How regulators lost their way on banking competition

For some time the evidence has been growing that, while we’ve regulated reasonably effectively for stability in our financial sector, productivity and efficiency has come a poor second. This is both in terms of the capacity for big banks to use market share to generate super-profits at the expense of customers, and the efficiency with which we convert our vast pool of savings into new investment. 

Now the Productivity Commission has opened that issue right up with its draft report on Competition in the Australian Financial System. The gist of which is, in regulating for stability, we’ve regulated against competition and productive investment.

Case in point: the much-lauded “macro-prudential” measures taken over the last couple of years by the Australian Prudential Regulation Authority designed to curb systemically risky interest-only lending to housing investors. It was celebrated as recently as yesterday by Treasurer Scott Morrison as having cooled housing markets without resort to tax changes.

The PC says it has delivered a windfall for the banks:

The ROE (return on equity) on interest-only investor loans doubled, for example, to reach over 40% after APRA’s 2017 intervention to stem the flow of new interest-only lending to 30% of new residential mortgage lending… largely due to an increase by banks in the interest rate applicable to all interest-only loans on their books, even though the regulator’s primary objective was apparently to slow the growth rate in new loans.

Competing smaller banks were unable to pick up dissatisfied customers from this re-pricing of their loan book because of the application of the same lending benchmark to them. 

Better yet: “this additional cost impost — part of which (through the tax deductibility of interest on housing investment loans) is being paid now by all Australian taxpayers.”

And the way that APRA weighs risk in lending also tends, the PC argues, to “create a strong preference for home loan lending over SME lending unsecured by residential property.” It argues that, contrary to the Basel guidelines on risk, “a single risk weight (of 100%) applies to all SME lending not secured by a residence, with no delineation allowed for the size of borrowing, the form of borrowing (term loan, line of credit or overdraft) or the risk profile of the SME borrowing the funds.”

This complements a longer-term trend for Australia’s banks to direct lending to housing stock rather than new capital. Net result: an economy in which the financial system, with a vast trillion-dollar pool of savings, is focused on buying houses (and shares) rather than investing in new businesses.

Then there’s the lack of competition between the big banks, protected by what the PC sees as the now redundant four pillars policy that protects the majors from takeover or merger. The banks, however, try to disguise the lack of competition by snowing customers with a range of offerings that look different but don’t amount to genuinely competing products.

Innovation and rivalry in price is limited in most of the markets we examined. There appears to be more evidence of competition in product features. The markets for home loans, consumer credit cards, household insurance, wealth management and financial advice demonstrate this. Yet the proliferation of products appears excessive. And its contribution to paralysing consumers with uncertainty about the benefits of switching call into question the scope for product proliferation to improve outcomes for consumers.

Mobile phone and health insurance customers will be familiar with this — it’s a feature of the heavily concentrated markets late-stage neoliberalism has delivered us.

As if to demonstrate the PC’s points, the Commonwealth Bank’s half-year results out this morning illustrate how well-placed the big banks are to continue to churn out shareholder returns. After months of bad publicity, pressure from regulators, the government and the public, the bank’s shareholders will benefit with a tiny lift in interim dividend to a new high of $2 a share. That’s despite the bank revealing the estimated impact of the AUSTRAC money laundering case and remediation expenses totalling $575 million.

The $575 million is made up of a $375 million estimated cost to settle the AUSTRAC, which the bank says will be non-tax deductible, and a further $200 million to fix the problems that have already emerged, and those to be found in the continuing panel of inquiry commissioned by the lead regulator, APRA, which reports in April. The bank’s operating profit was steady on $7.348 billion for the half-year, while revenue rose 2% to $21.263 billion.

But the figure that will have analysts and shareholders salivating is a six-points rise in the bank’s net interest margin (NIM) to 2.16%. That is the first rise in the NIM for quite a while. Helping to boost it were lower borrowing costs for the CBA and the other big three banks, and the rise in fixed housing loan interest rates that resulted from APRA’s macro-prudential intervention.

As the PC notes: thank you regulators, thank you taxpayers.