How do you solve a problem like the banks? The Treasurer, Wayne Swan, has been trying to figure it out for three years. He’s getting closer.
For all the bluster about an outbreak of “war” between the banks, with NAB sending twee “break-up” letters to other banks, there is no escaping the fact that the global financial crisis decimated smaller lenders in Australia and major banks continue to write up to 90 per cent of all new home loans.
This lack of competitive tension drives higher fees and has helped enable the big banks to pass on higher funding costs to customers with out-of-cycle interest rate rises (remember too, that they also did not pass on the full interest rate cuts made by the Reserve Bank during the global financial crisis).
Addressing the problem of a lack of competition in the banking sector requires a mix of “supply-side” measures – to boost the number of competitive players – and “demand-side” measures – helping customers to drive competition by switching to lenders offering a better deal or service.
The Treasurer’s most recent bid to boost competition, his “Competitive and Sustainable Banking System” package released in December, shows promising signs of attempting to do both. Comprising, among other things, a ban on mortgage exit fees, increased support for smaller lenders and an inquiry into the feasibility of making bank account numbers portable – like mobile phone numbers – it is a vast improvement on the so-called “account switching package” he announced three years ago. That has left consumers drowning in paperwork if they decide to switch banks.
A series of internal Treasury emails released this week under freedom-of-information laws has given valuable insight into the development of this new package while also hinting at the shortcomings of Treasury’s advice to its minister on this most sensitive of subjects.
The package appears to have sprung to life in mid-September last year. On September 17 a political adviser to Swan sent an email titled “Bank Funding Five Point Plan” to Treasury staff, essentially summarising five main points from a meeting with Swan about banks. The adviser cheerfully suggests Treasury review the points and then ” get cracking on pulling the 5PP (new nickname!) together”.
“We are getting cracking now!” Treasury responded three minutes later.
At this stage the package consisted of three long dot-points about measures to increase funding for lenders, one dot-point about supporting mutuals and foreign banks, and just one sentence about the need to “further explore practical and effective ways of helping consumers drive competition”.
Treasury responded, nominating two consumer policy options: making mortgage fees more transparent, and exploring the idea of account portability. Treasury staff enthusiastically mocked up a one-page mortgage fee disclosure document and sent it to the Treasurer’s office, reporting later that “the approach was very well received by Ollie [Swan’s political adviser]. I flashed the one-pager and he was very impressed (and that was the black and white version).”
But amid all the Treasury backslapping, an external bomb lobbed.
On October 1 a senior Treasury official sent an email to Swan’s political adviser, with a copy to the Treasury secretary, Ken Henry, advising that an undisclosed person (name removed for “breach of confidence” reasons in the FOI documents) had suggested the Treasurer also ban exit fees on new mortgages.
An appositely named Treasury official, Nick Loan, emailed back advising that, while such a measure would indeed make it easier for consumers to switch banks, the cost would likely be passed on to other customers through higher interest rates or higher upfront fees.
The Opposition has seized on this particular email to hammer the government, insisting that banning exit fees will simply push up interest rates.
But there is more to the story than that. The reason for banning exit fees is that they are a hidden cost that consumers do not take into account when choosing a loan. We assume “oh, she’ll be right, I’ll never move” and sign on to the loan with lower upfront fees.
Exit fees are designed to back-end mortgage costs and reduce upfront fees and interest charges to lure more customers. But once lured, they also act as a disincentive for customers to switch, thereby reducing competition.
So even if banning exit fees meant they were replaced by entry fees, this would have the benefit of making the charges more transparent. In the longer run, the ability of customers to better assess the actual cost of a loan should create custom for lenders offering a cheaper deal, thus driving down prices.
Banning mortgage exit fees essentially reverses a cross-subsidy between switchers and non-switchers. Switchers now shoulder the cost of lower interest rates by paying exit fees. Under the new arrangements, non-switchers will pay more so that switchers can switch. And who knows, one day when the supposed non-switcher gets genuinely fed up with their bank, they can become switchers too. That is the point.
Swan has had a chequered history on bank competition reform, but his embrace of new aggressive measures to boost the “demand” side of the competition equation is promising and suggests he may have a better grasp of the issue than some of his Treasury advisers, who have tended to favour supply-side measures.
Helping customers to vote with their feet helps to drive competition, lower prices and better service among banks.
In addition to banning mortgage exit fees, Swan has recruited a former Reserve Bank governor, Bernie Fraser, to conduct a review of the feasibility of making account numbers portable. The proposal is similar to when telecommunications companies were forced to make mobile phone numbers portable so consumers could switch providers. But bank account numbers are more complicated, due to the complex array of transactions that hang off accounts, like direct debit authorities, regular scheduled payments and linked accounts and mortgages.
Should direct bank account number portability be too costly, Fraser will explore other avenues for making switching easier by requiring banks to take more of the responsibility for switching customers’ accounts. Banks are now only required to help customers that are switching write letters to their individual direct debitors to update their details.
In some European countries, customers can simply walk into their new bank and sign a piece of paper authorising it to switch all their payments over to the new account. How refreshing.