The latter focused on the more wealthy segments and were typically very selective in terms of accepting new customers. Liberalization during the 1990s paved the way for the influx of new private-sector banks, the first of which was HDFC, launched in 1995. The bank’s research had identified a significant middle-class market, which expected a high quality of service and was willing to pay for it. These customers were not prepared to tolerate poor service and long queues in the public-sector banks, but equally were less trusting of the international banks and less attractive to those banks because they were outside the very high-income brackets.
As a new entrant, HDFC needed to develop its marketing mix in order to target these customers and persuade them to switch to HDFC. The basic value proposition that underpinned HDFC’s approach was that of ‘international levels of service at a reasonable price’. Specific marketing mix decisions were as follows.

Product

To meet the needs of the chosen mid-market segment, HDFC offered a comprehensive range of banking services, comparable to the product range of international banks. This was supported by the targeting of specific products to sub-segments based on differences in needs, expectations and behaviours. Staff were recognized as being of considerable importance, particularly those on the frontline, and the bank paid particular attention to recruiting staff with good customer service skills.

Price

HDFC offered its initial bank account with the requirement for a minimum balance of Rs 5000 – significantly below the typical international bank requirement of Rs 10 000, and so significantly cheaper, but still higher than the publicsector requirement of Rs 500. This ensured that HDFC had the margin to support the delivery of superior service, while remaining significantly cheaper than the international banks.

Promotions

HDFC supports its product and service offer with the usual range of above and below the line marketing promotion, with direct mail, e-mail and SMS becoming increasingly important. A significant recent innovation has been the use of sophisticated analytical techniques to test and evaluate campaigns. This has enabled HDFC to gain a better understanding of how customers respond to marketing promotions and use this information to develop more effective campaigns in the future. In addition, this analysis has enabled HDFC to target its communications more effectively, thus reducing marketing spend and the costs of acquisition.

Place

HDFC focused attention on the 10 largest cities in India, which account for close to 40 per cent of the population, and concentrated on gaining maximum market share in those areas before expanding to other cities. The decision to operate with a central processing unit allowed the bank to keep the cost of establishing a branch network relatively low, and thus supported more extensive coverage (around 500 branches in around over 200 towns and cities). Alongside its branch network, HDFC also delivered its services via ATMs, phones, the Internet and mobiles to ensure that it met the diverse set of needs of its midmarket customers.
The success of HDFC is evidenced in growth rates of 30 per cent per annum and a string of awards from AsiaMoney, Forbes Global, Euromoney and many others.

 
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Case Study

A direct-mail campaign at ING Direct

Since bursting onto the scene in 2003, ING Direct has used its high-interest, hassle-free savings product to win the hearts and wallets of UK consumers. Demand has remained strong, and the company has become the world’s leading direct savings bank in a short space of time. However, a proportion of ING Direct’s customer base was flagged as ‘do not mail’. This was preventing the company from giving their customers the opportunity to hear about (and take advantage of) promotions and offers that might potentially be of interest. ING Direct is not alone in encountering problems with the ‘opt-out’ option. Many financial services companies believe that customers fail fully to understand the implications of ticking the box marked ‘do not wish to receive further marketing communications’.
At present, ING Direct offers only one product to the UK marketplace. Although the company’s customers are exceptionally loyal, with 98 per cent happy to recommend ING Direct (TNS surveyed 1934 customers in September 2004), any future product launches could be hindered by the number of optedout customers. The aim of this test campaign was therefore clear-cut: to open the door (and the letterboxes) to the potential of cross-selling across ING Direct’s existing customer base. To re-engage with these customers, the company needed to communicate directly and present a simple yet compelling reason for them to re-think their decision not to receive marketing communications.
‘After talking to our Royal Mail Key Account Manager, we discovered that a financial services company in a similar situation had used a mailing to achieve the success we were looking for,’ explains Sarah Barnes, Direct Marketing Manager at ING Direct. ‘So direct marketing, with its ability to reach and influence named individuals while minimizing cost, was the logical medium for us.’

The campaign objectives were as follows:

● to invite customers to opt back in to receiving marketing material

● to explain how they are currently missing out on future product and service news, as well as other offers and promotions that could be of interest

● to target a random 10 000 customers from the ING Direct database

● to encourage the target audience to complete and return a postal response or call the ING Direct call-centre

● to measure the campaign against three key criteria – response rate (%), cost per customer, and number of complaints received.

The company chose to mail a straightforward A4 folded letter, with a perforated reply slip, in a C5 branded envelope that promised ‘no catches with ING Direct’. The letter outlined the key benefits that customers would enjoy once they had decided to opt back in. These focused on being kept up-to-date with future ING Direct products, services and promotions. To illustrate the point, the letter spelled out that the customer may have already missed out on the chance to celebrate the company’s first birthday on board the Orient Express. The letter also reassured customers that there were no hidden catches – ING Direct never passes personal information to other companies, so customers would never receive unwanted communications from elsewhere.
‘Royal Mail worked very hard to help us with the campaign’, says Sarah Barnes. ‘As well as suggesting the mailing in the first place, they advised us on including a Business Response envelope to ensure maximum response, something we had not initially intended. We decided to use Mailsort 2, and are delighted with the results. The power of Royal Mail is clearly demonstrated by the fact that every single response was received by post – there was no telephone response whatsoever.’
ING Direct mailed 10 000 letters at a cost of some Ă‚ÂŁ9000. The campaign achieved an excellent response rate, which means that the company can now communicate its offers and promotions and cross-sell future products and services with more of their customers.

 
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