Banking services: cost-effective switching arrangements
Chapter 1: Account switching and competition
1.1. The proposal to explore options to assist customers to more easily switch banking service providers was included in the Government's package of measures for A Competitive and Sustainable Banking System, which was announced on 12 December 2010. The presumption seemed to be that improved arrangements for switching accounts — deposit accounts and mortgages were mentioned specifically — would spur competition among providers and deliver lower prices and other benefits to customers.
1.2. Competition in banking services has been the subject of repeat inquiries over the past thirty years, with the most recent report — by the Senate Economics References Committee (the Senate Committee) — released in May 2011. The Senate Committee's report (Chapter 7) also addresses various aspects of account switching; given the overlap of the parties consulted, it is hardly surprising that many of the issues raised — and some of the sentiments — expressed in the Senate Committee's report should have echoes in this report.
1.3. Views differ on what constitutes appropriate competition in the market for banking services. Ideology aside, most people would be comfortable with arrangements which delivered desirable services at fair prices to customers and reasonable profits to providers and which, at the same time, avoided reckless behaviour by borrowers and/or lenders of the kind that could lead to meltdowns in the financial system. Australia has moved towards such a situation over the years, based on policies that see market forces as generally the best determinants of lending and deposit interest rates but which also recognise the need for firm prudential regulation to override these forces when they stray out of control.
1.4. The relevance of bank concentration and bank profits as measures of competition in banking services are subjects for debate. Banking in Australia is relatively concentrated but that is not necessarily a barrier to active competition, either among the major banks or between those banks and the smaller players. The major banks do earn good profits but, viewed as a return on equity these have been fairly steady over the past three decades (averaging around 16 per cent) and below comparable returns of many other large companies. But these are in part debating points and they downplay the significance of stability — as well as prices and profits — in a sustainable market for banking services. Seen in that broader context, the global financial crisis (GFC) has provided perhaps the best test of all — and Australian banks passed that test rather better than most. This is not to suggest that Australia has arrived at its 'Goldilocks' market for banking services: there is always some scope to enhance competitiveness, as well as some risks to guard against.
1.5. Of the major drivers of competition in banking services some are within the direct reach of domestic policy makers, others are much less so. The former include policies on bank amalgamations and new entrants, measures to help level the playing field for accessing funds (such as those in the December 2010 package), and the whole gamut of prudential and other regulatory requirements. Drivers which are largely external include structural and cyclical shifts in global financial markets (for example, the rise and then demise of international securitisation markets and the GFC), and on-going innovations in products and processes (for example, internet banking).
1.6. Central to this review is the issue of how significant policy measures to enhance account switching are likely to be in boosting competition in banking services and delivering worthwhile benefits to customers. Three questions suggest themselves. First, are current obstacles to switching a major barrier to customers pursuing their desired banking relationships? Secondly, would easier switching arrangements contribute to increased competition among financial institutions and deliver worthwhile benefits to customers? Thirdly, can easier switching arrangements be implemented at modest cost to industry and with zero or negligible flow-on charges to customers?
1.7. Publicly accessible data bearing on these questions are rather limited but a number of general points can reasonably be made:
- Current avenues for switching banking products (most notably transaction accounts) can involve hassles which are likely to discourage some potential switchers, but large numbers of switchers are able to get the job done. These numbers suggest that customers who are sufficiently motivated to switch find it reasonably easy to do so, and that the problems encountered by others may have more to do with motivation and perceptions, rather than real barriers.
- Switching arrangements hardly rank as a major direct driver of competition in the market for banking services, but they are relevant to facilitating access by customers to the benefits of increased competition arising from innovations, and other sources; and
- Given the observations in (i) and (ii), it would be reasonable to infer that any new arrangements for easier switching should come with modest price tags.
1.8. It is apparent that large numbers of customers currently switch providers when the potential financial gains are sufficiently attractive to justify the effort involved. This is most obviously the case for those products which seem to be of most concern to governments, namely mortgages and deposit accounts, which are mentioned specifically in the terms of reference for this review.
1.9. So far as mortgages are concerned, several points can be noted. To begin with, not all existing mortgage holders are likely switchers; many will be quite content with their present provider. Some may have considered switching only to be discouraged by exit fee imposts. Others again will have been persuaded by their existing provider's retention team (and the offer of better terms) to stay, rather than switch. The bottom line, however, is that the housing mortgage market over the past couple of decades has seen significant switching by borrowers who have been motivated to change providers to gain a better deal:
- In the 15 years or so preceding the GFC, competition from regional banks, credit unions, building societies and other non-bank lenders attracted (new and existing) customers away from the majors, doubling their market share to around 40 per cent of new housing loans and reducing net interest margins on these loans in the process. Much of this growth, occurred on the back of burgeoning securitisation markets (particularly in the US and Europe) where smaller banks and non-banks could borrow much of their funding needs at rates comparable with those paid by the major banks for their wholesale funds.
- Inappropriate pricing of risk in overseas securitisation markets led to its virtual closure in 2008, which contributed mightily to the GFC. With the demise of the securitisation markets the majors (and their acquisitions) regained their dominant market share of the housing mortgage market, with close to 80 per cent of new loan approvals in recent years.
- In the more subdued post-GFC credit environment, competition remains keen and considerable switching is occurring. Many banks, for example, have been offering discounts of 70-100 basis points on their standard variable mortgage rate to new customers and some have abolished exit fees ahead of the Government's ban taking effect.
- Offers of discounts and other inducements, together with the active involvement of mortgage brokers, are contributing to considerable refinancing of mortgage loans. ABS data suggest that roughly one third of new housing loan approvals in 2011 to date are refinances of earlier loans with a new lender. In other words, considerable switching is still occurring, notwithstanding the successes of bank retention teams in retaining many customers. (Customers who are retained through the offer of a better deal effectively receive a benefit comparable with that which they would otherwise obtain by switching to a new provider, without having to make the switch.)
1.10. In the case of deposits, investors have been receiving 'market' interest rates on most deposit products since deregulation gathered momentum in the 80s, and they have actively switched funds between accounts to take advantage of this situation. The intense competition to lend for housing (and other purposes) in the years of easy credit prior to the GFC has given way in the past few years to intense competition for deposits, as global securitisation and other funding sources have dried up or become too expensive. As rates for term deposits and internet deposits have risen customers have moved in large numbers to those institutions offering the most attractive terms.
1.11. None of this is surprising. The financial benefit of switching term and internet deposit accounts is easy for customers to calculate, banks actively market 'special rate' deals, and switching itself is straight forward; unlike mortgages, there are no exit fees, credit checks or transfers of mortgage documents to worry about, and no need for identity checks where funds are transferred from established transaction accounts with other institutions. Transfers can be executed by phone or over the internet, which opens up the field to players without branch networks. ING Australia, which focuses on internet and phone banking services, is understood to have acquired 100,000 new customers in 2010.
1.12. In short, considerable switching of mortgage and deposit accounts is occurring and appears to have been increasing over recent years. (Similar comments can probably be made about credit card accounts where, for example, balance transfers are commonplace and actively marketed by some institutions.) These are big ticket items for the customers who have them. They are competitively priced and the process of switching from one provider to another to gain a better deal seems to be largely free of serious impediments for most customers.
1.13. The situation in respect of transaction accounts is less clear cut. The popular focus tends to be on mortgages but the potential barriers to account switching are probably most pronounced in the case of transaction accounts.
1.14. Transaction accounts are the accounts into which individuals and businesses channel their incomes and cash flows and from which they fund a variety of payments. In general, net balances in these accounts attract minimal or zero interest but on-going administration fees also tend to be quite low. Offers of lower fees and charges are always welcome but compared with the often substantial gains to be had from switching home loans or term deposits the potential gains from switching transaction accounts would not loom nearly as large for most customers. This suggests a lesser financial incentive for customers to shop around for better deals in transaction accounts per se. (In shopping for a better deal on their mortgage loan some customers may end up switching their transaction accounts as a condition of gaining the mortgage deal). It is probably also the case that non-financial considerations, such as access to the most convenient points of contact (physical or electronic) for conducting their banking, and dissatisfaction with the service provided by their existing provider, weigh more heavily in the decisions of customers moving transaction accounts than they do for mortgage and deposit accounts.
1.15. Motivations aside, switching transaction accounts is somewhat more demanding than switching mortgages or deposit accounts. Additional identity checks are likely to be required, and for many customers there will be a number of direct debits and credits to be transferred. The perceived hassles involved in these processes by prospective switchers are usually greater than the problems experienced by people actually making switches. Nonetheless, such perceptions, combined with the absence of clear financial incentives to offset the effort required, would suggest a certain amount of inertia when it comes to switching transaction accounts. Why bother if the hassle of switching is likely to outweigh the potential benefits? And if the transaction accounts on offer from different institutions are broadly the same anyway, why change?
1.16. Against this background it is a bit of a surprise that transaction accounts are also an area of considerable switching activity. In its submission to the recent Senate Committee inquiry, the Commonwealth Bank Group reported that it '… opens and closes over a million personal transaction accounts a year in the context of having over 5 million personal transaction accounts.' Other banks and the Australian Clearing and Payments Association (APCA) indicated to the same inquiry that they considered '... there is substantial switching and effective competition in transactional banking services.' At a CEDA function last week the CEO of National Australia Bank indicated that its campaign of clearly differentiating its products terms from those of the other major banks had yielded approximately a quarter of a million new customers since February 2011. APCA and Choice provided separate estimates to the Senate Committee inquiry which pointed to switching rates of around 8-10 per cent of transaction accounts per annum.
1.17. These numbers of 8-10 per cent, which are comparable with estimates of switching rates in some European countries with more formal switching mechanisms, raise again the threshold question of the seriousness of current impediments to switching transaction accounts. Clearly, those impediments should not be exaggerated. At the same time, to argue that every customer who wishes to switch transaction accounts can do so without difficulty would also be an exaggeration: for some customers, switching does raise problems which might be alleviated if simpler and more effective formal switching arrangements were available.
1.18. Some arguments in support of this latter judgement are:
- while the numbers of customers switching accounts are quite large, the stock of such accounts is many times larger (currently around 34 million);
- while not themselves a direct driver of increased competition, simple and cheap switching arrangements could help to facilitate the flow-on to more customers of the benefits of spurts in competition whenever they occur and whatever their source — these spurts (for example, from lower funding costs or technical innovations) mean the best deals are likely to come from different institutions (or groups of institutions) over time, making switching a more common and frequent activity; and
- effective formal switching arrangements might not only encourage more customers to switch, but also assist those who currently switch under their own steam.
1.19. The recurring emphasis here is on the attractiveness of 'simple', 'cheap,' and 'effective,' switching arrangements — arrangements that might assist both in nudging hesitant switchers across the line, and accommodating serial switchers. Given the thrust of the analysis in this Chapter, more elaborate proposals, with likely costs out of proportion to their potential benefits, have little appeal. A couple of options of the latter kind are considered briefly in Chapter 2 while Chapter 3 details a relatively simple, cheap and effective alternative.