The draft report by the Productivity Commission into competition in the financial sector released on Tuesday is a withering attack on the banking sector – one that paints it as bloated and uncompetitive, and which has seen a focus on stability override a desire for competition.
The Australian banking sector is dominated by the big four – Commonwealth, Westpac, ANZ and NAB. Together they control just over 80% of all owner occupier home loans and 85% of all investor housing loans:
This high market share was not always the case.
From the mid 1990s to mid 2000s cheap credit from international lenders saw an influx of non-bank lenders, which reduced the share of home loans to banks to around 75%.
And then the GFC hit – cheap credit dried up, non-bank lenders either folded or were taken over by banks and the big four consolidated:
The impact of the GFC and the desire for financial stability hangs over the Productivity Commission’s report, which argues that many of the measures designed to increase financial stability have the unintended consequence of reducing competition.
Indeed, policies designed to promote stability have also meant that the big banks have done very well from the GFC. The report notes that such is the market power of the big four, “the shock of the GFC saw barely a blip in the net interest margins of major institutions”.
One of the biggest ructions during the GFC was the jump in the price of short-term credit – credit which had been used by both non-banks and banks to fund a significant chunk of their lending:
This meant banks had to get funding from elsewhere – and the easiest place was from Australian deposits. It meant the interest rates for term deposits quickly went up – great for investors, but it meant the cost of finance for banks also rose:
Banks over the past decade have used this as the excuse for not cutting home loans by as much as the cash rate. But despite the costs of both term deposits and short-term finance no longer being at levels they were during the GFC, the difference between interest rates offered by banks for both home loans and small business loans and the cash rate is now much greater than occurred during the GFC:
A similar increase has occurred for the interest rates of credit cards. Since the middle of 2014 the average credit-card interest rate has been 19.75% – during that time the cash rate has fallen from 2.5% to the current 1.5%:
Now the Productivity Commission does argue that recent “macro-prudential” measures designed to increase financial stability – such as limiting investor credit growth and liquidity coverage requirements – have “undoubtedly increased” the costs to banks. But pointedly it argues “the bulk of these costs have been passed on to new and existing borrowers”.
Indeed, if we look at the difference between what banks charge in interest for home loans and what they pay in interest for term deposits, we can see that the situation is actually better now for banks than it was prior to the GFC:
This has meant, as the commission noted, that while individual banks might “jostle to attract new borrowers with hints of slightly different interest rates, consumers overall are unable to make effective use of this”.
And one problem is that the loyalty of customers is not rewarded with lower rates. Banks in effect know most people don’t change their bank, and thus they take advantage of that loyalty.
One measure the Commission argues is for the Australian Securities and Investments Commission to provide an online service that allows “consumers to select different combinations of loan and borrower characteristics” and to compare interest rates of loans and the specific fees and charges that would affect the total cost of a loan.
But while there are things that could be done to improve competition, one problem is that moves to improve stability of the sector are not only limiting competition they are making banks more profitable – at taxpayer’s expense.
Moves such as limiting lending to investors, and reducing interest-only loans to 30% of new mortgage loans, which have dampened somewhat the boom in the housing market, have also created, the commission argues, “a windfall profit opportunity”.
The issue is that the Apra sought to reduce investor housing lending and interest-only loans because these are inherently more risky and also more likely to lead to a housing price bubble. As a result, banks increased investor loan interest rates:
And while that in itself is fine, the problem is that the banks have increased the interest rates “on both new and existing investment loans”. This, the Commission argues “boosted lenders’ profit on home loans, and saw a decline in competition from some smaller lenders in the home loan market.”
These new regulations have not only increased the net interest margins for banks, they have also led to an indirect cost to the community.
Because the interest paid by investors has increased, this also raises the ability for these investors to negatively gear their properties. As a result, an extra $500m per year was paid in taxation deduction to negative gearers – an amount that would only be partially offset by increased tax paid by banks making greater profits.
The report is a timely one given the banking royal commission begins sitting next week. It highlights the conflict between efforts to improve stability and competition – the initial response from both the government and the opposition appears to be that stability remains the key concern – and the power of the big four looks set to remain.
Greg Jericho is a Guardian Australia columnist