Centre For International Finance And Regulation report launch

I am very pleased to be here at the launch of this important report into Competition in the Financial Sector.

I want to acknowledge my friend and constituent David Gallagher; Peter Kell from ASIC who is also a constituent in Bradfield; Rob Nicholls who I have known through the communications sector for nearly twenty years; Henry Ergas about whom the same can be said; Fred Hilmer, a great champion of competition policy over many years; Peter Mason; and many others. Of course I would also like to acknowledge Rob’s fellow authors and researchers:  Carolyn Evans, Deborah Healey, Marina Nehme and Charlotte Penel.

It is perhaps no surprise that a number of people with a strong telecommunications sector background are involved in this report and today’s event, because the promotion and fostering of competition has been a strong theme in communications sector policy since the late nineteen eighties. 

So too of course has it been a strong theme in the banking sector, going back to the opening up of the Australian banking sector to competition from foreign banks in the early eighties.

In my brief opening reflections I want to draw out three themes: the importance of competition as a driver of innovation and consumer benefit; the tension, when it comes to the financial services sector, between competition and system stability; and thirdly some of the ways that technology and innovation in particular is increasingly helping to resolve that tension by intensifying competition in a way which does not challenge system stability.  In this last area in particular I think today’s report has some particularly interesting ideas and observations.

If we cast our minds back to the nineteen eighties, the case for competition as a driver of innovation and consumer benefit was far from obvious.  Those were the days when, if you wanted a home loan, you needed to have saved with the same institution for ten years or more, and to have consistently shown the branch manager due deference and respect whenever you met him – and I do say ‘him’ quite deliberately.

It was a good example of non price rationing of a service where demand exceeded supply.

The arrival of the foreign banks in the eighties shook up the Australian banking market considerably.

Over the last thirty years we have seen an extraordinary change in the banking market. 

Today mobile bankers go to a customer’s home to try to win their business.  Mortgage brokers allow the customer to compare a range of home loan offerings.  And there has been very substantial product innovation, with new products such as mortgage offset accounts, along with much greater flexibility in home loan structure and repayment options.

Competition has been a key principle in economic reforms over the past two decades. Industry after industry has been opened up to greater competition, delivering huge benefits to consumers as new entrants have a strong incentive to innovate and disrupt.

I mentioned earlier the parallels with telecommunications.

I recently looked at the development of the mobile sector over the last twenty five years in Australia, in a period where there have been at least three and at various stages four vigorous competitors. It is a good case study of the benefits of competition.

Start with take up. In June 1996 there were 3.6 million mobile services[1].

By June 2013, there were over 31 million mobile services in operation.[2]

Next look at the prices customers pay for their mobile services.  In the 15 years from 1997 to 2012, the cost of mobile calls fell by half.[3]

Perhaps the most important benefit competition has delivered is the rate at which the latest technologies are rapidly introduced.

New technology has been introduced into developed markets at a dizzying rate over the past twenty five years: from AMPS to GSM to CDMA to 3G to LTE and many other variants in between.

But there is an important difference between telecommunications and financial services.  If a major telco were to collapse, it would of course be highly disruptive – but it would not threaten the broader economy in the same way as the collapse of a major bank.

A critical policy objective for our financial system is preserving system stability.

The Murray Inquiry, which reported late last year, observed that Australia’s financial system weathered the global financial crisis relatively well.

We did not have the disturbing spectacle, as both the US and the UK did, of well known banks and financial institutions collapsing, and panicky depositors lining up in the hope of recovering their savings. 

Now there is an evident tension between increasing competition - and preserving system stability.

We saw a recent example of this tension in the response of the previous government to the global financial crisis.

Under Treasurer Wayne Swan, concentration in the banking sector significantly increased, reducing competition and increasing the pricing power of the big four.

The major banks' combined market share rose from 60 to over 80 per cent from 2007 to 2009.  During this period significant non-bank operators such as Wizard, Aussie, Rams and Challenger exited the home loan business or were acquired by the banks, while Bankwest was acquired by CBA and Westpac bought St George.

Allowing these acquisitions to proceed was explained to be part of the policy response to the global financial crisis.  But of course it affected the competitive landscape, as did other decisions taken in the same context.

For many decades there had been no government guarantee of bank deposits in Australia.  The Rudd Government hurriedly introduced a bank deposit guarantee on accounts of up to one million dollars.

They also provided a wholesale funding guarantee.  This gave banks a significant competitive advantage, as the peak body for credit unions and mutuals pointed out at the time.

The result: we have a more concentrated banking sector than we did a few years ago.

The data shows that Australia’s ‘big four’ banks are among the most profitable in the world. According to the Bank for International Settlements, the pre-tax earnings as a share of total assets for Australia’s major banks was 1.28 per cent in 2013.

The BIS report also showed that the big four have bigger net interest margins than most banks of similar scale in other countries.[4]

The concentration extends into adjacent markets: the big four also have a large share of the wealth management market.

As today’s report notes, the current market structure in Australian banking has two important implications: “the absence of vigorous rivalry…is likely to mean that the welfare of retail banking consumers is not optimised” and “ the level of innovation may not be as high as is feasible”.

In the issues that are raised with me by constituents about the big four banks, there is one I would highlight particularly: the lack of innovation in the provision of financing to small business.  Small business finds it harder to get debt financing than big business, it pays a higher rate for it, and the position has got worse since the global financial crisis. 

By far the most common debt product available to small business is a credit card – with of course high rates.  Non credit card loans, where available, are very often secured by a mortgage over the business owner’s home. 

According to a paper given at the RBA’s May 2012 Small Business Finance roundtable, small businesses face a considerably higher rejection rate when seeking external finance than big businesses.[5] 

One of the enduring policy features of the Australian banking system has been the ‘four pillars’ policy, which prevents mergers between the big four banks.

The report being launched today recommends the removal of the four pillars policy.  While I always welcome arguments about how to make Australia’s economy more efficient and competitive, I do not agree with this particular proposal. 

There are however many themes in this report which I very much agree with and welcome.  One of them is the scope for technological disruption to increase competitive intensity in financial services, with the report making some specific recommendations about crowd sourced equity funding.

In my view the scope for technology to drive disruption in financial services, and deliver benefits to consumers, is very high.

Many entrepreneurs are working on ideas to use technology to deliver financial services in different – often disruptive – ways to better meet the needs of customers.

Every day it seems that there are new ideas being developed and new fintech services coming to market.

Just in the past few months I have spoken with Chris Gilbert and Jonny Wilkinson of Equitise, a crowd sourced equity funding platform already operational in New Zealand; with Dan Bennett of OurCrowd, the Israeli-founded crowdsourcing platform which is in the Australian market targeting sophisticated investors; with Martin Dalgleish and Daniel Foggo of RateSetter, the peer to peer lending business, which launched locally in October 2014; and with Kelly Bayer Rosemarin of Commonwealth Bank who briefed me on the bank’s latest products including Daily IQ, an app which lets business customers get real time data on their iPad.

Let me say a bit more about peer-to-peer lending.

This is a classic example of what the economic textbooks call ‘disintermediation’ – rather than person A lending to a bank and person B borrowing from the bank, instead person A lends to person B and there is no need for the bank in its traditional intermediary role.

Traditionally however it was impractical or very expensive for person A to find people who wanted to borrow money directly – and it was also risky because the person she found might be a poor credit risk.

The internet makes it possible at very low cost for person A to find someone wanting to borrow – and for person B to find someone wanting to lend.

It also makes it much easier for person A to learn about person B and make an assessment of that person’s likelihood of repaying the loan. In addition, as RateSetter explained to me, they have some clever tools to help manage risk, with borrowers paying a ‘Risk Assurance Charge’ into a ‘Provision Fund’ which exists to compensate lenders in the case of a default. The amount paid into the fund is determined by a number of factors, such as the borrower’s credit rating from independent credit reference agencies.

This is a powerful example of the way that digital technology and the internet makes it possible to develop completely new approaches to providing financial services. The notion of a lender and a borrower being matched directly, and transacting directly with each other, is fundamentally different from the traditional banking model.

I spoke earlier about the difficulty that small business faces in obtaining finance today.  This is an area where internet based approaches – such as crowd sourced equity funding and peer to peer lending – can offer some significant new options.

Using the internet to publicise your business and pitch for capital can make it feasible to raise equity in smaller amounts – and from a larger number of investors – than is possible using traditional methods.

This is so for two key reasons. First, the internet lets you publicise the investment opportunity to a large number of people for a very low cost. Secondly, the transactions costs per investor are much lower than traditional methods – making it feasible to attract relatively small sums from a large number of investors as a means of raising the desired amount of capital.

The report being launched today proposes some fascinating ideas for further disruption – bank account number portability being one of them.  One of the issues which deters customers from changing banks is the switching cost.  This is a particular issue for business customers, who will likely have concerns about:

• How they notify customers of new account details;
• The transfer of payments between existing and new accounts;
• changes to stationery or business listings with the old account details;
• and even concerns about what the change in account details may signal to their customers.

The authors of this report point to work by the UK Financial Conduct Authority which found that 35% of consumers and 40% of businesses ‘would be much more likely or more likely to switch if they had portable account details’.[6]

The report’s authors in my view are right to look towards mobile number portability as an example – this is the set of arrangements under which end users can have their number moved from one telecommunications carrier to another within a matter of hours. 

This occurs because it is mandated by regulation.  Consumers derive great benefit from it.  But I can say from my experience as an Optus executive in 2000 and 2001 when it was introduced that many of our sales people were dead against it; I have no doubt the same argument was made inside Telstra and Vodafone.

I came across a similar issue in the last parliament, serving on the Joint Committee on Corporations and Financial Services, which was investigating the superannuation sector.  I was surprised to discover that in the superannuation sector there is still very heavy use of paper based transactions.

This is hugely inefficient – as is clear to any Australian who has ever sought to move their superannuation balance from one provider to another. There is legislation to mandate new arrangements, the so called ‘Superstream’, but there is a fair way to go yet.

Let me close by emphasising the support of the Abbott government for technology-led innovation in financial services – as in every other segment of our economy.

We have committed to introduce legislation this year to facilitate crowd-sourced equity funding (CSEF).  Recently we released a consultation paper outlining key elements of the proposed framework for public companies. The paper also seeks feedback on whether the CSEF framework should be extended to proprietary companies.

We have also made changes to the tax treatment of Employee Share Schemes. From July 1, there will be expanded tax concessions for employee share schemes to make it easier for small start-up companies to attract and retain the talent they need to grow.

Let me congratulate the authors of this important report.  Competition is a powerfully important policy tool – particularly when it comes to delivering benefits to customers.  But there are many whose interests are well served by the existing arrangements.

There are also powerful arguments in favour of system stability in financial services.

It is not unusual in economics that we need to weigh up competing objectives.

The exciting thing I believe is that technology led innovation in financial services offers the opportunity to stimulate competition and deliver better and cheaper services to consumers – without compromising system stability.  Indeed the rise of peer to peer lending potentially leads to a system which is not so dependent on a small number of intermediaries – hence actually reducing systemic risk.

These are important issues to investigate – and I thank the authors of this report for the light they have cast upon them.  I am sure it will have an impact on policymakers – and I thank you for the opportunity to join you at this launch.

[1] AMTA, 'Ten Years of GSM in Australia'

[2] ACMA Communications Report 2012-13, p8

[3] ACCC ‘Changes in the prices paid for telecommunications services in Australia report’ 2013–14, p95

[4] “Big four on top of the world for profitability, says BIS”, Sydney Morning Herald, June 29, 2014 www.smh.com.au/business/big-four-on-top-of-the-world-for-profitability-says-bis-20140629-3b2c6.html

[5] Source: Mihovil Matic, Adam Gorajek and Chris Stewart, Small business funding in Australia, Small business finance roundtable, Reserve Bank of Australia, May 2012.

[6] CIFR Competition in Financial Services p94