SFF misunderstands the Competition Authority's message about banks' operating costs

High operating costs indicate weak competitive pressure

The Association of Financial Institutions (SFF) issued a press release today stating that, according to the association's assessment, the combined operating costs of Arion Bank, Íslandsbanki and Landsbankinn increased by five billion between 2009 and 2011, on a merger-adjusted and tax-equivalent basis. This is similar to the assessment of the Competition Authority in a report No. 1/2013 Financial services at a crossroads which states that the banks' operating costs increased by 18 billion at 2012 prices, but that half of the increase can be attributed to the effects of mergers and acquisitions, and 1,5 billion due to the financial transaction tax on wages and taxation for the funding of the operations of the Financial Supervisory Authority and the Debt Ombudsman. In its calculations, the Competition Authority had also taken into account the estimated 2012 operating costs, which were assessed based on the banks' nine-month accounts.

The SFF's coverage does not suggest that the three major commercial banks within the association's ranks have taken on board the message the Competition Authority wanted to convey through its coverage of banks' operating costs and interest rate margins. The large commercial banks are expanding through acquisitions and their operating costs, with or without the effects of mergers, are increasing. The Competition Authority's observations strongly suggest that the discipline on their operations is less severe than is generally the case in other sectors of the post-crash economy. Operating costs are, however, only one part of the picture, although they certainly indicate that competitive pressure in the financial market is lacking. Only effective competition is likely to compel banks to share the benefits of economies of scale with their customers.

High interest rates are a heavy burden on households and businesses.

The organisation makes the comparison of interest rates in the report a particular point of discussion. In this regard, the Competition Authority points out that according to a report by the European Commission, known as the Liikanen report, only a few Eastern European countries had an interest rate spread above 21 basis points on total assets. In most other Nordic countries, this ratio was below 1%, compared with just over 3% in Iceland. It must be considered an incredible argument that this large difference is normal and is caused solely by the „accounting methods“ of revalued loan portfolios and a high proportion of deposits in total funding, as the SFF implies.

As regards the impact of the revalued loan portfolios on the interest margin, the banks must demonstrate that this impact was significant in order to overturn the conclusions set out in the Competition Authority's report. SFF has not done so in any way. In this regard, it should be noted that the interest income on which the Competition Authority based its assessment does not include the income effects of revaluing loans and receivables, which is a separate item in the banks' accounts. The impact of the loan portfolio revaluation on interest income is therefore relatively limited, although it does exist due to the application of effective interest rates to the income recognition related to the revalued loans.

As for the deposit ratio, it seems SFF's argument can be understood as the organisation's view that it is natural for a bank that funds itself largely through deposits to have a higher interest margin than other banks. Such an argument is contradictory, as deposits are generally a cheaper source of funding for a bank than issuing bonds in the market, and should lead to lower lending rates in the market if competition is effective. It cannot be seen that a high proportion of a bank's funding from deposits can justify a large interest margin. The banks' argument on this matter is therefore weak.

SFF's response supports indications that competition is lacking.

It is particularly noteworthy that the Association of Financial Institutions is behind the commercial banks' joint response to the report. It would be concerning for an organisation of this kind to be a channel for viewpoints based on the banks' operational information and which concern the very core of the competition that exists between them under competition law. The association's participation in this discussion supports the indications that competition in the financial market is deficient, as the Competition Authority points out in its report. It would be a sign of a healthier competitive environment in the market for commercial banking services if each of the commercial banks were to participate in a discussion of this kind independently.