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Awaiting the arrival of challenger banks

by Staff | 08 Jun 2017

The government has made clear it wants more banks in Australia, but it remains to be seen whether genuine competition can be sustained by the sector here.

shutterstock_449042617 (1)If the UK experience is anything to go by, more competition in banking should be possible.

Since 2014, 14 new banks have been approved in the UK, with another 20 entities in talks to obtain a Prudential Regulatory Authority (APRA equivalent) banking licence, the Standing Committee on Economics reports.

A list of all the banks and new application notices for banks in the UK can be found here.

However, Australia is not the UK, and the local experience relating to banking competition has not matched up to the progress of our northern hemisphere cousins.

In Australia, only one entity not already associated with a bank has managed to secure a banking licence – in August 2016 Tyro Payments was approved to become the first non-bank Authorised Deposit-taking Institution (ADI) in more than a decade.

Meanwhile, since starting in January 2016, the UK’s startup unit, jointly run with the PRA and banking regulator, the Financial Conduct Authority, has created a legitimate feeding environment for challenger banks over there.

The local equivalent – ASIC’s “regulatory sandbox” – was unused until May this year after launching at the end of 2016 and has since welcomed just one participant in the form of specialist share trading app, Goodments. 

Foreign banks have ventured onto Aussie soil, but as many new entrants have begun emerging from the places like Japan and China, the market share they’ve been able to take away from the local players remains insignificant.

Meanwhile, the more than 100 banks, credit unions and building societies, as well as other non-bank competitors outside the big four – both homegrown and foreign – still continue to fight over a small piece of the overall pie.

There is a raft of proposed changes in the pipeline designed to make it more easy to become a bank in Australia. Many are outlined in the Standing Committee on Economics report – chapter four highlights its recommendations relating to banking competition.

Shifting the goalposts

The main changes to make it easier to become a bank, include: a review of the the 15 per cent threshold for substantial shareholders in ADIs under the Financial Sector Shareholdings Act; possible new licensing requirements for ADIs to determine whether they present an undue barrier to entry and whether a formal “two-phase” process for licensing prospective applicants like in the UK is needed; and whether APRA’s processes in assessing and granting a banking licence could be made more transparent.

The process of getting a banking licence in Australia was outlined recently by InFinance here.

Indirectly, other recent measures will help promote competition in banking outside of the big four, Treasurer Scott Morrison outlines.

Morrison highlights competition as one of the factors behind the creation of the controversial levy, which the big four and Macquarie Group will start paying quarterly starting in March next year, as part of his latest speech introducing the Bill containing the new bank levy.

“Importantly, it will also support competition in the financial system by providing a more level playing field for smaller banks and other providers of financial services who compete with the larger banks who enjoy cheaper costs of funding,” Morrison notes.

Banks have it good

Further, Morrison outlines the advantages banks have under the current arrangement

thanks to the taxpayer-funded implicit guarantee, an arrangement which he says “has helped to embed their dominant position in the market.”

“For example, the major banks are accredited to use internal ratings-based models that allow them to reduce the amount of capital that they must hold, lowering their funding costs relative to the smaller banks who rely on standardised risk weights,” Morrison notes. Morrison’s speech to parliament can be read here

This isn’t the only indirect measure the government is pursuing to encourage more competition in banking.

The Productivity Commission’s new inquiry into the state of financial system competition, in tandem with the latest round of in-depth inquiries into specific financial system competition issues by the Australian Competition and Consumer Commission, will likely throw up ideas for the government on how to encourage competition in banking.

APRA is simultaneously reorganising itself and its procedures to make it easier for challenger banks to enter the market – as APRA’s chairman Wayne Byers outlines during his latest appearance before the Senate Economics Legislation committee.

APRA has appointed new senior executives to its leadership team based around a new centralised unit tasked with reviewing APRA’s licensing activities to account for an “increasingly diverse range of applicants that wish to engage with us.”

“We expect this review will lead to changes to the current licensing process to better accommodate more innovative business models, structures and products,” Byers highlights.

The two-phased approach to licensing for certain types of new entrants that APRA is considering would allow eligible new entrants time to establish the resources and systems necessary to be able to comply with the more onerous aspects of the prudential framework.

Policy can’t buy culture

It’s clear the government is prioritising competition in the banking sector, but whether policy settings are enough to encourage innovation in Australia’s banking sector remains to be seen.

As hinted in the Standing Committee on Economics’ report following a review of the four major banks, perhaps innovation and entrepreneurialism in Australia’s oligarchic system require more than encouragement from the government.

“The committee does not believe, however, that… [a reform agenda is] enough on [its] own

to sustain a culture of innovation and competition in Australia’s banking and financial sector.”

Even combined with the expected 150 per cent growth in the use of fintech services over the next year, as predicted by investment firm UBS, the ability of challengers to effectively disrupt traditional banking business such as payments, foreign exchange and remittance services is far from certain, the committee points out.

“The creation of such a culture is necessary to improve consumer outcomes. This is because the committee expects that start-up firms will emerge with business models that effectively disrupt the status quo,” the committee notes.

Perhaps it’s the very existence of the implicit guarantee that systemically important banks have which is stifling innovation, suggests Andrew Bailey, formerly head of the UK’s PRA and now leader of the UK’s Financial Conduct Authority.

“In my view, an important contributor to stable competition is to ensure that the orderly failure of firms is possible,” Bailey tells UK media. 

“An industry in which firms cannot be allowed to fail is also likely to be one in which very few firms seek to enter and compete with well entrenched, established participants,” Bailey suggests.

The balancing act the government is required to perform to encourage innovation at the same time as foster stability in the banking system is by no means lost on APRA’s Byers.

“We will seek to balance this benefit [encouraging new entrants into banking] with the community’s reasonable expectations that a deposit-taker or insurance provider should be soundly managed, including having a sufficient level of financial strength,” Byers notes.

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