Chapter 4
Assessing competition in the Australian banking market
Overview
4.1
The Committee agrees with Treasury that:
Competition is the cornerstone of efficiency and productivity
in any market. It promotes fair prices, enhances living standards and ensures that
scarce resources are allocated to their highest value uses.[1]
4.2
The extent of competition in the Australian banking industry has been
examined in two recent reports by the Senate Economics References Committee.
Some observations from these reports are:
The Australian banking market is dominated by four large
banks, now accounting for around ¾ of the market. This has resulted from a
series of mergers going back more than a century.[2]
A consequence of these mergers has been a long-run tendency
towards increased concentration within the Australian banking industry. There
was a temporary reduction in concentration with the deregulation of the 1980s,
mostly reflecting the entry of foreign banks and conversion of the larger
building societies, but this has now been overwhelmed by the ongoing mergers.
As a result the Australian banking market is now, by some criteria, the most
concentrated it has been for more than a century...The Australian banking market
is now quite concentrated by international standards. This is likely to be one
reason it is more profitable, and has wider interest margins, than banks in
most comparable countries...[3]
4.3
There are a number of metrics by which the state of competition can be
assessed. As Treasury and NAB explained:
These include market share, pricing, profitability, market
contestability and product innovation. An assessment of the state of
competition in banking requires consideration of all these indicators, and none
of these indicators should be used individually as an exclusive and definitive
indicator of the state of competition in the banking sector.[4]
...two critical measures, and this is how our investors look at
it: what is the return on the equity that our shareholders have put into the
business and what is the return on assets?[5]
4.4
These and other indicators are assessed in this chapter.
Number of products available and competitors
4.5
The banks often defend the state of competition by pointing to the
number of players and products.[6]
It is true that there are a large number of lenders and deposit‑takers in
Australia:
Australian banking customers are currently served by a wide
range of providers. These include 12 Australian-owned banks; 9 foreign-owned
bank subsidiaries; 35 foreign bank branches; 11 building societies and more
than 100 credit unions. Further, there are currently around 111 providers of
over 2,200 mortgage products; 66 providers of over 420 different credit cards;
and 114 providers of over 992 different types of deposit account.[7]
4.6
This indicator, however, also shows a sharp decline in the number of
providers and products available in recent years:
In October 2007, the Australian mortgage market was serviced
by over 150 financial institutions offering over 2,117 home loan products. In
November 2010, this had fallen to 100 financial institutions offering 1,600
products.[8]
4.7
The more important point is that the number of competitors is not a good
indicator of competition:
...an industry with four participants...can be either a tightly
organised cartel gouging customers or highly competitive; the number of
participants in the industry is not the important thing.[9]
4.8
There are hundreds of corner stores competing with Coles and Woolworths
but this does not mean that these two stores do not dominate grocery retailing.
In the same way, the four major banks dominate the banking market,
notwithstanding a long tail of small financial organisations.
Intensity of competition
4.9
More relevant, but harder to quantify, is the intensity of competition
between banks. As noted in earlier chapters, National Australia Bank has
recently adopted a more competitive stance but only on certain products and it
is unclear how long it will be sustained. Occasional bouts of heavily
advertised 'competition' are not sufficient to demonstrate a truly deep-seated competitive
ethos.
Measures of concentration in the Australian banking market
4.10
There are two common measures of market concentration. The first is
simple; the market share of the largest three, four or five firms.
4.11
In Australia, the four major banks now dominate the Australian banking
market, accounting for around three-quarters of deposits and assets and a
larger share of home loans (Table 4.1, last row and Chart 4.1). One witness
referred to the market as 'almost a quadropoly'.[10]
Chart 4.1: Share of
owner-occupier housing loan approvals
Source: Reserve Bank of Australia, Statement on Monetary Policy,
February 2011, p 49; update of chart in their Submission 41, p. 5.
4.12
The weakness of this measure is that it is rather arbitrary how many
firms are included, and it can make a difference to the results. For example,
Westpac's takeover of St George (then the fifth largest bank) added
significantly to the market share of the 'four largest' banks, but had little
effect on the share of the 'five largest'.
4.13
A preferable measure of concentration is the Herfindahl-Hirschman
concentration Index (HHI). This is calculated by summing the squares of the
market shares (expressed as proportions). This means the measure can vary from
0 representing perfect competition to 1 representing monopoly.[11]
A market with X equally-sized competitors will have an index of 1/X.
4.14
Professor Sathye suggested 0.18 represents a 'red light', over which the
index is indicating a worrying degree of concentration.[12]
The ACCC uses 0.2 as a guide.[13]
Table 4.1: Measures
of concentration in Australian banking market
| |
Assets |
Deposits |
Home loans |
|
Share of 4 largest
banks |
HHI |
Share of 4 largest
banks |
HHI |
Share of 4 largest
banks |
HHI |
|
1890 |
0.34 |
.06 |
|
|
|
|
|
1913 |
0.38 |
.10 |
|
|
|
|
|
1950 |
0.63 |
.14 |
0.64 |
.15 |
|
|
|
1970 |
0.68 |
.16 |
0.68 |
.16 |
0.771 |
.211 |
|
1990 |
0.66 |
.12 |
0.65 |
.12 |
0.65 |
.13 |
|
Oct 2008 (pre-mergers) |
0.65 |
.11 |
0.65 |
.12 |
0.74 |
.15 |
|
Oct 2008 (post-mergers2) |
0.73 |
.14 |
0.75 |
.15 |
0.86 |
.20 |
|
February 20112 |
0.773 |
.163 |
0.78 |
.16 |
0.87 |
.21 |
1 Assuming all owner-occupier housing loans were made by
savings banks and accounted for all their loans. 2 Counting
BankWest and St George as parts of Commonwealth and Westpac respectively. 3
Not consistent with previous statistics due to reclassification by ANZ
and Commonwealth.
Source: Secretariat, calculated
from data in APRA, Monthly Banking Statistics, October 2008, February
2011; RBA Bulletin, June 1990; Butlin et al (1971), White (1973).
4.15
The extent of concentration is attested to by some witnesses
representing small business:
Currently, the major banks are providing two thirds of
business credit. SEN research shows that 90 per cent of WA small businesses
have applied for finance from the big four banks.[14]
4.16
As illustrated by Charts 2.1 to 2.5, the major banks have essentially
grown their market share over the past century by successively taking over the various
banks and building societies established in the previous century.[15]
This is reflected in a long‑run tendency towards increased concentration
(Table 4.1), only temporarily interrupted in the 1980s by the entry of foreign
banks and conversion of the larger building societies. Australia's banking
market is now, by some criteria, the most concentrated it has been for more
than a century.
4.17
The Australian banking market is also now quite concentrated by
international standards (Table 4.2, Chart 4.2).[16]
Table 4.2: Measures
of concentration, 2008
| |
Concentration measures (based on assets)1 |
|
% share of 4 largest banks |
HH index |
|
Australia |
84 |
.19 |
|
Canada |
76 |
.17 |
|
France |
82 |
.21 |
|
Germany |
47 |
.10 |
|
Japan |
57 |
.10 |
|
Netherlands |
97 |
.33 |
|
Sweden |
99 |
.30 |
|
Switzerland |
82 |
.32 |
|
UK |
84 |
.21 |
|
United States |
<59 |
<.10 |
1Only
includes domestically-headquartered banks which rank in the world's top 1000. In
Australia this includes nine banks accounting for 80 per cent of the market.
Sources: Secretariat, calculated from data in The
Banker, July 2009; Bank for International Settlements (2009, p 39).
(Comparisons in 1980 and 1990 can be found in Senate Economics References
Committee, Report on bank mergers, September 2009, p 7.)
Chart 4.2: Share of
assets held by three largest banks (average 2000-2008)
Source: Treasury, Submission 102, p 13.
4.18
This is likely to be one reason the Australian banks are more
profitable, and have wider interest margins, than banks in most comparable
countries (Table 4.3), although this also partly reflects that it has fewer non‑performing
loans. Australian banks' operating costs are not especially low.[17]
4.19
The Australian banking market is commonly regarded as an oligopoly:
The banking sector, like a number of other sectors in
Australia—maybe because of size and population—have those tendencies of
oligopolistic markets...we should continually keep such markets under
surveillance or oversight to ensure that consumers get the best results or
outcomes from those markets.[18]
Table 4.3: Profitability
of banks (% to assets, 2009)
| |
Pre-tax profits |
Net interest margin |
Net gains from trading |
Net fee income |
|
Australia |
0.9 |
1.9 |
0.1 |
0.5 |
|
Canada |
0.7 |
1.7 |
0.1 |
0.9 |
|
France |
0.2 |
1.1 |
0.3 |
0.4 |
|
Germany |
-0.0 |
0.8 |
0.2 |
0.4 |
|
Japan |
0.3 |
1.0 |
0.1 |
0.3 |
|
Netherlands |
-0.1 |
1.2 |
0.0 |
0.4 |
|
Sweden |
0.3 |
1.0 |
0.3 |
0.4 |
|
Switzerland |
0.2 |
0.6 |
0.6 |
0.9 |
|
UK |
-0.1 |
0.9 |
0.5 |
0.5 |
|
United States |
0.4 |
2.7 |
0.3 |
0.7 |
Source: Bank for International Settlements (2010, p 29).
4.20
An oligopoly does not necessarily prevent strong competition but it does
make it less likely:
You could have one of the big banks providing intensive
competition if they so chose, and to some degree NAB is providing some level of
tension. However, in an oligopoly structure, there is little incentive for one
of the players to be aggressive because, all that does is cut their profit
margins over time. They simply fall into a cosy club arrangement. So what you
need is those independent competitors who, for lack of a better word, disrupt
the oligopoly... Even within an oligopoly structure, one of the oligopolists may
engage in periodic bouts of competition or, as I describe it, the odd angry
shot... but will that continue over time? [19]
Competition can be strong in quite concentrated markets and
weak in markets that are not highly concentrated. There is nevertheless a
tendency, all else equal, for markets to be less competitive when more
concentrated.[20]
Economies of scale in banking
4.21
Economies of scale can be a force promoting concentration in banking,
and hence reducing competition. The Reserve Bank comment that:
While a larger bank can, in principle, spread fixed costs
across a greater range of activities, thereby taking advantage of economies of
scale, larger institutions also suffer some diseconomies of scale (e.g.
difficulties associated with governance).[21]
4.22
Some submitters stressed the importance of economies of scale to
differing extents:
In order to survive in the long term, banks need a certain
scale to dilute their fixed costs and they need effective diversification both
of assets and liabilities to ride out the peaks and troughs of the business
cycle. This becomes a virtuous circle, with large and diversified banks
rewarded by better credit ratings that more enable them to expand further. A
viable bank is naturally a big bank. As a result, banking is a natural
oligopoly. Given the size of the Australian economy, four banks seems about
right. It would not be wise to tinker with the current situation.[22]
Economies of scale in retail banking are significant and
constitute a substantial barrier to competition. Scale influences the underlying
cost of a banking business in various ways including, but not limited to, its
influence on an ADI's credit rating...the ability to spread the cost of complying
with regulation...[and] funding infrastructure investment in branch networks and
payments systems, purchasing/cross-selling power, IT synergies.[23]
Scale lowers the cost of capital because of increased
diversification (e.g. most smaller players operate in just a few asset
classes with real estate security concentrated geographically)...economies of
scale in retail banking derive from IT capabilities, branch network presence,
discretionary overheads (risk, marketing, finance, etc) and the spreading of
risk. But these are small proportion of cost base and are being attacked by
falling IT costs/ new technology and shift in consumer towards internet vs
branch. More important is cost of funding which ultimately depends on credit
rating/quality of lending book.[24]
4.23
Empirical studies of economies of scale in banking were surveyed by the
Reserve Bank. They summarise the results as:
Studies of economies of scale in banking tend to be
inconclusive. One study, which is now quite dated – Berger et al. (1999) –
summarises that most estimates of maximum efficient size lie in the range of
$100 million to $25 billion of assets. However, Wheelock and Wilson (2001) note
that firm conclusions on economies of scale for larger banks are difficult as
there are few institutions, and a recent review by the Committee on the Global
Financial System (2010) of the empirical literature suggests that there is
little evidence for the existence of scale or scope economies in international
banking.[25]
4.24
The ANZ Bank's reading of the literature is even more agnostic:
The literature on economies of scale in retail banking is inconclusive,
reflecting conjecture about the point at which diseconomies occur and the
diversity and uniqueness of the cases examined and the considerable variation
in regulatory and operating environments across countries.[26]
4.25
A UK parliamentary committee recently examined the arguments on
economies of scale, and were sceptical about claims that there were significant
advantages to consumers from banks with significant market shares merging:
The large banks have told us that ultimately consumers will
benefit from lower prices resulting from the economies of scale and synergies
provided by larger more diversified banks. We agree that there are economies of
scale/minimum efficient scale in retail banking which will ultimately limit the
total number of firms in the market. However, we question whether the need for
economies of scale justifies banks having a 30% share of the market or whether
such benefits, if they exist, will be passed onto consumers in a market where
competition is deficient. Indeed, such economies of scale benefits are likely
to be outweighed by the negative impact on competition by those providers who
are perceived to be ‘too big to fail’.[27]
The profitability of banks in Australia
4.26
Profitability is another measure of competition:
The best test of competitiveness...is to look at the
outcomes—that is, are the banks making an excessive profit?[28]
4.27
Notwithstanding some increase in bad debts, the Australian banks'
profitability held up during the global financial crisis and reached record
levels in 2010 (Chart 4.3).
4.28
One component of this profits growth arising from banks persuading
Australian households to take on more debt. Some of this has been of benefit to
those households, allowing them to improve their education or their health. But
much of it seems to have been spent on conspicuous consumption or in bidding up
housing prices.
4.29
Professor Sathye's interpretation is that banks':
...profit margins have gone up significantly. These statistics,
which are calculated from APRA’s statistics, show that there is not enough
competition in the market.[29]
Chart 4.3:
Profitability of banks operating in Australia
Source: Reserve Bank of Australia, Financial
Stability Review, February 2011, p. 22.
4.30
Over a longer period, it has been noted that the share of national
income accounted for by financial institution profits has grown strongly (Chart
4.4).[30]
Chart 4.4: Financial
corporations' profit share
Source: Australian Council of Trade Unions, Submission 89, p 5.
4.31
A former Reserve Bank governor has mused:
I, like you, have often wondered why banks are so
profitable—and they certainly have been extremely profitable in Australia... They
always were very profitable, let's face it. They were very profitable in the
regulated phase, and some of us thought that those profit rates would go down
in the deregulated phase, as competition heated up. So you can understand why people
are very interested in profits and very surprised that profits or rates of
return on equity have remained so high.[31]
4.32
Other submitters put the view probably held by a significant share of
the public:
And the only reason our banks are making such huge profits is
because they are simply ripping us all off.[32]
One does not have to be a rocket scientist to understand that
in spite of banking costs rising (a little) for them to borrow, the banks are
making Super profits at the expense of their customers.[33]
4.33
Such comments struck Professor Valentine as unfair:
...bank bashing had little justification...the media and
politicians, from both parties I might say, have adopted the approach of the
Queen of Hearts in Alice—first the verdict, then the trial. In other
words, there is no proof to justify the abuse which has been heaped on the
heads of bankers. I have said on a number of occasions in a light-hearted way
that there seems to be an argument for antivilification laws to protect
bankers.[34]
4.34
The banks justify high profits as necessary to maintain high credit
ratings and thereby lower funding costs which they could pass on as lower loan
interest rates:
Bank performance measures are critical for a bank to retain a
high credit rating – without a high credit rating, the cost to access money and
capital markets is higher. If banks have to pay higher rates for money, then
individuals and businesses will also pay higher rates to borrow from banks.[35]
4.35
Professor Sathye is not convinced:
I do not agree with that analysis that more profits mean a
better rating or that the credit rating of the banks will be affected if their
profits are lower. As a matter of fact, the Canadian banks have lower profits
than the Australian banks, but their rating is not affected; their rating is
similar to that of Australian banks...a credit rating does not depend exclusively
on the profits that the banks make. A credit rating takes into account a number
of factors, and those factors are basically the prudential standards in
Australia and the asset qualities of banks.[36]
4.36
Another perspective comes from comparing profits in the financial,
resources and other sectors. Around 2005 these were broadly the same in
aggregate. Now the resources and financial sectors' profits are well above the
other sector (Chart 4.5).[37]
Chart 4.5: Underlying
profits of ASX 200 Companies
Source: Reserve Bank of Australia, Statement on Monetary Policy,
November 2010, p 49.
Measures of return on equity
4.37
A related measure is banks' return on equity. The Governor of the
Reserve Bank remarked to the Committee:
I would assess the current state of profitability of the
majors as good. They are earning quite a healthy rate of return on their
equity...[38]
4.38
The Bank commented more recently:
As the major banks' profits have recovered, their average
return on equity has increased to near pre-crisis levels, at almost 15 per cent
in 2010. Analysts are forecasting a further small rise in 2011.[39]
4.39
The Governor mused that this issue could become more telling in the
future:
There are arguments about whether in the fullness of time—in
a new regulatory world where banks, particularly globally, hold a lot more
capital and are inherently therefore less risky— equity holders ought to expect
a lower rate of return because of a lower risk profile. That is quite an
interesting question...[40]
4.40
A banking analyst pointed out that the Australian banks' return on
equity in 2010, of 16 per cent, is the same as their average return on equity
over the past thirty years, and lower than many other large Australian
companies.[41]
National Australia Bank said that the GFC had reduced its return on equity from
around 16 per cent to 13 per cent and:
...13 to 16 does not represent an excess by Australian return
standards.[42]
The returns on equity and returns on assets over the last 10
years of the “big 4” are substantially lower than, for example, those of
Woolworths or Telstra. Yet, their businesses are much more risky and hence
demand a higher level of return.[43]
4.41
One response to this is that the largest Australian non-bank companies
include Telstra, the supermarket duopoly and large mining companies, all of
which could be argued to be themselves operating in uncompetitive industries
where supernormal profits may be earned.
4.42
Another response is to question the claim that banking is a risky
business.[44]
One indicator that banking in Australia is a relatively low-risk industry is
that the major banks' return on equity has only once turned negative in the
past thirty years and only twice dropped below 10 per cent (Chart 4.6). The
explicit guarantees that government have provided (see Chapter 12) and the view
that governments regard them as too big or important to be allowed to fail (see
Chapter 11) are other factors that should lead investors to regard bank shares
as lower risk.
4.43
In turn this low risk should imply that banks do not need to earn as
high a return on equity as other companies to attract capital:
Profit levels are very strong and have increased in the last
year or so after benefiting from government support. The fact that the
government reduces bank shareholder risk would suggest that earnings should be
closer to say 10 per cent return on equity rather than the 15 to 20 per cent
currently being achieved.[45]
Chart 4.6: Major
Australian banks' return on equity
Source: Westpac, Submission 72, p 27.
4.44
Australian banks' return on equity was similar to that in comparable
countries in the years before the GFC. The difference since then has been that
Australian (and Canadian) banks had only modest dips in returns, while European
and US banks as a group incurred large losses (Chart 4.7).
Chart
4.7: Large banks' return on equity
Source: Reserve Bank of Australia, Submission 41,
p 25.
4.45
Professor Sathye reports:
If you look at the profit data of the banks, the average
return to shareholders in Australia over the last five years has been something
like 9.5 per cent, which is probably the highest in the OECD countries...[46]
4.46
Professor Valentine defended the returns earned by banks:
...nobody I have seen has presented evidence of excess returns
over any reasonable period of time.[47]
4.47
Treasury made a simple but telling observation on the adequacy of banks'
returns:
I do not see anyone withdrawing from the market because of
lack of profitability.[48]
Interest margins
4.48
For a long time before the global financial crisis, banks' margins had
been decreasing (Charts 4.8 to 4.11 and 5.1). The main forces driving down
margins were the impact of deregulation and increasing competition from former
building societies, foreign banks and non-bank mortgage lenders.
4.49
There were also some other forces at play:
A large and efficient mortgage broker network had established
itself. By the middle of the [1990s] decade, 30% of all housing loans were
being originated through brokers. The second factor contributing to competition
was the enhanced use of the Internet. The Internet reduced search costs for
prospective housing loan borrowers, enabling them to more easily compare loan
products online, including fees and charges...The third factor was greater focus
by foreign-owned subsidiaries on Australia’s retail banking markets.[49]
The sustained downward pressure on the net interest margin is
one of the clearest, long-term economy-wide benefits of the deregulation of the
Australian financial system...Competitive pressures from non-prudentially
regulated lenders and new bank entrants in the period since 1995 also played a
role in the fall in the net interest margin. New technologies that permitted a
lowering of the industry's operational costs would also have played a part.[50]
Chart 4.8: Bank net
interest margins
Source: Department of the Treasury, Submission 102,
p 15.
Chart 4.9: Banks'
net interest margin
Source: Reserve Bank of Australia, Submission 41,
p 20.
Chart 4.10: Net
interest margins – four major banks
Source: Treasury, Submission 102, p 16.
Chart 4.11: Major
banks' net interest margin
Source: Reserve Bank of Australia, Financial
Stability Review, March 2011, p 23.
4.50
A recent econometric study by Kirkwood (2010) attempted to quantify the
contributions to the reduction in margins, finding that about two-fifths was
due to a decline in operating costs and one‑fifth due to competition from
mortgage originators.
4.51
Since the global financial crisis, however, the interest margins of the
major banks in Australia have widened (Charts 4.9, 4.10 and 4.11). This broad
pattern was common to all four major banks (Chart 4.10) and to both their
domestic and foreign operations (Chart 4.11).
4.52
There are differing interpretations of this. One view is that there is
just a bit of random variation in recent years and the underlying margins have
been fairly steady for a number of years.[51]
4.53
An alternative interpretation is that margins have started to rise as
competitive pressures have eased:
The reduction in banking competition has enabled banks to
increase their margins at the expense of both mortgage holders and business
customers.[52]
...the period between 2000 and 2007 when we had very intensive
competition as demonstrated by the reduction of net interest margins during
that period. We had St George, BankWest, Aussie Home Loans, RAMS and Wizard and
those players provided intense competition that did keep the big four banks
honest. With the removal of those competitors...you saw the ability of the four
big banks to start increasing their net interest margins...[53]
4.54
A third interpretation, put by the banks themselves, is that:
From the beginning of 2007 we saw wholesale funding,
particularly international funding and short-term funding, increase in price
significantly. For the first six months of that the banks absorbed that cost
and that will have had an impact on their margins, so we have had a bit of a
dip, if you like. Banks then started to pass some of those costs on, but they
also started to reprice for risk, which will cause an increase in the net
interest margin.[54]
4.55
APRA emphasised the latter factor:
...it is generally agreed that risk was not being adequately
priced in the global banking system in the lead-up to the global financial
crisis so some repricing of assets (and hence widening of margins) was to be
expected and was prudent.[55]
4.56
The Committee asked the Reserve Bank for their analysis. They replied
that 'the early stages of the financial crisis saw funding costs rise more
quickly than lending rates' and 'the small increase in margins following their
trough in the financial crisis is likely partly to reflect the removal of those
temporary factors'.[56]
4.57
They add that margins can be also be affected by other factors such as:
-
higher risk margins on lending, which have been encouraged by
supervisors, will have boosted net interest margins (given these do not adjust
for either expected or actual losses of principal);
-
an increase in the amount of equity funding is likely to have
boosted banks’ margins (equity is a non-interest bearing liability that
increases a bank’s interest earnings);
-
derivatives to hedge interest rate risk can have a substantial
effect on banks’ margins over short periods of time; and
-
some institutions may have shifted the balance between fee and
interest income.[57]
4.58
The Treasury Secretary was more agnostic:
Over the last two years, the net
interest margin has increased from 2¼
percentage points to 2½
percentage points – back to 2005 or 2006 levels. It is too early to judge
whether this post-GFC widening can be explained fully by a lessening of
competition, but it does provide a case for close examination of the factors affecting
competition.[58]
4.59
The interest margins are wider for the major banks than the regional
banks (Chart 4.8). Asked about possible reasons for this, the Reserve Bank
replied:
The higher credit ratings of the major banks allow them to
raise wholesale debt on less expensive terms than the regional banks.
Differences in the composition of the different banking
sectors’ assets and funding liabilities.
-
While deposit liabilities comprise a greater share of the major
banks’ funding liabilities than they do for regional banks, relatively
expensive term deposits make up a considerably greater share of regional banks’
funding liabilities (28 per cent) compared with the major banks’ funding
liabilities (20 per cent). This would be offset, somewhat, by the fact that the
regional banks have a greater share of equity funding.
-
Lower margin household lending makes up a greater share of the
regional banks’ assets than it does for the major banks’ assets. Likewise,
regional banks are relatively underweight in the credit card market, a
relatively high‑risk and high-margin product.
Moreover, different banks can offer customers different fee
and interest rate combinations. Consequently, one institution might report a
higher net interest margin but lower fee income than its competitors.[59]
4.60
The ANZ's explanation was:
...the relative dominance of higher yielding (and higher risk)
business segment on the books of the majors...[and] the higher credit ratings of
the major banks which affords lower wholesale funding costs.[60]
4.61
The Commonwealth Bank distinguished between margins on its household
lending, which it claims have continued to shrink, and margins on business
lending, which have expanded as risk is repriced.[61]
4.62
The net interest margins in Australia are within the range of comparable
countries (Chart 4.12).
Chart 4.12:
International bank net interest margins (2004-2010)
Source: Australian Bankers' Association, Submission 76, p 17.
Interest spreads
4.63
Closely related to the interest margin is the interest spread; the
difference between average lending rates and average funding costs (Chart 4.13).
On the Reserve Bank's calculations, this has also widened somewhat since the
GFC after a long period of narrowing.
Chart 4.13: Major
banks' interest spread
Source: Reserve Bank of Australia, Submission 41, p 21.
4.64
The differences between the margin and the spread reflect an increased
share of liquid assets and the fall in interest on them compared to loans,
increases in arrears and bad debts, derivatives transactions and increases in
equity.
Bank fees
4.65
As well as interest margins, banks make profits from fees and so the
size of these fees is also pertinent to considerations of competition. Banks'
fee income from households rose to $5 billion in 2009, as higher fees on loan
accounts more than offset a drop in fees on deposit accounts (partly reflecting
the ATM fee reforms discussed in Chapter 14).
Table 4.4: Banks'
fee income from households ($ billion)
| |
2007 |
2008 |
2009 |
|
Housing loans |
1.0 |
1.1 |
1.2 |
|
Personal loans |
0.4 |
0.5 |
0.6 |
|
Credit cards |
1.2 |
1.3 |
1.4 |
|
Deposits |
1.8 |
1.9 |
1.7 |
|
Other fees |
0.1 |
0.1 |
0.1 |
|
Total |
4.5 |
4.9 |
5.0 |
Source: Reserve Bank of Australia, 'Banking fees in
Australia', Reserve Bank Bulletin, June quarter 2010, p. 33.
4.66
The Reserve Bank explained:
One of the forces influencing the structure of bank fees was
the increased competition from mortgage originators in the mid 1990s. As
interest margins came under downward pressure, banks began to unwind the cross‑subsidies
that had existed between mortgage and deposit accounts. One specific outcome of
this was that banks introduced periodic mortgage and account servicing fees.
While, in aggregate, consumers of banking services benefited from this process,
the consumers of the financial services that had previously been heavily
subsidised were worse off...More recently, the financial crisis has had two
opposing effects on bank fee income. First, more aggressive competition for
deposit funding saw banks reduce and remove exception fees on deposit and
transaction accounts for both business and personal customers. Second, there
was a repricing of credit and liquidity risks on loans and bank bill
facilities, which led to increased fees, particularly on undrawn loan
facilities held by businesses. In particular, the total banking fee income
reported by the major banks in their 2010 financial results indicated a 4 per
cent decline in fee income.[62]
4.67
A widely cited estimate by Fujitsu Consulting is that:
Australian households are likely to be paying close to $1,000
for their banking services, assuming they have a full range of products and
services and typical transaction patterns, compared with $749 in the UK and
$850 in the USA.[63]
4.68
The assumption that all households pay for a full range of services,
however, is not realistic. The Reserve Bank data suggests that the average
household pays about $500 -- half Fujitsu's estimate -- for bank fees (the $5
billion in Table 4.4 divided by around 10 million households). Given
this, not too much weight should be placed on Fujitsu's comparison between fees
in Australia and overseas.
4.69
Bank fees may fall disproportionately on the poor:
Wealthy consumers (people with mortgages, people with term
deposits or other investments, and members of professional associations) all
receive generous fee exemptions and no attempt is made to recover the costs of
individual transactions from such customers. This means that poorer customers
who do pay fees subsidise their wealthier counterparts on a per transaction
basis, although the banks would argue that they still make more income from
their wealthy customers through their other business with the bank, despite the
lost fee revenue.[64]
Table 4.5: Unit
fees on credit cards ($)
| |
2007 |
2008 |
2009 |
|
Annual fees for no-frills cards |
48 |
49 |
52 |
|
Cash advance fee at own bank's ATM |
1.4 |
1.4 |
1.2 |
|
Cash advance fee at other banks' ATM |
1.6 |
1.6 |
1.4 |
|
Late payment fee |
31 |
31 |
31 |
|
Over limit fee |
30 |
30 |
30 |
Source: Reserve Bank of Australia, 'Banking fees in
Australia', Reserve Bank Bulletin, June quarter 2010, p. 34.
4.70
National Australia Bank took a strategic decision to cut fees which were
damaging its reputation:
We were the first and only bank to completely abolish
exception fees, which drove 50 per cent of complaints into the bank. We were
the first and only bank to abolish account-keeping fees, which drove
significant complaints into the bank. We have abolished mortgage exit fees.[65]
4.71
There are reasons to think that there will be insufficient competition
leading to excessive charging of some kinds of fees.
This is because consumers do not expect to pay penalty fees
at the time they open an account or take out a loan or credit card, thus they
do not negotiate over these terms (even if they are aware of them). Nor, for
similar reasons, do they choose one financial product over another based on the
amount of penalty fees.[66]
4.72
ASIC has indicated it is considering issuing a regulatory guide on
unfair fees in general.[67]
This is discussed further in Chapter 10.
Barriers to entry
Another indicator of the competitiveness of markets is
whether there are significant barriers to entry. A number of factors have been
suggested as impeding new entrants to the banking markets. From the 1940s to
the 1980s there was a simple and decisive one; the government discouraged or
would not allow it. But there remain other significant considerations.
Branch networks
4.73
Professor Sathye notes:
...it will be hard, well‐nigh impossible, for the new
entrant to create a vast network of branches like that of the Big Four.
These banks have already developed long‐term relationship with customers
and it would be hard to make inroads into this strength of the banks. Online
financial service provision is a possible alternative and it is being used
effectively in the deposit market by some of the banks such as the ING Direct.[68]
Low interest deposits
4.74
The existing banks, particularly the majors, have the advantage of a
legacy of low or no interest deposits:
Those wondering about the absence of competition in retail
banking might consider the impossibility of any new player building a
substantial transaction deposit base on which no interest is paid: it is just
not on...[69]
4.75
The implicit bargain of low interest on deposits in exchange for free
services has been very tax effective for banks and their customers (albeit paid
for by taxpayers in general and by bank customers in the form of a less
efficient banking system). One estimate puts the lost tax revenue at around $3
billion a year.[70]
4.76
It has also made it harder for new entrants to compete. This may be
gradually changing as banks have to compete more for deposits and electronic
transactions erode the value of free services.
Financial planners
4.77
A submitter argued:
...the four major banks now control a significant share of the
financial planning market. This market share is increasing through the banks
offering consumers “free” financial plans. Over the years, I have seen a number
of these plans prepared by various banks for my clients. They all have one
feature in common: the products recommended are always those of the relevant
bank or its associated insurance / managed funds arms.[71]
Bundling
4.78
Bundling of products may also be a problem:
Banks also make it almost impossible to get a loan unless you
have all your banking with that bank, and this reduces competition. There
should be no coercion or otherwise to get a loan other than on its merits, and
not whether you bank with them.[72]
Bank providers can bundle housing loans, with personal loans,
with credit cards, and transaction accounts, in such a way as to provide a
strategic commercial advantage, whilst at the same time leveraging potential
clients in relation to wealth management and personal risk insurances, as well
as general insurances.[73]
...if one financial institution chooses to bundle their account
services together and give you a special rate on your mortgage because you take
other accounts with them, for example. I think it has been indicated to the
committee already that that is the kind of thing that is a brake on moving.[74]
There should be a possibility for a mono-line new market
entrant to compete in one segment.[75]
Bank bundling of products and stickiness of relationship result
in customers being less price sensitive. Customers who choose to have several
transaction accounts or products with an institution have a greater propensity
to stay with that institution.[76]
4.79
Westpac's CEO referred to bundling as a factor further limiting
competition between their Westpac and St George brands:
...typically, customers do not do that [bank with both Westpac
and St George]...It may be that they have other products and services as well,...
typically, people do not only move for price.[77]
Advertising
4.80
The sheer size of the major banks allows them to spend enormous amounts
on advertising which most new entrants could never match. The four major banks spend
over $1 billion a year on advertising.[78]
Perceived safety and size
4.81
A survey showed that 19 per cent of customers believe a larger bank is
safer.[79]
This may partly explain why 43 per cent of the customers of the big four banks
have never even considered switching to a smaller bank or credit union.[80]
Attitude of ratings agencies
4.82
As discussed further in Chapter 9, the behaviour of ratings agencies,
which exert an important influence on the cost of funds for financial
intermediaries, may exacerbate the tendency for concentration by favouring
larger entities.
Regulatory change
4.83
The major banks may be best placed to cope with regulatory change:
Australia’s largest domestic banks once more have an
advantage in their ability to find, in their domestic scale, immediate
resources for the process changes, system changes, compliance and
administration that new regulations may require. A recent example of
legislation with the potential to inadvertently reduce competition in
Australian financial services was the National Consumer Credit Protection
Act, as it related to the provision of merchant point of sale credit. While
fully supportive of the principles behind the reform, the burden of compliance
requirements would have disproportionately disadvantaged HSBC and other affected
credit card providers.[81]
...increased regulation of the banking sector may have the
unintended consequence of placing a higher burden of compliance and increased
costs on the smaller banks in comparison to the major banks. It is often
fundamentally more expensive for smaller players to comply with new
legislation, if that compliance relies on system based solutions. The fixed
cost of developing these solutions does not vary greatly in relation to the
size of an institution, therefore the unit cost of compliance falls as the
scale of business increases.[82]
Cross-subsidies
4.84
It has been suggested that the size and diversity of the four major
banks allows them to cross-subsidise areas where competitive pressures arise to
see off new entrants:
The major banks have a massive ability to cross-subsidise one
area for another.[83]
4.85
Cross-subsidising is undesirable on efficiency grounds as well as its
implications for competition:
...one segment of customers subsidising another...if sustained
for long periods of time, ... will impact on resource allocation in the different
customer bases and therefore asset allocations in our economy.[84]
Credit reporting
4.86
Limitation on credit reporting under the Privacy Act 1988 has
been mentioned as an impediment to new entrants:
Australia is one of only a handful of OECD countries
restricting credit reports to negative information...Negative credit reporting
gives established lenders a clear information advantage over new entrants when
assessing lending risk. Their large existing customer base gives them broad
insight into a consumer's ability to make repayments. In contrast a new lender,
having to rely on the limited information available on credit reports, will
have significantly less capacity to accurately differentiate high- and low-risk
borrowers.[85]
Perceptions of competition
4.87
The Chamber of Commerce and Industry Queensland surveyed its members and
almost 90 per cent agreed that there should be more competition in the
Australian banking industry. Asked about their biggest concern relating to the
banking industry, 'competition' was nominated by 12 per cent and 'difficulty in
switching banks' by a further 5 per cent.[86]
(This is not inconsistent with the earlier result; it just reflects many regarding
competition as less of a concern than high interest rates and charges.)
4.88
Most Australians believe that the banking market is overly concentrated:
72 per cent of survey respondents said that the big four
banks in Australia have too much market power.[87]
4.89
There are also perceptions of collusion:
Additionally this style of advertising currently being
deployed by the NAB Bank in saying they have broken up from the other Banks
suggests historic collusion on how banks charge consumers fees and set interest
rates.[88]
4.90
In some cases, suspicions about banks leads submitters to suggest a
return to a policy widely advocated in the past (see Chapter 3) and nationalise
the banks:
Parliament could act upon this by nationalizing banks as they
cannot be trusted.[89]
Overview of competition
4.91
Witnesses differed on their views of the adequacy of competition. It was
unsurprising that the major banks themselves argued there was sufficient
competition. Among more independent witnesses, there were some who seemed
comfortable:
I think there is a lot of competition in the market.[90]
4.92
The Governor of the Reserve Bank distinguished between competition in
deposit and loan markets:
Four years ago the competition was all in lending money.
There was very intense competition to lend. But now there is very intense
competition to raise money on the part of financial institutions.[91]
Other things have happened as well that affect the competitive landscape, but
this is a very fundamental change in the state of the world. That said, the
market, I think, remains more competitive than it was in the mid-nineties and
borrowers have access to a larger range of products than they once did. The
overall availability of finance to purchase housing, in particular, seems to be
adequate.[92]
4.93
A similar point was made by the CEO of ANZ Bank:
...the nature of competition has changed. Competition in the
deposit market has never been so intense. Deposit rates have been bid up as
financial institutions compete for stable sources of funds.[93]
4.94
The Governor of the Reserve Bank referred to cycles in competition:
Competition is cyclical, to some extent. Competition is at
its most intense usually around the peak of the business cycle when the risk
that everybody is taking on is actually much greater than they think.
Subsequently, the nature of those risks become clearer and people retreat from
risk taking and the competition to lend...abates considerably and the competition
to raise funds and shore up balance sheets gets much stronger.[94]
Multi-brand banking
4.95
Perceptions of competition may be affected by multi-brand banking.
Westpac explained their strategy:
...our strategy is one of offering customers choice through our
multi-brand model, our key retail brands being Westpac, St George, Bank SA and
RAMS. Each designs and implements their own customer strategies and plans. They
have different marketing approaches, and it has become increasingly clear to us
that they attract different types of customers.[95]
4.96
At one point in her testimony, the Westpac CEO claimed the two brands
are 'competing against each other for customers'.[96]
But she had earlier conceded that the branches branded as St George do not
compete with those branded as Westpac:
...customers who choose St George are not the customers who
would choose Westpac. There is very little overlap there.[97]
4.97
She claimed that St George caters for customers wanting a certain type
of banking experience:
...they see it as warm and friendly. It is down to earth. It is
straightforward. It is community orientated. It is local. It is very
grassroots. It is people based. It has a human-touch element to it.[98]
4.98
This raises questions about what type of bank Westpac customers must be
seeking.
4.99
Questioned about advantages to customers, the Westpac Group's CEO
suggested:
...St George has the benefit of now being part of an AA-rated
bank with a stronger capital base, which means that it can price products in an
improved way...[99]
4.100
Having a AA rating undoubtedly allows a bank to raise wholesale funds
more cheaply. Whether this is passed on to customers is much less clear. Before
the merger, home loan interest rates from the higher rated Westpac were not
less than those from the lower rated St George. Currently, the Committee
observed that lower rated entities such as Credit Union Australia are offering
home loans at lower interest rates than the higher rated major banks.[100]
4.101
It is important to note that among the conditions imposed by the
Treasurer in approving Westpac's acquisition of St George in October 2008 was
that Westpac would be required to retain all Westpac and St George retail
banking brands including Bank SA, and maintain the existing number of Westpac
and St George branches and ATMs, for a period of three years.[101]
4.102
A couple of months after her appearance before the Committee lauding the
St George brand, Westpac's CEO announced that the St George branches in
Victoria would be replaced by branches reviving the name of Bank of Melbourne.
4.103
Other submitters saw the multi-brand strategy as designed to 'create an
illusion of more competition than actually exists'.[102]
4.104
Some submitters felt it was potentially misleading for large banks to market
themselves under multiple brands, and called for:
...the Government to make it a requirement for institutions
that are wholly owned subsidiaries of other financial institutions to clearly
articulate that ownership within all signage, advertising and marketing
material.[103]
Banking competition in regional areas
4.105
Banks may not be competing to provide a good service in remote areas.
One bank admitted:
...the banks, 10 years ago, clearly broke a bond of trust with
the community when they closed branches. There is no question about that; it
was a mistake.[104]
4.106
Bendigo and Adelaide Bank, the only bank with headquarters outside a
capital city, related the decline in regional representation to the impact of
greater competition:
...non-bank mortgage providers in the 1990s...entered the market
because they identified that banks were subsidising their other activities by
charging relatively higher rates on home loans. By competing on price in the
home mortgage market alone, they were able to quickly gain material market share.
The banks responded by competing with them on price. As a result...banks were
forced to cut costs as revenue shrank. This resulted in bank job losses, branch
closures and banking utility being withdrawn from individual communities—many
of them based in rural Australia.[105]
4.107
They warned of the deleterious effects:
Once a bank left town, people were forced to go to other
places to do their banking and, pretty soon, they were doing their shopping in
other towns as well. Before too long, most businesses in the towns that lost
their banks closed...Some do not have banking services anymore and some do not
have a meaningful business presence at all.[106]
Committee view
4.108
The Committee note that even during the period of the GFC when the real
economy slowed markedly, the profits of the major banks held up well. The
returns they offer investors more than match those from other industries,
despite the explicit and implicit support they received which makes banking a
less risky activity.
4.109
While the Committee prefers banks to be profitable rather than
unprofitable, their very high profits are ultimately paid for by households and
small businesses. They are also a reflection that competition is not as keen as
it should be.
4.110
The Committee commends the Reserve Bank for the information it publishes
on bank profitability in its semi-annual Financial Stability Review.
Further such information would help inform the public debate.
Recommendation 2
4.111
The Committee recommends that the Reserve Bank publish further
regular information on banks' interest margins and returns on equity; and
compare these to returns in other industries to allow an assessment of whether
risk-adjusted returns in the banking sector are sufficiently high to suggest
that competition is inadequate.
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