The Government has announced measures to increase competition among banks. ‘Open banking’ is designed to make it easier for Kiwis to shop around for financial products such as credit cards or mortgages. But will open banking deliver a better deal for consumers?

ANZ Bank recently announced a $2 billion after-tax profit in the full year to the end of September, up 8% on the previous year. Westpac notched up a profit of $1.16b, up 12%.1 Banks’ profits have been rising for several reasons: they have cut staff, the pandemic accelerated online banking at the expense of (more costly) over-the-counter banking, loans have increased as consumers have needed to borrow larger amounts to meet ever inflating house prices, and the margins that banks make on those loans have increased. In short, the banks have benefitted from an economic environment that supports profitability, as well as some clever thinking by the banks themselves.

Large profits have prompted Prime Minister Jacinda Ardern to question whether banks are serving their communities well. It is a sentiment many of us would adhere to. Why haven’t the banks cut their mortgage rates and shaved a few hundred million off their profits to make life a little easier for struggling households? The hard-headed economic response is that they haven’t because they don’t have to. Banks exist to maximise profits, like most businesses. The problem is not the profits themselves, but that banks are not incentivised to offer more competitive rates.

The banking system in New Zealand is dominated by a small number of big players — ANZ, Westpac, ASB and BNZ — what economists call an oligopoly. Oligopolies tend not to be competitive because there is very little incentive to undercut prices. If one of the big four banks, for example, tried to grab market share by offering lower mortgage interest rates, it would risk starting a price war that would damage margins across the big four banks. Add to this the fact that we consumers tend to be loyal to our chosen bank and don’t shop around for the best deal, partly because switching banks is a troublesome process.

It is not so much a lack of competition, but the threat of competition that is the problem. An oligopoly can work just fine if there are low barriers to entry into an industry. Incumbents know that if they are not competitive and make large profits, this will encourage new players to enter the market.

Setting up a bank in New Zealand and gaining significant market share is very difficult. You just have to look at Kiwibank, which hasn’t been able to break the dominance of the big four even with the backing of the government.

At its heart, open banking is about sharing financial data. Under open banking banks are required to share their customers’ financial data with other financial service providers. The Government’s announcement about open banking earlier this month was actually an announcement to apply the recently established Consumer Data Right (CDR) framework to the banking sector.

The idea is that other providers can use this financial data to develop money manager apps or price-comparison websites to help individuals and businesses find the best deal when they are looking for a new credit card, a savings account, a term deposit, a mortgage provider, or any other financial product. And that’s just the tip of the iceberg. The idea is that open banking will encourage innovation in new financial services to come up with new ideas such as account onboarding, personal finance management, bill management and payment, tax return filing and tax payment, and financial auditing apps. Crucially, it is intended to put pressure on incumbent banks to lift their game.

Open banking is at various stages of development in the UK, EU, Brazil, Japan, Mexico, Canada, Hong Kong and Singapore. But, it is fair to say it is at its early stages. Open banking does not happen overnight. As noted above, it requires legislation around consumer data rights, as well as development of the technological frameworks for data sharing through application programming interfaces (APIs). In countries such as the UK, incumbent banks have been slow to open up their data, entry of new players takes time, and consumers often need time to become comfortable with having their financial data shared between institutions.

The central idea is that open banking encourages innovation in financial products and services, and makes it easier for consumers to shop around for financial products and services. All this tends to lower prices and therefore profitability.

In countries such as the UK, where open banking has been developing for a number of years, there has been innovation in financial services. However, some argue that opening the banking sector to more competition could have unintended consequences. It could actually lower competition if, for instance, a large tech firm decided to start offering financial services.2 This hasn’t happened yet in any of the countries that are opening up their banking sectors, so this is an hypothetical discussion. But some experts are concerned that large tech firms with their established business networks, strong brands, considerable financial resources, large customer bases, access to big data, cutting edge analytical skills, and advanced technologies could enter and come to dominate the financial sector. Just look at the dominance of the likes of Google, Microsoft, Apple and Amazon have in their existing sectors.

We like to think of the technology sectors as innovative and competitive — and they are to a large degree — but technology platforms have a predisposition to dominate because consumers prefer to interact with a limited number of platforms and technology often has the capacity to lock out competitors. For example, what if Google entered the financial services industry and started demoting it's competitors’ products and services in search results? Or Apple prevents other financial software providers from accessing the Smartphone interface?

None of this is a deal breaker. But, competition authorities such as the New Zealand Commerce Commission will need to stay on their toes and develop rules that prevent large, vertically-integrated platforms from gaining dominance and discriminating against product and service provision by third parties – preferably well before it happens.

1 https://www.stuff.co.nz/business/130365586/how-banks-make-so-much-money-while-households-and-businesses-struggle

2 Source: Borgogno, O. & Colangelo, G. Open banking and the ambiguous competitive effects of data portability, Competition Policy International, (November 2022)