The big four banks maintain that competition in SME banking is intense and there is no need to interfere with the current market structure. On the other hand, SMEs, their representative bodies, politicians and even the Reserve Bank of Australia are calling for greater competition.
This is one of the most challenging issues faced by the Financial System Inquiry, which has been charged by the federal government with developing a blueprint for Australia’s financial system and the financial services industry.
Whenever there are four strong suppliers in any market it would be reasonable to expect a healthy level of competition and whilst this is certainly the case in some areas of banking – notably home loans, wealth management and deposits – the same cannot be said for SME banking.
Whilst we do have four strong competitors operating in the SME segment, we do not necessarily have strong competition. The RBA in its submission to the inquiry emphasized that “the market for small business loans rather than home mortgages should be the focus of inquiries” noting that “this market has more structural impediments to competition than most”.
SME banking is certainly different in several aspects that inhibit genuine competition. These include:
Most SMEs don’t understand or trust their bank and they tend see the big four as very much the same in terms of their products, service, terms and conditions, credit policies, etc.
Accordingly they are sceptical whether changing from one bank to another will make any material difference to their business. This manifests itself in a “better the devil you know” philosophy.
And despite what politicians say about “taking your business down the road to another bank” this remains a problematic and often a last resort action.
It’s hard for the big four to achieve permanent and profitable brand differentiation
SMEs have a point: it is difficult to distinguish between the SME banking propositions of the big four, and with good reason. Technology can be copied or developed and talent is mobile, as demonstrated by the number of bankers who swap teams these days.
Bankers move frequently and with continued resizing and restructuring it is nigh on impossible for any bank to differentiate itself on the basis of its people and culture.
Further, price is rarely a sustainable differentiator because no bank can afford to always be the cheapest. The markets reward earnings not market share.
Barriers to entry are high
SME banking is arguably the most expensive platform on a cost-to-income basis and it is where banks really suffer from bad debts. The financial barriers to entry are huge and include the amount of capital required, IT, staff, compliance, premises, etc.
The big four have a significant advantage over smaller competitors in fund raising. Smaller banks have to pay more for their funds, whether it is from term deposits or the capital markets. Then there is the “too big to fail” view that whilst the government might allow a smaller SME lender to fail, it couldn’t allow one of the big four to fail.
Each of the big four has invested vast amounts of capital over many years to reach the stage where they have sufficient numbers of SME customers to enable them to generate solid returns on investments. But these returns, and the time and cost required to achieve and maintain them, are not so attractive as to make taking on the big four a compelling proposition for new direct competitors.
Australian experience with the food and automotive sectors suggests we are keen to support the underdog but are reluctant to pay a premium to do so. This also seems to apply in banking.
Many SMEs are open to switching to the independent second-tier banks, but when they realise they may not save money on products and services that may not be as extensive or sophisticated as those provided by the big four, they understandably find it difficult to justify switching.
Whilst politicians and other stakeholders argue that there needs to be greater competition in SME banking, it is politically difficult to justify and implement changes that disrupt the current balance of power.
Governments are notoriously wary about being seen to be making decisions that favour one section of an industry over another. Further, the big four are powerful organisations with deep pockets, collectively spending over $1 billion a year on advertising, much of which is directed at the SME sector.
On the other hand, SMEs whilst numerically significant are fragmented and their representative bodies lack the financial and organisational firepower to match the banks.
Following the global financial crisis there has been much discussion on the need for greater competition in SME banking, but during this period the dominance of the big four has only increased. The “why” this has happened is the easy question, the “what can be done about it?” is much more difficult.
All stakeholders, but especially SMEs, will await the findings of the Financial System Inquiry with anticipation and hope.
Neil Slonim is an independent business banking advisor and commentator. He is the founder of TheBankDoctor an online resource centre designed to help SMEs understand, quantify and mitigate their bank risk.