25 August 2015

CIFR report on Competition In Financial Services

Bank account number portability as a pro-competition mechanism?

The Centre for International Finance and Regulation (CIFR) has released a 154 page report [PDF] on Competition In Financial Services that suggests adoption of that portability.

CIFR comments
The research question for this project was ‘What are the optimal competition law and policy settings that should apply to the financial services sector?’
The research question was driven by two Australian Government inquiries which will affect competition policy in the financial services sector. The Financial System Inquiry chaired by David Murray and the Competition Policy Review, chaired by Professor Ian Harper
The project has three objectives. 
The first is to investigate the nature of competition in certain sectors of the financial markets. Meeting this objective will provide Australian evidence on which decisions as to the competitive settings in the sector can, or should be, adjusted. 
The second is to consider the mechanisms by which competition in the financial services sector can be promoted. This includes an analysis of the approaches used on an international basis for the promotion of competition in financial services. Meeting this objective will provide evidence on which decisions as to allocation of responsibility for promoting competition can be made. 
The third is to consider the sector-specific competition settings in the financial sector, including the balance between competition and stability. As the global financial crisis did not provide Australia with direct experience of the practical limitations of this balance, the work investigates theoretical approaches and international experience. Meeting this objective will provide evidence for appropriate policy settings if there are to be any sector-specific competition policy exemptions. 
CIFR goes on to state
International work from central banks, international financial institutions and academic sources in this field is still dominated by the effects of the financial crisis. There are three critical themes:
(a) an increased focus on macroprudential regulation; 
(b) a focus on regulations that respond to the globalisation of the financial markets; and 
(c) the introduction of anti-competitive policies such as government intervention and consolidation after the financial crisis.
These sources have also offered key policies to promote competition, which include the independence and strength of regulators, consumer policies such as the facilitation of switching, financial literacy, and easing entry and exit restrictions. 
There are three characteristics of retail banking in Australia:
(a) the stability of the sector is sound and retail banking had a relatively soft landing in the aftermath of the financial crisis; 
(b) there is limited competitiveness and this is reflected in the static state of market share between the four major banks and very slow and marginal improvement gains even by strong second tier competitors; and 
(c) product and service innovation is limited.
There are two important implications that flow from these issues:
(a) the absence of vigorous rivalry, whilst providing stability, is likely to mean that the welfare of retail banking consumers is not optimised; and 
(b) the level of innovation may not be as high as is feasible and barriers, including prudential regulatory barriers to entry or expansion, mean that the extent of rivalry is unlikely to change without some form of promotion of competition.
We recommend the removal of the ‘four pillars’ policy for the following reasons:
  • The four major banks are protected by an implicit government guarantee that impacts market operation with little observable benefit to consumers, and may be a source of consumer disutility. 
  • The four pillars policy has prompted increased vertical integration within the sector, particularly in the area of mortgage products. 
  • There are sufficient merger protections provided by Part IV of the Competition and Consumer Act 2010 (Cth). 
  • Competition and contestability arise when there are reasonably low barriers to entry and exit from the sector. It is not clear that low barriers to entry exist in Australia, and evidence to support this view comes from the failure of international banks to gain a significant toehold in the retail banking sector in Australia. One deterrent to entry is the regulatory focus on the four pillars.
We recognised that this position is at odds with the view of the Financial System Inquiry. The rationale in the report of the Inquiry was to prevent mergers between the four pillars, and the current competition law achieves this objective.
The report examines crowd equity funding as a disruptive force in the banking sector. We recommend that crowd equity funding be permitted with the following safeguards:
  • The Australian Securities and Investments Commission (ASIC) should take an active role in monitoring crowd equity funding and be willing to sue in case of fraudulent action. 
  • Any intermediary online platform should have a financial services licence with limited duty of care. 
  • There should be a cap for business raisings through crowd equity funding of $2 million in a 12-month period.
In terms of competitiveness, Australia’s banking sector lies broadly between the US and the UK, and is comparable with the world overall. However, statistical measures indicate that competition in the domestic sector peaked in 2004. 
We recommend two specific policies to promote competition in retail banking without the structural intervention that would otherwise be required to improve the intensity of competition in the retail banking sector:
  • Introduce bank account number portability. This would use ‘know your customer’ and central database systems in a similar form to those that have been used for mobile number portability in Australia for the last decade and a half. 
  • Introduce customer access to data held by banks to allow third parties to compare bank offerings across all banks.
It is interesting to note that these two recommendations are consistent with the productivity proposals issued by the UK Government in July 2015.
In discussing portability CIFR states -
One of the issues which deters consumers from changing suppliers is the associated switching cost (Fuentelsaz, Maicas and Polo 2012; Colgate and Lang 2001). The Financial Conduct Authority (FCA), a UK financial regulatory body that is independent of the UK government, released a report in March 2015 that highlights the benefits of account number portability (bank account number portability) in encouraging consumers to switch. The report predominately concentrates on Current Account Switching Service (CASS), a service provided in the UK to allow for customers to switch more easily by automatically switching all direct debits, standing orders and bill payments within seven working days and providing a redirection service for up to 13 months. The report also provides important insights into the workings of bank account number portability. These can be used to understand how this mechanism can be introduced into Australia as an effective tool to make switching easier and simpler, which is a necessary component in the financial system for vibrant competition. 
4.7.2 Benefits of bank account number portability 
The FCA report finds that bank account number portability would encourage more customers to switch. Based on recent quantitative consumer research, the report revealed that 35% of consumers and 40% of businesses ‘would be much more likely or more likely to switch if they had portable account details’ (Financial Conduct Authority 2015: 53). The research signalled that customers view bank account number portability as having ‘less risk and is more seamless as a process than CASS’, as there is no requirement to change details or to notify consumers of any changes (Financial Conduct Authority 2015: 53). Further quantitative research shows that, for small and medium-sized enterprises (SMEs) and charities, bank account number portability is viewed as a more convenient mechanism. This is because ‘they would not have to notify their customers of changing details, worry about transferring certain payments, make changes to stationery, or be concerned about what the change in account details may signal to their customers’ (Financial Conduct Authority 2015: 53). Moreover, bank account number portability is seen by customers as reducing the chances of encountering problems such as incoming payments going astray. Thus, the main benefits for incorporating bank account number portability are that switching is made easier and quicker for customers by allowing existing direct debits and credits linked to the account to be automatically transferred to the new institution, meaning that the risk of error for payments going amiss would diminish. 
4.7.3 Possible implementation of bank account number portability 
The FCA report provides technical advice on what measures are required for bank account number portability to be implemented. This includes the following prerequisites: payments, as well as the existing balance, would need to be transferred from the old to the new account, and a record of both the payments to be transferred and the current and any previous account numbers would also be required. Essentially, for bank account number portability to be effective, the customer’s details and payments would need to be accessible by the old and new institution. 
According to the FCA report, these requirements could be dealt with via two different methods. The first potential method is based on the existing market structure, but would incorporate bank account number portability by building additional infrastructure that includes the prerequisites, as previously referred to, such as retaining information on payments and account information, and routing payments and balances. This additional infrastructure would be run centrally, but providers would still work under their own existing systems. The second concept is a ‘central utility model’ based on a ‘central shared banking platform’. The ‘utility’ model could include features such as a ‘Know-Your-Customer’ (KYC) database (which stores the customer’s details for identification) and a ‘payment mandates database’ for all payments to be transferred through a common payment infrastructure that would identify which institution the account is linked to (Financial Conduct Authority 2015: 54). The idea is for providers to retain their different products and services, interest rates, internet banking sites, or mobile banking applications to continue offering competing products to customers, whilst using a common infrastructure system. Unfortunately, the FCA does not delve into the specifics of how bank account number portability would be implemented, but rather provides a framework to be further examined. 
4.7.4 Portability implementation in Australia 
Implementing account number portability in Australia would require compliance with the relevant regulatory safeguards, especially in the context of anti-money laundering and counter-terrorism, that have been constructed over the years. Consequently, an Australian model would need to include a ‘Know Your Customer’ database and a ‘payment mandates database’. Currently, the Australian payment system is based on the direct entry system, which essentially is a series of bilateral networks between financial institutions to facilitate the transactions of direct credits and debits. In other words, an electronic payment system to transfer money. For this to occur, each customer has a customer account number to identify the specific account, and a bank, state, branch (BSB) number to indicate which financial institution, state and branch the customer’s account number is linked to. To switch in Australia, customers are required to change their BSB, customer account number and redirect incoming or outgoing transactions to the new account details. 
The Fraser (2011: 8) report, commissioned by the Australian government, developed a similar idea to the FCA report on bank account number portability. The report conceptualized an alternative numbering system with a central account registry to store the details of the customer’s account, including that of the customer’s institution, which would be updated each time a switch occurs, as well as, a ‘central hub’ or clearing house whereby all direct payments would be transferred. The existing BSB number and account number system would thus be replaced with a unique customer account number with the clearing house and central registry acting as a mechanism for rerouting payments. The report alternatively describes the possibility of a de-centralized approach whereby institutions would be held responsible to reroute payments and retain their own account registry of switched account numbers which would be available to other financial institutions (Fraser 2011: 8). The report however, concludes by arguing that the costs involved in building the infrastructure necessary for bank account number portability and for it to function, outweighs the benefits. 
Of interesting note however, the Fraser (2011) report does not provide a reason for why the current BSB and account number could not be merged to form a unique customer account number rather than having to develop a completely new one. Furthermore, the report does not examine whether a current banking institution, such as one of the four big banks could manage the centralized payments system, which could be checked by the remaining big banking institutions and would avoid the costs of establishing a new institution. Perhaps a simpler alternative however, could be to merge the current BSB and account number in order to form a unique customer account number rather than having to develop a completely new one. This parallels the mobile numbering approach where two digits after ‘04’ previously indicated the network operator and now only do so for non-ported numbers. 
4.7.5 Additional detailed option for bank account number portability 
There is also a report by Jain and Kudidhi (2010) from the Infosys Institute that envisages a similar but much more detailed idea of how bank account number portability could be implemented, compared to the Fraser (2011) and Financial Conduct Authority (2015) report. The authors propose a method that entails a local database for each institution to initiate switching requests, as well as a central database with all customer account numbers that would be accessible to all banking institutions. A clearing house agency would be given the responsibility to manage this database by updating the requests made by the new serving bank and informing the old serving bank of the customer’s request to switch. The old serving bank would be responsible for undertaking closure procedures including cancellations of ATM/Debit cards and transferring to the new bank the customer’s details whilst informing the clearing agency of this process. Finally, the new bank would perform a KYC process requirement and make switching requests via its local database that is connected to the central database. The report however, does not provide any assessment of the costs involved in this bank account number portability initiative. A centralised database system is also important and is sometimes regarded as a high cost item. However, a process could be established where one of the four big banks manages the database, which is then checked by the remaining big banking institutions. This would avoid the costs of establishing a new institution. In the telecommunications sector, Telstra runs the equivalent data repository known as the Integrated Public Number Database.