Australian Banking Oligopoly Analysis

This assignment provides an in-depth analysis of the Australian banking sector's oligopoly market, with a focus on the big four banks' dominance. It discusses how this has created barriers for small banks to survive and has led to poor performance in the financial sector. The researchers suggest strategies such as non-collusive oligopoly and open banking systems to promote competition and improve customer satisfaction.

ECO511 - Economics for Business
Assignment 4: Essay Question
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Table of Contents
Introduction......................................................................................................................................2
Analysis...........................................................................................................................................3
Theory of non-collusive oligopoly..............................................................................................3
Issues faced in Australian banking sector........................................................................................3
Evidences related to Australian banking sector...............................................................................4
Evaluation of the situation based on theory.....................................................................................5
Conclusion.......................................................................................................................................7
References........................................................................................................................................8
List of figure:
Figure 1: Non-collusive Oligopoly Market (Kinked Demand Curve).............................................6
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Introduction
The studies have indicated the fact that the four major banks ANZ Bank, Westpac, National
Australia Bank and Commonwealth Bank of Australia are assumed to control around 75% of the
market share. In fact, the banks are also expected to experience lower funding costs as compared
to small rivals (Bakir, 2019). It has also been pointed out that financial technology professionals
have not been mature enough to deal with the issue of competition among the large and small
banks. The power of each of the larger banks needs to be reviewed in order to take control of the
competitive scenario. The situation can be evaluated on the basis of the non-collusive oligopoly
theory and evidence about the situation would be gathered from various media reports (Apergis
& Cooray, 2015). The aim of the research is to suggest a suitable strategy so that the Australian
banks are able to operate as independent entities and they are able to serve large number of
customers. The research also has the scope to relate the theory with that of the scenario so that
the performance of each of the banks can be measured despite the competition.
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Analysis
Theory of non-collusive oligopoly
Selmier (2016) has indicated the fact that one of the most significant features of oligopoly
market is that of price rigidity and so in order to explain this phenomenon kinked demand curve
is used. The concept of kinked demand curve arises as a result of the unconventional behaviour
of the sellers. The situation is that if the seller raises the price of a particular product then the
rival is not expected to follow the seller (Selmier, 2016). On the other hand, Bakir, (2019) argued
that if a particular firm reduces the price of the product then the other firm is likely to follow that
firm. It can be stated that every price level is expected to be matched by an equivalent price
level. As a result, the demand curve is assumed to be kinked. It can be stated that the non-
collusive oligopoly involves entry barriers for the new firms within the market (Bakir, 2019).
Additionally, the firms also choose product banding and differentiation so that they are able to
ensure high customer satisfaction. However, it can be stated that the rival firms are
interdependent on each other while taking important decisions regarding the setting of prices
within the economy (Selmier, 2016). (Taylor & Tyers, 2017) stated that it is expected that the
firms would formulate their own strategies and the rival firms would react to these strategies
appropriately. There would be no collusion among the firms participating in the competition.
Issues faced in the Australian banking sector
The big four Australian banks are expected to dominate over time as they own combined assets
worth $3.6 trillion which is twice the value of economic output of Australia (Financial Times,
2019). Around 80% of the mortgage borrowers are likely to have borrowed from one of the big
four banks and they have also made the financial sector of Australia to be more concentrated
(Financial Times, 2019). Some of the analysts have been pointing out the credit crunch that is
likely to reduce the level of economic growth within Australia and the country might experience
recession (Taylor & Tyers, 2017). The Australian banks are assumed to experience bad debt with
falling house prices in different parts of Australia. The banks may not be able to recover the full
volume of the loans even by selling the homes of the borrowers who have defaulted. The studies
have also indicated that Australian government has encouraged the other banks to challenge the
situation of oligopoly in Australian banking sector after it has been pointed out by the top
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economic advisor that the market dominance of the big four lenders has been harmful to the
customers (Financial Times, 2019).
The researchers have pointed out the fact that the big four commercial banks have been
constantly exploiting the power they over more than three-quarters of the country’s lending
capacity. The credit card business of the banks has been providing its customers with inferior
products as per the government report that has been released by Productivity Commission. The
banking sector is assumed to experience intense scrutiny by the Royal Commission regarding the
illegal activities that they have been practising overtime (Xu, Gan & Hu, 2015). The big four
banks have the tendency to pass on higher cost towards the customers and also dictate the prices
of the products as per their market power. Additionally, it has also been indicted by the analysts
that the banks have been well-placed so that they are able to offer different products to the
customers at competitive prices (Financial Times, 2019). The lower funding cost, scope and size
have boosted their share so that they are able to gain adequate access to the offshore funding
rates (Xu, Gan & Hu, 2015). The non-bank institutions and the micro-lenders are forced to
follow the prices that are set by the big four banks and there is less competitive threat posed by
the small banks. The increased dominance of the big four banks have forced the small banks to
merge and the banking licenses have plunged during the increase in demand.
Evidence related to the Australian banking sector
Evidences have indicated the fact that the credit rating agencies might play a key role in
increasing the dominance of the Australian banks indicating the possibility of government
bailouts. The studies have indicated that the government is working in this field so as to enable
more market entrants after easing the restrictions on foreign banks (Financial Times, 2019). The
analysts have stated that the big four banks in Australia take customers for granted and charge
high prices for the products. Market competition is also likely to have reduced the power of the
small banks and they were unable to carry out their business appropriately. The customers were
also charged with some of the fees that were never provided to them (Reuters, 2018). The
evidence has been gathered from authentic sources related to the Australian banking sector
which states that the big four banks have been exploiting the customer's overtime by charging
high prices for the products and deviating from the quality of services that are supposed to be
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provided. Critics have also highlighted that the four pillar policy involves government guarantee
to the big four banks regarding the reduction in cost of funding and also control the entry of
small banks within the economy.
Evaluation of the situation based on theory
The study has indicated the fact that big four banks have formed an oligopoly market structure
within the Australian banking sector which is posing a problem to the local customers. The
market dominance of the big four financial institutions needs to be controlled so that overall
performance of the banking sector can be improved (Financial Times, 2019). There are a series
of initiatives that the small banks need to adopt so as to sustain within the Australian banking
sector despite the healthy competition posed by the big four banks.
For instance, it can be assumed that the prevailing price of the oligopoly product within the
market is OP or QE. In case if one of the big four banks raises the price of the product above OP
then the small banks must not react to the change in price. As a result of the high price charged
by the bank, the customers would automatically deviate to the other products that are offered at
low rates. As a result, the sale of a big bank would reduce considerably (Bakir, 2019). The
demand curve dE is found to be price elastic. On the contrary, if the big bank reduces the price of
the product below QE, then the small banks are expected to reduce the price of the banking
products further. It can be indicated that the demand curve ED is inelastic. By reducing the price
of the banking products, the small banks would be in a profitable position with the increase in
number of customer base. It can further be stated that at an output lower than OQ, the MR curve
dA is likely to be corresponding to dE part of the AR curve. Moreover, if the output is found to
be larger than OQ, then the MR curve BMR would be corresponding to the AR curve ED. It can
be observed that there is a slight discontinuity between the points A and B. It can be inferred that
MR curve is believed to be verticle between these points (Bakir, 2019). The studies depict the
fact that equilibrium can be attained when the MC curve passes through the discontinuous region
of the MR curve. Hence, OQ amount of equilibrium products would be offered at OP price. As
far as the cost is concerned MC curve would shift from MC1 to MC2. The resulting price and the
level of output would remain unchanged. This also indicates the stickiness of the prices as the
oligopoly markets are more stable as compared to the level of cost. This can be an effective way
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Output
Price and Cost
E
D
d
A
B
P
O Q MR
MC2
MC1
in which the small banks can survive in the Australian banking sector and the customers would
also have the scope to purchase the products at lower prices.
Figure 1: Non-collusive Oligopoly Market (Kinked Demand Curve)
(Source: Author’s Creation)
The small banks would be able to set up their business successfully in Australia in case if the
government develops the open banking system where the banks need to share their products and
customer information with the customers and also the third parties. This kind of information
sharing is assumed to raise price transparency and also help to decide the price of the product
based on the behaviour of the consumers. Hence, the most appropriate product would be
recommended to consumers. It is expected that open banking would be able to raise the level of
competition within the financial sector as the banks allow the customers to choose from a wide
range of products that suit their preferences. The small banks are also assumed to merge their
back offices so that they are able to develop the competencies to compete with the big banks
(Taylor & Tyers, 2017). The mergers would enable them to use innovative ways to influence
customers within the financial sector.
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Conclusion
The overall study has emphasized on the performance of the big four banks in Australia that has
turned the Australian banking sector into an oligopoly market. The banks have been constantly
dominating in the Australian market which has posed a problem for the small banks to survive.
In fact, the customers are also not satisfied with the prices at which the products are offered by
the big banks. The poor performance of the financial sector has led to entry barriers for the
micro-lenders. Hence, there is a need to control the level of dominance of the big banks and the
small banks must also be able to sustain within the economy. The researchers have suggested a
non-collusive oligopoly strategy for the small banks to take advantage of the market competition.
Moreover, the open banking system to be introduced by the Australian government can also be
an important strategy through which the banks would have the scope to interact with the
customers and offer them with the products and services as per their demand. It can be concluded
that there might be further issues during mergers among the small banks which must be
considered as an effective way to regain the market share.
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References
Apergis, N., & Cooray, A. (2015). Asymmetric interest rate pass-through in the US, the UK and
Australia: New evidence from selected individual banks. Journal of Macroeconomics, 45,
155-172.
Bakir, C. (2019). How do mega-bank merger policy and regulations contribute to financial
stability? Evidence from Australia and Canada. Journal of Economic Policy
Reform, 22(1), 1-15.
Financial Times. (2019). Australian regulator vows to tackle ‘cosy oligopoly’ of big banks.
Retrieved 30 August 2019, from https://www.ft.com/content/d940092a-25f2-11e9-8ce6-
5db4543da632
Financial Times. (2019). Foreign banks take aim at Australia’s big four oligopoly. Retrieved
from https://www.ft.com/content/668d60fe-97de-11e9-8cfb-30c211dcd229
Reuters. (2018). Australia's competition watchdog to review banking oligopoly. Retrieved from
https://www.reuters.com/article/australia-banks-competition/australias-competition-
watchdog-to-review-banking-oligopoly-idUSL3N1RN6E8
Selmier, W. T. (2016). Design rules for more resilient banking systems. Policy and
Society, 35(3), 253-267.
Taylor, G., & Tyers, R. (2017). Secular stagnation: Determinants and consequences for
Australia. Economic Record, 93(303), 615-650.
Xu, J., Gan, C., & Hu, B. (2015). An empirical analysis of China’s Big four state-owned banks’
performance: A data envelopment analysis. Journal of Banking Regulation, 16(1), 1-21.
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