Magazine article IPA Review

Whose Business Is It?

Magazine article IPA Review

Whose Business Is It?

Article excerpt

THE broad conclusion to emerge from the Prices Surveillance Authority's (PSA) analysis of Australian banks is that the current structure of financial institution fees and charges is inefficient. Evidence presented at the inquiry showed that about 90 per cent of a bank's fee revenue comes from the account-keeping fee, with account-keeping costs comprising only 26 per cent of total costs. Transaction-fee revenue, on the other hand, makes up 10 per cent of fee revenue and 74 per cent of total costs. The inquiry concluded that "...financial institutions are not setting relative price signals consistent with the cost of services ..." According to the PSA, banks are using the wrong cost-driver (account-keeping costs, instead of transaction costs). Is it possible that the PSA understands the underlying costs facing banks better than he banks themselves, or is the PSA missing something?

INCENTIVE: The banks have a considerable incentive to charge fees that accurately reflect the costs they face. If they don't, they lose profits and customers. If what the FSA says is true, why haven't the banks altered their pricing structures accordingly?

The PSA claims that low-transaction customers are being overcharged to fund the transactions of other customers. While it is obvious that overcharging is undesirable for customers, it is also undesirable for banks as it encourages customers to shift their money to a competitor that does not overcharge. Banks also need to avoid undercharging customers. Undercharging attracts customers who cost more than they earn for the bank.

If the PSA is right, banks could increase their profits if they reduced account-keeping fees and increased transaction fees. Customers with a high volume of transactions would then pay higher fees. These customers would then economize on transactions and, if the increase in price is significant enough to warrant the effort, shift their custom to a lower-priced competitor. If the competitor has the same 'inefficient' cost structure as the customers' original bank, it would find that it also needed to reassess its pricing structure. This is because it would be attracting new high-transaction customers, while its low-transaction customers, paying high account-keeping fees, would be leaving. This 'domino effect' would continue until all banks in the industry were charging fees that accurately reflected their costs.

The likely reason as to why this chain of events hasn't happened is that banks are already charging fees that accurately reflect the economic costs of providing services to their clients. Economic costs take into account not only accounting costs, like those analysed by the PSA, but also opportunity costs.

Transactions generate revenue for banks in forms other than transaction fees. When you deposit a cheque in your account, you cannot draw on it straight away. Generally it takes five to seven days for the funds to 'clear'. This means that the bank can profit from lending or investing your money for almost a week. On the ocher hand, maintaining an account for you which has only a small balance does not give the bank the opportunity to earn revenue from your funds. Thus the bank needs to recover the full cost of maintaining that account. If this cost is not recovered, the bank makes a loss providing this service to you.

The PSA intends to monitor banks over the next three years in their fee restructuring, since the PSA questions, for example, the charging of account . …

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