The benefits of competition in financial services+continuing innovation – FEB 2022

1. What are the benefits of continuing competition in the financial services sector?

2. How is future competition assisted through continuing innovation in product offerings and productivity?

3. How does the past guide the future in delivering financial services?

In summary, competition is the most important ingredient for good capitalism to flourish and financial services is at the heart of any good capitalist system of commerce. Moreover, in an ever-increasing digital age, innovation in product offerings is the key to growth in market share and client retention for financial services market participants, as is reduced labour costs through productivity gains important for revenue growth and sustained profitability.

Having a level playing field among all competitors in financial services, both new and old, who ALL must be regulated, is highly important and necessary to preserve confidence in our finance sector.

From the consumers (or clients) viewpoint, increased competition can only be good. More competition breeds more initiative, breeds cutting edge technology, breeds better service and breeds a better value proposition.

History is always instructive and so it is useful to look at the history of the Australian financial services sector over the past 50 years and examine how it has grown and developed in that time from an “innovation and competition viewpoint.”

Forty-six years ago, when I started my financial services career, the Australian financial services sector (although it was not known by that name until about 1990) was made up of approximately 10 large banks, about 50 building societies of varying sizes and approximately 400 credit unions also of varying sizes and 30 or so finance companies. The largest finance companies were wholly owned by banks.

Cash was king, bank issued “bankcards,” launched in 1974 were poorly accepted by bank customers who saw them as the equivalent of todays “pay day lenders” and banks alone controlled the payments system for cash and cheques. Electronic Funds Transfer (EFT) was not even a twinkle in anyone’s eye. Electronic Data Processing (EDP) the forerunner to Information Technology (IT) was only just beginning to make inroads into banking systems and processes.

Fifty years ago, banks were essentially the sole provider of business loans as well as most home loans and banks provided both at call and term deposit savings products to mum and dad investors. Building Societies, as the name implies, provided basic home loan and savings products, while credit unions essentially provided what were termed “thrift” savings and personal loan products.

Finance companies provided small business loans to businesses that were rejected by the banks and personal loan borrowers who had less than a perfect credit history as well as young kids who wanted a loan to buy their first car, with the loan often guaranteed by mum and dad.

That was the state of play in 1976 and indeed the way it was, for 50 years before that! Over the ensuing 45 years the financial services landscape has changed dramatically. Banks merged and this ultimately created the prevailing “four pillars” banking policy. Building Societies are now all but extinct. Credit Unions have merged, and there are seemingly only a handful left. Many of those that are left have become mutual banks.

Finance companies have been replaced by credit cards and “pay later” products. Many business borrowers now look to non-bank mortgage funds as a good source of mortgage finance for SME borrowings and for construction and development loans. Moreover, fintech lenders are now a huge source of loan funds for unsecured business lending.

Fund Managers, as a collective, are now a multi-trillion-dollar sector as is the superannuation fund sector. Non-bank lenders now account for nearly 18% of the home loan market. Cash is no longer king with less than 15% of all “value transactions” made by cash and falling rapidly. ATM’s spitting out cash, are fast becoming dinosaurs.

EFT and POS options are now the main ways we purchase goods and services. Banks are closing branches at the rate of knots and we are all being coerced (or forced) to use on-line banking options and/or digital wallets and mobile phones to conduct all our “banking.” Face-to-face banking as we knew it, is all but dead.

Bitcoin is now a part of our everyday lexicon, which at one level is a good thing but at another level it does need, in my view, better regulatory oversight to protect investor funds. To this end, the Reserve Bank of Australia, (RBA) announced late last year that it would set up a Central Bank Digital Currency (CBDC) to provide better protection for those seeking to invest in Bitcoin products.

The issue however with a CBDC is that an electronic version of Australian dollar cash would need to be issued by the RBA. That would mean that Bitcoin investors in the CBDC would bypass our trading banks, if they could hold digital cash in an account directly with the RBA. This could reduce the capacity of commercial banks to lend money to support the economy.

If too many individuals were able to hold digital Australian cash with the RBA, you could find a situation, in which large parts of the financial system get bypassed and that could have some very big structural implications for the financial services sector.

Separately, big tech players such as Apple and Facebook have increased their dominance over digital payments with the ACCC vowing to crack down on fintech’s and the incursion of Apple, Facebook and Google into financial services without being regulated like banks and other financial institutions.

Financial Institutions now steer customers to their apps to use their products. Finally, call centres including offshore call centres using “cheap labour” are now part of everyday banking. How the world of banking and finance has changed in 50 years! So, what is the future, particularly in relation to increased competition and innovation?

Firstly, we must level the playing field. To that end, the Federal Government is planning to legislate new powers in 2022 to designate platforms such as “Apple Pay” as official payment systems. That would ensure that the US tech giant is held to the same rules as Australian banks. The ACCC has obtained documents and conducted interviews in its investigation into Apple Pay. It is also examining banking, payment and technology issues as it becomes more deeply involved in regulating financial services.

The issue here is that you have banks setting up digital platforms either to work with fintech’s or to funnel everything through their own portals and the banks are all jockeying for position to have everything through their bank, so that the bank owns the customer. On the flip side, you have Apple, Google, and Facebook all trying to get a bigger foothold in the finance sector without being regulated!

We are now essentially a cashless society and we have buy-now, pay later products, people getting involved in cryptocurrency, plus all sorts of fintech’s developing, and so we need to make sure this all works in a pro-competitive fashion otherwise there will be major issues developing sooner than later which will be a potential disaster.

The more that we are cashless and the more people are using their phones to make payments, then the more we must think about how we can get more competition and more innovation.

Banks such as the CBA and many others, have been complaining they cannot configure their digital wallets in the way they want to, to provide all the services they want, to their consumers unless they can get access to Apple’s “near-field communication.”

The ACCC is currently examining the design of iPhones that restricts payment cards, including those of the banks, from making ‘‘tap and go’’ payments unless they are stored in Apple’s digital wallet.

Apple, which operates outside the existing payments regulations, charges the banks a few cents for every $100 of transactions. The fees are not disclosed but could be approaching $100 million a year and will only grow as smart-phone payments become the norm. For its part, Apple insists only its ‘‘digital wallet’’ can access the iPhone’s near-field communication (NFC) chip.

In my view that prohibition by Apple is a substantial lessening of competition by excluding others using its exclusionary behaviour. If you want to have a digital wallet on an Apple device – using the CBA for example – but there are many others – you have to route all the payments through Apple Pay and that means your digital wallet is limited in what it can do and Apple won’t give you direct access to their “near-field communication.’’

In my view, the ACC needs to keep up its competition crusade against the tech giants, and have the Federal Government establish ‘‘up-front rules’’ for digital platforms. If we don’t, then we will have two or three companies controlling innovation and therefore those same two or three companies controlling the internet. That’s not good for competition.

So instead of chasing anticompetitive behaviour, this process would set up “dos and don’ts” rules, which is largely about self-preferencing behaviour. There is self- preferencing in terms of Google and Apple apps. If you want to have an app, it’s got to be on Google Play store or Apple app store. That just does not work.

Assuming the financial services playing field can be levelled, which it must and will be, in I hope, the next 18 months, then I expect that the future of competition and innovation and productivity will look something like this.

We will slowly move towards a more US style system of financial services where there will be many more niche specialist nimble players – competing alongside the big banks
– all regulated by either or both APRA or ASIC and under the watchful eye of the ACCC.

These specialist players will continually want to innovate in terms of product offerings and productivity to always be competitive and therefore relevant in the Australian world of financial services.

These specialist niche players will include – in no particular order –

Lending

Investments

Systems and processes

Future innovations in financial services in terms of product offerings will be concentrated on the acceleration of technology, including Artificial Intelligence (AI) so as to provide clients and customers with continual real-time cutting-edge solutions to their complex financial needs.

While new products will always be developed, albeit in my view, at a slower pace, the future of financial services will be more about delivery existing products (that is -financial solutions) even more quickly, efficiently, transparently and cost effectively, all in a paperless worldwide system on a 24/7 basis.

Client communications will be significantly automated using various apps, programs and devices. Big data will enable financial service providers to specifically target individual client’s, product needs and algorithms will hone in on individual client’s historical financial product usage and performance and by reference future potential financial product needs.

Physical contact will become a rare event and phone contact even less, but still available, but as the last line of contact options. These processes will provide huge productivity gains for financial institutions, who will concentrate on higher value clients and transactions. At the same time providing streamline cost effective processes for “sausage factory” day to day low value transactions.

The new financial services world is somewhat daunting but inevitable, as consumers continue with their insatiable appetite for tech savvy solutions and ease of convenience for everything in their life including money!

John (JT) Thomas

This opinion piece is provided by John (JT) Thomas, a 46-year veteran of the financial services industry and since 1987 a specialist in commercial mortgage funds. Considered by many to be the father of the modern commercial mortgage fund sector, JT helped establish and then managed – for 17 years – what became the largest and most successful commercial mortgage fund in Australia – The Howard Mortgage Trust – with assets exceeding $3 billion. Under JT’s stewardship, investors never lost one cent of their investments and indeed, investors always received competitive monthly returns. JT was also Chair of the $40 billion mortgage trust industry sector working group.

JT has been proudly involved with Princeton for eight years and sits on both the Princeton Credit Committee and the Princeton Compliance Committee as well as being an advisor to the Princeton Board.