Cereal offenders: Banks make a meal of charges

Some time ago, in mid-2004, there was a glimmer of hope that the national Treasury might be gearing up to finally take on the issue of excessive market power in South Africa’s banking sector. There are numerous manifestations of this problem, but it is painfully obvious to most of us in the area of banking charges. The glimmer of hope came in the form of a piece of research commissioned by the Treasury entitled Competition in South African Banking.

But as one read through the report it became clear that, while the researchers seemed to be on the right track, they lacked sufficient evidence to nail the culprits down. They conclude that “ownership of and control over the National Payments System is concentrated in the hands of the four biggest banks. It is possible that a complex monopoly exists, but a detailed investigation of this issue was not within the remit of the task group.”

They define a “complex monopoly” as what “occurs when firms, whether voluntarily or not and with or without agreement between them, so conduct their business that it prevents, restricts or distorts competition”.

The banks tend to counter accusations of anti-competitive behaviour with two arguments: they point to the vast (overwhelming, in fact) number of different packages on offer within and between the big four banks as evidence of competition and choice for the consumer. Furthermore, they argue, even if they wanted to collude it would be almost impossible to do. This latter argument is probably true for explicit collusion, where regular communication would be required for collusive strategies to be kept up to date with changes in the banking environment. However, that is precisely why the report did not allege explicit collusion but rather implicit collusion.

To see how this implicit collusion might occur, consider the somewhat simpler case of muesli. Until fairly recently the muesli market was a niche one, with one dominant manufacturer, Nature’s Source, currently owned by Bokomo. Probably owing in part to the high returns and the fact that healthier eating trends are changing consumers’ spending patterns, Tiger Brands entered the market. Its products were of similar quality, but at prices that substantially undercut Nature’s Source. Such under-pricing is a well-known strategy of very large firms that can afford to incur short-term losses for the longer-term benefit of gaining customers, or even eliminating their competitors altogether (as Coca-Cola did in the 1990s when Pepsi attempted to enter the South African market). What followed the appearance of this new firm? As time went by Nature’s Source price dropped and Tiger Brand’s price rose, until eventually they were sufficiently close that you had to look quite closely to see which was which in terms of price. Then they both began to rise, slowly, and have not fallen since.

So what’s the lesson? Well, first, competition in a market is, as free-marketeers never tire of telling us, generally a good thing. Second, it is a delicate plant whose fruits whither if the ground is not weeded regularly for anti-competitive behaviours. It should be fairly obvious, too, that coordinating on a price does not require producers ever to talk to each other. Here it would simply have required one firm to notice that it was losing market share—leading it to drop its price—and the other to see that it could increase its price without losing many consumers. Once they stabilised at the same level, both would know that it was not in either firm’s longer-term interest to undercut each other, and could then gradually increase prices at a sufficiently slow rate that neither lost market share before the other also raised its price by a similar amount.

Something else emerges from this example, though. As it happens, the large firm was at the time, and still is, the only retail producer of whole breakfast oats, which are also one of the ingredients—after being toasted—in its muesli product. Other than the additional cost of mixing and preparing the ingredients, muesli also has ingredients like cashew nuts and raisins that are more expensive (in the retail market at least) per kilogram than oats.

Yet the large firm’s muesli price was barely above the price of its oats in the other market in which it was completely dominant. In other words, its pricing in one market revealed unintentionally the extent to which it was abusing its market power by charging very high margins in another.

The case of the banks is, of course, more complex than cereal, by virtue of the fact that there are at least four significant players, never mind that the products on offer are not just basic consumer goods. The principles, however, remain the same. With common—arguably exorbitant—levels of retail charges, the banks have no incentive to undercut each other. Because the industry, like the muesli market, can only sustain a certain number of firms, the prospect of competition resolving the problem is small. As a result, regulatory intervention is required. 

Apparently a new report on the banking sector was commissioned and is due for release this year. Hopefully that will provide more substance for the competition authorities to work with in tackling a matter of very real public interest. In the meantime, perhaps they could take a look at the whole-oats market …

Sean Muller, an economics masters student at the University of Cape Town, is a Public Policy Partnership Fellow. He writes in his personal capacity

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