When someone insists there are $20 notes on the footpath, it’s a good idea to check whether it’s simple and legal for someone to go ahead and collect them. If it is, are we sure the free money isn’t a mirage? If it isn’t, that tells us where the work needs to start.
Last week, the Commerce Commission released its draft market study into retail banking.
The report’s draft findings suggest banking isn’t particularly competitive. The large banks sporadically push to increase market share but more often do not. Smaller banks have difficulty competing with the larger banks’ offerings. Non-Australian banks don’t feature much in our retail banking landscape.
The study provided some estimates of profitability in the banking sector. But if retail banking in New Zealand is inordinately profitable, why aren’t smaller banks or new foreign entrants competing those profits away?
Less-than-competitive outcomes are not inherent or necessary in a relatively small market. But high regulatory barriers have larger effects in smaller markets. And regulators in banking, like those in other sectors, pay little attention to the effects their regimes have on competition.
The reports real work focused on the barriers that may stop existing or new competitors from grabbing what may otherwise seem like $20 notes on the footpath.
Suppose you were one of the country’s smaller banks and wanted to compete more aggressively.
First up, switching costs in banking are higher than they need to be.
Most people have lengthy sets of automatic payments set with their existing banks, making switching a hassle. Payments New Zealand runs a switching service to ease some of that burden. However, regulations set by the Anti-Money Laundering and Countering Financing of Terrorism Act mean that, before opening an account, a prospective banking client must pull together a hefty set of documents to prove their identity.
The rules don’t just hurt competition in a broad sense. They also impose particular harm on vulnerable groups with fewer formal identification documents or more difficulty in proving attachment to a fixed address.
Rules that make it harder to switch providers lock in an advantage for larger incumbents. Banks rely on depositors’ funds, particularly funds held in transaction accounts, as a stable and low-cost source of capital for lending. Wholesale funding has a higher capital cost. If you have to convince potential clients your deal is good enough to be worth the hassle, you will be at a disadvantage relative to more established competitors.
But it gets worse.
Prudential banking regulation aims to protect depositors and to avoid systemic risk to the banking system. Smaller banks pose little systemic risk: if one fails, it does not take the banking system down with it. Nevertheless, the draft report says that “since 2008, the Reserve Bank allowed major banks to hold significantly less capital than small banks for lending with a similar risk profile”.
Smaller banks not only face a higher cost of capital than larger banks, they must also hold more of that more-expensive capital against their lending.
It is, then, tricky for smaller banks to compete on price. Regulation inflates their costs relative to those of their larger competitors.
Moving beyond capital requirements, the Commerce Commission highlighted a “very high” overall regulatory burden on the banking system.
It’s easy to say it is proper for a sector such as banking to face high levels of regulation. But remember that regulation tends to favour large incumbents, who can spread the cost across a larger revenue base, over smaller competitors and those who have yet to enter the market. The larger banks could well be net beneficiaries of existing red tape rather than victims of it.
The commission suggests banking sector regulation “imposes a significant barrier to new entry”. It has also forced smaller banks and non-bank deposit takers to put significant time, effort and resources into keeping up with regulatory changes. In a less regulated environment, those resources could be deployed towards competing with their larger rivals. Overregulation has “directly constrained their ability to expand”.
Complying with frequently changing requirements under the Credit Contracts and Consumer Finance Act has been a burden across the entire sector, particularly for smaller providers.
And compliance with Anti-Money Laundering regulations has particularly hindered FinTech providers who need business banking services.
None of this should be a surprise. The Reserve Bank’s prudential framework has not considered the effects of its rules on competition. Neither has it been required to give regard to competition.
The draft report also points to a promising change. The Deposit Takers Act, which introduces deposit insurance, requires the Reserve Bank to take account of “the need to maintain competition within the deposit-taking sector” as one of several objectives. It’s a start. The draft report urges it to go further, recognising that existing levels of competition are not ideal. It warns that the depositor compensation scheme that will back deposit insurance could too easily set levies that have anti-competitive effects.
The Commerce Commission really should be commended for this report. Its draft report on supermarkets spent enormous time and effort trying to estimate supermarkets’ cost of capital and profitability. However, it seemed not to have occurred to the commission, in its draft report on retail grocery, that high profits should encourage new entrants wanting a slice of high profits. The final report turned to those barriers to entry.
This time, its draft report spent less time agonising over precisely how profitable the banks may be and more time on the barriers that may stop existing or new rivals from competing those profits away while benefiting consumers.
The sharper focus meant the commission could come to practical recommendations around regulatory barriers that the Government could ease to reduce large incumbents’ advantages over others.
As the coalition agreement between National and Act requires the commission’s future market studies to maintain this focus, the draft report into banking is also a promising sign for studies yet to come.
Rather than try to guess whether there are $20 or $50 notes on the sidewalk, it is far better to check whether policy and regulation have made it impossible for anyone to pick them up.
Dr Eric Crampton is Chief Economist at the New Zealand Initiative. This article was first published HERE
The report’s draft findings suggest banking isn’t particularly competitive. The large banks sporadically push to increase market share but more often do not. Smaller banks have difficulty competing with the larger banks’ offerings. Non-Australian banks don’t feature much in our retail banking landscape.
The study provided some estimates of profitability in the banking sector. But if retail banking in New Zealand is inordinately profitable, why aren’t smaller banks or new foreign entrants competing those profits away?
Less-than-competitive outcomes are not inherent or necessary in a relatively small market. But high regulatory barriers have larger effects in smaller markets. And regulators in banking, like those in other sectors, pay little attention to the effects their regimes have on competition.
The reports real work focused on the barriers that may stop existing or new competitors from grabbing what may otherwise seem like $20 notes on the footpath.
Suppose you were one of the country’s smaller banks and wanted to compete more aggressively.
First up, switching costs in banking are higher than they need to be.
Most people have lengthy sets of automatic payments set with their existing banks, making switching a hassle. Payments New Zealand runs a switching service to ease some of that burden. However, regulations set by the Anti-Money Laundering and Countering Financing of Terrorism Act mean that, before opening an account, a prospective banking client must pull together a hefty set of documents to prove their identity.
The rules don’t just hurt competition in a broad sense. They also impose particular harm on vulnerable groups with fewer formal identification documents or more difficulty in proving attachment to a fixed address.
Rules that make it harder to switch providers lock in an advantage for larger incumbents. Banks rely on depositors’ funds, particularly funds held in transaction accounts, as a stable and low-cost source of capital for lending. Wholesale funding has a higher capital cost. If you have to convince potential clients your deal is good enough to be worth the hassle, you will be at a disadvantage relative to more established competitors.
But it gets worse.
Prudential banking regulation aims to protect depositors and to avoid systemic risk to the banking system. Smaller banks pose little systemic risk: if one fails, it does not take the banking system down with it. Nevertheless, the draft report says that “since 2008, the Reserve Bank allowed major banks to hold significantly less capital than small banks for lending with a similar risk profile”.
Smaller banks not only face a higher cost of capital than larger banks, they must also hold more of that more-expensive capital against their lending.
It is, then, tricky for smaller banks to compete on price. Regulation inflates their costs relative to those of their larger competitors.
Moving beyond capital requirements, the Commerce Commission highlighted a “very high” overall regulatory burden on the banking system.
It’s easy to say it is proper for a sector such as banking to face high levels of regulation. But remember that regulation tends to favour large incumbents, who can spread the cost across a larger revenue base, over smaller competitors and those who have yet to enter the market. The larger banks could well be net beneficiaries of existing red tape rather than victims of it.
The commission suggests banking sector regulation “imposes a significant barrier to new entry”. It has also forced smaller banks and non-bank deposit takers to put significant time, effort and resources into keeping up with regulatory changes. In a less regulated environment, those resources could be deployed towards competing with their larger rivals. Overregulation has “directly constrained their ability to expand”.
Complying with frequently changing requirements under the Credit Contracts and Consumer Finance Act has been a burden across the entire sector, particularly for smaller providers.
And compliance with Anti-Money Laundering regulations has particularly hindered FinTech providers who need business banking services.
None of this should be a surprise. The Reserve Bank’s prudential framework has not considered the effects of its rules on competition. Neither has it been required to give regard to competition.
The draft report also points to a promising change. The Deposit Takers Act, which introduces deposit insurance, requires the Reserve Bank to take account of “the need to maintain competition within the deposit-taking sector” as one of several objectives. It’s a start. The draft report urges it to go further, recognising that existing levels of competition are not ideal. It warns that the depositor compensation scheme that will back deposit insurance could too easily set levies that have anti-competitive effects.
The Commerce Commission really should be commended for this report. Its draft report on supermarkets spent enormous time and effort trying to estimate supermarkets’ cost of capital and profitability. However, it seemed not to have occurred to the commission, in its draft report on retail grocery, that high profits should encourage new entrants wanting a slice of high profits. The final report turned to those barriers to entry.
This time, its draft report spent less time agonising over precisely how profitable the banks may be and more time on the barriers that may stop existing or new rivals from competing those profits away while benefiting consumers.
The sharper focus meant the commission could come to practical recommendations around regulatory barriers that the Government could ease to reduce large incumbents’ advantages over others.
As the coalition agreement between National and Act requires the commission’s future market studies to maintain this focus, the draft report into banking is also a promising sign for studies yet to come.
Rather than try to guess whether there are $20 or $50 notes on the sidewalk, it is far better to check whether policy and regulation have made it impossible for anyone to pick them up.
Dr Eric Crampton is Chief Economist at the New Zealand Initiative. This article was first published HERE
2 comments:
I opened a joint bank account this week for a small business venture between two existing businesses. It was not easy. We have had to have documents verified by a third party, proof of address etc etc. I was surprised that they didn't require a blood sample and a promise of my first child's life as a security.
This was with a bank that we already dealt with and have significant loans from.
The system is nuts.
Similarly - I wanted a credit card with a 5k limit - I have a 4k limit with another bank, but inflation means that this isn't quite enough for some regular payments. I had a 25-year relationship with the bank, during which I had no debts, and don't think they ever had less than 20k of my money. For the last 10 years, they have had at least 50k. At the time of application, they had 250k.
After 7 hours work trying to provide all the nit-picking information they asked for, the application stalled because I couldn't provide a statement which was less than 3 months old for a source of income irrelevant to paying my credit card bill anyway! Literally couldn't - the provider produces a statement once a year and is unresponsive to requests for anything dfferent.
So - I had to go back to the bank with which I have a 4k limit credit card (which they won't increase for the same reasons!) and now keep it 5k in credit, effectively giving me a 9k payment limit.
How mad is that? Thank you, regulators, for being so careful in ensuring that I don't get into financial difficulty!
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