ECON90015 Economics | The Financial Industry of Australia

• Internal rivalry and the market structure: Which market structure best describes the market (i.e. perfect competition, monopoly etc.)? Provide measures of industry concentration if you can. Do you have reasons to believe that the market structure is likely to change in the future? Is the struggle for market share and increased profitability reflected mainly in price competition or in non-price competition? If it is non-price competition, what form does it take?

 

• Threat of entry: Are there barriers to entry in your chosen industry? Consider how brand loyalty, economies of scale, intellectual-property law, and government regulation can each contribute to barriers to entry.

 

• Substitutes and complements: Are there important substitutes and complements (in consumption) that could affect industry profits? You can consider related products that are either currently available or might soon become available.

 

• Bargaining power of buyers: Is the input of your chosen industry bought by few large buyers with market power or a multitude of price-taking individual buyers with no market power? How does that affect profits? Have producers made relationship-specific investments with their buyers?

 

• Bargaining power of suppliers: Is the market for inputs in your chosen industry concentrated or competitive? Here, you can choose to consider the markets for labour, land, raw materials, and capital. How does the relative concentration in that market affect input costs, and how can input costs affect your chosen industry’s profits? Have the producers in your chosen industry made relationship-specific investments with their input suppliers (for example, moving their factory close to a supplier’s business)? Can the supplier exploit this situation and how would that affect profitability? Are there substitute inputs that producers in your chosen industry can turn to?

 

• Costs: What sort of cost structures do the firms in the industry face? Do the firms face any economies/diseconomies of scale, scope, and/or learning? How will these cost structures likely to affect the firms’ profit-maximising decisions?

 

• Technological change: Are there technological changes that are likely to affect profitability in your chosen industry?

 

• Government policy: Are there government policies that affect profitability via any of the factors above (e.g., raising barriers to entry) or in a different way?

 

• Price discrimination: To what degree are firms in your industry able to engage in price discrimination? What type of price discrimination is it? How important is price discrimination for firms’ profits?

 

Introduction

Australia is among the developed countries and has a very stable economy. It has been ranked among the top five richest countries in the region of Asia-Pacific. It has enjoyed more than a decade of economic prosperity and even during the great 2008 economic recession it posted a positive economic growth result though it was a decline (Karmel & Brunt, 2013). Australian economy is denominated by five major industries namely the Financial, Business Consulting, Metals and Mining, Energy and Utilities and Healthcare. The industry of choice is The Financial Industry.

The financial industry of Australia is dominated by four big major banks which include the National Australia Bank (NAB), Commonwealth Bank (CBA), Australia and New Zealand Banking Group (ANZ) and Westpac Banking Corporation (WBC). There are several other small banks and non-bank financial institutions but have a small market share in the financial industry.  The Global Finance has ranked all the big four major banks of Australia among the top thirty safest banks in the world. The financial industry of Australia has been its major contributor towards the national economic growth and still continues to be. It promises a bright future and the Australian Bureau of Statistics results predict its profitability to increase in future and hence contribute much towards improving the economic growth of Australia.

The Market Structure of the Financial Industry of Australia

The market structure generally refers to market characteristics which affect the nature of competition that exists between firms in an industry (Helpman & Krugman, 2015). The characteristics can be organizational or competitive in nature. Market structure is divided into four major types which include the monopoly, monopolistic competition, perfectly competitive and oligopoly markets. The financial industry of Australia basically faces the oligopolistic market structure which refers to a market structure involving only a few large firms controlling the entire market. The financial industry of Australia consists majorly of only four big banks with some other small banks and non-bank institutions. The four big banks have control over the entire financial sector occupying over eighty percent of market share. This means that the other small banks and non-bank financial institutions occupy less than twenty percent of the Australia financial industry market share. Estimates show that the total capitalization market of these four big banks is approximately five times the total market capitalization of the other small banks and non-bank financial institutions. Due to the fact that the financial industry of Australia is oligopolistic, much of price competition is not involved as the four major big banks determine the profit maximizing prices to raise their profits and reduce competition.

The Market Concentration and Collusion Behavior of the Australian Financial Industry

The dominance of the financial industry of Australia by the four big major banks with a market share of over eighty percent represents a relatively high level of concentration in the overall industry market. The four big banks almost offer homogenous products. As a result the four big banks in the industry have colluded together to form cartel like arrangements (Sathye, 2011). This is due to the fact that most of the main shareholders of the four big major banks in the financial industry are the same. This means that there interests are common among all the big four major banks. Due to this, the four big major banks have taken the advantage of setting up high prices to maximize their profits without any fear (Davis, 2009). A common agreement is made about the overall market price by all the four big major banks none of which should retaliate.  The four pillars policy which regulated the Australia’s financial industry by preventing the four major big banks from forming mergers hence maintaining competition has of late contributed much towards this cartel like collusion behavior of the four big major Australian banks since its now preventing competition. The four major big banks make their decisions irrespective of the other small banks and non-bank institutions since they rule the market and no loss can result to them as a result of any changes made by the small minute banks and the non-bank financial institutions.

Interdependence in the Industry

Due to the fact that the financial industry of Australia is oligopolistic, it means that the firms in the industry are interdependent on each other. The four major big banks depend on each other for various factors such as price and output determination (Otchere & Chan, 2013). The collusion cartel like behaviour of the four major big banks highly encourages the interdependence between the banks. They have to depend on each other to maximize their profits. Any action taken by one bank might adversely affect the other banks and hence immediate action for adjustment has to be taken by the other banks. However due to the cartel like collusion behavior of the four big dominant banks, they undertake actions together as one such as the interest rates with which to accept deposits and offer loans (Mazzeo, 2012). Policies made by the big four are all aimed at maximizing their profits and dominating the entire market. As a result the four big major banks of Australia have been making supernormal profits and the same trend is anticipated in future.

Entry into the Industry

Due to the collusion cartel like behavior in the Australian financial industry, it has been hard for new investors to join the industry. In fact, the financial industry of Australia is classified among the industries with highest entry barriers which are as a result of the market dominance by the four big major banks. The collusion behavior of the big four has almost eliminated competition in the industry (Worthington, 2012). As a result the banks can lower their interests as they wish to prevent new entrants into the industry. The government also supports these banks to a greater extent. In fact the four pillars policy which ensured competition persisted in the industry has been seen preventing further competition. Most of its regulatory policies highly favor the big four and as a result new entrants find it difficult to enter the market. The initial capital is also high and not affordable for most of investors to enter the industry. A competitor willing to enter the industry and compete with the big four requires very huge startup capital which may not be available for many investors in Australia.

Suppliers and buyers bargaining power in the industry

Due to the dominance of the Australian financial industry by the big four major banks, the suppliers have more bargaining power than the buyers in the industry. The collusion cartel like behavior of the big four major banks of Australia has increased the suppliers’ market power. They have joined together to tailor their interest rates to achieve and maintain maximum profits. Sometimes the big four major banks even set their lending rates higher than those set by the Reserve Bank of Australia particularly those of housing in order to maximize their profitability (Williams, 2009). This is an extortionary measure to consumers who have no other choice than to accept the set interest rates as they have no other banks offering favorable interest rates. In nutshell, the suppliers have more bargaining power than the buyers and hence they set interest rates which make them achieve maximum profits as they wish.

Elasticity of demand and supply in the industry

The financial industry of Australia faces an inelastic demand and supply. The change in the price of financial products in the industry does not affect the demand so much (Trubik & Smith, 2010). A good example is the increase in interest rates by the big four. Consumers have to cope up with the changes as the industry is oligopolistic in nature and consumers have no other option as they have no other alternative banks which offer favorable terms than the big four major banks. The supply is also inelastic as the big four major banks tend to accept deposits at lower interest rates and offer loans at higher interest rates in order to make more profits.

Conclusion

Australia is among the top five richest nations in the region of Asia-Pacific and has always posted a positive economic growth. Its financial industry is oligopolistic in nature as it is dominated by four big major banks with some other small banks and non-bank financial institutions. The financial industry has been the major contributor of the gross domestic product of Australia and it promises a bright future (Dawson & Patrickson, 2011). The big four offer homogeneous products with similar interest rates which are set high to maximize their shareholder’s profit. The industry has cartel like collusion behavior which arises due to the fact that the major shareholders of the big four banks are the same and have similar interests among the four major banks.

The collusion behavior of the big four major banks has prevented new entrants into the market due to their large size which enables them to enjoy the economies of scale and hence offer favorable price on their products which other firms cannot offer. Government support and high initial capital involved in entering the industry have also been major barriers to entry. In a nutshell, the financial industry of Australia contributes much towards its economic growth but regulations should be introduced in the industry to protect consumers.

References

Davis, K. (2009). Banking concentration, financial stability and public policy. The Structure and Resilience of the Financial System, ed. by C. Kent and J. Lawson.

Dawson, P., & Patrickson, M. (2011). Total quality management in the Australian banking industry. International Journal of Quality & Reliability Management, 8(5).

Helpman, E., & Krugman, P. R. (2015). Market structure and foreign trade: Increasing returns, imperfect competition, and the international economy. MIT press.

Karmel, P. H., & Brunt, M. (2013). The structure of the Australian economy. Melbourne.

Mazzeo, M. J. (2012). Product choice and oligopoly market structure. RAND Journal of Economics, 221-242.

Otchere, I., & Chan, J. (2013). Intra-industry effects of bank privatization: A clinical analysis of the privatization of the Commonwealth Bank of Australia. Journal of Banking & Finance, 27(5), 949-975.

Sathye, M. (2011). X-efficiency in Australian banking: An empirical investigation. Journal of Banking & Finance, 25(3), 613-630.

Trubik, E., & Smith, M. (2010). Developing a model of customer defection in the Australian banking industry. Managerial Auditing Journal, 15(5), 199-208.

Williams, B. (2009). Factors determining net interest margins in Australia: domestic and foreign banks. Financial Markets, Institutions & Instruments, 16(3), 145-165.

Worthington, A. C. (2012). Malmquist indices of productivity change in Australian financial services. Journal of international financial markets, institutions and money, 9(3), 303- 320.