The 'four pillars' policy

Melbourne Business School’s Professor Ian Harper has written an article in today’s AFR (subscription required) attacking the ‘Four Pillars’ policy recently reindorsed by the Labor Treasurer. This policy limits mergers between the four major Australian banks.

Professor Harper has two main arguments. One is that such a policy is unnecessary since the ACCC has the power to disallow mergers which it sees as not being in the national interest and, in making this determination, the ACCC would be able to sort out the cost-benefit case for allowing or disallowing mergers. The second argument is that the four major Australian are ‘bonsai banks’ that are ‘pot-bound by a regulation which blocks the most natural route to growth and scale’. He asks that the banks be given the ‘same opportunity to grow as any other Australian company’.

None of these arguments seems self-evidently correct.

The ACCC is an agency of government that assists in the promotion of competition in the Australian economy. If successive governments make the judgement that maintaining minimum levels of competition among the banks is a desirable social policy it is entirely appropriate to enact policies which achieve this. What matters here is the government policy itself not whether it hands over responsibility to the ACCC. The only issue is whether the ‘four pillars’ policy is sensible or not.

The second argument is that our banks are too small to realise economies of scale. I am not expert on such matters but it would be nice to see some empirical evidence on this. Are Australian banks with their privileged oligopoly position unable to access funds internationally at the lowest cost? Are costs of managing deposits or making loans locally too high to promote productive efficiency in banking? I would like to see some evidence on this rather than poetic claims about 'bonsai'.

According to Fortune the National Australia Bank is the 239th largest firm by revenues in the world. The Commonwealth Bank is the 340th, the ANZ is 376th and Westpac is the 464th. Ranked among the world’s banks on the basis of revenues the National Australia Bank is 35th largest, the Commonwealth Bank is 45th, ANZ is 50th and Westpac is 56th. Are these banks minnows? Just how big do you need to be to realise economies of scale in banking?

Furthermore, as banks increase in scale is there always an efficiency dividend or are there x-inefficiency concerns? Banks in Australia seem to be out of touch with their customers and to increasingly offer depersonalised, inflexible services at the same time that bank fees are rising strongly – over the past 10 years fees from households have quadrupled. This evidence does not clinch things since it is possibly consistent with increasing efficiency and offering a wider range of services. But it is also consistent with lack of competition and banks squeezing customers using their monopoly power.

And why are mergers among domestic banks the most ‘natural route to growth and scale’? If the primary economy sought is better access to international capital markets why focus growth locally where customers are offered only restricted banking choices and limited competition?

The suspicion is that the major banks wish to further consolidate their monopoly power in a limited market by decreasing the limited competition and by improving their already substantial opportunities for coordination. The evidence on increasing fees and surging profits is consistent with this view.

Finally, it is not sensible to claim that the banks should be given the 'same opportunities as other Australian companies' when they are quite unlike other Australian companies both in terms of the size and the fact that they obtain banking licences from government. It is entirely appropriate that governments isolate those large businesses that impact on the lives of every Australian and expose them to specific scrutiny and regulatory effort.

Update: Joshua Gans also comments on the Harper article.

St George Bank should not become part of Westpac

The ACCC should object to the proposed takeover by Westpac of the St George Bank on the grounds that it will reduce competition. My guess however is that Treasurer Swan will have already given indications that the merger be permitted.

There would be some cost-savings generated by the merger because branches could be closed and moderate network externalities realised. But these businesses are already large so that the gains in terms of having lower cost access to capital markets would be very modest.

The main effects will be however to reduce the very limited competition Australians have with respect to choice of banking service. The 'big four' banks offer lousy, expensive service and yet yield bloated profits to their shareholders on the basis of their preexisting market power. Service will be marginally worse not better should this takeover proceed because there will be still less competition.

Why can't the banks come up with innovative market ideas and improved service to extract better returns for their shareholders? Or are the only strategies open to the financial geniuses in the big four banks those involving takeovers of smaller Australian banks or dud investments overseas?