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A useful little piece taken from a United Kingdom VAT & Duties Tribunals Decisions
Source : http://www.bailii.org/uk/cases/UKVAT/2005/V19238.html
COBE's business
COBE is licensed to provide credit and is regulated, within the UK, by the Financial Services Authority. Its business is run in much the same way as any other credit card business: its customers are issued with cards which entitle them to make purchases, and obtain cash advances, up to an agreed aggregate maximum amount. COBE is required to finance its customers' purchases by paying to the retailers and other suppliers, through the banking system, the cost of the goods or services acquired by the customer, less a charge—a variable percentage of the price—known as "interchange", and to make cash available, also through the banking system, to satisfy its customers' demands for advances. Monthly, customers who have any sum outstanding must pay to COBE an amount between a specified minimum and the total then outstanding. Those who do not pay the full amount are charged interest and COBE also levies some fees and penalties, for example for late payment by customers of the minimum amount. The interest, fees and penalties (that is, all of COBE's receipts from its customers, other than of capital) are together known as "finance charges".
Three characteristics of the credit card business are of relevance in this appeal. The first is the considerable amount of capital which is necessary. The second is the customer's right to make purchases, or obtain cash advances, without notice provided he remains within his agreed credit limit. The third is the fact that, in consequence, the amount of capital which is at any time outstanding (and, correspondingly, the overall sum owed to COBE by its customers) is variable. Although, as we shall mention later, some predictions can be made with reasonable accuracy and certainty about the behaviour of a large group of people such as the customers of a credit card bank, there are seasonal variations—particularly at Christmas—in the amounts those customers spend, and general economic conditions, wholly outside the issuer's control, may encourage or discourage spending, or increase or diminish the amounts which customers as a group pay in discharge of their outstanding balances each month.
A credit card company, like any other lending institution, earns its profits from the difference—the "spread"—between the amount it can earn, in the form of the interest and other charges due to it from its customers, and the cost to it of obtaining the funds used to pay for the customers' purchases and cash advances—its working capital. Although there are, we understand, quite wide differences between the amounts credit card companies charge their customers, tempered by special offers and discounts, there is nevertheless intense competition and, in consequence, continual downward pressure on the amounts which can be charged, particularly by way of interest. It is correspondingly in the companies' interests to minimise the cost to them of the funds they use. Credit card companies must, not least for regulatory reasons, have some capital of their own but they are not required to fund the entirety of their operations from their own resources. They may instead (and, in practice, almost all do) borrow some of their working capital.
While issuers which carry on other types of business in addition may draw on several sources for their capital—for example the UK clearing banks may use the sums kept by customers in their current accounts on which little, if any, interest is paid—"monoline" issuers (that is, those which have little or no other business activity) such as COBE do not have access to relatively cheap and plentiful funds. COBE has been able to accept retail deposits since September 2000, when it obtained regulatory approval to do so, but, because it is not a conventional high street bank, must always offer a significant interest rate in order to attract funds. Such companies may—as COBE has done—borrow from their parent companies, or they may borrow on the capital markets. The former course has two disadvantages: the parent may not have sufficient funds of its own and, even if it has, the regulatory authorities in both the UK and the US impose limits on the amounts which may be lent and borrowed in this way. COBE's borrowing from COBUS is restricted by the Federal Reserve to $550 million, too little to satisfy its needs. A simple borrowing on the capital markets is comparatively expensive for an institution such as COBUS, which has a much lower credit rating than a UK clearing bank, while COBE has no credit rating at all of its own and, if it were to borrow, would have to procure COBUS's guarantee of the loan. Even then, the Financial Services Authority ("FSA"), COBE's UK regulator, will not permit it to be over-reliant on its parent.
The credit rating of a financial institution, and of securities issued by such institutions and others (for example quoted companies) is determined by credit rating agencies, of which the best known are Standard and Poor's, Fitch and Moody's. The best possible rating (using Standard and Poor's system) is AAA, signifying that the risk of default is no greater than that on US government bonds. On the same scale, the lowest commercially recognised rating is BBB which, in the period with which we are concerned, was COBUS's rating. Unsurprisingly, the higher an institution's credit rating, the lower the interest rate it must expect to pay on borrowed funds; but an institution cannot (except over a comparatively long time) acquire a higher credit rating because of its track record, and even then there will be material, external, factors which it cannot control itself. In addition, COBE's credit rating, if it had one, would be adversely affected by its being a monoline business with no opportunity to offset losses from one activity against profits derived from another.
Source : http://www.bailii.org/uk/cases/UKVAT/2005/V19238.html
COBE's business
COBE is licensed to provide credit and is regulated, within the UK, by the Financial Services Authority. Its business is run in much the same way as any other credit card business: its customers are issued with cards which entitle them to make purchases, and obtain cash advances, up to an agreed aggregate maximum amount. COBE is required to finance its customers' purchases by paying to the retailers and other suppliers, through the banking system, the cost of the goods or services acquired by the customer, less a charge—a variable percentage of the price—known as "interchange", and to make cash available, also through the banking system, to satisfy its customers' demands for advances. Monthly, customers who have any sum outstanding must pay to COBE an amount between a specified minimum and the total then outstanding. Those who do not pay the full amount are charged interest and COBE also levies some fees and penalties, for example for late payment by customers of the minimum amount. The interest, fees and penalties (that is, all of COBE's receipts from its customers, other than of capital) are together known as "finance charges".
Three characteristics of the credit card business are of relevance in this appeal. The first is the considerable amount of capital which is necessary. The second is the customer's right to make purchases, or obtain cash advances, without notice provided he remains within his agreed credit limit. The third is the fact that, in consequence, the amount of capital which is at any time outstanding (and, correspondingly, the overall sum owed to COBE by its customers) is variable. Although, as we shall mention later, some predictions can be made with reasonable accuracy and certainty about the behaviour of a large group of people such as the customers of a credit card bank, there are seasonal variations—particularly at Christmas—in the amounts those customers spend, and general economic conditions, wholly outside the issuer's control, may encourage or discourage spending, or increase or diminish the amounts which customers as a group pay in discharge of their outstanding balances each month.
A credit card company, like any other lending institution, earns its profits from the difference—the "spread"—between the amount it can earn, in the form of the interest and other charges due to it from its customers, and the cost to it of obtaining the funds used to pay for the customers' purchases and cash advances—its working capital. Although there are, we understand, quite wide differences between the amounts credit card companies charge their customers, tempered by special offers and discounts, there is nevertheless intense competition and, in consequence, continual downward pressure on the amounts which can be charged, particularly by way of interest. It is correspondingly in the companies' interests to minimise the cost to them of the funds they use. Credit card companies must, not least for regulatory reasons, have some capital of their own but they are not required to fund the entirety of their operations from their own resources. They may instead (and, in practice, almost all do) borrow some of their working capital.
While issuers which carry on other types of business in addition may draw on several sources for their capital—for example the UK clearing banks may use the sums kept by customers in their current accounts on which little, if any, interest is paid—"monoline" issuers (that is, those which have little or no other business activity) such as COBE do not have access to relatively cheap and plentiful funds. COBE has been able to accept retail deposits since September 2000, when it obtained regulatory approval to do so, but, because it is not a conventional high street bank, must always offer a significant interest rate in order to attract funds. Such companies may—as COBE has done—borrow from their parent companies, or they may borrow on the capital markets. The former course has two disadvantages: the parent may not have sufficient funds of its own and, even if it has, the regulatory authorities in both the UK and the US impose limits on the amounts which may be lent and borrowed in this way. COBE's borrowing from COBUS is restricted by the Federal Reserve to $550 million, too little to satisfy its needs. A simple borrowing on the capital markets is comparatively expensive for an institution such as COBUS, which has a much lower credit rating than a UK clearing bank, while COBE has no credit rating at all of its own and, if it were to borrow, would have to procure COBUS's guarantee of the loan. Even then, the Financial Services Authority ("FSA"), COBE's UK regulator, will not permit it to be over-reliant on its parent.
The credit rating of a financial institution, and of securities issued by such institutions and others (for example quoted companies) is determined by credit rating agencies, of which the best known are Standard and Poor's, Fitch and Moody's. The best possible rating (using Standard and Poor's system) is AAA, signifying that the risk of default is no greater than that on US government bonds. On the same scale, the lowest commercially recognised rating is BBB which, in the period with which we are concerned, was COBUS's rating. Unsurprisingly, the higher an institution's credit rating, the lower the interest rate it must expect to pay on borrowed funds; but an institution cannot (except over a comparatively long time) acquire a higher credit rating because of its track record, and even then there will be material, external, factors which it cannot control itself. In addition, COBE's credit rating, if it had one, would be adversely affected by its being a monoline business with no opportunity to offset losses from one activity against profits derived from another.
