Sample on Market Structure In Australian Banking Industry

Question: Discuss about the Market Structure in Australian Banking Industry. Answer: Introduction: Market structure is the nature of competition that exists between the firms in an industry. Oligopoly and monopolistic competition are the most common market structures that exist in the Australian market. Banking is one of the most important industries in Australia and oligopoly exists in this industry with only four big firms dominating the industry. Oligopoly is a market structure where a small number of firms have a larger share of the market and hence they dominate the market. This makes entry and exit of firms really difficult in such type of a market structure. Oligopoly is very similar to monopoly except that instead of only one firm; two or three firms dominate the market. The products produced in an oligopoly market could be homogeneous or differentiated. The banking industry in Australia is a very good example of oligopoly market structure. There are four major institutions which account for 85% of the total banking industry and include National Australian Bank (NAB), Commonwealth Bank (CBA), Australia and New Zealand Banking Group (ANZ) and Westpac (WBC). The total market capitalization of these institutions is 5 times the market cap of the remaining banks, mutual funds and other institutions of the industry. (KPMG, 2011) Cartel Arrangement in Australian Banks The big four financial institutions have formed kind of a cartel arrangement. This is because the majority shareholders of all the four banks are the same and hence they have common interests in all four banks. The aim of a shareholder is to maximise profit which is possible if the banks act as a monopoly but since here there are four banks, a cartel type of arrangement will be made to maximise the shareholder profits. (Varian, 2010). The major shareholding in these banks constitute of HSBC, Citibank and JP Morgan Chase. As a result of this cartel arrangement, there are barriers to entry in the banking industry, in fact Australian banking industry is known to have the highest barriers to entry and it is impossible for a new entrant to compete with the bigger players without a minimum cost and risk. Due to the cartel arrangement, there is very low competition pressure which is evident from the fact that the banks could easily escape the passing of interest rate cuts in full to the borrowers in 2012. Also these banks have wider interest margins and have lower costs which make them even more profitable. The banks enjoy support from the government and hence are able to dominate the industry on regulations basis. (Yeates, 2013) Market Concentration Competitiveness in a market can be determined by a method called HHI (Herfindhal- Hirschman Index. HHI measures a firms size in relation to the industry and the competition between those firms. The HHI ranges from 0 to 1. A higher HHI indicates concentration of power and less competition and vice versa. A market with a HHI of 0.18 or more is considered highly concentrated and a HHI of 0.1 or more as concentrated. (Bikker, Haaf, 2002). The Australian banking industry had HHI between 1000- 1500 till 2010 and as such can be regarded as concentrated. The market concentration has increased over the years due to acquisition activities undertaken by big banks including CBA and Westpac. (Harms, 2010) Effects of Market Concentration Market concentration has effects on various aspects of the economy which include the profitability of the bank, the economic efficiency, financial and economic stability of the country. The effects of an increased market concentration are that there is decrease in competition which results in market inefficiencies. Due to absence of competition among the big banks, a dead weight loss occurs. Due to concentration, the firms behave more like a monopoly where all four firms act as one and charge similar interest rates. This leads to creation of more producer surplus than consumer surplus and hence is not good for the society. These banks had increased the lending rates particularly for housing loans more than RBAs official cut rate in 2010 as a result of this dominance and the customers accepted the same because they have no other banks to go to. The four banks have also adopted a four pillar policy according to which there is restriction of merger or acquisition of banks by each other. The four pillar policy along with the monopolistic nature of competition further leads to reduced competition among the four firms and as such there is a greater dead weight loss that the society suffers. The profitability of the banks also increases due to market concentration. All the consumers of Australia blindly have faith in the big four banks and thus would accept low interest rates on their deposits and increased interest rates on loans. This increases the interest spread and hence banks profitability. During end of 2007 when global financial crisis had hit the world, the Australian economy could pass as a stable economy due to the policy regulations of these big 4 banks, the financial stability was maintained. This is also one of the reasons why market concentration has been accepted by the government of Australia. However, in order to eliminate the market inefficiencies which is a direct loss to the consumer, it is necessary an external pressure is applied to these banks to increase consumer surplus by increasing competition between these firms. The external pressure can be applied by the government, mutual banks or credit unions. Conclusion Regulation of big banks by the external forces is one way to increase economic efficiencies. Another could be to reduce the market concentration. This is not possible with the existing domestic banks as they are too small in size to compete with the big banks; however entry of global banks which are bigger in size could reduce the market concentration as they will not be bonded by the four pillars policy. However, the government should address one issue i.e. the protection of the Australian consumers in case these foreign banks fail. (Davis, 2007) Also the big banks should compete for price where they would compete to get a larger market share and higher profits, in such case pareteo efficiency will be achieved. References KPMG, (2011), Building Societies and Credit Unions, KPMG Varian, R. (2010), Intermediate Microeconomics, 8th edition, New York: W.W. Norton and Company Yeates, C., (2013), Banks Make $71 Million Profit a Day, The Sydney Morning Herald, accessed online on 8thAugust,2016,available at https://www.smh.com.au/business/banks-make-71-million-profit--a-day-20130623-2oqrw.html Harms, S.K., (2010), Market Concentration in the Banking Sector- Household Loans, Parliament of Australia, accessed online on 8th August, 2016, available at https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/FlagPost/2010/November/Market_concentration_in_the_banking_sector_-_household_loans Bikker, J.A., Haaf, K., (2002), Measures of Competition and Concentration in the Banking Industry: A Review of the Literature, Economic Financial Modelling, summer 2002 Davis, K., (2007), Banking Concentration, Financial Stability and Public Policy, Reserve Bank of Australia Conference, August 2007