Chapter 5
Competition in the market for small business finance
Introduction
5.1
The increase in margins on small business lending, and some complaints
about lack of finance, suggest that competition may not be as intense as it
should be in the market for lending to small businesses.
Views about current extent of competition
5.2
A strong consensus emerged from small businesses across industries that
competition had declined and was now inadequate among lenders:
...number one on our wish list would be an increase in
competition because we have seen concentration within the marketplace in recent
times.[1]
...52 per cent of respondents were of the view that there has
been a reduction in competition in the small business lending market over the
last 12 months to two years.[2]
There also appears to be relatively little price competition
across the major lenders.[3]
We see a return to competition in the market as being
absolutely essential. We would also be concerned if there were any further
diminution of competition in the market through acquisitions or mergers, be
they between banks or other large financial service organisations.[4]
,,,as far as automotive finance goes there are really only
two players in the market at this stage and certainly all the major businesses
typically have a relationship with those financiers.[5]
5.3
The Reserve Bank acknowledge that competition for small business lending
has been lacking, at least temporarily:
Since the onset of the crisis, competition in lending has
decreased. The easing in competition is to some extent cyclical. During periods
of strong economic growth, banks tend to compete aggressively for business
lending by cutting their margins and relaxing their lending standards. However,
when the economic and business outlook is uncertain and loan losses are rising,
as has been the case over the past couple of years, banks see the loans as
being more risky and pull back a little....as the Australian economy strengthens,
there may be some incentive for new or existing lenders to expand their lending
in this sector and compete away some of this spread.[6]
5.4
The bankers themselves concede that the global financial crisis reduced
competition:
Immediately prior to the global financial crisis when credit
was very cheap, very cheap credit meant that there was fierce competition
amongst a whole range of lenders to provide businesses with loans. That choice,
that competition, has undoubtedly diminished as a number of those players have
been forced out of the market, but we are seeing signs of those players
returning.[7]
5.5
The Australia Institute's David Richardson views the manner in which
banks change their interest rates synchronously as indicative of a lack of
competition:
A good example of the exploitation of market power on the
part of the banks follows the increases in official interest rates by the
Reserve Bank of Australia. Objectively bank costs have not changed from one day
to the next but the banks use the official interest rate decisions as cover to
increase their interest charges...The clear impression from watching bank
interest rate changes is that official interest rate changes are taken as the
signal to change bank lending rates whether bank costs justify an increase or
not. It looks like a textbook example of oligopolistic pricing in which the
main players set a common price to maximise their collective earnings. Usually
explicit collusion to set prices is illegal but there is implicit collusion
that may take other forms. For example, one firm may emerge as the price leader
occasionally announcing changes in prices that are copied by other participants
in the market...In the case of banking, it is actually the RBA that acts as an
unofficial price leader. The RBA announces interest rate changes which are
followed by the banks, at least on their lending side. Hence the RBA acts as
the price leader and the banks follow the leader irrespective of their costs.[8]
5.6
There are hopes of improvement in competition:
Competition in the small business lending market has eased
from the strong levels just prior to the onset of the financial crisis, but we
think it should recover as the economy continues to strengthen.[9]
5.7
Business, however, is yet to observe this:
We have not seen a significant increase in competition, no.[10]
The role of non-ADI lenders
5.8
The global financial crisis has reduced the role of lenders who are not
authorised deposit-taking intermediaries (banks, building societies and credit
unions).
5.9
The Reserve Bank estimates that:
The non-ADI lenders were about 10 per cent of the market in
2007...they are probably about five per cent of the market now...[11]
5.10
In some cases the tougher global financial conditions may have hastened
but not caused the demise of non-ADI lenders:
...certainly with some of them—their business models were not
sustainable in a medium-term sense. They were sustainable in 2007, but they
were obviously not sustainable in the height of the crisis and they probably
would not have been sustainable going forward.[12]
Bank switching costs
5.11
The Council of Small Business of Australia's submission focuses on
reducing switching costs between banks as a way of improving competition. They
advocate the Government:
...regulate with respect to some of the high costs of switching
banks that currently exist. For example, bank account number portability, like
mobile phone number portability, has the capacity to promote choice, reduce
costs and increase productivity.
...work with State and Territory governments to overcome other
barriers to switching banks that are attendant on business loans for
mortgage-secured businesses, such as stamp duty costs.[13]
5.12
Questioned at the hearing, other business representatives also indicated
this is an issue:
We certainly have some anecdotal evidence of transaction
costs associated with switching banks or financial institutions...some
[businesses] have indicated that they find it difficult to switch banks or it
is just too costly for them to switch banks, so therefore it is a hindrance...[14]
...the government must act as it did in the household mortgage
sector to reduce the barriers to switching providers. We believe the
Productivity Commission should do a full review of the costs and constraints
faced by small business when they engage with banks to secure finance.[15]
If exit fees act in an almost prohibitive way for the
transfer of funds from one institution to another, they effectively act in an
anticompetitive manner in the market.[16]
I, for one, changed our financial institution about 15 years
ago after our family had been with them for a hundred years, and it was not an
insignificant cost to us with all the extra things such as stamp duty and all
that sort of activity which made what seemed a simple business decision at the
time start to look like maybe we should not be doing it because there was going
to be a direct out-of pocket cost.[17]
5.13
Treasury also highlighted the importance of switching:
...switching is probably one of the best things you can do in
terms of stimulating competition...[18]
5.14
They were, however, less critical of the current amount of switching:
...Australia’s switching rates are actually no lower—and
probably higher—than other major countries.[19]
5.15
Rival lenders are also opposed to banks' high exit fees:
...they are in our view operating as a definite brake on the
ability of consumers to leave...[20]
5.16
A report by the House Economics Committee recommended that:
...as part of the adoption of responsibility for the regulation
of credit...the government consider mechanisms...for addressing unfair entry and
exit fees.[21]
5.17
In particular, exit fees (or 'early termination fees') on variable
interest rate loans and establishment fees for new loans act as a disincentive
to change banks. This was put to the banks:
Senator HURLEY—... Can you comment on the ease of any
businesses being able to take advantage of that and whether you see that has
eased or become more difficult?
Mr Münchenberg—I
do not know of any reason why it would have become more difficult. I would have
thought that it is reasonably straightforward for business customers, subject
to whatever arrangements they have in place.[22]
5.18
The Committee is not aware of any study of the size of exit fees on
loans to small business but an indication may be gleaned from a study by ASIC
in 2008 on exit fees on home mortgage loans. This found that exit fees have
been increasing, both absolutely and as a proportion of total bank fees.[23]
A typical exit fee charged by a major bank for a repayment of a $250,000
variable interest rate loan after three years was around $1,000 and over 90 per
cent of mortgage products from major banks had exit fees.[24]
5.19
The study also shows that exit fees charged in Australia are much higher
than those charged by banks in the UK and US (Chart 5.1). A similar conclusion
was reached by the Reserve Bank:
...by international standards we have relatively high exit fees
on mortgages...[25]
Chart 5.1:
Comparison of selected bank fees
Source: ASIC, 'Review of
mortgage entry and exit fees', Report no. 125, April 2008, p. 11.
5.20
Treasury suggested exit fees could be challenged:
With exit fees it is questionable and some people say that
they could be challenged as a term of an unfair contract. So the government has
introduced—under the new credit legislation—capacity for individuals to
challenge unfair conditions in terms of contracts...Treasury questions exit fees... [26]
5.21
Section 72(4) of the Uniform Consumer Credit Code states:
A fee or charge payable on early termination of the contract
or a prepayment of an amount under the credit contract is unconscionable if and
only if it appears to the Court that it exceeds a reasonable estimate of the
credit provider's loss arising from the early termination or prepayment,
including the credit provider's average reasonable administrative costs in
respect of such a termination or prepayment.[27]
5.22
As far as ASIC was aware, however, no cases had proceeded under this
section.[28]
A likely reason is the legal costs for an individual borrower are dauntingly
large when there is no guarantee of a case being successful. Justice Morris may
not have helped when in a related case he ruled that:
...there is no implied obligation to refrain from charging an
unconscionable establishment fee, rather, that a lender is at risk if it
charges an unconscionable establishment fee.[29]
5.23
Small businesses do not have access to this consumer protection so are
even less able to challenge exit fees.
5.24
Some business organisations are reluctant to embrace a ban on exit fees:
I am hesitant to bandy around the word ‘ban’. Given that my
members are essentially participants in the free market capital economy that we
have, they would want the right at all times to charge whatever fees they want
in their own businesses. So I think it would be fair to say that, rather than
dictating what fees and charges an institution could or could not charge, the
key is transparency. [30]
5.25
Bank exit fees are not the only impediment to switching banks:
It could be relationship factors. They are used to dealing
with one bank, one branch and so forth and so on. [31]
There is also a perception amongst small businesses that
there is not much benefit from trying to shop around, as the banks all have
similar application and assessment processes.[32]
During the crisis people who had solid banking relationships
have tended to say, ‘Look, I’m going to really value this.’[33]
Anecdotal evidence from our members suggests that banks are
currently less interested in winning additional business from small business
customers. Some members have stated that banks are worried that businesses
trying to leave their current provider must be doing so because they represent
a bad risk.[34]
5.26
Another barrier to switching between banks is stamp duties. Under the Intergovernment
Agreement on Federal Financial Relations, stamp duties on mortgages are
scheduled to be abolished before 1 July 2013.[35]
5.27
Bank account portability has been suggested as another means of
facilitating switching. Asked about this, the Australian Bankers' Association
responded:
Whilst we can appreciate the appeal of such a concept, this
will not be pursued by the wider industry at this stage given the very high
cost, complexity and disruption involved in the potential implementation of
such a facility. By way of background, the account number (including the BSB
component) is a unique (to each bank) identifier which permits all the bank’s
systems and customers’ systems (e.g. payroll, accounting packages etc) to
‘know’ where to send funds. Financial institutions maintain separate IT systems
for the different payment clearing systems and each IT system is integrated
into many other product and accounting systems. Account portability would mean
a fundamental change to each of the IT systems used to exchange payments and
substantial rebuilding of other systems. Moreover, many businesses and service
providers, including government departments (such as ATO and Centrelink) have
IT systems which store BSB and account number information for their staff (for
payroll purposes) and customers. It would require them to also update their IT
systems and payment records at considerable expense.[36]
Committee view
5.28
Exit fees are not the only factor reducing switching between banks, but
this is no justification for maintaining this impediment to competition. While
there are valid arguments for some exit fees on fixed-rate loans, no convincing
justification has been put forward for exit fees on variable-rate loans. It is
not a sufficient response to say that excessive exit fees may be challenged in
the courts. This is too expensive and risky an option for a small business.
Recommendation 1
5.29 The Committee recommends that banks abolish exit fees on variable-rate
loans. If banks do not do so by the end of 2010, then guidelines or
regulations, or if necessary new legislation, should be used to compel them to
do so.
5.30
The Committee supports the abolition of stamp duties on mortgages.
The Government's bank funding guarantees
5.31
The bank funding guarantees were the subject of a report by the
Committee in 2009. The Committee did not call for a repeal of the guarantees
but called for a review of the premia charged for the wholesale funding guarantee.[37]
5.32
The Committee also expressed concern that:
The introduction and implementation of the guarantees served
to greatly increase the lack of confidence in those institutions not the
beneficiaries of guarantees, with the consequence that most experienced
unsustainable requests for redemptions within a very short period.[38]
5.33
Treasury regards the schemes as positive for small business:
Without the Guarantee Scheme, banks (including both majors
and non-majors) would have had no choice but to ration credit to
businesses and consumers, and charge higher interest rates.[39]
5.34
The guarantees have probably benefited smaller domestic banks, but at
the expense of the larger domestic banks, foreign banks operating as branches
and unregulated entities such as mortgage trusts. Given the arguments
(developed further in the following chapter) about smaller banks lending more
to small business, the guarantees have therefore probably had a supportive role
for small business lending. It could have been even more supportive if the
smaller, lower-rated, banks were not charged a higher premium for the
wholesale funding guarantee than are the large banks.
5.35
The Australian Bankers' Association opined that:
The guarantees, for which the banks paid more than a billion
dollars in fees, supported market confidence and stability during a period of
great uncertainty internationally, and facilitated the continuing provision of
affordable credit by banks to their small business customers.[40]
The Government's support for mortgage-backed securities
5.36
Initially, the programme of support for residential mortgage
securitisation could have been attracting some lending to home lending at the
expense of small business loans.
5.37
With the second tranche of the programme, Treasury regarded the scheme
as supportive for small business:
...the Government’s direct investment of up to $16 billion in
the residential mortgage-backed securities...market has enabled smaller lenders
to lend at competitive interest rates and maintain a higher level of lending
and market share than would otherwise have been possible. Applicants’ small
business lending commitments are taken into account under the second tranche of
this initiative.... The extension to the RMBS program includes an additional
objective of supporting lending to small businesses. Consequently, lenders who
seek support under the RMBS program are encouraged to outline how active they
are in lending to small business and to allocate part of the proceeds raised
under the program to lending to small business. This is one of the factors that
the AOFM assesses when deciding whether to support an RMBS deal.[41]
Navigation: Previous Page | Contents | Next Page