This chapter examines competition across key sectors of the financial system, including banking, payments, financial markets, wealth management and insurance.
Competition is a process of rivalry between individuals or firms in the sale and purchase of goods and services. It is the cornerstone of a well-functioning financial system, driving efficient outcomes for price, quality and innovation. Competition is desirable because it generally leads to better consumer outcomes.
Assessing competition and contestability
As competition is a dynamic process, rather than an outcome, it is difficult to measure and must be assessed indirectly using a range of indicators. These include market concentration, barriers to entry, margins, profitability, operating costs, switching behaviour, firm behaviour and customer satisfaction.
High levels of market concentration can raise concerns about the level of competition in a market, but it is not sufficient to look at this issue alone. Competition can be strong between players in a concentrated market. Indeed, market concentration can be a by-product of competition, if more efficient firms grow at the expense of their less efficient competitors. In addition, the threat of new entrants can exert price discipline over an incumbent, even in the absence of existing competitors. This threat of competition is called ‘contestability’.
As with other industry sectors, incumbent firms in the financial system have significant advantages over new market entrants. These advantages include brand recognition, existing customer bases and established distribution arrangements. Large incumbent firms have additional advantages in sectors where scale or network effects are important, such as payments or FMI, in which case new entrants will find it difficult and expensive to attract customers away from existing providers.
Trends affecting competition
Government policy should take into account how potential future trends in markets may affect the level of competition over time. Competition issues today may resolve themselves over time, while highly competitive markets today may become less competitive. The Inquiry must consider how potential future trends may affect the level of competition over the medium to long term.
Over the medium term, technology will increasingly affect the level of competition in the financial system. In some ways, technology is improving competition. It enables consumers to compare and switch between products, making new business models, such as online-only banks and peer-to-peer lenders, viable.
However, technology also has the potential to reduce competition. Technology is introducing new economies of scale into financial markets. For example, the use of data is becoming increasingly important in understanding risks and meeting consumer needs, giving players with large customer bases the capacity to develop competitive advantages by leveraging their pre-existing data sets. Although these developments should make the financial system more efficient, they could potentially lead to less competition in the medium to long term.
How does the Government promote competition?
Governments facilitate the operation of markets by upholding property rights and the rule of law. They also intervene in markets to promote competition, particularly where there is market failure, where firms have accrued excess market power or where there are regulatory distortions in the market. The Government seeks to promote competition in the financial system in several ways:
- Preventing firms from building up excessive market power and/or abusing market power. The financial sector is covered by the competition provisions of the Competition and Consumer Act 2010. The Australian Competition and Consumer Commission (ACCC) is responsible for determining whether proposed mergers and acquisitions in the financial sector would substantially lessen competition. It is also responsible for enforcing provisions relating to the misuse of market power; third-line forcing; and other exclusionary conduct, cartel conduct and price signalling. The Payments System Board (PSB), which has responsibility for setting the payments policy of the Reserve Bank of Australia (RBA), plays a unique role in regulating access regimes and fee arrangements for payment schemes.
- Promoting competition by increasing a market’s contestability. The Government can do this by reducing regulatory barriers to entry, such as licensing or authorisation requirements, or by reducing barriers to consumer switching, such as by introducing mandatory disclosure requirements or abolishing exit fees.
There is a potential trade-off between competition and stability. One of the objectives of prudential regulation is to ensure that market participants do not take inappropriate risks when competing for greater market share. Maintaining sustainable firms may also promote long-term competition.
The Government can also affect competition by imposing compliance costs on market participants. The regulatory frameworks administered by the Australian Securities and Investments Commission (ASIC), the Australian Prudential Regulation Authority (APRA), and the Australian Transaction Reports and Analysis Centre (AUSTRAC) affect the cost bases of market participants. Many submissions highlight aspects of regulation they claim are harming competition by increasing the costs of particular businesses. For example, although large institutions face the biggest absolute costs, smaller competitors may face a higher relative burden.
The Inquiry’s principles for competition policy
To facilitate competition, the Government should:
- Ensure market participants do not act anti-competitively or build up excessive market power through mergers and acquisitions
- Remove regulatory impediments to competition, such as barriers to entry and distortions to level playing fields, subject to trade-offs with other policy objectives that the regulation seeks to achieve
- In the case of network goods and natural monopolies, ensure market participants have access to infrastructure and data that enable them to compete for consumers, subject to considerations around the investments that initial market participants may have made in developing the infrastructure or data sets
- Facilitate consumers’ capacity to understand and compare products, and ensure that consumers are able to switch between products at a reasonable cost and through a simple process