Article no. 5/2012The branches, however, remain, and in many cases have even increased in number rather than decreased across the country. Until recently, local branches were a prerequisite for attracting and retaining customers. The location and distribution of branches has thus been one of the main prerequisites for market penetration in the financial market. As an indication of this, JPMorgan Chase, the largest bank in the United States, opened 200 branches last year.
Some predict that the wait for information technology to revolutionise branch-based thinking in business banking is coming to an end. In May this year, the magazine „The Economist“ featured the future of financial services in a special report. It was predicted there that the ground might now be fertile for major changes. Three factors were cited in this regard: Firstly, the financial crisis has led to declining returns in retail banking, and banks are therefore facing the need to cut costs by reducing their branch network, a task they have generally deferred in better times. Secondly, a revolution in the capabilities of mobile phones will lead to customers visiting their branches less frequently. It is predicted that this technological development will change the behaviour of bank customers more radically than, for example, internet and cash machine banking have to date. Thirdly, people are now more accustomed than before to transacting online, such as booking flights, filing tax returns, etc.
No one knows for certain what will happen in this matter. One thing is certain, however: it is the needs of the customer and the efforts of financial institutions to meet them that will determine the outcome. This is where competition comes into play. History tells us that the development of the financial market will not be hand-guided, except to a small extent, by either governments, the management of financial institutions, or the owners of IT companies like Bill Gates. The development of the financial market is about the efforts of financial firms to acquire and retain customers. They do this by finding the most cost-effective ways to deliver financial services in the manner that best suits the customer. The financial firm that does this best is the most competitive.
The general principle is that competition in business is necessary, as it increases consumer welfare and promotes efficiency in the economy. Specifically, it contributes to the following:
In economic hardship, the importance of promoting competition grows. The experience of most nations with economic crises shows that measures which promote competition contribute to a faster recovery of the economy.
All of this is crucial for the development of the financial market. In general, too much time is spent debating how the financial market should develop, how many financial institutions we can do without, and what the strategy should be. That time would be better spent on discussions and actions aimed at creating the best possible framework for competition, ensuring that financial institutions can, on the basis of competition for customers, offer them good service in the most efficient way. And that includes creating conditions where the forces of competition compel financial institutions to streamline their operations.
Of a similar vein were the findings of a British banking commission, known by its chairman's name, Sir John Vickers, which reported its findings in September last year. The report covers the financial market in a broad sense and proposes a wide range of reforms. The commission places great emphasis on competition issues. It proposes, among other things, that the British government ensures, in its agreements with the country's largest bank, Lloyds Banking Group, that the sale of part of the bank's assets leads to a strengthening of the competitive position of its rivals, thereby strengthening competition in the market. The Committee also believes that barriers to entry in the banking market and the cost to consumers of switching banks are significantly hampering competition in the market. The Committee proposes that switching costs be reduced by requiring banks to ensure that the transfer of customers between banks is quick and straightforward.
In this context, the decisions of the EFTA Surveillance Authority (ESA) on state aid for the re-established Icelandic commercial banks are noteworthy. The decisions were published earlier this month. In them, the ESA consistently addresses the banks' prospects for viability and safety following the state aid, on the one hand, and the effects of the state aid on competition, on the other. The institution also assesses whether specific measures are needed to ensure that the state aid does not harm competition.
Information technology costs are one of the largest cost items in banking. According to information the Competition Authority obtained while preparing a discussion paper on competition in the banking market last year, information technology costs, including salaries, accounted for around a quarter of the operating costs of Arion Bank, Íslandsbanki and Landsbankinn. According to the banks' information, there was little to suggest that this cost would decrease in the coming years.
Efficiencies in the financial system can be achieved in various ways. In the report by the Minister for Economic Affairs and Trade on the future structure of the financial system, which I mentioned earlier, several approaches are outlined; e.g. technological improvements, increased automation, better use of human resources, a review of the branch networks of banks and savings banks, and increased cooperation between the latter. Various developments have taken place in this area recently, including a reduction in the number of branches.
The banks' institute created a framework that supports optimisation.
The Competition Authority has dealt with various related matters in recent quarters. It is worth recalling that the authority concluded two investigations concerning Reiknistofan bankanna this summer. The other had a long lead-in and concerned an examination of the cooperation between competitors, which consists of the joint ownership of the company by financial institutions. The other investigation concerned the Reiknistofan's acquisition of Teris, the mutual information technology company of the savings banks. Both of these investigations concluded with the same decision, No. 14/2012.
The decision concludes that the collaboration between competitors embodied in RB and RB's acquisition of Teris could, without changes, harm competition. However, RB and its owners were willing to accept conditions to ensure competition. The following is intended to be ensured by the conditions:
Another case of a tug-of-war concerned Landsbankinn's acquisition of Arion Securities Custody, which is now called Verdis. This merger was investigated in 2011. The supervisory authority considered that the joint control of a key service company by two large commercial banks would lead to a distortion of competition. The authority gave the parties the opportunity to propose conditions that could remedy this distortion. At that time, the parties to the case were not prepared to go as far in this regard as the regulator considered necessary. For example, they were not prepared to agree to the type of conditions that have now been imposed on RB.
The parties to the case appealed the decision of the Competition Authority to the Competition Appeals Board. Before the panel, the appellants put forward more extensive proposals for conditions than they had previously. On that basis, the appeals panel quashed the authority's decision and directed it to reconsider whether the acquisition could be made subject to conditions. In accordance with the ruling, the supervisory authority reconsidered the matter. However, by the time that review was at a final stage, Landsbankinn had abandoned the acquisition.
Financial market restructuring is rarely discussed without the topic turning to mergers between financial institutions. Following the collapse, there have even been voices suggesting that the necessary restructuring can only be achieved through a merger between two of the three major banks. The competition authority has generally warned against such ideas due to the significant concentration that would result from such a merger.
It is worth emphasising here that when assessing the legality of mergers, the regulator must consider efficiencies, provided they directly benefit consumers and do not hinder competition. However, in recent years the Competition Authority has repeatedly concluded that the acquisition of savings banks by commercial banks hinders competition. [In this context, one can mention the decision on Kaupþing's acquisition of SPRON and Sparissjóður Mýrarsýslu just before the collapse, and the decision on Íslandsbanki's acquisition of Byr. The authority then presented detailed arguments that the same applied to Landsbankinn's takeover of Sparisjóður Svarfdæla. In three of these four cases, however, the Competition Authority agreed that the financial position of the respective savings banks was such that a market-distorting change was inevitable anyway.
It is therefore clear from these cases that the Competition Authority has in the past considered that further consolidation in the financial market would constitute a barrier to competition. Furthermore, international research shows that the efficiencies often claimed for bank mergers are illusory. These studies are cited in the Authority's report on competition in the banking market. They are also discussed in the report of the Minister of Economic Affairs on the future structure of the financial system.
Clearly, mergers that hinder competition are even less likely to lead to efficiencies. Such a merger is, in fact, a contradiction in terms, because a merger that gives its parties protection from competition simultaneously robs them of a crucial incentive to improve efficiency. Namely, the incentive to outperform their competitors.
The Competition Authority's message to the financial market is simple: the optimisation of the financial market is a crucial part of shaping it for the future. The best way to achieve this optimisation is to strengthen competition, as it stimulates and encourages good performance. Actions that hinder competition are likely to have the opposite effect. In conclusion, I would like to touch upon a few issues concerning competition in the financial market, which are therefore of great importance for its future. These issues relate to the main theme of removing barriers to entry in the financial market, thereby making it easier for new and smaller companies to establish themselves, improving competitive pressure on the major players and, at the same time, promoting efficiency.
Firstly, the structure of the financial market needs to be carefully considered. Thus, the arrangement of payment mechanisms, payment systems and other core infrastructure of the financial market must be such that the entry and growth of new and smaller financial firms is not hindered by those already established in the market.
Unfortunately, we have examples of such obstacles in the past. For example, following raids on payment card companies and Fjölgreiðslumiðlun in 2006 and 2007, the companies were fined over 700 million ISK for preventing a new competitor from establishing itself in the market. This case led to extensive changes in the structure of the payment card industry in Iceland. Furthermore, Fjölgreiðslumiðlun was removed from the ownership of financial institutions, and the Central Bank's current ownership of Greiðsluveitan, as the company is now called, was subject to detailed conditions. which are intended to ensure that new and smaller financial institutions have access to the Icelandic financial market.
These changes are linked to the decision I referred to at length above concerning the Bank's Clearing House. Further matters are, and have been, under consideration relating to the structure of the payment card market.
Secondly, it is important to closely monitor the competition practices of the three major banks and, where applicable, place restrictions on them in accordance with competition law. In the merger cases I mentioned earlier, the Competition Authority argued that the three banks were in a jointly dominant position. The Authority is currently investigating whether the three banks have abused a potential joint dominant position by tying certain loan terms to the condition that other financial services for the customer are provided by the same bank, i.e. bundling different services. The outcome of this case is likely to shed further light on the constraints that may be placed on the banks when it comes to competing with smaller rivals.
Thirdly, it is necessary for normal competitive conditions in the financial market that restrictions are placed on banks' ownership of commercial enterprises, and that the restructuring and sale of such enterprises is accelerated as much as possible. The Competition Authority has taken a keen interest in these matters, as evidenced by the various reports it has published on the subject, as well as numerous decisions in which conditions have been imposed on banks' ownership of companies. It is obvious that the extensive influence and ownership of the banks in business life is not healthy for competition among financial institutions.
Fourthly, the Competition Authority emphasises ensuring that there is no unlawful cooperation between financial institutions, as such cooperation necessarily impairs the ability of new and smaller companies to compete. For this reason, the Competition Authority has sought, among other things, to place reasonable limits on any necessary cooperation regarding the payment difficulties of households and businesses, so that cooperation intended to benefit customers does not develop into its opposite.
Fifthly, the government and financial institutions must work together to create an environment where it is as easy as possible for a customer to switch financial institutions. It is crucial that such switches are easy and quick, that the transfer of deposits and other contractual agreements is without difficulty, and that transparency is ensured. The Competition Authority has repeatedly called for action to be taken on this matter. As I mentioned earlier in my speech, the matter has finally been set in motion, with the government and the three commercial banks now having committed to reducing this type of barrier to entry.
All these issues are significant for the future optimisation and shaping of the financial market.
Final words
Competition is the best friend of efficiency. The best thing we can do for the banks of the future is to allow these friends to work together in harmony and not pit them against one another.
And let us not forget that the government and those working in the financial markets do not have a monopoly when it comes to shaping financial activity. The customer and their habits will play a significant role.
Páll Gunnar Pálsson
Director-General of the Competition Authority
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