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Bank Branch Rationalisation: Should We Allow or Encourage Limited Cooperation?
Phil Hanratty
Economics, Commerce and Industrial Relations Group
Australian banks now face intensified competition in many areas. Mortgage
originators(1) provide vigorous competition in residential lending while
the growth of compulsory superannuation has reduced the flow of household
funds into bank deposit accounts. Although bank profitability has remained
at high levels, it is expected to fall in coming years as the full effects
of competition come into play. These new forces of competition are adding
to enduring bank desires to cut operating costs in order to protect and
enhance profits. One major way of reducing operating costs is to reduce
bank branch networks.
Traditionally, branches were essential in contacting and engaging retail
customers, often on a lifelong basis. Individuals often started as child
customers of a bank via their own deposit account and progressed to being
borrowers when they grew up, took a job and purchased a house or some
consumer durable. Branches were also places where many decisions on lending
to local small and medium businesses were made. As well, many administrative
and accounting functions were performed at the branch level.
However, in recent years changes in technology and commercial practices
have led to the transfer of many of these functions to regional and national
bank centres. Loan application decisions have been streamlined and centralised;
many administrative and accounting requirements have been centralised
and/or contracted out. As well, customers have become more willing to
switch banks to get better deals. These changes have made the bank branch
somewhat irrelevant, although it is still valuable in marketing and customer
servicing. Australian banks have been reducing their branch numbers for
some time, in response to these changes. For example, in the period from
June 1991 to June 1995 the total number of branches operated directly
by the Big Four banks (NAB, Westpac, The Commonwealth Bank, ANZ) fell
by 9.4%, from 5,481 to 4,966.(2)
Some banks (and commentators) have argued that the restrictions on mergers
and takeovers, especially between the Big Four, should be relaxed or abolished.
This would permit, amongst other things, more extensive rationalisation
of bank branches. This will, it is argued, reduce operating costs enough
(by reaping economies of scale) so that the new competition from non-bank
intermediaries can be adequately met.
Currently, mergers and takeovers amongst the Big Four (and the two largest
life insurers) are banned by the Government. Takeovers of regional banks
by any of the Big Four must also be approved by both the Government and
the Australian Competition and Consumer Commission (ACCC). In their submissions
to the Wallis Inquiry into the Financial System, some banks have argued
that these restrictions be scaled back so that only the normal ACCC competition
guidelines apply.
The argument is often put that the very existence of a substantial number
of banks creates strong barriers to branch rationalisation. Individual
banks will be reluctant to be the first to close their branches in particular
suburbs and country towns since this will lead to a loss of customers
to the branches of other banks still operating within those towns and
suburbs. The initiating bank will thus have reduced operating costs but
at the expense of seeing their customer base cut dramatically. Since the
latter effect on profits will probably outweigh the former effect, in
many cases banks have been, it is argued, reluctant to take the first
step. The result is stalemate where no bank is satisfied; excessive costs
and inefficiency continue.
The economic benefits of rationalising the bank branch system will continue
to be substantial (especially in terms of increasing bank productivity
towards international standards), notwithstanding its costs to customers
of reduced branch availability. However, the already substantial reduction
in branch numbers in recent years indicates that current market structures
in banking are not a major barrier to rationalisation. As well, if more
rapid reductions are required, there are ways of facilitating this further
rationalisation without going down the irreversible road of allowing mergers
and takeovers, amongst the Big Four in particular. An alternative would
be to allow, or even encourage, some cooperation between the banks to
negotiate and implement coordinated branch rationalisation so that no
individual bank gained any substantial competitive advantage from the
process but where the total number of bank branches was substantially
reduced(3).
For example, if on average each suburb or town now has, say, branches
of 6 banks, it might be sensible to allow/ encourage, these banks to plan
a coordinated reduction to, say, 3 in each suburb or town. This would
substantially reduce costs and yet still provide some reasonable competition
for customers. Banks could negotiate so that the aggregate branch reductions
were evenly spread amongst all banks. This would mean for example that
banks would then have branches in only every second suburb or major town
of their previous network. The flows of customers into new accounts with
branches remaining in their town or suburb would tend to offset each other
in aggregate terms, so that no individual bank would be disadvantaged
and yet all would reap the benefits of lower costs and higher productivity.
Indeed, competition could be further preserved in this situation by
compelling banks to perform transactions for other banks, for a fee which
covered the costs of such transactions. Customers are already able to
use the Automatic Teller Machines of some other banks to operate their
deposit accounts. This could be broadened to encompass a much wider range
of transactions. But it would be crucial to monitor the fees for such
transactions-servicing for other banks to ensure that they merely covered
costs and did not deliberately discourage servicing.
This strategy of allowing/ encouraging limited cooperation amongst banks
to achieve operational economies of scale would need the approval of the
ACCC in order to proceed. The ACCC would require clear evidence of enduring
customer benefits (e.g. lower transaction fees/ loan rates or higher deposit
rates) before approving it.
Allowing or encouraging limited cooperation to pursue the benefits of
economies of scale, while still preserving the broader context of vigorous
competition, is a strategy that might be usefully pursued in other situations
as well. It has been a central element in Japanese industrial policy,
for example, to encourage such specific instances of cooperation (especially
in attempts to reduce excess industry capacity) where the benefits were
clearly larger than the direct economic costs of diminished competition.
It would seem preferable to follow this road of limited cooperation
rather than allow mergers and takeovers between the Big Four. The latter
policy course could lead to much larger losses in competitive pressures
across the full range of bank activities but yet probably achieve no more
in terms of branch rationalisation and lower operating costs, when compared
to the former approach. Limited and clearly specified cooperation, within
the context of a vigorous competition policy, could be the best avenue
for generating the market structures/ practices which will maximise economic
efficiency and welfare.
Endnotes
- Lenders who sell off their mortgages in professional capital markets.
- Reserve Bank of Australia Bulletin, September 1991: S19 and
December 1995:S32.
- Mitchell, Alan. 'Banks Run with Merger Message'. Australian Financial
Review, 11 September 1996.
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