The Australian Banking System is an Oligopoly

Oligopoly is a well-defined theory of economics that needs little introduction. All economists from Keynesians to Classicists agree on its parameters. Put simply, it is “a situation in which a particular market is controlled by a small number of firms. An oligopoly is much like a monopoly, in which one company exerts control over most of a market. In an oligopoly, there are at least 2 firms controlling the market.”[1] Even to an outsider of economics, this appears to describe well what has happened inside the Australian banking system with the “four pillars.”

The Four Pillars

The “four pillars” is a name given to the four banks that dominate the Australian Banking sector. These are, in descending order of size, the Commonwealth Bank, Westpac Banking Corporation, the Australia and New Zealand Banking Group and the National Australia Bank. The “four pillars” name conveys importance – and indeed, the banks are of significant importance to the stability of the Australian economy at large – but given their similarity to each other, the banks might well be known as the “four sisters.”

By any stretch of the term, the “four pillars” operate in a virtually unchallenged oligopoly, controlling between them around 80% of the Australian banking sector at any one time. The issue is a constant topic of discussion (and grievance) in the Australian media (one article referred to them as the “four pillows”), who note that the banks have become omnipotent since deregulation of the finance industry occurred at the beginning of the 1980s, after the by-now infamous Campbell Report (1981).

How the Oligopoly was Created

Deregulation of the Australian financial system began in the early 1980s. Its primary goal was to stabilize the Australian economy (which was doing badly at the time) and put Australian banks on a more even footing with their international peers. The steps taken to achieve this in the initial phase of deregulation were the free-float of the Australian dollar and the abolition of direct interest rates and portfolio controls for banks and other financial institutions at the end of 1983, issuing new foreign exchange licenses in 1984 and granting foreign bank licenses in 1985.

Assessing these reforms is difficult. Likewise, try to establish if deregulation was in fact responsible for the breakaway group of four large banks in Australia is almost impossible to tell. Giving banks the ability to compete on a level playing field with international competitors is no bad thing in itself, of course. And allowing the Australian dollar to free-float is in line with most economies around the world. That is not to say that the process happened without anyone observing.

A series of mergers (mergers are almost always acquisitions) occurred in the 1980s and 1990s, which, at least in part led to the oligopoly that the Australian banking system now plays host to.  National and regional governments allowed their own savings banks (such as the NSW bank or the State Bank of South Australia, for example) to be purchased by larger commercial banks, in a series of bolt-on acquisitions. I believe now – although it is easy to be wise after the fact – that these acquisitions should not have been given the go-ahead by the competition authority, as they were sowing the seeds for the oligopoly now evident in the sector.

Assessing Oligopolies

That banking in Australia is an oligopoly is hardly surprising. In his book, Principles of Economics (2008), Gregory Mankiw gives examples of oligopolies that exist in various industries in the United States based on figures provided by the U.S. Census Bureau and the Federal Trade Commission. The list is extensive. It includes breakfast cereal with a concentration of 92%[2], soft drinks with a concentration of 93%, and beer, with a concentration of 85%. These figures at least show that banking is not alone as an oligopoly.

Given that so many industries take the structure of oligopolies, why is there such an issue when banking takes a similar market structure? In short, the answer is that banks most likely play the role of scapegoats. They become an easy target for everything that is ill with the economy. 

The Herald Sun neatly captures this in one of its opinion pieces from August 2008:[3]

“Kevin Rudd[4]  goes for a crowd favourite – greedy bankers:

Kevin Rudd stands accused of bank-bashing after vowing to penalise financial institutions that lavish executives with multi-million-dollar pay packages without requiring them to follow responsible investment practises.

Mr. Rudd has asked the Australian Prudential Regulation Authority to prepare rules penalising banks that reward risky behaviour by requiring them to have greater capital reserves than those with more responsible investment practises.

…How the crowd hoots!”

The reality is that oligopolies – in the banking industry or otherwise - aren’t as bad as the media and others would like to portray. A cursory glance at interest rates offered by the “four pillars” shows that they offer consumers a reasonably good spread of interest rates on loans over the same period[5]. By the principles of an oligopoly, all would be striving to offer as small a spread as possible. I still contend that the Australian banking system is an oligopoly but that it is in fact quickly heading towards a monopoly.

In 2012, the range between the market capitalizations of each of the four pillars varied between $30bn and $35bn. As of May 2014, the range is over $51bn, with the Commonweath Bank opening up a considerable distance between its valuation and that of the National Australia Bank (see chart on next page) Likewise, in 2012, the range between the leading two banks, Commonwealth Bank and Westpac Banking Corporation was approximately $20bn. It is now $25bn.

Bank	Market Cap (May 2014)
Commonwealth Bank	$130bn
Westpac Banking Corporation	$105bn
Australia and New Zealand Banking Group	$91bn
National Australia Bank	$79bn

Source: Bloomberg

An Increasing Need for Regulation

The “four pillars” which began as “the six pillars” (when it included Australia’s two large insurance firms), seem sacred to successive governments in Australia. Various excuses are given for the sanctity of the four. The latest on record was given by the head of the current government’s financial system inquiry, David Murray, whose reasoning goes: “if you relax the four pillars policy and went to three, inevitably in some unforeseen circumstance you would finish up having to go to two. And at two, there is definitely a too big to fail question.” So much for sound economic analysis.

What Murray and others in government consistently fail to recognize is that countries which suffered massive banking crises in the not-too-distant past all had banking oligopolies which, in fact, were less concentrated than Australia’s (Australia’s being the most concentrated banking sector in the world)[6]. Given this is the case, it would seem like negligence to ignore the fact that Australia’s banking industry is need of a regulatory shake-up. However, despite the glaring need, there is still opposition from the big four and even the financial regulator in Australia.

When the IMF provided an assessment of Australia’s big 4 in November 2012, the response from those in Australia was predictably hostile. After suggesting in the report that the big 4 should possibly hold more capital to further bolster financial system stability, “Australian Prudential Regulation Authority chairman John Laker and ANZ’s John Morschel rejected the finding, and Westpac’s Lindsay Maxsted warned the banking industry risked becoming globally uncompetitive if there was a further increase in capital requirements.”[7] Anyone who has taken a look at the Australian banking sector would know that these individuals aren’t overly concerned with competition. Capital requirements often have leaders of the banking industry come over in a fit of competitive spirit, however. The IMF’s report was also met with the common lambast that Australian banks are “amongst the most highly capitalized in the world.”

Further Down the Road

As I have pointed out elsewhere in this paper, Australia’s banking industry is not only an oligopoly but it appears to be heading towards a monopoly (or at least a duopoly). The financial industry, which is now a few times the size of Australian GDP (admittedly not unusual for most countries´ financial sector) is in desperate need of regulation. There exists a good chance that the gulf between the largest bank in the “four pillars” will open up a bigger and bigger gap between itself and the fourth biggest of the group.

The popular media in Australia often mentions politicians and financial leaders talking about the need to be competitive internationally (as Australia’s banks seek to tie up business abroad), but this ignores the fact that Australia avoids many banking crises by the very fact that it hasn’t been closely linked to the global financial system until now. By becoming more intertwined with outside banking systems, its risks become more systemic.

Australia’s authorities have failed to see that these banks are already “too big to fail.” By allowing them to grow in the same manner in which they have been until now is negligent on their part. The fifth biggest bank by assets is only around a quarter of the size of the fourth[8], meaning the hegemony is unlikely to be broken anytime soon. The Australian government needs to take action in one of any number of ways. Among potential measures which they could take are:

i)             Higher capital controls for the four pillars than other banks. In this manner, at least other banks are given an incentive to play “catch up.”

ii)            Higher capital controls for all banks, thereby making the system safer, although possibly doing little to break up the existing oligopoly.

iii)           Allow a foreign bank to take over one of the four pillars. This is probably too politically unpopular to ever happen now.

iv)           Nationalize and merge some smaller banks to create a fifth pillar.

v)            Re-regulate some sections of the financial system, such as funds, to encourage new business startup and banks to break off sections of their businesses.

Conclusion

I believe that the seeds for Australia’s banking system oligopoly were sown in the 1980s by a series of government bank sell-offs. From my reading of the literature, there was little strategy behind these sell-offs with no thought given to the consequences of what the purchase of these assets by larger commercial banks would mean for the banking system. Those changes occurred and are now impossible to undo. Given this, regulators need to look at some changes to implement before the banks’ oligopoly becomes any more dangerous to the economy at large.

The reality is that none of the measures I have suggested here are likely to be given the go ahead (with the exception of higher capital controls and probably only after it is too late). Australia’s banking system is clearly an oligopoly and becoming more entrenched in that position as time goes on. Its regulators and politicians need to force through some changes in the financial industry before it becomes the latest textbook example of how a country whose regulators failed to react to the signs before it was too late.

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[1] Taken from: http://www.investopedia.com/terms/o/oligopoly.asp

[2] Meaning that the top 4 producers have a concentration of this amount.

[3] http://blogs.news.com.au/heraldsun/andrewbolt/index.php/heraldsun/comments/bash_the_greedy_scapegoat/P80/

[4] Then Prime Minister of Australia

[5] http://australia.deposits.org/

[6] http://www.tai.org.au/node/1926

[7] http://www.clmr.unsw.edu.au/article/risk/imf-reports-australias-high-compliance-international-standards-raises-concerns-over-market

[8]