Federal Treasurer Scott Morrison presented the Productivity Commission’s long-awaited final report on competition in the financial system on Friday (3 August), claiming that “power needs to be put back in the hands of the consumer” through greater access to data and “more players, more innovators and a level field upon which to play”.
The PC report, which was handed to the government on 29 July, stated that the major banks have “sustained prices above competition levels, offered inferior-quality products to some groups of customers, subsumed much of the broker industry and taken action that would inhibit the expansion of smaller competitors in some markets”.
These are indicators of the banks using their dominant market position to the “detriment of consumers”, the PC alleged.
It noted that “only if all other banks were to merge” that they would be able to compete with the biggest two, the Commonwealth Bank of Australia and Westpac.
The major banks rejected the claim that their market dominance enabled them to control and move prices at their own discretion.
ANZ argued that the PC’s conclusion overlooks the “evident competition between the [major] banks”, while CBA noted that market concentration is not demonstrative of degree of competition.
NAB’s contention was that it “does not act collectively or in concert with any other market participants”, and further, that it is not immune to the effects of competition, which it said is reflected in “changes to [its] market share over time, as well as long-term trend decline in profitability metrics”.
The PC didn’t share the major banks’ view that new market players are genuine threats, saying that newcomers (whether non-bank lenders, fintechs or challenger banks) are “unlikely to significantly alter the balance of market power” in the foreseeable future.
It explained that despite many non-major banks, customer-owned banks and non-bank lenders offering more competitive prices on a variety of products — supported by a business model that relies on cheaper sources of funding such as deposits — their market share is still small.
The pricing paradox
The PC rejected the big four’s claims that the growing range of products and benefits offered to customers, mortgage rate discounts and low cost-to-income ratios brought on by competitive pressures are evidence that competition is strong in the financial system.
The commission said that data on profitability, pricing and product development show that there is non-competitive pricing in the banking market, especially the prices set by major banks.
“Major banks are the dominant force in the market. As a result, they are able to charge higher premiums above their marginal costs, compared with other institutions. Approximately half of the loan price that major banks charge is a premium over the marginal cost — double the margin that other Australian‑owned banks have,” the PC report stated.
The banks’ refusal to acknowledge their power over market prices is further contradicted by a “recurring argument” the industry has used against increasing costs, which is that such cost rises will have to be passed on to consumers, the PC said.
Its report stated that despite changes to prudential regulations resulting in increased funding costs, the major banks have been able to recoup these higher costs by increasing interest rates for borrowers and the rate hikes did not result in them losing significant market share to smaller players offering cheaper rates.
The PC further noted: “Rate increases were made possible in part by strong demand for housing loans in some segments; but even where regulators intervened specifically to curb this demand, ADIs were able to increase rates for new and existing borrowers, using their pricing power to increase their profits despite regulatory shocks.”
It pointed out that non-major lenders tend to follow the lead of larger players, so a rate hike can have a cascading effect in the market.
The lack of competition is further reinforced by obscurity around prices, according to the PC, which said that advertised prices are often inconsistent with actual prices paid by customers.
“The absence of accessible public data on actual prices is a distinguishing feature of this industry,” the PC report stated.
It added that discounts offered on standard variable rates are generally not publicly accessible, and further, that the rate borrowers will pay are revealed once they are well into the application process.
Additionally, bundled products, such as those that combine mortgages with other credit products, “further obscure the actual value and comparability of individual components”.
What’s more, a single financial product can have multiple prices structured in different ways based on borrower characteristics or on what the bank is looking to achieve, like acquiring a new customer.
The onus is currently on customers to negotiate prices with banks, the PC said. However, lack of price transparency leaves them negotiating from a position of weakness.
Given prices also depend on the customer’s negotiation skills, only those who are financially savvy or those with financially savvy representatives such as brokers are likely to obtain better deals, it argued.
The PC claimed that the “rise of brokers” and accompanying costs (i.e. upfront and trail commissions) have been “fuelled” by the lack of price transparency, and further, that even brokers might not be aware of all the options available to customers because “unadvertised and uncertain discounts are common”.
“This is an unusual market indeed, when consumers are conditioned to expect a discount (of an uncertain size) from a published comparison rate, but that rate is not usually the market price for that borrower,” the report noted.
It also said that a “blizzard of barely differentiated products” — nearly 4,000 different residential property loans and over 250 credit cards — combined with opaque pricing means customer loyalty is easy to exploit.
“The large number of marginally different products appears more reflective of a capacity for price discrimination than of competition,” the report stated.
Suggested moves to empower consumers and boost competition
One recommendation made by the PC to counter this was the introduction of a new home loan interest rate tool that takes into account the factors that influence rates, such as borrower characteristics.
“With access to digital data, actual home loan interest rates recently negotiated can and should be continuously collected by APRA and made accessible to consumers via an online calculator by ASIC (with an elapsed time of no more than six weeks),” the PC report recommended.
“Consumers would be able to see the market median interest rate offered to all home loan borrowers in similar circumstances to them.
“The specific loan and borrower characteristics that are included in the online calculator should be developed through consultation and consumer testing.”
The PC also supported the impending open banking regime, coming into effect on 1 July 2019, as well as the Consumer Data Right that falls within it, saying that open data could allow consumers to “access to better and a greater range of product and service offerings, and making shopping around, switching or negotiating more attractive”.
It additionally acknowledged that open data could allow “competing and complementary providers of banking services (such as fintechs) to attract potential customers and develop new products suited to customers’ needs”.
It outlined the many barriers to entry for new market players, including limited brand awareness and consumer trust; licensing, operational and market prudential requirements; limited resources; and limited experience in navigating the financial regulatory framework.
As such, it advised that in the long term, lowering barriers to entry and growth, including through better access to customer data, could lead to fintechs favouring competition with the major banks over collaboration, which can be the case when fintechs seek to leverage the scale and reach of established banks.
The PC was opposed to increasing the banks’ costs, saying that doing so “without altering their market power” would be counterproductive to competition, and in fact, would harm consumers as the costs would be passed on to them through rate increases.
Rather, it said that policy measures that address conflicts of interest and anti-competitive regulations could “mitigate adverse outcomes for consumers even if the current industry structure remains largely intact”.