Thursday, February 15, 2018

A modest proposal for better behaved banks

Suddenly, banks are behaving nicely. They are no longer charging for the use of teller machines, the chief executive of the National Australia Bank took a day out of his $6.6 million a year job to sell copies of The Big Issue, and from this week it’ll be really, really easy to transfer funds. It’ll take seconds rather than days, and you won’t need to look up a BSB. You’ll be able to use a phone number or email address instead.

Could it get any better? Absolutely, and the route is spelt out in one of the submissions to the Productivity Commission’s inquiry into competition in the financial system, which is running in parallel with the banking industry royal commission.

The Productivity Commission has found that, notwithstanding the banks’ belated success in bringing service into the 21st century, they and their competitors aren’t particularly competitive. There’s half as many of them as there used to be in 1999. Instead of charging all their customers the best possible rate as competitive firms would, they charge their existing mortgage holders $66 to $87 a month more than new ones, in what amounts to a penalty for loyalty.

In the words of the commission’s draft report: “rivalry through price competition is rarely evident”. Half of all bank customers don’t switch banks, and the banks count on it.

Over time their prices tend to converge, as might be expected in a competitive industry, but the commission finds that they don’t necessarily converge on the lowest possible price, which is the sign of an industry that is not competitive.

The smaller banks aren’t much help. Their operating costs are much higher than the big ones, and on the occasions when the government has given them a leg-up to cut those costs, they've used it to boost their margins rather than cut their prices.

When the Prudential Regulation Authority prevailed on the banks to cut the flow of interest-only loans to investors, they did it by lifting what they charged on all interest-only loans, new and existing, in an inversion of their usual practice of reserving special treatment for new customers.

Their average margin on those loans climbed from 3.5 percentage points above the cash rate to almost 4.5 points, producing a nice extra profit that they didn’t compete away by charging other customers less.

The commission wants it made easier for new banks to enter the market to take on the old ones, and it wants the competition regulator to police them in the same way it polices petrol stations.

But it hasn’t taken on board – yet – a much more powerful proposal from one of its own, Dr Nicholas Gruen, who used to be a productivity commissioner.

He says we’ve made our biggest productivity gains by destroying the understructures that allowed protected industries to overcharge and provide bad service. We slashed tariffs, ushering in much cheaper prices for clothes and cars. We presented Telstra with a competitor and then with several more. We did away with the two-airline policy. All in the 1990s.

The few cozy restrictions that survived – such as those for taxis, pharmacies and newsagents – are being rendered redundant by technology. It’s increasingly easy to order rides, drugs and news online.

About the only demonstrably non-competitive industry left is banking (although electricity and gas retailers deserve a special mention, which I’ll save for another day).

How much do banks overcharge us? A Bank of England study finds that if the bank itself (the equivalent of our Reserve Bank) offered its own banking services direct to customers on the same terms as it offers them to the banks, which is cost recovery, and if it did it in digital currency, it could permanently lift GDP by 3 per cent.

By way of comparison, our Treasury finds that the proposed cut in the company tax rate (which would have to be financed by increasing other taxes) would permanently lift GDP by 1 per cent.

The Bank of England number may well be an overestimate, but by definition it would cost us nothing. The central bank (in our case the Reserve Bank) would offer deposit and mortgage services at cost.

And it would do it for super, as suggested last year by former treasurer Peter Costello. The government-run super funds (those for public servants) return an enormous 2.2 percentage points a year more than the retail funds, and a handy 0.6 points more than industry funds. The government has advantages others do not. It has massive scale, it actually runs the financial system, and it is trusted in a way the private sector is not.

Gruen isn’t suggesting for a moment that the private banks would disappear. He doesn’t want that. He merely wants them exposed to the same sort of competition that Woolworths and Coles have faced from Aldi – competition from the lowest cost provider.

The competition would have to be fair, there would have to be no tax advantages. But if it is possible to provide an essential service at the lowest possible cost, it is worth asking why we wouldn’t. It's worth asking why we would continue to protect banks when almost every other industry that overcharges us has been made to stop.

In The Age and Sydney Morning Herald