Banking market study draft report – summary

Written by Sam Williamson

On 21 March 2024, the Commerce Commission published its preliminary findings on factors affecting competition in the personal banking sector – Personal banking services market study – Draft report (the draft report) – with draft recommendations on improving competition.

Competition overall is limited, sporadic, and not sustained
Overall, the Commission found that New Zealand’s four major banks (ANZ, ASB, BNZ and Westpac) do not currently face strong competition in the New Zealand market when providing personal banking services, such as home loans and transaction, savings, and term deposit accounts. The Commission found that Competition amongst the major banks appears sporadic, with occasional periods of relatively intense competition to increase market share, then competition cools while the banks focus on maintaining profit margins.

This absence of competition potentially results in a range of poor outcomes for New Zealand consumers, including higher prices, limited choice, and comparatively slow technological innovation. The Commission also found that the lack of competition may account for the disproportionately large profits derived from the major banks in New Zealand compared with international peers, given New Zealand’s relatively low-risk banking sector.

Smaller providers do not provide meaningful competition
The draft report finds that smaller providers (e.g., smaller registered banks, non-bank deposit takers, and fintechs) do not exert any meaningful constraint on the major banks, as they lack the scale to compete on products like interest rates given cost disadvantage compared with the major banks. Smaller providers also struggle to compete on non-price dimensions (e.g., range of products, service, perceptions of trust and security, and digital capabilities) because they have less resources to put into developing their service offerings.

Kiwibank sits between the major banks and the smaller providers and imposes some constraints on the major banks; however, lacks the capital backing to consistently drive stronger competition.

Regulation of the banking sector impedes competition
The draft report identified a range of prudential and other financial regulations and policy settings that also potentially impede competition in the banking sector. The report recommends changes to some of these regulations as a way to improve competition:

• Regulatory barriers to entry and expansion – The banking sector is highly regulated, which the draft report finds may constrain other potential providers’ ability to enter and compete. Specifically, new entry from traditional offshore banks is unlikely because of the cost and time it would take to build sufficient market share to become profitable. Likewise, smaller providers who have entered face disproportionately adverse challenges from the overall regulatory burden due to their lack of scale. The draft report claims that the RBNZ’s capital requirements are the most significant regulatory barrier. In the Commission’s view, it is constraining entry of new market participants and the expansion of incumbent smaller providers. The draft report recommends that the RBNZ reviews its prudential capital settings to ensure they are competitively neutral and smaller providers are better able to compete.

• Regulatory environment should better support competition – The bulk of the draft report’s recommendations focus on how the regulatory environment could be adapted to improve competition in the banking sector. In the Commission’s view, policy makers and regulators should explicitly consider competition when making decisions relating to the banking sector. Specifically,
  • • RBNZ should explicitly and transparently consider competitive effects when making decisions, particularly when it is implementing the levy for the new Deposit or Compensation Scheme, as a disproportionate distribution of the levy may disadvantage smaller providers.
    • RBNZ should be statutorily obliged to “promote competition”, rather than simply “maintain competition” when making decisions.
    • RBNZ should broaden access to its exchange settlement account system (ESAS) accounts which is a key input into the provision of personal banking services through its function as a settlement system (enabling payments between banks), and an account system (that pays interest at OCR on overnight balances) [1] Enabling smaller banks and fintechs to access ESAS directly will
      1) remove their dependance on the major banks for access;
      2) improve innovation; and
      3) promote competition.

• Regulatory impediments to innovation by fintechs – Fintechs are a potential source of innovation and competition, however, the Commission found that they face a number of impediments, such as opening and maintaining a business bank account, access to New Zealand’s financial markets infrastructure (including ESAS), meeting the costs and complexity of regulatory requirements, obtaining sufficient capital, and gaining access the consumer data they need to provide their services. In the Commission’s view, initiatives like open banking [2] have the potential to revolutionise banking by driving ongoing innovation and competition, particularly through incentivising fintechs to enter the New Zealand market. The Commission recognises that steps are underway to create an open banking eco-system that will enable fintechs to compete and recommends that the government sets a clear deadline for having open banking fully operational by mid-2026. The draft report also recommends several methods for how barriers on banks working with fintechs imposed by the Anti-Money Laundering and Countering Financing of Terrorism Act 2009 (AML/CFT) regime could be relaxed.

• Empowerment of consumers through regulation – The draft report found that many consumers are unlikely or unwilling to switch banks out of disengagement or inactivity, which disproportionately favours the major banks. Consumer disengagement reduces competition because if customers do not readily search out and switch to the best deal, the incentives amongst market participants to compete on price and quality are limited, and in turn weakens competition. The draft report recommends that the government oversees the development of better tools and services to help consumers find the best deals and enhanced switching services. Additionally, the draft report recommends a suite of regulations aimed at ensuring mortgage advisors help consumers get the best deal and support greater competition for home loans through changes to how home loan rates are advertised by providers as well as greater transparency in how mortgage advisers are remunerated.

• Regulatory barriers to consumer switching – As well as behavioural disincentives, the draft report found that there are regulatory barriers for consumers switching banks (e.g., customer identification processes or processes to demonstrate affordability of a loan). The draft report recommends reducing these regulatory barriers by reviewing the Credit Contracts and Consumer Finance Act 2003 with respect to home loan refinancing to make it easier for consumers to switch providers without triggering an affordability re-assessment and simplifying the burden on Māori trusts from the AML/CFT Act.

The Commission has called for submissions from interested parties on the draft report by 4pm, Thursday 2 May 2024.

Article by Sam Williamson

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1 Currently only a limited number of the major banks have direct access to ESAS accounts and other entities must access the ESAS accounts via one of these major banks.
2 Open banking refers to a system in which consumers can make payments and instruct their banks to share their financial data, such as account information and transaction data, with third party providers such as fintechs.