Title: Market Power
1Market Power Pricing Behaviour
Banking Enquiry
- Banking Enquiry - Technical Team Presentation
- 18 June 2007
2Introduction
- Structure of retail banking in South Africa
- Market Shares and level of concentration
- Barriers to entry
- Sources of Market Power
- Product differentiation
- Information Asymmetries
- Search and Switching Costs
- Rational Oligopoly behaviour
- Competition Bertrand and Cournot
- Horizontal restraints agreements and concerted
practices - Price shadowing
- Strategic avoidance of price competition
- Effectiveness of competition in South African
Banking - Penalty Fees
- Discussion of possible remedies
- Basic banking product
- International experience
3Structure of Retail Banking in South
AfricaMarket Shares and Level of Concentration
- National Treasury and the South African Reserve
Bank on Competition in South African Banking
(April 2004) - the concentration levels of the South African
banking industry are high, but not out of line
with other emerging markets. However, it is in
the market segments rather than at firm level
that concentration is even more marked. For
example, while the Big Four (ABSA, First Rand,
Nedcor and Standard) accounted for 83 of the
total deposits of the public in June 2003, they
accounted for 92 of mortgage loans and 89 of
bank financed installment sales. Each of the Big
Four has a scale monopoly (25 or more market
share) in one or more of the retail market
segments (credit cards, current accounts,
mortgages or leasing and instalment sales). - Technical Team analysis shows that this situation
has not changed materially since 2004.
4Structure of Retail Banking in South
AfricaMarket Shares and Level of Concentration
Table 1. Market shares for cluster of personal
banking products in low income and middle income
segments (average based on various sources)
5Structure of Retail Banking in South
AfricaMarket Shares and Level of Concentration
Table 2. Market shares for personal transaction
product segment (average based on various
sources) and DI900 monetary value of month end
balances.
6Structure of Retail Banking in South
AfricaMarket Shares and Level of Concentration
- Figures not based on market definition, so
individual banks market share of relevant
anti-trust market not conclusive (cluster vs
segment approach). - Retail banking sector is very concentrated
regardless of how market is defined. - The four banks share more than 80 of the market
at the broad retail banking level and in the
market segments. - Personal transactional account segment very
concentrated top four share approximately 90.
7Structure of Retail Banking in South
AfricaBarriers to Entry
- High entry barriers explicit and implicit
- Explicit R250 Million required capital to become
a registered bank and other costs of entry (e.g.,
high fixed costs, time taken to build reputation)
- Newly registered banks must obtain a SAMOS
account with the SARB and membership of PASA and
the Banking Association. Membership and usage
fees to be paid to PASA and SAMOS and ultimately
Bankserv or any other operator or association
(like Mastercard and VISA). All of these are
explicit costs that mount-up as a would-be
entrant expands its participation in more payment
streams. - Implicit Discretion of Registrar in granting
license and approval of existing clearing banks
of new-entrants and innovations in payment
streams (danger of turf protection).
8Structure of Retail Banking in South
AfricaConclusions
- South African banking sector characterised as an
oligopoly. - Individual banks likely to have some degree of
market power. - Considerable scope for strategic interaction.
- However, these factors alone are not sufficient
to conclude whether or not competition is working
effectively. - Competition analysis must probe whether market
power of individual banks is appreciable and, if
yes, implications for conduct and strategic
interaction and - Scope for and extent of coordinated conduct
(horizontal restraints/concerted practices). - Taking all these factors into account is
competition likely to be effective given the
likely rational behaviour of the banks?
9Market Power
- Own-price elasticity of demand measures the
extent to which a firm exercises market power. - The more inelastic the price elasticity of demand
the more likely the exercise of market power. - Distinction between market demand curve and
residual demand curve. - As the number of firms increases, for a given
market elasticity, the more elastic the demand of
the single firm. - So, in a market that becomes more concentrated,
individual firms demand (residual demand) will
be more inelastic. - BUT although this implies some market power it
does not indicate whether it is appreciable.
10Market Power 2
- Market power implies the ability of the firm to
maintain prices above the competitive level. - Depends on the elasticity of the firms residual
demand curve. - In addition to market shares and concentration,
this is influenced by - Barriers to entry
- Availability of substitute products and degree of
product differentiation - Asymmetry of information
- Costs of searching and switching
- Strategic interaction between firms
11Market Power 3
- The South African Competition Act defines market
power as the power of a firm to control prices,
or to exclude competition or to behave to an
appreciable extent independently of its
competitors, customers or suppliers. - Section 7 of the Act
- A firm is dominant in a market if
- It has at least 45 of that market
- It has at least 35, but less than 45, of that
market, unless it can show that it does not have
market power, or - It has less than 35 of that market, but has
market power.
12Market Power 4
- OFT Guideline on Market Reference Inquiries
- A firm may have market power, and the capacity
to act in ways that may restrict or distort
competition, with a market share below that
usually regarded as necessary to suggest
dominance for the purposes of CA98. Much will
depend on the constraints exerted by its
competitors or its customers. - Important factors constraining or facilitating
market power that will be discussed here product
differentiation, information asymmetries, search
and switch costs.
13Market Power 5Product Differentiation
- Horizontal product differentiation relates to
different preferences of consumers. - Vertical product differentiation relates to
differences in the quality of products (real or
perceived). - Product differentiation dampens the degree of
price competition between firms by making the
residual demand curve of each firm less elastic. - Therefore, does confer some degree of market
power on the differentiating firm. - Pro-competitive to the extent of meeting a
variety of customer preferences and needs, and - Innovation and quality improvements rewarded
-
14Sources of Market PowerProduct Differentiation
- Elements of horizontal and vertical product
differentiation in banking. - E.g., expenditure on top-of mind advertising a
form of vertical differentiation. Suggests that
banks can influence consumers willingness to pay
(also dependent on income levels of consumers). - Horizontal differentiation reflected in different
packages and product bundles targeted at
different customer segments
15Sources of Market Power 2Product Differentiation
- However, intrinsic horizontal differentiation may
in fact be limited. - Bank is multi-product firm E.g. Transactional
banking consists of a bundle of features for
which customers are charged. - Farrell and Klemperer note, selling an extra
variety can attract demand away from rival
suppliers for this firms existing varieties - So, all the multi-product oligopolists will tend
to offer similar products and product lines. Each
bank may offer many features on the transactional
product but, intrinsically, there will not
necessarily be much variety produced by the
industry as a whole. - Farrel J and Klemperer P (2006) Coordination and
Lock-In Competition with Switching Costs and
Network Effects, from www.paulklemperer.org
16Sources of Market Power 3Information Asymmetries
- When customers have sufficient information they
are able to use this information to make
efficient and rational choices. - However, when firms have more information than
their customers about the attributes of their
products, this information asymmetry confers on
these suppliers a degree of market power over
their customers. - In SA banking sector there are significant
information asymmetries that prejudice consumers.
This is particularly true in the case of personal
transaction accounts. There are a bewildering
array of different packages and bundled offerings
with complicated fee structures
17Sources of Market Power 4Information Asymmetries
- Technical team experienced considerable
difficulties in trying to compare the different
offerings, both within and across banks. - Submissions by consumers and other anecdotal
information tells a similar story. - The wide array of packages and bundled offerings
complicate choices for customers but do not seem
to reflect intrinsic horizontal product
differentiation between the banks. - This may have a significant dampening effect on
the extent of price competition. - Consumers may also not be sufficiently informed
to be able to choose between differentiated
offerings on the basis of positive criteria other
than price
18Sources of Market Power 5Search and Switch Costs
- Wilson, Charles, M. 2006., Markets with Search
and Switching Costs, MPRA Paper No. 131.
http//mpra.ub.uni-muenchen.de/131 - Search costs are the total costs spent by a
consumer in identifying and interpreting a firms
product and price offering, regardless of whether
the consumer buys the product from that firm or
not. - Switching costs are the total costs incurred by a
fully informed consumer through deciding to
change suppliers that would not have been
incurred by remaining with the current supplier
19Sources of Market Power 6Search and Switching
Costs
- Wilson notes further
- Due to the assumption that search costs, unlike
switching costs, are incurred unconditionally on
the decision to switch suppliers it is shown that
the anticompetitive effects of search costs are
consistently larger than those from an equivalent
level of switching costs. The finding suggests
that obfuscation practices that aim to deter
customers from switching, such as competing on
deliberately complex tariffs, may be particularly
powerful relative to practices that increase the
costs of substitution between firms.
20Sources of Market Power 7Search and Switching
Costs
- Complicated packages and bundled offerings
suggest significant search costs re
transactional product offerings. - Switching costs
- Competition tends to be more robust when
consumers are able to easily switch from one
supplier to another in response to a competitive
price or some other factor that offers the
customer better value for money. - However, when customers are restricted from
switching due to inconvenience, administrative
hurdles, monetary costs, and/or other factors,
competition may be inhibited.
21Sources of Market Power 8Search and Switching
Costs
- Banks have argued that switching costs are not a
significant barrier. - Refer to churn figures which are higher in South
Africa relative to other countries. - Higher churn does not really tell us anything
about the effectiveness of competition in
bringing about switching. - Search costs may dampen price competition,
despite higher churn figures. - Churn figures greater in the lower income
segments i.e., current and savings accounts - Reasons Account abandonment? Lower switching
costs associated simplified product offerings?
Opportunity cost of time lower for low income
customers?
22Churn figures calculated by Standard Bank for
market segments
Source Standard Bank Presentation, 13 November
2006.
23Sources of Market Power 9Search and Switching
Costs
- The pattern in these churn figures more or less
consistent with other banks data on churn - Sophisticated customers in the middle and higher
income categories tend to purchase more complex
packaged and bundled offerings which may have
higher switching costs associated them. - Less financially sophisticated customers in the
low income segment may be able to switch more
easily possibly due to the simplified nature of
the product, but other factors may be at play. - Churn figures higher for more atomised products
like term deposits and home loans where
switching costs are likely to be lower.
24Rational Oligopoly Behaviour Cournot Bertrand
Competition
- Although firms in an oligopoly may recognize
their interdependence this alone does not mean
they will not compete. - Cournot firm competes by setting output, given
the output of its rivals. - With Cournot type competition price will be
greater than marginal cost but difference
between price and MC reduce as the number of
firms increase. - Bertrand firms compete by setting price, given
prices of rivals
25Rational Oligopoly Behaviour Cournot Bertrand
Competition
- In simple Bertrand model (even with only two
firms) outcome is similar to perfect competition
(PMC). - But simple Bertrand model is not realistic.
Assumes homogenous products. If one introduces
product differentiation, then price will exceed
marginal cost. - However, the fact that price is greater than
marginal cost does not mean that there will not
be effective competition. - Must consider other factors contributing to
market power of firms and nature of oligopoly
interaction
26Rational Oligopoly BehaviourHorizontal
Restraints
- Where firms recognize their interdependence they
may have an incentive to not act independently
but coordinate their conduct (either by direct
agreement or indirectly through some other
arrangement) in order to restrict or prevent
competition. - There is no evidence of collusion in the setting
of fees and charges on transactional products. - However, there is concern that arrangements among
the banks in certain payment streams may restrict
competition. - In the case of ATMs and payment cards there
appear to be arrangements among the banks which
may serve as a basis to introduce restrictions
which may inhibit competition. - E.g., Absence of direct charging for ATM
withdrawals and restrictions on entry of non-bank
providers restricts the extent to which ATM fees
can be competed down.
27Rational Oligopoly BehaviourPrice Shadowing
- Firms will either shadow one anothers pricing
upwards or will follow a price leader who tends
to set a price umbrella under which firms can
safely keep their prices up at an
above-competitive level. Firms who are aware of
their strategic interdependence can achieve this
outcome without the need for any kind of
coordination they are able to act unilaterally
to implement their best strategy in order to
maximize profits. - Our analysis of transaction fees is not
conclusive. In some cases fees diverge
considerably across banks whereas in other cases
there are parallel movements. - However, price following not unprecedented in SA
banking - Standard Bank ATM carriage fee adjustment in
1997, and - Banks responses to repo rate adjustments
28Rational Oligopoly BehaviourStrategic avoidance
of price competition
- Recent developments in the economics of search
and switching costs tell an interesting story
about the incentives of firms in oligopoly
markets where such costs are present. In such
cases firms may have an incentive to gain and
extend market power by making it difficult for
customers to shop around and switch to more
competitive offerings or by disrupting or
preventing any standardization or compatibility
of offerings that would otherwise facilitate
switching and price competition. - We have noted in previous slides the prevalence
of information asymmetries, search and switching
costs in the South African banking sector all
factors which facilitate strategic avoidance of
price competition by oligopoly firms. -
29Penalty Fees
- The level and incidence of penalty fees
particularly concerning because they add to the
overall costs faced by customers of transactional
banking products. - Customers often not aware of the full extent of
the penalty fees they will incur and only become
aware, after incurring substantial costs, after
experiencing the full effect of the penalty fee. - In the case of rejected debit orders due to
insufficient funds the debit order request may be
resubmitted a number of times against the
customers account. For as long as there are
insufficient funds in the account the debit order
request will be rejected and the customer will
incur a penalty fee. - Poor customers are hit particularly hard as a
result of these fees as they are most likely to
experience shortfalls in income and to
temporarily have insufficient funds in their
accounts (e.g., at the end of the month when most
payments become due).
30Penalty Fees
- Data analysed by the technical team suggest that
a substantial portion of bank fee income is
derived from penalty and penalty type fees.
Further, it is suggested that these fees have
become an important revenue stream for the banks. - There is no relationship between the level of the
penalty fee and the cost associated with the
transaction that generated the penalty fee (e.g.,
debit order rejection) - Rejected debit order penalty fees are set at a
level considerably higher than the estimated cost
of those transactions. - Cost estimate based on confidential submissions
of certain banks.
31Effectiveness of Competition in South African
Banking
- There are a number of factors that may inhibit
effective competition in retail banking in South
Africa. Primary among these are - The information asymmetries that arise out of
inadequate disclosure of product and price
information to customers - Significant costs of searching that arise out of
the complicated packages and fee structures
making it difficult for customers to shop around
and make efficient and rational choices and - Switching costs, which act as a barrier to
customers moving from their current provider to a
more competitive alternative.
32Effectiveness of Competition in South African
Banking
- To the extent that these factors indicate some
degree of market power the enquiry must assess
whether this power is appreciable and, if it is,
what impact this would have on the likely
rational and strategic behaviour of the banks. In
this regard, are the banks likely to avoid direct
price competition (through obfuscating price or
product differentiation and/or cautiously
following each other) or are they likely to
compete in order to gain a foothold in a growing
but untapped low income consumer market? - It appears that in South Africa, banks may face
the prospect of competing for a share of an ever
growing yet untapped market. In such an
environment competition may be more intense and
banks forced to compete on price as they grow
their share of the market. However, this does
depend on the scope for growth. If it is limited,
competition may only be temporary.
33Discussion of Possible RemediesBasic Banking
Product
- The remedies here refer to those that would
enable the consumer to play a more proactive role
in ensuring effective competition - Focus on two areas basic banking product and
switching - Propose for discussion the introduction of a
simplified basic banking product that has easily
identifiable features that are generic across all
the banks and over which the banks can compete on
price. - The product would have to be designed so that it
meets certain minimum customer requirements but
is sufficiently simple so that it can be
identified as the core basic banking product. - Similar to Mzansi but more widely available
34Discussion of Possible RemediesBasic Banking
Product
- There are number of points to consider with
regards to the design of this product - Should there be a fixed fee per month for the
bundle of transactions, or unbundled pricing of
the transaction items? - The fixed fee is probably preferable because
consumers can compare more easily on the basis of
a single fee rather than a set of unbundled
transaction fees. Unbundled transaction fees are
also likely to be price higher relative to the
options in the various bundled packages. - The product must not become a dinosaur that does
not improve with new innovations and advances in
technology. - A regular review process, with input from civil
society, may be needed to ascertain whether any
adjustments are needed in order to meet customer
needs.
35Discussion of Possible RemediesBasic Banking
Product
- The product must fit some general profile that
cuts across a significant section of the customer
base. - If the basic product cannot be used effectively
by a significant number of customers then it will
not succeed in stimulating price competition as
customers will move to other packages that better
meet their needs. - It must be possible for customers to add on
additional features if they so wish. - It is important that individual tastes be catered
for that otherwise may not be catered for in the
generic product This is the apple but you
can add candy if you like! - Banks should be free to offer other
differentiated bundles and packages in addition
to the basic product.
36Discussion of Possible RemediesInternational
Experience
- United Kingdom Competition Commission market
investigation of Personal current account banking
services in Northern Ireland. - Introduced a package of remedies to address
factors preventing effective competition in
Northern Ireland - Easy-to-understand terminology and descriptions
of personal current account services. - Explanations of the levels of charges and
interest rates and how and when they are applied. - Information on statements.
- Summary and breakdown of charges and interest.
- Advance notice of charges and debit interest
incurred. - Regular rights reminder.
- Changes to the switching process
37Discussion of Possible RemediesInternational
Experience
- Switching packs have been introduced in a number
of countries. - E.g., Republic of Ireland
- Two switching pack systems have been
implemented in Ireland a Personal Account
Switching Code (January 2005) and a Business
Account Switching Code (June 2006). These codes
were developed by the Irish Banking Federation
the representative organization for the retail
banks. - The Competition Authoritys final report on
competition in the (non-investment) banking
sector in Ireland, published in September 2005
recommended that the Irish Banking Federation
should develop codes for switching personal and
business current accounts - The financial regulator published its consumer
protection code- which is mandatory for banks- in
August 2007
38Discussion of Possible RemediesInternational
Experience Switching Packs
- Republic of Ireland example continued..
- The switching codes are a set of rules that the
banks must adhere to, and standards that they
must endeavour to achieve, in order to facilitate
an efficient, predictable and reliable system for
individual consumers and business who wish to
switch their account. - For personal account customers, the balance on
the account, standing orders and direct debits,
plus any charges will be transferred from the old
bank directly to the new bank within 7 working
days and the old account closed. Business account
customers follow a similar process, with the same
time scale of 7 working days, but have to also
consider their payroll system, informing their
own customers, and the most suitable date to
switch. Switching is free.