More banking competition comes with risks

The optimists among us are hopeful the Commerce Commission’s study into the banking sector will eventually improve competition and lower the cost of services for consumers.

The pinch is that achieving this will come at a cost, and potentially create a battle between the competition watchdog and banks’ prudential regulator — the Reserve Bank.

The fixes the Commerce Commission recommended in its draft report on the sector, released last month, infer a bunch of trade-offs need to be made to weaken the dominance of the big four Australianowned banks.

Its key recommendations include: changing the rules around how much capital banks need to hold to even the playing field between the big and small players, increasing Kiwibank’s access to capital to enable it to grow, and requiring banks to share their data with third parties — a process known as open banking.

The issue the Reserve Bank and Government will face, if they follow the recommendations, is they come with some downside risk.

Let’s look at the first point, which commission chairman John Small believes is the most salient — getting the Reserve Bank to change its bank capital rules, aimed at preventing banks from collapsing.

Bank capital rules

Banks and the Reserve Bank quite publicly went to war when consultation on updating the rules began in 2017.

The sector argued the Reserve Bank was overdoing it, requiring them to fork out billions to withstand an Armageddon-level crisis. The Reserve Bank dug its heels in and is still overseeing the phasing in of its tougher rules, which will fully take effect in 2028.

While it’s still reviewing the commission’s report, the Reserve Bank last month told the Herald it didn’t plan to change its capital rules.

The likelihood of the bank loosening its stance is slim. It only decided on the rules in 2019, then delayed their implementation due to Covid-19.

Reserve Bank governor Adrian Orr stood up to powerful bank chief executives. It’s unlikely he’s going to kowtow to the Commerce Commission.

One might argue it makes sense to let the bank capital issue be — if not in the name of making the financial system more resilient, then for the sake of sticking to a plan finally in motion.

However, there might be a chance of the Reserve Bank bending on a financial stability issue that isn’t yet set in stone — the design of its deposit compensation scheme.

Deposit insurance scheme

The scheme, set to go live next year, will see deposit-takers pay levies into a Government-backed fund that would be used to reimburse depositors up to $100,000, should their deposit-taker collapse.

Small banks and non-bank deposit-takers are worried the Reserve Bank wants to charge them proportionately higher levies to reflect the fact they’re at higher risk of running into trouble than big banks.

The commission is cognisant of this but it’s also aware of the point the Reserve Bank raises — the small deposit-takers have the most to gain from the scheme, as it’ll give people the confidence to put their savings with institutions that might otherwise have been deemed too risky.

The irony here is that there’s a chance giving savers too much confidence to put their money with riskier deposit-takers could actually see the pendulum swing in the opposite direction, away from enhanced financial stability and towards greater competition.

The spotlight is very much on the Reserve Bank to set the levies in such a way that doesn’t create perverse incentives nor stymie competition.

Growing Kiwibank

Moving on to one of the Commerce Commission’s other key recommendations — enabling Kiwibank to grow.

In order to achieve this, the Government, which owns Kiwibank, would need to either inject billions of dollars of capital, or forgo some control of the state-owned bank by enabling it to bring in capital from a third party.

Neither option is particularly politically appetising.

The Government is running a campaign on fiscal prudence and debt reduction. Voters will rightly question how it’s managed to find money to boost Kiwibank, but can’t keep public servants employed. It might also get nailed if it tried to partsell a state-owned enterprise, even if this was actually a sensible option.

Open banking

To the Commerce Commission’s third key recommendation — getting the Government to tell banks they need to have open banking operational by mid-2026.

Open banking sees banks share customers’ data with third parties, should customers request this. So, it sees financial technology firms provide some banking services using banks’ infrastructure. Opening banking should promote innovation by making it cheaper to make payments or helping people budget by bringing together all their financial information in one app, for example.

The trade-off is that security could be compromised. With the surge of sophisticated scams, banks are urging people to keep their details private.

Creating new avenues for people to tap into bank accounts could make them more vulnerable to scams. For people to harness the benefits of open banking to the point this pressures banks to innovate, they need a higher level of financial literacy.

Better financial literacy more generally would go a long way to improving competition among banks.

If more people had the capacity to shop around for cheaper debt and more lucrative ways of saving and investing, banks would be forced to innovate more.

In the absence of this, policymakers and regulators are left deciding what trade-offs they’re willing to make to enhance competition among banks.

Should they decide they’re happy to take a more hands-off approach towards regulation, consumers need to be prepared to take on the risks that come with the benefits.