The dominance of the four major banks and their pricing power
Oligopoly in the banking industry is not an unusual phenomenon. The involving characteristics of banking industry such as economies of scale and small retail margin of banks. Banking industry in Australia has become increasingly concentrated with four major banks dominating the industry. It has been determined by the Australian Government that the four major banks have a significant pricing power. In case of an oligopoly market where only few firms compete. The “Big four banks” of Australia which have the largest share of the market are National Australia Bank, Westpac, Commonwealth Bank and Australia and New Zealand Banking Group(Andrievskaya and Semenova, 2016.).
These four banks dominate the banking industry. However, Australia has a very profitable and competitive financial sector. The four financial sectors in order to increase their profits can set any prices without the fear of loosing the market share. These four famous banks of Australia form a cartel arrangement in a way that the shareholders tries to maximize profits acting as a monopoly market structure. The cartel formation therefore acts as a barrier to entry for the new entrants in the banking industry of Australia.
These banks have a higher interest margins which makes them even more profitable. The banking sector of Australia is oligopolistic in way that they maintain their position in the market with the help of opaque pricing. In case of an oligopoly market the firms usually depend upon each other while deciding the price(Salim, Arjomandi and Seufert, 2016). The banking sector in Australia is therefore oligopoly. The four major banks of Australia comprises of eighty five percent of the banking industry. Due to the oligopolistic market in the banking sectors of Australia, it is very difficult for any new entrant to compete with the “big four”.
There is also a presence of market concentration within the four banks. According to a recent research the biggest four banks of Australia will make a profit of around A$6.2 billion over the next four years. As a result of the rise in market concentration in the banking industry of Australia , there has been decrease in the market competition which lead to increase in inefficiencies. As a result of these the banks acts as a monopoly and charges a similar interest rates thereby decreasing market competition(Andrievskaya and Semenova, 2016).
The government also supported the oligopoly market of the banking sector in Australia where the finance minister claimed to support oligopoly in the banking industry. High level of concentration in the market also reported to have higher prices along with decrease in the competitiveness in the market. As a result of this the customers used to have blind faith in these banks and therefore, it also resulted to huge profitability. In the year 2010, the banks of Australia had also increased its lending rates in case of housing loans. Oligopolistic markets tends to set up high barriers for entry and also depends on how the other firms in the market depends.
The presence of a cartel arrangement and the challenges faced by new entrants
The Australian banking sector therefore has the similar characteristics. According to the Australian Banking and financial report, the financial institutions of Australia has both cost and scale advantages along with investment advantage. The banking industry of Australia had a highly concentrated Herfindahl Hirschman Index. As a result of the acquisition taken place by Westpac and the Commonwealth Bank of Australia, there had been increase in the market concentration over the years. As a result of market concentration there has been rise in the profitability(Turner and Nugent 2015). The market leaders are therefore able to manipulate the market. The shareholders of the ‘big four” are similar though the “ big four” are the different entities altogether.
However, there had been a lot of reform in the banking sector of Australia. As a result of rise in the con centration in the market, there had been a lot of reports of the economic inefficiencies. There had been also a result of increase in the consumer surplus due to the monopolistic behavior of the banks. The four pillar policies were made by the Australian government in order to avoid the mergers of the four major Australian banks. The policies had also been criticized for not been competitive. The banks of Australia had therefore adopted the four pillar policies to avoid acquisitions. Along with adopting the policies the banks also had monopolistic nature which lead to the rise in deadweight loss which the society actually suffers.
The banking industry structure of Australia therefore acts similar to an oligopoly market. With the help of concentration ratio and the Herfindahl Hirschman Index the competition within an industry can be measured(Salim, Arjomandi and Seufert 2016). The banking sector market of Australia is dominated by the only four banks out of fifty four banks. In the fiscal year of 2017 it had earned a profit of A$31.5 billion. As a result of highly concentrated market, the performance of the banks are also affected. However the dominating firms enjoy higher profitability as they can implement prices and charges according to their will.
The big four banks of Australia therefore seemed to have an oligopolistic market. It also has a high market concentration along with high HHI index. High concentration in market has led to low market efficiencies(Andrievskaya and Semenova2016). Therefore, in order to increase the market efficiencies there is a need of regulation for the banks. However, the regulation of the large banks will not be possible by the domestic banks as they will not be able to compete with the large banks. However, the entry of global banks in the Australian banking sector is recommended which can very well lower the concentration in market. Therefore, in order to conclude it can be stated that the banking sector of Australia has both oligopoly and monopolistic competition.
The impact of market concentration on competition and efficiency
TASK 2
- Classical economics – it originated in the late eighteenth century which refers to the dominant school of thought for economics whose originator was the economist Adam Smith.
- Keynesian economics – Keynesian economics was founded by John Maynard Keynes after Great Depression is an economic theory of total spending and its effects on output.
- Supply side economics- this is a theory of macroeconomics which states that economic growth can be achieved with the help of tax cuts.
QUESTION 2
- Mortgages and interest rates- the longer the time taken to pay the mortgage, the buying cost of the houses become higher because interest is need to be paid for the longer period of time( Hasan 2013).
- Insurance premiums for motor vehicles- it is also known as automotive insurance where the insurer assumes that any loss may incur through the result of accident.
QUESTION 3
Capital adequacy requirement is considered as the amount of capital that the banks or other financial institutions have to hold as per the requirement by the financial regulators. This capital adequacy requirement is expressed in the form of capital adequacy ratio of equity and the banks or other financial institutions are required to hold this ratio as a percentage of the risk-weighted assets (Fatima 2014).
QUESTION 4
The Capital Asset Pricing Model is considered as a financial model that helps in describing the relationship between systematic risk and expected returns for the assets or particular stock. The wide application of capital asset pricing model can be seen throughout the finance process in order o price the risky securities, to generate expected returns for the assets and to calculate the costs of capital (Ross 2013).
QUESTION 5
Some of the major reasons for property revaluation are to gain understanding about the difference between value and price; to gain effective guideline for the investment decisions; to get the correct market value of the property at the time of selling or buying; to obtain the legal documents about the property; to know the extent of tax deduction and others (Beaglehole 2015).
QUESTION 6
The main use of Compound Interest can be seen for the calculation of interest on the initial principles along with the accumulated interest of previous period. The main use of Net Present Value can be seen in analyzing the profitability of a particular project. Internal Rate of Return is used for the estimation of the profitability aspect of a potential investment (Rossi 2015).
QUESTION 7
Banks provides their customers with different kinds of products, Six of them are Savings Account that is used to save money; Current Account that is used by businesses; Debit Cards that are used for money withdrawal; Credit Cards that is used for various shopping and other payments; Loans and Mortgages (Chocho?ákováet al. 2015).
QUESTION 8
Banks are governed by government regulations along with certain requirements like Basel I, Basel II and Basel III. The banks are needed to consider the monetary policy of the countries along with the basic banking standards. However, the insurance companies are regulated by statutory law, administrative regulations and jurisprudence as these regulate the insurance industry (Baltenspergeret al. 2014).
QUESTION 9
In case of studying property markets various statistical data are used. Using the various statistical techniques property markets can be learnt. Property markets are also known as the real estate. One statistical technique used in the property market is regression, for example stepwise regression model and correlation can also be used.
The government’s support for oligopoly in the banking sector
4.3 Activity
QUESTION 1
- Banking industry- the knowledge of the principles of economics are applied to the different financial industries. There are many functions of money in the economy
- Insurance industry- this industry acts as a mediator between policy maker and capital market. Application of capital asset pricing model is used.
QUESTION 2
Decision making is one of the key factors of managerial economics. The different economic aspects also help the managers in taking different economic decisions. It is also a process in which the business makes decision.
QUESTION 3
- a) In the finance industry, one major way to evaluate the wok performance is the analysis of the performance metrics. Some of the crucial performance metrics are revenue per employee, attendance, turnover, efficiency and others.
(b) The required feedback of the performance can be gained through different appraisal programs, employee survey and personal view point of other employees.
QUESTION 4
Different types of taxation, interest rates, money supply and the budget of the government are the different forms of government policies (Guttmann and Rodgers 2015). Monetary policies and the fiscal policies are the two types of economic policy. This kind of policy usually influences the behaviour of the economy. Economic principles on the other hand helps in solving the problems related to business.
QUESTION 5
Positive economics is that branch of economics which is concerned with the representation of the economic phenomena. Unlike normative economics it is concerned with the development of statements that are positive.it also includes th4e testing of the theories of economics. Positive economics also answers “what is” when a certain coursed of action is to be taken.
QUESTON 6
- Principles of microeconomics – this usually refers to the fundamentals of microeconomics. This branch of economics shows how an individual maximizes its utility.
- Principles of macroeconomics- the study of the economic issues which affects the entire nation or economy such as inflation, unemployment rate and interest rates is defined as macroeconomics.
QUESTION 7
NPV is considered as the difference between the present value of cash inflow and the present value of cash outflow for a certain period. NPV can be described as the sum of all discounted future cash flows (Hasan 2013).
The calculation of NPV is done by the calculation of the costs as well as benefits for each period of time of the investment.
QUESTION 8
IRR can be considered as a metric and its use can be seen in capital budgeting for estimating the profitability of potential investments. IRR is a rate of discount and it makes the net present value of a particular project’s all cash flow equal to zero (Andor, Mohanty and Toth 2015).
QUESTION 9
According to the principle of Cost and Benefits analysis, the cost of particular financial information in the financial statement must not offset the benefit of that information to the users of financial information. In other words, this aspect implies that the financial information is not free. Thus, the principle of cost and benefit is considered as a common sense of rule (Nas 2016).
QUESTION 10
The circular flow of income states the ways by which money flows to the economy. It is defined by the flow of money, goods and services which runs in the opposite direction in a closed circuit. The flow of money is between the consumers and the producers or between the firms and the households.
QUESTION 11
Modern Capitalism is considered as an economic system that is based on the private ownership of the production, distribution and exchange means. On the other hand, it can be said that modern capitalism can be regarded as privately owned production mean economic system where the products are produced for the purpose of maximizing the profit (Sombart 2017).
QUESTION 12
- Intrinsic theory of value – it is also known as fundamental value which relates to the value of goods, company, stock or services.
- Labour theory of value – according to this theory the economic value of a commodity depends upon the amount of labour required to produce it.
References
Andor, G., Mohanty, S.K. and Toth, T., 2015. Capital budgeting practices: A survey of Central and Eastern European firms. Emerging Markets Review, 23, pp.148-172.
Andrievskaya, I. and Semenova, M., 2016. Does banking system transparency enhance bank competition? Cross-country evidence. Journal of Financial Stability, 23, pp.33-50.
Baltensperger, E., Buomberger, P., Iuppa, A.A., Keller, B. and Wicki, A., 2014. Regulation and intervention in the insurance industry-fundamental issues. The Geneva Reports, 1(1), pp.1-63.
Beaglehole, E., 2015. Property: A study in social psychology. Psychology Press.
Chocho?áková, A., Gab?ová, L., Belás, J. and Sipko, J., 2015. Bank customers’ satisfaction, customers’ loyalty and additional purchases of banking products and services. A case study from the Czech Republic. Economics and Sociology.
Fatima, N., 2014. Capital Adequacy: A Financial Soundness Indicator for Banks. Global Journal of Finance and Management, 6(8), pp.771-776.
Guttmann, R. and Rodgers, D., 2015. International banking and liquidity risk transmission: Evidence from Australia. IMF Economic Review, 63(3), pp.411-425.
Hasan, M., 2013. Capital budgeting techniques used by small manufacturing companies. Journal of Service Science and Management, 6(01), p.38.
Joshi, M., Cahill, D., Sidhu, J. and Kansal, M., 2013. Intellectual capital and financial performance: an evaluation of the Australian financial sector. Journal of intellectual capital, 14(2), pp.264-285.
Nas, T.F., 2016. Cost-benefit analysis: Theory and application. Lexington Books.
Ross, S.A., 2013. The arbitrage theory of capital asset pricing. In HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING: Part I (pp. 11-30).
Rossi, M., 2015. The use of capital budgeting techniques: an outlook from Italy. International Journal of Management Practice, 8(1), pp.43-56.
Salim, R., Arjomandi, A. and Seufert, J.H., 2016. Does corporate governance affect Australian banks’ performance?.Journal of International Financial Markets, Institutions and Money, 43, pp.113-125.
Sombart, W., 2017. The Jews and modern capitalism. Routledge.
Turner, G. and Nugent, J., 2015. International linkages of the Australian banking system: Implications for financial stability. JASSA, (3), p.34.
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