Friday, October 9, 2015
Carolyn M Evans, University of New South Wales (UNSW) Faculty of Law; ThinkEvans Pty Ltd, Deborah Healey, University of New South Wales (UNSW) - Faculty of Law, Marina Nehme, UNSW Australia, Rob Nicholls, Centre for International Finance and Regulation (CIFR); UNSW Law Centre for Law, Markets and Regulation, and Charlotte Penel, University of New South Wales (UNSW) analyze Competition in Financial Services.
ABSTRACT: Research into consumer welfare has produced evidence that is consistent with the assumption that competitive markets yield optimum outcomes for consumers.
This research paper focuses on a specific question, namely ‘what are the optimal competition law and policy settings that should apply to the financial services sector’?
This question framed by two inquiries that were commission by the Federal Government in 2014, and which have now provided their reports. These are the Financial System Inquiry, chaired by Mr David Murray AO, and the Competition Policy Review, chaired by Professor Ian Harper. The effects of the reports will impact on competition policy and the financial services sector.
In the financial services sector, the failure of a single institution can have a compounding effect on the sector, and on national and global economies. In particular, there is systemic risk from inter-institution lending, and this effect is more complex in Australia due to the small number of major players.
In retail banking in Australia, following a similar practice in most developed countries, if an unsecured creditor is a retail depositor, their deposit is insured by the government. That is, if a retail bank fails, the Federal Government will make the depositors whole.
The regulatory system, particularly the prudential regulatory system, is designed to protect depositors’ and borrowers’ interests, and this protects the interest of the government. The effect is that regulatory policy on banking has prioritised stability in consideration of the sovereign risk associated with the risk of retail bank failure.
However, this approach also creates a policy dilemma. The dilemma concerns the extent to which the retail banking sector can attain the benefits of the vigorous rivalry from effective and efficient competition, without unduly risking stability and the potential of a devastating call on the public purse.
Specifically, in the context of effective and efficient competition, there is limited competitiveness in retail banking in Australia. This is reflected in the static state of market share between the four major banks, and very slow and marginal improvements gains even by strong second tier competitors. Furthermore, the retail banking sector’s capacity for product and service innovation is limited.
Although the absence of vigorous rivalry is conducive to stability within the retail banking sector, it is likely to detract from the welfare of retail banking consumers. Furthermore, the level of innovation may not be as high as is feasible and barriers, including prudential regulatory barriers to entry or expansion, mean that the extent of rivalry is unlikely to change without some form of promotion of competition.
The paper consequently makes a four-point recommendation for the removal of the ‘four pillars’ policy:
• The four major banks are protected by an implicit government guarantee that impacts market operation with little observable benefit to consumers, and may be a source of consumer disutility.
• The four pillars policy has prompted increased vertical integration within the sector, particularly in the area of mortgage products.
• There are sufficient merger protections provided by Part IV of the Competition and Consumer Act 2010 (Cth).
• Competition and contestability arise when there are reasonably low barriers to entry and exit from the sector. It is not clear that low barriers to entry exist in Australia, and evidence to support this view comes from the failure of international banks to gain a significant toehold in the retail banking sector in Australia. One deterrent to entry is the regulatory focus on the four pillars.
The authors recognise that this position is at odds with the view of the Financial System Inquiry. However, the rationale in the report of the Inquiry was to prevent mergers, and the current competition law achieves this objective.
The paper recommends two specific policies to promote competition in retail banking without the structural intervention that would otherwise be required to improve the intensity of competition in the retail banking sector:
• Introduce bank account number portability. This would use ‘know your customer’ and central database systems in a similar form to those that have been used for mobile number portability in Australia for the last decade and a half.
• Introduce customer access to data held by banks to allow third parties to compare bank offerings across all banks.
Significantly, these two recommendations are consistent with the productivity proposals issued by the UK Government in July 2015.
The research paper also examines crowd equity funding as a disruptive force in the banking sector, and recommends that crowd equity funding be permitted with the following safeguards:
• ASIC should take an active role in monitoring crowd equity funding and be willing to sue in case of fraudulent action.
• Any intermediary online platform should have a financial services licence with limited duty of care.
• There should be a cap for business raisings through crowd equity funding of $2 million in a 12-month period.
Crowd equity funding is a social phenomenon. Through its use of social media, it has attracted people who have previously never been interested in investing in companies. Instead of being feared, this interest should be nurtured through the promotion of investors’ financial education.