The Best Banking Regulator? Competition

Australian banking is in a tough spot. The recent Commonwealth Bank scandal, involving a systemic breach of anti-money laundering laws, has exposed a culture of idleness and neglect in the sector.

Over a span of three years, Commonwealth, Australia’s largest bank, failed to report more than 53,000 transactions that may have allowed terrorists and criminals to launder millions of dollars. This could leave the bank exposed to billions of dollars in civil penalties. Commonwealth’s shareholders are rightly outraged, with stock price losses amounting to nearly $8 billion. A class-action lawsuit from many of the bank’s 800,000 shareholders is likely to follow.

With so much at stake, how could Commonwealth have been so careless?

The answer, as an editorial in The Australian aptly put it, is a complete lack of competition in the banking sector. Australia’s big banks can afford to be lazy because there aren’t enough vigorous challengers to keep them in check. If we want to make banks more responsive to shareholders and more attentive to customers, they need to face the same stiff competition that punishes companies in other sectors when they step out of line.

Unfortunately, this is the opposite of what we currently have. For decades, the Australian government has propped up the country’s largest banks through its “Four Pillars” policy. The policy maintains the separation of the four biggest banks—Commonwealth, ANZ, Westpac, and NAB—by making them immune from takeover. This includes protection from foreign competition and an array of subsidies and implied guarantees.

Ironically, conserving the dominance of the Big Four is justified as ensuring greater competition. Proponents claim that without government protection, the banking sector may become concentrated into one or two enormous banks. Yet there is no evidence that a freer market in banking would lead to more concentration. In fact, it is exactly this kind of protectionism that has led to a more concentrated system.

The Big Four make up around a quarter of Australia’s stock market, more than in any similar nation. Restricting competition has allowed them to capture the Australian market by regulatory default.

Instead of recognizing this, however, many have called for more government regulations as the answer to the banking sector’s ills. Yet, decades of government restrictions are the very reason banks have become less responsive to consumers and shareholders. A lack of competition is the problem, and more regulation isn’t the answer.

Take a look at other industries. Uber broke a taxi cartel that was devoid of innovation and customer service. Amazon’s recent announcement to enter the Australian retail and grocery market is set to shake up supermarket chains in a similar way. When consumers gain the ability to choose, businesses become more responsive to their wishes and behave accordingly. More competition works in other industries; why wouldn’t it work in the banking sector?

If we want to make banks more accountable, the government should remove all the subsidies and protections propping up the Big Four. Knowing that a taxpayer backstop isn’t there to protect them will force banks to focus more on ensuring safety and soundness.

If we want to make banks serve consumers better, we should force them to vigorously compete for customers. Without government protection, banks must focus on beating their competition with lower prices and better services.

If we want less concentration, the Four Pillars policy’s stated goal, the government should make it easier for new entrants to challenge powerful incumbents, not erect arbitrary barriers that protect the biggest banks.

With shareholders angry and the government looking to act, this is a potential watershed for Australian banking. We can either continue down the same path, maintaining protection for the largest banks while wondering why they aren’t more responsible. Or we can blaze a new trail, ensuring accountability to customers and shareholders by letting consumers vote with their wallets.

We have tried more government regulation and it hasn’t worked. It’s time to let competition discipline bad banks.

Originally posted to Spectator Australia.