Oligopoly in the Australian Banking Sector

Oligopoly in the Australian Banking Sector

By Adiktd

Introduction

The Australian banking sector is dominated by four institutions who together account for over 85% of the domestic home loan value. These firms; National Australia Bank (NAB), Commonwealth Bank (CBA), Westpac (WBC) and Australia and New Zealand Banking Group (ANZ), have a collective market cap of over 400 billion dollars (Tradingroom 2013), five times the total assets of the remaining banks, mutual funds and various other financial institutions combined (KPMG 2011). Although the market is said to be highly competitive (Wikipedia 2013) the high concentration of market power by a small number of firms can be likened to a form of oligopolistic behaviour. As the market leaders are able to manipulate the market, forcing smaller firms and consumers to comply. The four pillars policy adopted in 1990 can be attributed to this as it restricted any merger or acquisition of the “Big Four Banks” by each other or any other potential international institution (Treasury of Australia 1997). This is credited with providing the relative shelter from the global financial crisis that the Australian financial markets were provided and has since been a case for the continued enforcement of the policy. This report will however attempt to show that this uncompetitive behaviour is detrimental to the stability and efficiency of the Australian economy.

Market Structure

The Australian banking sector has one of the highest barriers to entry of any market. This is due to not only the various capital and regulatory requirements, but also due to the level of market power that the current “big name players” possess. “This pre-existing dominance is the biggest barrier to entry for new competition. In many cases, the incumbent is so entrenched, it's impossible for others to even begin to compete without considerable risk and cost.” (The Sydney Morning Herald 2013).
 Although the “Big Four” are technically separate entities, on examination of the annual reports of these banks it has been found that the majority shareholders and “proxy” board members are the same. These include large international banks and fund managers such as HSBC, JP Morgan Chase, and Citibank, (spankyourbank n.d.) As shown in the following table.

Due to the high level of mutual shareholder ownership across the banks, it can be inferred that these shareholders would have similar interests in each of the banks achieving the maximum profit and as in economic text books (Varian 2010) the firm’s profits are maximised when it can act as a monopolist or in the case of the Australian banking sector collude to form a cartel style of arrangement. There has over the past few years been widespread reform of the banking sector, as the government has begun enforcing more competitive behaviour resulting in more transparency and allowing customers to move more freely between institutions. (Dept. of Treasury Australia 2012)

One common method for determining the level of competitiveness in a market is with the use of a Herfindahl–Hirschman Index (HHI). The HHI is a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them (Varian 2010) with a higher value indicating a less competitive market. Upon examination of the HHI of the market (based on total resident assets of all banks operating in Australia for the period 2002-2010) it can be seen that the market is becoming ever more concentrated. The Office of Fair Trading (OFT) has stated in 2003: ‘The OFT is likely to regard any market with a post-merger HHI in excess of 1800 as highly concentrated, and any market with a post-merger HHI in excess of 1000 as concentrated.’ This increase in concentration is mainly due to the acquisition of the Bank Western Australia by CBA and the acquisition of St George Bank Limited by Westpac Banking Corporation in late 2008. (Stanford 2011)

Table 2

Herfindahl-Hirschman Index [2]

2002 end June	1319
2003	1349
2004	1267
2005	1251
2006	1207
2007	1130
2008	1104
2009	1195
2010	1453
2010 end Dec	1448

Effects of Increased market concentration.

This increased concentration in the market can cause a plethora of economic inefficiencies as the market shifts away from a competitive outcome. These efficiencies occur as firms no longer need to compete with each other to the extent that they did previously resulting in a deadweight loss being imposed as the market is not pareteo efficient. As firms behave in a more monopolistic manner this can also lead to social welfare issues as more consumer surplus is replaced with ever increasing producer surpluses. This combined with the level of co-ownership of the “Big Four” and the protection provided by the Four Pillars Policy and high barriers to entry inherent to the market will in all likely hood result in an ever increasing divergence away from a competitive outcome and as such a greater deadweight loss to society. This however as this would more than likely continue to fuel the increasing profits for the banks, resulting in little to no incentive for them to act in any other manner without external pressure. This external pressure can come from either government intervention, action groups, fringe competitors such as credit unions and mutual banks or most likely a combination of all three.  

Recommendations

As can be seen by Australia’s relative shelter from the financial meltdown that was the Global Financial Crisis of 2008 the “domestication” of the nation’s four largest financial institutions provided stability and protection from a severe economic downturn. This protection however must be noted that as with most policy decisions it is not without its faults. As the banks are so entrenched with domestic mortgages and collateral, a home-grown housing crisis (similar to the American housing bubble that was the precursor to the GFC) could ultimately prove catastrophic to the state of the national financial markets. It is up to the banks to ensure that they take adequate measure to diversify their exposure to risk with the goal of maintaining market stability. This security from take-over and the high level of market penetration that each of the “Big Four” possess over the market ultimately has the potential for two completely different outcomes, one efficient and the other monopolistic. If the four banks compete on price to obtain a larger market share and increased profits then the outcome will be similar to that of Bertrand’s competition which is pareteo efficient. However if the banks (possibly under pressure from shareholders) collude and form a cartel arrangement to act as a single monopoly then without external intervention the economy would suffer an extensive dead weight loss and the biggest losers would be the consumer of bank products, with less income available after fuelling the ever increasing profits obtained by the banks (The Sydney Morning Herald 2013) (The Australian 2013). Last financial year the “Big four” were able to achieve an after tax profit equivalent to $1500 for every current Australian citizen (News.com.au 2012). This extremely high level of abnormal profit shows that market conditions are far from that of a competitive outcome as we would expect under Bertrand’s competition that bank profit levels would average out to zero, not be amongst the most profitable in the world. (Australian Financial Review 2012)

Sources

AFR. 2012. bank customers pay for oligopoly. 30 Oct. Accessed Oct 28, 2013. http://www.afr.com/p/opinion/bank_customers_pay_for_oligopoly_HHFglGWlJZ0Ih3Lq5ZniSL.

Dept. of Treasury Australia. 2012. bankingreforms. Accessed Oct 27, 2013. http://www.bankingreforms.gov.au/content/Content.aspx?doc=switching.htm.

KPMG. 2011. “building societies and credit unions.” KPMG. Accessed October 27, 2013. http://www.kpmg.com/AU/en/IssuesAndInsights/ArticlesPublications/Financial-Institutions-Peformance-Survey/Building-Societies-Credit-Unions/Documents/building-societies-and-credit-unions-2011.pdf.

News.com.au. 2012. big four banks among worlds most concentrated. 10 Dec. Accessed Oct 28, 2013. http://www.news.com.au/business/companies/big-four-banks-among-worlds-most-concentrated/story-fnda1bsz-1226533197943.

spankyourbank. n.d. Who are the Bank's shareholders? Accessed Oct 28, 2013. http://spankyourbank.com.au/who-are-the-bank-shareholders.

Stanford, John. 2011. Concentration in Australian Banking. Feb. Accessed Oct 28, 2013. http://www.visualartist.info/jonstanford/news/concentration-in-australian-banking.

The Australian. 2013. major banks tipped for 27bn profit haul. 21 Oct. Accessed Oct 28, 2013. http://www.theaustralian.com.au/business/financial-services/major-banks-tipped-for-27bn-profit-haul/story-fn91wd6x-1226743452791.

The Sydney Morning Herald. 2013. banks make 71 million profit a day. 23 06. Accessed Oct 28, 2013. http://www.smh.com.au/business/banks-make-71-million-profit--a-day-20130623-2oqrw.html.

—. 2013. Oligopolies as safe as money in the banks. 18 Sept. Accessed Oct 26, 2013. : http://www.smh.com.au/money/investing/oligopolies-as-safe-as-money-in-the-banks-20130917-2tvlk.html#ixzz2iyDDwdQR.

Tradingroom. 2013. Quotes and Charts. 27 October. Accessed October 27, 2013. http://www.tradingroom.com.au/.

Treasury of Australia. 1997. “RELEASE OF THE REPORT OF THE FINANCIAL SYSTEM INQUIRY AND INITIAL GOVERNMENT RESPONSE ON MERGERS POLICY.” Canberra ACT: Department of Treasury Australia, 9 April. http://fsi.treasury.gov.au/content/PublicInformation/Pressreleases/PR090497.asp.

Varian, Hal R. 2010. Intermediate Microeconomics 8th ed. New York: W.W Norton and Company.

Wikipedia. 2013. Banking in Australia. Accessed Oct 28, 2013. http://en.wikipedia.org/wiki/Banking_in_Australia.

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[1] Image taken from http://www.independentaustralia.net/Wordpress/wp-content/uploads/2013/02/Fig1Hunter.png Feb 27th 2013

[2] Sourced from http://www.adelaide.edu.au/saces/publications/papers/issues/SACES_EconomicIssues32.pdf :

   Derived from APRA, Monthly Banking Statistics, www.apra.gov.au