Bankable Frontier Weblog

In June 2005, the European Union competition authorities announced a full scale Sector Inquiry into competition in retail banking.  Citing the desire to further integrate retail financial service markets in Europe, the Commission said that the Inquiry would investigate factors which hinder retail banking competition. In some ways, the Competition seems to be picking up the mantle of the UK’s Cruikshank Review of Banking Services, published in 2000. This extensive inquiry resulted in findings that certain aspects of UK retail banking, notably the payment system and the provision of finance to small businesses, were uncompetitive.

Meanwhile, the Competition Commission in South Africa recently issued a tender for a research study into the national payments system and competition in the banking sector there. This followed the final report of a National Treasury Task Team in 2004 on the issue of Competition in Banking, known as the Falkena Report. The Falkena Report  extensively quoted the Cruikshank Review, and indeed, used it as a guide. Although not yet officially released, this report together with the announcement of the follow-on study has attracted widespread media coverage.  The intended study in South Africa is preliminary to a formal investigation of the kind announced by the EU.

Recently, US courts and Australian regulators have reached conclusions that some practices of the major credit card associations are uncompetitive and have ruled to change these. These card associations are owned by member banks, and operate extensive retail payment systems for their members.

These actions by regulators signal concerns that all is not well for consumers in retail banking, even as banks are reporting record profits in many markets.  The precise causes of concern differ in different markets, although the lack of effective competition is common theme.

In South Africa, there is rising concern about the increasing concentration of assets in the hands of a few (four) big retail banks. The 2004 Annual Report of the Registrar of Banks in SA showed that the Herfindal-Hirschman index, which measures concentration in the banking sector, was at its highest level in more than a decade. As shown below, concentration levels had declined until 2001, when a series of bank failures promoted consolidation in the industry. While there had been no bank failure in 2004, the four large banks had further consolidated their position in the local market.

Source: SARB (2005) Annual Report of Department of Bank Supervision

By contrast, the European retail banking market, considered as one market, is nowhere near as concentrated; and the competition concerns there may have more to do with obstacles to integration across EU national markets. Removing the obstacles will undoubtedly promote greater concentration in banking Europe-wide, as larger regional or global banks are able to enter and compete against local rivals.

Ironically, the heightened scrutiny of banks by competition watchdogs comes at a time when banks themselves in these markets report robust competition—see for example the 2005 Price Waterhouse Survey of SA banking executives. So why are the regulators not convinced?

There appear to be at least two underlying factors in the structure of the banking industry which are generating the ongoing concerns. The first is the presence of strong economies of scale in banking, which was discussed in a previous post. This means that larger banks will tend to increase their dominance over time.

The second is related, although separate. Large banks in most countries control the clearing systems through which millions of payments are made daily—via ATMs, credit cards, stop orders and so on. Payment systems, like other networks, are subject to spill-over effects which can entrench the power of incumbent systems against newcomers: exactly because a system is widely used, it is useful to participants. A new system with limited usage would struggle to achieve the same level of utility. This entrenched advantage gives some monopoly-like pricing power to the clearing banks which control access to the heart of the system. The ‘payments franchise’ is increasingly valuable as banks’ traditional advantages in other business segments have been eroded: for example, they face greater competition in lending from non-banks and capital markets, and hence pressure on their interest margins. Fee income therefore becomes all the more important. Fees from consumers for making payments and transfers make up an important portion of the non-interest income of a typical SA retail bank.

Payment systems are complex and delicate pieces of financial infrastructure—hence the somewhat tentative approach followed by the regulators mentioned above to investigate thoroughly before pouncing. However, this last bastion of banking privilege is under close scrutiny, if not yet direct attack, in the countries cited. These new investigations, following on from the recent court judgments in other jurisdictions, are worth watching. Their outcomes will shape the payment systems of the future.