Submission to the Financial System Inquiry 9. Competition and Consumer Regulation

Introduction

252. This Chapter comments on some areas of policy which are not ‘core’ issues for the RBA, but in which it takes an interest both because of their intrinsic importance and because they can overlap with its responsibilities for prudential supervision. The Chapter also discusses briefly the RBA's own customer services.

Competition policy

253. In the RBA's view, a coherent set of competition policy principles should apply to all industries, and be administered by the ACCC with economy-wide responsibilities. The same broad principles which are used to evaluate mergers in other industries should be applied to the financial sector. They should focus on three issues:
     • Would the merger lessen competition?
     • Would the merger change the cost structure of the industry concerned?
     • Does the merger have public policy implications beyond those that relate to competition and costs?
254. The Trade Practices Act prohibits mergers that are likely to significantly lessen competition in a ‘substantial market’ in Australia unless the ACCC judges the merger as providing net public benefits. The Act has sufficient scope for these principles to be addressed. In its judgements, the ACCC needs to recognise that competition policies cannot be implemented in a vacuum and that other considerations, such as financial stability, are also important. It will need to consult widely with relevant parties.
255. Notwithstanding the liberalisation of entry into banking, two separate policies have principally determined the core structure of the financial sector over the past five years. These have been the ‘six pillars’ policy, which has prevented mergers between the four largest banks and large life offices, and the ‘four plus one’ interpretation of the provisions of the Trade Practices Act by the ACCC in its consideration of bank mergers.
256. The ‘six pillars’ policy has its origins in the decision of the previous government, in May 1990, to block a proposed merger between the ANZ Bank and National Mutual, the second largest life insurer in Australia. The merger would not have breached any legislative or prudential guidelines and was not seen as a threat to stability of the financial system. Rather, the government took the view that the merger would have reduced the ‘diversity of institutions and effective competition in banking, in life insurance, and more generally the provision of financial services’. Its judgement was that such a merger would reduce competition more than was in the national interest. In reaching this view, the government made it clear that it would not entertain proposals for mergers between any of the four largest banks or the two largest life insurers. It argued that large financial institutions should develop their own business or make smaller acquisitions.
257. The policy has never had a legislative basis and it is timely that it is being reviewed. The RBA believes that the ACCC should evaluate the competitive impacts of proposals for mergers and acquisitions in the finance sector on the same basis as proposals in any other sector. In doing so, the ACCC will have to grapple with difficult issues of market definitions and the extent to which other institutions are potentially effective competitors.
258. These issues were also raised by the ‘four plus one’ interpretation the ACCC placed on Section 50 of the Trade Practices Act when evaluating the proposal by Westpac to acquire Challenge Bank in September 1 In allowing the acquisition to go ahead, the ACCC focussed on the market for banking services in Western Australia, rejecting arguments that the relevant market was national. The ACCC argued that regional banks were an important source of competition to the majors in most states, and allowed the acquisition to proceed only because BankWest would remain independent, as the ‘plus one’ providing effective competition to the majors. The ACCC extrapolated this analysis to possible future proposals, arguing that any purchase by a major bank of the last remaining regional bank in any state would be likely to substantially lessen competition and that the ACCC would ‘need highly persuasive evidence to be convinced otherwise’. Under this policy, acquisition of a number of regional banks by a major bank is effectively ruled out.
259. The RBA believes that the focus on a state market may be overly restrictive. In its view, competition in the market for banking and other financial services should be analysed at the national level. While institutions with a regional focus may be important in some markets, particularly for some retail services and lending to small businesses, where local knowledge is useful, these factors are becoming less relevant. Delivery systems such as ATM and EFTPOS networks are making regional markets more readily contestable by institutions without a strong physical presence in those areas. Electronic banking enables customers to access a number of banks through post-office tellers. Telephone banking and, increasingly, the Internet, allow bank customers to conduct many transactions such as paying bills and moving funds between accounts, balance inquiries and obtaining product information without visiting a branch.
260. The forces operating on the financial services sector are mostly national in scope. Despite inter-state differences in industry structure, there is little difference in the interest rates charged and paid by the same financial intermediary in the different states. As in the global market, ongoing changes in information technology and in delivery systems are lessening the importance of geography in defining markets for financial services in Australia.
261. The benefits to customers and shareholders of any merger between a major bank and a regional bank will obviously need to be assessed on a case-by-case basis. The RBA believes that outright prohibition would be too strict an interpretation. That said, the RBA is not advocating a spate of bank mergers. There is no compelling evidence that economies of scale exist in banking either in Australia or abroad. Large banks do not typically have lower average costs than smaller banks, and both specialised and multi-product banks appear to be commercially viable.
262. A frequent argument is that bank mergers would reduce costs by facilitating a rationalisation of banks' extensive branch networks. This argument has some merit, although rationalisation is already under way and will continue whether or not mergers take place. Mergers of banks operating in the same geographic areas are likely to promise the greatest savings through branch rationalisation.
263. Another argument is that even the largest Australian banks are too small to offer a full range of international services to all their customers, putting them at a competitive disadvantage. However, large corporate customers generally maintain relationships with a number of banking entities, reflecting the fact that different banks have expertise in different areas. No bank can be the most efficient in all activities. Australian financial institutions need to decide whether international expansion requires sheer size, or expertise in specialist areas which offer strong potential for growth.
264. Finally, improvements in information technology are increasing the scope for cost savings through the centralisation of information processing and payments. Economies of scale clearly exist in such activities. The issue is how best to realise them. One option is the merger of institutions. Another is for the development of organisational structures (alliances, outsourcing etc.) which allow institutions to take advantage of the potential savings without merging.

Industry structure and prudential issues

265. As well as being subject to the Trade Practices Act, mergers among banks and substantial acquisitions by banks of other financial institutions require RBA approval, because of their possible consequences for the prudential soundness of the banks involved. In the normal course, the RBA would not seek to interfere with the judgment of banks' senior management and board about the commercial viability of an acquisition proposal. If, over time, the financial system were to become much more concentrated, or if there were proposals which would themselves produce a substantial increase in concentration, the RBA might need to take into account such questions as:
     • Would a heavily concentrated banking system be more or less vulnerable to financial shocks?
     • Would the RBA's options for managing serious weakness in one large bank be significantly reduced if there were only one or two others?
266. Australia's banking system, in which four major banks account for around three quarters of most banking business, is not excessively concentrated by international standards. A reduction from four large banks to three would not greatly increase concentration nor would it necessarily reduce competition significantly. The Netherlands, for example, has had three dominant banks competing vigorously since 1990. However, commentators suggest that the market dynamics in Australia are such that there would quickly be pressures to move from three to two. If this were to occur, it would give Australia the most concentrated banking industry in the industrialised world, and would take us into unchartered prudential waters. (How could a merger be arranged if one of the two banks got into difficulty?) This is a very big step to take and would require community support, but it should not be ruled out of order altogether.

Consumer protection regulation

267. All companies must conform to a range of consumer protection regulations under the Corporations Law and the Trade Practices Act. Financial institutions are subject to a wide range of additional consumer protection requirements. Many of these are set out in Chapter 3. These requirements are due, in part, to the increasing complexity of many financial products and services and to the sometimes ad hoc regulatory responses to them. The Consumer Credit Code, due to commence on 1 November 1996, is intended to replace inconsistent State Credit Acts which applied different standards to products and institutions from state to state. However, even after decades of work there are still doubts about the consistency of implementation.
268. In addition, codes of practice for banks, building societies and credit unions, expected to be adopted at the time of the commencement of the Credit Code, require that institutions fully disclose fees and charges and establish internal and external dispute handling processes. Similarly, life offices and general insurance companies have codes of practice that emphasise disclosure.
269. Table 7 highlights the consumer protection requirements and the range of ‘regulations’ with which financial institutions must comply, over and above the usual requirements of the Corporations Law and Trade Practices Act. The current extent and variety of consumer regulation in the financial sector and the lack of consistency in application is excessively costly. There is considerable scope for rationalisation which could improve the position of consumers and reduce compliance burdens on institutions.
270. Centralising and harmonising consumer protection regulation on a product basis would go a long way towards overcoming the distorting effects of inconsistently applied regulations. As discussed earlier in this Submission, it need not conflict with prudential supervision on an institutional basis. The responsibility should be vested in a single national authority – perhaps along the lines of the Personal Investment Authority in the UK. Such an authority would take over the various finance sector consumer-related activities of the states, the ASC and the ISC. It should also become responsible for the work undertaken by the RBA, through the Australian Payments System Council, on the Electronic Funds Transfer Code of Conduct and the codes of practice for banks, building societies and credit unions.
271. If a national consumer authority were to be established, the RBA believes it should adopt a flexible, non-statutory approach, with close working links with service providers and consumers, and rely where possible on self-regulation supported by a high degree of transparency. This would minimise the impact of regulation on costs and innovation and encourage industry to lift service standards beyond minimum requirements. The APSC and the Banking Industry Ombudsman Scheme have found this approach particularly valuable in carrying out their work. A new consumer authority should also establish a mechanism for close communication and consultation with the prudential supervisors of the institutions it deals with, to reduce the likelihood that consumer-related requirements will constrain institutions in a way that might damage their financial soundness. This could be achieved through regular consultation with the Council of Financial Supervisors.

The RBA's ‘commercial’ activities

272. In addition to its responsibilities for monetary policy and prudential supervision and its role as banker to the commercial banks, the RBA participates in the financial system as a provider of services. Under its legislative charter, insofar as the Commonwealth requires it to, the RBA acts as banker and financial agent of the Commonwealth. It does not have this business, or any other business, as of right – it must provide quality services at competitive prices.
273. The RBA provides specialised banking, cash and registry and settlement services to the Commonwealth and a limited range of other clients. It recognises that these services compete with private sector providers. In line with the principles of competitive neutrality endorsed by the Council of Australian Governments for such competition (the ‘Hilmer principles’), the RBA aims to recover fully the cost of these services largely through fees and charges. Within the RBA's structure, banking, registry and settlement and cash services are organised and managed separately; accounting systems are structured so as to facilitate separate reporting of the full costs and revenues of the various commercial activities.
274. Although denied the opportunity to cross-subsidise from other income sources, the RBA is able to be a competitive supplier of transactional banking services by concentrating on systems dedicated to government needs. The RBA works actively with its government customers to improve cash management practices, especially through the joint development of electronic services designed to improve the efficiency of payments and collection systems.