Australian Retail Banking Industry Samples †MyAssignmenthelp.com

Question: Discuss about the Australian Retail Banking Industry. Answer: Introduction: The financial system of any country is the backbone of its economic stability and sustainable growth. Australia has very developed financial market which has significant contribution in nations economic growth. In 2015, it has contributed around $140 billion in GDP of country. Australian financial sector has strong regulatory system which makes the system refined, competitive and profitable (The Australian Government 2016). Australian retail banking industry is featured by high level of competition between four major banks. The four pillar bank policy of Australian government is the key element which features the current structure on banking industry. These four banks are the major market players which hold a significant portion of retail banking industry. Economic features of banking in Australia: Lending and deposits are the main activities of any financial system, which is dominated by banks in Australia. The supply of deposits for these banks and supply of lending from these banks depends on respective deposits and lending interest rates. Figure 1 shows that supply curve of deposits (SD) and supply curve of loans (SL) are both upward sloping. This shows a positive relationship between interest rate and supply of money. The interest rates and supply of money from depositors and banks are interrelated, the increased supply of loans are backed by increase in deposits and banks have to increase the interest rate of loan with the rise in interest rate of deposits, as interest rate on loans are always kept higher that deposits rates, so as to maintain the interest margin (PQ) to cover the operational costs other than deposit costs like salary, rent, costs related to technology, management, administration, tax expenses, etc. and to keep the desired retain profits. The level of mar gin is very much affected by the level of competition in market and negotiation skills of other party. DO represent the downward sloping demand curve for loans. OT represents the volume of deposits and lending respectively in case of equilibrium, in which it charges i1 interest rates on loans and pays i2 interest rates on deposits. Such interest rate and volume of supply is result of bank acting as intermediary between borrowers and lenders in market. In case the borrowed amount is directly made available to lenders in open market the volume of fund would be OT with interest rate i3. But this is quite simple concept which ignores many factors like charge for risk premium, pricing of different varieties of assets and deposits, decision related to loan and asset portfolio structure, inflation rate and other economic factors (Llewellyn 1999). The quantum of deposits and loans which can be created by banking system is dependent on monetary base, desired reserves ratio and currency drain ratio. The banks acts as creator of money with the help of concept of money multiplier and controls the demand for and supply of money in market. Reserve bank of Australia plays important role in this aspect by using monetary base which is a sum of notes and coins to be kept reserve under RBA. The monetary base affects the desired reserve ratio and currency drain ratio of banks which ultimately affects money multiplier. The increase in quantity of money, affects the price level, i.e., inflation rate in economy which is supported by the quantity theory of money. The relationship between money growth and inflation rate in Australia is depicted in figure 2 (McTaggart, Findly Parkin 2015). The banking market in Australia is not perfectly competitive as the large players (big four banks) enjoys the lucrative position and economies of scale which give them competitive advantage over other small players. And it cannot be freely competitive given the regulation requirement and government intervention. The market is highly concentrated which results in significant amount of profits in hands of these major banks. Although the major banks claim that competition among them leads to reasonable interest rates and provides price elasticity in market as customer can any time switch banks for better deal. But in real practice the competition is not very open and free. According to a survey approximately only three present of customers switch banks in a year (Fear, Denniss Richardson 2010). Oligopoly in Australian banking industry: With the adoption of four pillar policy by the Commonwealth Government of Australia in Australian banking sector, there has been domination of four major banks which together holds around 80% of total market share. These banks are; National Australia Bank (NAB), Westpac Banking Corporation (WBP), Australia and New Zealand Group (ANZ) and Commonwealth Bank of Australia (CBA) (Pandey 2017). The share of big four banks, which was around 65% in the total assets of all the banks had raised to approx. 78% in 2014 since the global financial crises (Eyers 2016). As per the data of PWC, (2016), the major banks holds 73.1% of total lending, 78.2% share in overall bank deposits and 80% market share of total bank retail deposits. According to Nichollas and Evans, (2015), out of countries collective household debt of $A1.3 trillion in 2014, the share of four banks was 85%. Since the market power is highly concentrated to these four banking institutes, the market structure of Australian banking industry is highly resembles to Oligopoly. These banks are like market leader, having full control over the market to manipulate and small banks and customers are forced to comply with their policies. The oligopolistic market structure has very few sellers with quite similar products, and each seller holds significant share in market and affected by the behaviour of other firms. Any change in prices, product quality and innovation by one firm influences the other firms forcing them to quickly respond by changing their strategies. There are elevated barriers to entry and expansion of new entrants (Tisdell Hartley 2008). Due to several regulatory and capital environment and existence of high level of market power in the hands of big four banks, the entrants has to face high level of barriers in Australian banking sector (Padley 2013).Any significant barrier to enter the market or high cost involvement in leaving the market are key factors to discourage the new entrants which allows the existing institutions to enjoy the market power. The chairman of ASIC, Mr Medcraft also described the Australian banking system as oligopoly. According to him these banks have price leadership and there pricing policies has to be followed by everyone (Roddan 2017). The market may seems to be in competitive nature looking at the four major banks and several other small competitors but statistics has shown that there has been rise in profits and consolidation of market share of these four banks in last 10-20 years (Eyers 2016). According to Yeates, (2013), there four banks dominates the market and earn huge profits. Thes e banks enjoys wider interest rate margin, which is third highest among the banks of developed countries. The operating costs for these banks are very low, which is fourth lowest in comparison to other countries. Economic and pricing policies: In Australian retail banking industry, pricing and economic policies are designed to attract customers, which are affected by level of competition prevailing in market. The interest rates, fees and other charges are quite similar between the major banks and largely influenced by any change in rates implemented by any one of them. According to an example cited by Deloitte, (2014), any change in rate by Reserve Bank of Australia is responded by big four banks within an average of nine days which shows close interdependence of policies of banks. The competition also exists in designing the quality of products and differentiation in features which promotes innovation. Often the prices are at margin to the majors for the small players and try to make modification in services. In order to compete in price level with major banks, some small banks focus on only one product which provides them cost benefits. The retail banks makes bundle of various complementary services and prices are determined for a whole bundle rather than a single services. Banks have different models to cover their costs while acting as intermediaries between depositors and borrowers. While price is the basic medium for competition among banks it is complicated to assess the actual price and for different services. The banking industry is not acting as free market and the existing government and RBA regulations affect the structure of banks and activities they can perform. For instance, there are some lending obligations which prevent banks to lend money to some individuals on their request for loan, likewise some prudential regulations like high capital requirements to prevent involvement in high risky loans. In context of source of funding, major banks rely much on long- term debts instead of short- term. Securitisation funding has decreased to a significant level. There has been stability in equity funding and deposits have always been important for them. The small banks which used to rely much on short- term debts and securitisation funding are now dependent much on domestic deposits. There has been rise in prices of asset- backed securities since global financial crises. The foreign banks also have moved their main source of funding from short- term debt to deposits recently. Thus the source of funding for these banks is mainly dependent on cost of funding, regulatory requirements and expectations of equity and credit stakeholders. The increased level of competition forced banks to increase the average rate on term deposits to attract customer, it is found to be more that 100bps according to report of Deloitte in 2014 which was below 60 bps before global financial crises. The smaller banks have to face with large funding costs than that of major banks. This is mainly because difficulties faced by small banks in accessing wholesale markets due to presence of major banks that are getting support from government and regulatory authorities and increase in competition for deposits (Bennet 2015). Pricing policy recommendation to Commonwealth Bank of Australia: Commonwealth Bank of Australia (CBA) is amongst the four major banks of Australia engaged in providing wide range of financial and banking services and products to individuals, small business, corporate and other big institutions. CBA is a multinational bank which mainly operates in Australia, New Zealand, and Asia Pacific countries along with carious other countries including UK and USA (The Australian 2014). The retail banking services of CBA includes consumer finance, home loan facilities, and retail deposits services and products to retail bank consumers (Commonwealth Bank 2015). Since the market structure of banking industry in Australia is somewhat like oligopolistic structure in which four major banks holds 80% of market share, the pricing policies on one bank is greatly influenced by the policies of others. The bank cannot much compete with other banks taking only the pricing factor; rather it has to concentrate on providing differentiated products and services with enhanced quality to increase customer satisfaction. At the same time it is mainly dependent on the monetary policy of Reserve Bank of Australia. The monetary policy of RBA comprises determining the cash rate in money market. This rate not only affects the interest rates of banks but also the borrowing and lending attitude of people, economic activity and inflation rate (Reserve Bank of Australia 2017). The pricing of retail advances should be determined after considering the cost of funding, insurance facility, refinance facility, risk factors etc. The bank should take measure to raise operational efficiency and reduce transaction costs to gain competitive advantages. Charging of higher rates to increase profits should be backed by better quality, more efficient and faster services to customers to maintain the customer satisfaction. The pricing policies should be such that it gives enough room for negotiation. The extent of negotiation should be such to keep suitable margin and which can be quantified. To cover costs banks can levy certain bank fees and has to ensure reasonable return on investment. Interest on unsecured loans should be charged to a level which prevents lender from any underlying risks. Bank should focus on creating long term advantages through short term investments. Although pricing policies of the bank is highly interdependent on the policies of RBA and other major banks, still the bank has to see that it has social responsibility to contribute to the betterment of society and should not use its highly advantageous position to exploit the people concern. The pricing, fixed by focusing only on market competition and cost factor, can fail if customers expectation and perception about the quality of product and services are not taken into account. Thus besides pricing the bank should focus on creating cost efficiency by industrializing their operations, investing in information technology, speeding up the introduction of new and diversified products, developing operations platforms, and setting up processing centres in central and regional areas. This will not only reduce costs but will also enhance the customer satisfaction (Leichtfuss et al. 2010) Conclusion: Retail banking includes home loan services, retail deposits and finance to retail consumers. According to microeconomic concept of law of demand and supply, the interest rate for deposits and borrowing affects the demand and supply of money in and economy. Monetary base, desired reserve ratio and currency drain are the key three factors which decides the quantum of borrowings and deposits in an economy. Monetary base is controlled by the Reserve Bank of Australia to control the flow of money and inflation rate in the country. Banking sector can never enjoy never enjoy the free flow of market and perfect competition to decide the prices on the basis of demand and supply as government regulation is necessary in this sector. In Australia the retail banking sector is not only regulated by RBA and government but is also dominated by four major banks which enjoys their power in determining the policies and pricing in this sector and gives a little room to small player in playing their role . The barrier to the entry and exit of firms is considered high in Australian banking sector giver the pre-existing competitive advantage and dominance of major banks. These banks earn huge profits and have very low costs. The price and policies of each bank affects the other major banks. This gives an insight of oligopolistic nature of competition in this sector. This market can be of concern if they start forming cartel to prevent competition. The increased market concentration and monopolistic behaviour negatively impacts the interest of small firms and consumers. There has been issue of mutual shareholding among these banks which results in common interest and less competition among these banks. Such behaviour can create negative externalities in financial market. The four pillar policy adopted by government of Australia to prevent merger between these banks can have two different consequences, which the attitude of banks can affect. They have option to either follow the healthy co mpetition on the basis of price and quality of services which will help them in obtaining high market share and pareto efficiency or they can collude to form a cartel which will ultimately damage the social interest. The government has trying to strongly regulate the market to prevent any monopoly and allowing entry of other banks including foreign banks to maintain the competition. There has been increased completion for domestic deposits for smaller banks and foreign banks. These banks have to face with high funding costs in comparison to major banks. The large banks mainly focus on long- term debts instead of short- term debts. Although price is basic medium for completion but banks have started focusing on providing diversified and innovative products and services in form of bundles as another medium for competition. Each bank including the major bank has responsibility to provide high quality and faster services to customers to increase their satisfaction. The banks have to increase their operational efficiency by using information technology and better platforms. Besides the motive of increasing profitability they have social responsibility towards society to encourage healthy competition f or the sustainable economic growth. 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