Virgin takes on high-street banking with Northern Rock buyout

As Richard Branson's Virgin Money acquires half of Northern Rock, can we expect some real innovation in the high-street banking sector, and value-for-money products? Simon Wilson investigates.

As Richard Branson acquires half of Northern Rock, can we expect some real innovation in the sector and value-for-money products? Simon Wilson investigates.

What's happened?

Virgin Money has bought the branch network "good bank" half of Northern Rock, the Newcastle-based mortgage lender that collapsed and was nationalised in 2007-2008. The price is an initial cash payment of £747m, a further £50m within six months of the deal completing, and a further payment of £80m if the bank is floated on the stock exchange within five years. The question now is whether Virgin, and its flamboyant boss Richard Branson, can breathe new life into the static world of British high-street banking, where five big players control 85% of the market.

What are Virgin's plans?

The overall strategy looks to be to consolidate Virgin's (post-acquisition) position as the seventh biggest bank in Britain by focusing on retail banking and lending. In Richard Branson's words, Virgin wants to "climb up the ladder through sensible growth" and "shake up the industry", as it did with the railways. As for branding, the name of the new venture is still up for grabs, with Branson suggesting he'll use social media to find out if customers would want the word "bank" in the new brand's name. What is certain is that the deal with the government involves a promise that the existing 75 Northern Rock branches will remain open presumably re-branded in Virgin's distinctive red and white style.

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What will change under Virgin?

Currently, even though Virgin Money's brand recognition is high, it offers a narrow range of banking products, including two "savings" accounts paying just 0.1%. When the deal is finalised and Northern Rock's one million savers and borrowers transfer to Virgin next year, the new bank is likely to offer more competitive deals across savings, credit cards, mortgages and investments, reckons Lucy Moore in the FT. Current accounts, however, will not be on offer until 2013. Indeed, so far the new entrants to the UK banking scene (Virgin, Metro Bank, Tesco and Handelsbanken) are notable for not offering the best value deals on loans and savings, despite their pledges to increase competition. That suggests it will be hard for Virgin to make a big impact, despite its phenomenal (near 100%) brand recognition.

What's its track record?

Patchy. The One Account, flexibly combining current account and mortgage debt, was a genuine breakthrough when it was introduced in 1997, and was championed by Branson himself. The Virgin Money credit card, thanks to a good deal struck with MBNA, has often been among the most competitive. But there have also been notable failures. When Branson launched his FTSE index tracking unit trust in 1995 it was touted as a refreshingly simple product charging just 1%. But it has failed to deliver on its core promise: to track the index. Since launch, the FTSE All Share is up 218%, while the Virgin product is up just 163%. Lots of other providers now do the job better for less.

Is Virgin in this for the long haul?

Possibly, given there are penalties if it exits. But if the past is anything to go by, there may be question marks over Virgin's long-term commitment. In 1997, when the One Account flexible mortgage (combining current account and mortgage debt) was rightly hailed as a genuine breakthrough, Branson declared: "we hope to turn the four big clearing banks into the four little clearing banks this account is going to be the most radical thing that's happened to the banking industry in the past 50 years". Four years later he sold his stake to one of the "big four", RBS. Moreover, Branson's main backer in the Northern Rock acquisition is a veteran US vulture fund specialist. He'll surely want a fairly quick turnaround and sale.

How have the other new entrants been doing?

Mixed. Sweden's Handelsbanken now has 105 branches in the UK. If most consumers have never heard of it, that's because it doesn't believe in aggressive promotion, but in word-of-mouth recommendation. The bank is deliberately growing slowly, and last year topped a customer satisfaction survey. From a standing start, Metro Bank has opened eight branches in the London area and has 40,000 customers attracted by the open-all-hours philosophy and personalised customer service. But given that 11,000 customers complain to their banks every day, Metro's impact has so far been limited. Yet even if executives at rival banks sneer at the upstart minnow, the slow progress belies Metro's "broader significance", reckons The Economist "its innovative use of technology shows how the main barriers to entry in British banking are now easily overcome". The Office of Fair Trading calculates that up to two-thirds of the start-up costs of a new bank are in its IT systems. Metro's deal with software firm Temenos lets it pay a monthly fee per customer, reducing up front costs and risk. Others may well follow.

How can Virgin shake things up?

To gain significant momentum, a new provider has to "offer best buys, or have an exceptional service proposition, or innovative products, or concentrate on niche areas", says Defaqto analyst David Black. "It is difficult to build up market share." Virgin faces a huge challenge, but really to shake things up, reckons Julian Knight in The Independent on Sunday, it should focus on three things. First, lending to first-time buyers. Second, offering inflation-proof savings. And third, creating a free mass-market current account with services attached that you would normally see with fee-charged packages. "It's going to be as interesting to see Virgin take on the big banks as it was the transatlantic airline carriers a generation ago." Get set for a bumpy ride.

Simon Wilson’s first career was in book publishing, as an economics editor at Routledge, and as a publisher of non-fiction at Random House, specialising in popular business and management books. While there, he published, a bestselling classic of the early days of e-commerce, and The Money or Your Life: Reuniting Work and Joy, an inspirational book that helped inspire its publisher towards a post-corporate, portfolio life.   

Since 2001, he has been a writer for MoneyWeek, a financial copywriter, and a long-time contributing editor at The Week. Simon also works as an actor and corporate trainer; current and past clients include investment banks, the Bank of England, the UK government, several Magic Circle law firms and all of the Big Four accountancy firms. He has a degree in languages (German and Spanish) and social and political sciences from the University of Cambridge.