The consumer inertia in banking

Two defining requirements for competition are a variety of offerings from sellers and a willingness by buyers to shop around. To those can be added the idea of contestability – are there barriers to sellers which might stop them offering a full variety of products?

In the financial services sector, there is an ongoing debate about competitive offerings but the greater mystery is why customers have historically been reluctant to shop around – even when there is a lot of choice.

" Regardless of how much ‘variety’ there is, historically consumers have exhibited considerable inertia in financial services." - Andrew Cornell

Regardless of how much 'variety' there is, consumers have exhibited considerable inertia in financial services as opposed to, for example, restaurants.

But is that reluctance dissipating? There are conflicting trends but in Australia, at least, customers do seem to be moving with greater alacrity.

According to the Australian Bankers’ Association submission to the current Productivity Commission review into the financial system, more than three million Australians have switched banks over the past three years with two-thirds finding it an easy process.

The research, by Galaxy, also shows almost two thirds have accounts at more than one bank while in 2016, 8 per cent of credit card balances were transfers – evidence of a shift between products.

Elsewhere though even the promise of radical new financial technologies (fintech) and the idea of 'open banking', where customers are given control of their financial data, allowing more competitors to pitch for their business, doesn’t seem to have driven consumer movement - yet.

It’s early in the fintech revolution, and the campaign is changing rapidly, but there have now been several robust surveys which demonstrate consumers remain reluctant to embrace new providers on a large scale.

The actual market shares of disruptors – be they peer-to-peer lenders, specialist payment providers or wealth managers – remain small.

A survey by Accenture in the UK found a profound reluctance by consumers to share their financial information with a third party, the essential step for “open banking”.

The survey of more than 2,000 people found privacy concerns would prevent a majority from changing their banking habits, with more than half (53 per cent) saying they would never change how they bank and take up more open services.

From next year, European Union laws will force banks to offer open access to customer data, with consent, to encourage competition and switching between lenders but that still requires a willingness by consumers to shift.

The Productivity Commission in Australia undertook a public inquiry into the benefits and costs of making public and private datasets more available - as a potential precursor to encouraging greater competition - and has now turned its eye to open banking.

History tells us too that people become more comfortable with new technologies and opportunities as they mature but financial information has always existed in a different category.

Indeed, trust – bolstered by strong regulation – in the banking system remains a telling competitive advantage for incumbent financial institutions in spite of the public opprobrium evident in some markets.

In Australia, the most graphic demonstration of new competition meeting willing buyers was when mortgage originators entered the residential property market in the 90s. Despite the belief from incumbents that their long relationships and branch networks would see off competition, the mortgage market proved to be highly contestable and in the following decade non-bank mortgage originators picked up almost one in four new mortgages.

Whether residual reluctance to shift is due to a lack of competition or a lack of contestability is a crucial debate. In Australia, the Productivity Commission is taking submissions on competition in the Australian financial system as we speak.

To be tested is the core proposition that customers actually don’t have the range of choice they appear to have. The argument is Australian banking is an oligopoly dominated by the big four; that oligopoly gives them market power; and that market power allows them to over-charge.

Perhaps to many that chain may seem self-evident but actually when using the methodologies favoured by competition regulators, the apparent market concentration in Australia doesn’t limit competition.

For a start, concentration waxes and wanes. After the financial crises, when many smaller and specialist institutions failed – including some of the remaining mortgage originators from the 90s – market concentration increased.

But in recent years, as conditions have stabilised, new competitors have entered or re-entered the market.

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Meanwhile, one of the telltale signs of insufficient competition – excess profits – is not visible in the evidence.

Bank returns (return on equity or assets), interest margins and fees have actually trended down since the crisis. According to previews by analysts of the current Australian bank reporting season, these trends are continuing.

To look at competition more technically, ANZ in its submission to the Productivity Commission review cited one measure favoured by the Australian Competition and Consumer Commission to assess competition.

The Herfindahl-Hirschmann Index (HHI) takes into account the market share of all market actors, not just the major banks but other competitors. It is used as a screening tool by competition authorities to determine the state of post-merger industry structures.

“For example, the Australian Competition and Consumer Commission (ACCC) is less likely to identify horizontal competition concerns where the post-merger HHI is less than 0.2 (or 2000),” ANZ notes.

Even in the period post-crisis of most concentration, that level was not breached.

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Another measure, the Hall-Tideman Index, considers the number of banks in the industry. Generally, the more banks, the lower the index value and hence the more diluted the market concentration.

It essentially captures how much new competition is entering or exiting the market. The ANZ submission notes in Australia the index shows both new entrants entering together with a declining market share of incumbents.

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Interestingly, while switching in financial services remains below levels which might indicate frantic competition, the ANZ submission proffers data showing switching is actually accelerating.

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ANZ notes in its submission “greater consumer pressure on banks could be achieved by making it easier for consumers to switch between banks”.

“Our experience is that consumers readily open new mortgage, deposit and credit card accounts, often in response to price. For example, the level of mortgage refinancing (owner occupier) has steadily increased over time.”

That chart confirms the qualitative experience of the Australian mortgage market: high rates of change in the early 90s when originators enter the market; decline as incumbents acquired disruptors; steady trend as product offerings expanded; a steep decline in switching immediately after the financial crisis; and a resumption of trend.

That trend, together with profitability data, would suggest the market is functioning. Should there be even more movement however?

It seems that comes back to customers. Choice exists. Price alternatives and different service models are available. Yet customers are reluctant to move.

They may well be satisfied.

But it’s interesting to consider some of the most radical and, it would seem, biggest threats to incumbent banks: new competitors offering more efficient technology but with the scale and brand power of major banks – for example, Amazon and PayPal.

Amazon has been lending to SMEs in the US, UK and Japan since 2011 and says it has lent more than US$3.0 billion. Obviously not insignificant amounts – but dwarfed by existing SME lending markets.

Amazon’s model is very clever. Via Amazon Marketplace, its on-line platform connecting product sellers with buyers around the world while providing payment facilities, Amazon lends to the sellers.

Amazon makes offers to potential borrowers based on the revenue and return data it collects via Marketplace. Algorithms analyse sellers’ product popularity, turnover rates, buyer reviews etc.

The loans are relatively small and shorter term, interest rates competitive with credit cards and other unsecured lending. Amazon automatically deducts payments from a seller’s Amazon account but the finance allows the seller to expand – and sell more on Amazon.

PayPal also lends to SMEs that use its services and says it has lent a similar amount to Amazon. A plethora of other fintechs are in the market.

These are genuine competitors, offering an innovative and cost effective alternative to traditional financial services. They have scale and appear to have encountered few barriers to entry.

Yet consumer appetite remains limited. That’s the challenge for all new competitors, policy makers and regulators: even with choice growing and contestability alive and well, consumers can still be reluctant to embrace new forms of finance. That does seem to shifting however.

Andrew Cornell is manging editor at bluenotes

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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