In May last year, finance minister Pravin Gordhan summoned the CEOs of the Big Four banks — Standard Bank, Absa, First National Bank and Nedbank — to his office. The bank bosses knew what they were in for. Their market conduct in retail was in question: bank charges were high and there was a lack of transparency around them . Gordhan wanted to rein in these charges.
In 2004 treasury and the Reserve Bank commissioned work into the competitiveness of banks in SA. That led to a banking inquiry by the competition commission in 2006, headed by advocate Thabani Jali, and the banks were forced to divulge the extent of their market dominance and practices.
It uncovered evidence of “abuse” — the Big Four were setting certain transactional fees and were found wanting on their disclosure policies that made interbank comparisons for customers difficult, if not impossible.
It became clear there was market concentration of the Big Four in SA, which is not unusual in other countries. But what was disturbing was that the commission found this market concentration had worsened between 2004, when the initial report was done, and 2008, when the Jali commission finished its inquiry .
Gordhan wanted to crack down: to get banks to commit to increasing competition, and making banking services cheaper and more accessible while preserving stability of the system. He could either strong-arm them through regulation or they could co-operate voluntarily. “Our financial sector has not really shown exemplary market conduct practices,” says treasury deputy director-general Ismail Momoniat. “There is an opaqueness where you can’t understand your statements or ATM charges or your retirement annuity statements because of the layered charges.”
At that meeting, the CEOs agreed , among other things, to :
Lower penalty fees on dishonoured debit orders and improve the management of the current debit order system;
Greater transparency regarding ATM pricing. All banks should display a message, either on a screen or by other means in the case of mini ATMs, telling the customer exactly how much they would be charged for that transaction, with the option to decline . FNB CEO Michael Jordaan says disclosure of this fee would require banks to share pricing information with each other, which needs careful co-ordination at an industry level, as well as an exemption from the competition authorities as banks would be sharing certain competitive fee information.
Produce a detailed breakdown of fees and charges on customers’ statements and create standards for disclosure that would be incorporated into a new Code of Banking Practice. The code was meant to be finalised by November last year, but Banking Association MD Cas Coovadia says it’s coming soon.
Provide banded and fee options, and bundled options for low-income customers;
Provide a fee calculator to reduce search costs and improve comparability of products and services; and
Reduce switching costs and assist consumers to switch.
But the reality is while the Big Four boast they have implemented 20 of the 28 recommendations of the Jali commission, this is misleading. Take the penalty on dishonoured debit orders: most banks have slashed it from R105 to R5 on their lowest plans, but customers of other packages are still stuck with the R105 fee.
With the bundled options (transmission and cheque accounts which include overdraft facilities, Internet and cellphone banking) you can now pay a one-off lower monthly fee, with the promise of “unlimited banking”. But most clients don’t realise that after, say four ATM withdrawals (such as in Nedbank’s case), you’re charged for it. FM research shows Standard Bank is the most expensive on ATM charges — R27,30 for withdrawing R2000 compared with the cheapest, Capitec’s flat rate of R3,75. But Standard Bank SA CEO Sim Tshabalala defends its position, saying the bank won’t compete on fees because it’s a larger bank with bigger costs, especially the costs associated with servicing ATMs.
Cash withdrawals made at ATMs are a common activity for most bank clients . In 2006, around 1bn ATM transactions were made through the network, generating gross revenues in excess of R4bn for the banks. The Jali commission found that fee arrangements between banks (similar to mobile operators’ interconnect fees) for use of the shared network have sheltered the provision of ATM services from effective price competition. The commission was particularly concerned with “off-us” transactions clients are charged for using another bank’s ATM.
In addition, clients are still penalised for making cheque, branch or Saswitch transactions. For example, FNB, which now has a different pricing formula to the other three big banks and is the cheapest on its bundled option (its EasyPlan account is even lower than Capitec’s fee), offers “unlimited” ATM withdrawals, debit and stop orders, card purchases, and Internet and cellphone banking. Jordaan says this pricing strategy has worked well for the bank, which is reflected in the latest research showing FNB is now the market leader in personal cheque accounts, winning 7% from its competitors over the past two years.
Absa deputy CEO Louis von Zeuner also talks about innovation and lower charges, saying today a client who goes with a bundled option could save R1400/year in charges, depending on their spending habits .
But the cost savings they speak of should be looked at in the context that clients who get “unlimited” banking services still pay R32 for each cheque, branch and Saswitch transaction — almost a third, and on some accounts more than half, of their monthly fee account . Banks argue that these services are labour-intensive, so cost more.
Switching of accounts is even more difficult and costly (see table on page 38). But Jordaan says “it is more a perception than reality that switching between banks is difficult. We have enabled our online channel for sales so new customers can now open accounts without even coming into an FNB branch. And we can switch a new customer’s debit orders over with a minimum of fuss.”
But that is not good enough considering banks’ earnings from fees. Bank charges are still “opaque” and that has forced government’s hand in regulating behaviour around bank charges. There is no regulator that presently oversees the market conduct practices of the retail transactional banking sector (the National Credit Regulator, NCR, oversees the banks’ credit business).
But new proposed reforms, expected to be legislated this year, will result in a retail market conduct regulator being created, which will develop principles on how banks should set and report their fees and what constitutes fair and unfair behaviour. This is part of treasury’s new shift to a “twin peaks” model of regulation (used in Canada and Australia), which will give various authorities more muscle. There will be one macro regulator considering prudential issues regarding the financial stability of the system, comprising the existing Reserve Bank body, plus various oversight committees. The other will be a micro regulator (retail market conduct regulator) based within the Financial Services Board (FSB), which will oversee market conduct . In addition, a Council of Financial Regulators will provide greater co-ordination between the diverse regulators on legislative and conduct enforcement.
This isn’t unique to SA. Globally, authorities have been forced to tighten regulations in the aftermath of bad lending practices that led to the financial crisis. Treasury wants to bring SA practices up to speed with comparable countries. “Everyone is looking at how to regulate apart from the capital and liquidity requirements set in [global banking supervision standards] Basel 3,” says Momoniat. “We want to make all regulators stronger so they can exercise their powers more intrusively in their supervisory roles.”
The area of market conduct is where “we must get tough”, he says. “We want banks to make banking cheaper, accessible and transparent. The banks are very good at making themselves rich, but not very good at explaining what they’re charging for and why they’re charging for it.”
A study by global consultancy group CRA, commissioned by Absa for the period of the Jali commission, concluded that “the average return on equity (RoE ), a measure of profitability of SA banks was — with the exception of 2002 — consistently higher than the weighted average of the world’s leading banks over the study period”.
Momoniat is floating the idea of imposing a levy on the industry to pay for a strong advocacy consumer group. “Banking is a regulated sector so they should pay a levy. It’s not the kind of money that would make them broke; it would create an environment that makes practices more acceptable and makes it easy to understand their rates so customers feel in control and can comfortably agree to charges upfront.”
The banks are uncomfortable with government trying to control prices, cautioning against a “regulator of profits” that will stifle growth. They have called for a meeting with Gordhan to discuss the proposed reforms. They say over- regulation could push up their already escalating costs and stunt growth at a time when advances growth is flat and affects their non interest income.
Says Coovadia: “The banking sector is already significantly regulated, with more regulations from Basel 3 leading to banking becoming more expensive. I don’t have a problem with treasury saying fees must be more transparent, but trying to regulate charges would be inappropriate.”
Von Zeuner adds to the chorus that controlling fees will “constrain and suppress” innovation. “No customer is the same, so you can’t cap fees. Also, no bank is the same, so can’t have the same cost structure. It will suppress the diversity banks have. A lot of work is being done by the industry in terms of switching of accounts and we’re doing a lot to provide customers with more information on their statements and recommendations on how they can reduce costs.”
Banks rely hugely on fees and commission for their non interest revenue. Coovadia says the regulations would stump banks’ ability to raise good capital. “Banks’ RoE and revenue are already under pressure. Banks need to compete with other businesses to maintain their shareholdings and get investors to buy into them. Basel 3 requires banks to raise more capital, but if they can’t grow their RoE, then they won’t be able to raise capital.”
But banks regulator Errol Kruger notes that banks shouldn’t be so reliant on fees that this overshadows their banking income. If one looks at banks holistically, they are there in the public interest but not “charitable institutions” — they have shareholders who do put pressure on them, especially during a downturn.
“But, equally, it’s prudent that they don’t become too reliant on net interest income,” says Kruger. “Fees should be fair; banks shouldn’t abuse clients. It’s not right for them, for example, to charge astronomical fees for dishonouring a debit order, where they become blatantly out of line. Fees shouldn’t be the balancing number to push up their income.”
But analysts say trying to control bank charges will add to the complexities and create other problems as banks would find other innovative ways to cover their costs. Treasury acknowledges this. “There has to be a balancing act. We realise if we try to reduce fees, banks will become unprofitable and it could force them to take on riskier lending,” says Momoniat.
The banks have been operating as an oligopoly where the Big Four dominated — not a cartel, like the construction industry. But because banking is a closely knit industry with few players, executives got together frequently at a high level to discuss and agree on issues concerning inter operability in the payment system. Banks know a great deal about each other, according to Jali, so are well placed to shadow business strategies and set rules and conditions that collectively favour themselves. This obstructs competition.
Market concentration is particularly high in personal transaction accounts, ordinary current accounts and transmission accounts (savings accounts with transactional facilities), where the Big Four together control more than 90% of this market. These facilities are bundled, packaged and priced, which varies from bank to bank, making the choices for consumers more complicated.
The result is the banks have maximised their profits by avoiding outright price competition (though competing for customers in other ways), and by taking advantage of the degree to which customers, once recruited, become locked in to a particular bank.
SA banks have a very fee-driven banking model (see tables on non interest revenue). They do not compete by fixing prices, but rather by differentiated product offerings and complicated pricing structures, says Penelope Hawkins, MD of Feasibility, a consultancy that helped draft the 2004 report into competitiveness of SA banks. Within established market segments, though, treasury says the Big Four tend to set their fees within a close enough range of each other so one cannot impinge on the market share of another .
The commission found that one of the banks may charge a lower fee (or no fee) for a particular transaction service in order to differentiate its product. However, for the same product, it will be prepared to charge a higher fee than its competitors for another transaction service. This is the classic rationale of oligopolists who stand to gain more in the medium and longer term if they refrain from price competition in the short term for the sake of temporary market share gains.
It is clear that there are large fixed costs in the banking industry. About 80% of banks’ costs are fixed and these costs in turn are common costs that are difficult to allocate to particular products or, in some cases, business units. As a consequence, the banks argue that there are large economies of scale. So, in this kind of industry there will be prices that are in excess of the marginal cost of providing any particular service necessary to cover all those fixed costs and provide a return to shareholders.
The reality remains, however, that the cost structure of retail banking — high fixed and common costs — drives concentration in banking and places certain limits on the extent of competition, says Hawkins.
But banks argue that the costs of establishing and maintaining physical branch networks and ATMs are substantial. This poses a significant barrier for new entrants, especially smaller players, who do not have established branch infrastructure.
“There is definitely a different cost structure if you compare bigger banks with the smaller ones,” says Zeuner. “On the commercial side, servicing all sectors of the economy costs more in terms of infrastructure, so cost structures can get complex.”
He uses the costs of servicing and maintaining ATMs as an example. Absa has 8000 ATMs, a third more than its competitors. “One has to consider the components that make up the cost of an ATM: there is the initial substantial investment of the physical ATM, the maintenance and sending out a van to the ATM, the dependency on Telkom so we can maintain a 90% availability of keeping it online — all that comes at a huge price.”
He adds that one must bear in mind the costs of putting cash into the ATM when it is depleted, as well as the telecommunications costs. “But again, we’re doing our best to see how we can making banking cheaper through mobile, Internet and prepaid cards, which should reduce the costs.”
The banks say they are also using retail stores such as Pick n Pay and Spar to cut the costs of banking.
Treasury still has to thrash out the nuts and bolts of its proposed plan after consulting with industry. There is no doubt there is room for charges to fall further. Customers have a constitutional right to know what they are being charged for upfront.
But government should be careful about over regulating so as not to kill an industry which is at the heart of every economic activity. The solution is to try to drive competition by opening up the market and breaking the oligopoly.
There is potential for greater competition from innovative banking minnows such as Capitec, as well as other banks and non bank players in the payment system such as retailers and telecommunication companies. These players have the potential to impose an effective competitive constraint on the Big Four banks across the retail market, but their success depends on whether existing restrictions on competition, both on the supply and the demand side, can be effectively addressed.
Source: Financial Mail
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