Inquiry into matters relating to Credit Card interest rates

Transcription

1 Committee Secretary 15 August 2015 Senate Standing Committees on Economics PO Box 6100 Parliament House Canberra ACT 2600 Inquiry into matters relating to Credit Card interest rates The Westpac Group thanks the Committee for the opportunity to lodge a submission with the Inquiry. In addition we endorse the submission lodged by the Australian Bankers Association. Section 1: Westpac Group perspective on the level of competition in the market The Westpac Group supports a dynamic and competitive Credit Card market in Australia that provides consumers with the benefits of choice. We consider that an analysis of the Credit Card market indicates that it is highly competitive, providing real choice for consumers. The key indicators of competition include: Market share and the range of providers operating (both Authorised Deposit-taking Institutions (ADIs) and non-adis); the types and number of products available; ease of entry by new players; and consumer behaviour and preferences, including ease of switching for consumers. The major banks market share in the Credit Card segment has changed little since the early 2000s and remains lower than in The major banks current share of Credit Card balances is 68%, which is lower than their share of household deposits at 81.3% 1. 1 APRA Market Data, June 2015.

2 Figure 1: Majors Share of Credit Card Balances (% of Financial System) 76.0% 74.0% 72.0% 70.0% 68.0% 66.0% 64.0% Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Source: Reserve Bank of Australia (RBA) data Wide range of providers and product availability Consumers can currently choose from over 80 Credit Card providers, both ADIs, including banks and credit unions, and non-adis, offering over 250 products. 2 The wide range of options available to consumers is reflected in Table 1 below. Products are offered across three key product categories designed to meet the needs of different customers: 1. Low or no-fee low feature card; 2. Lower interest rate low feature card; and 3. Rewards cards with a rich range of lifestyle benefits, for example, complimentary insurance. 2 Source: Credit Card Finder, 30 th July 2015

3 Table 1 Credit Card Products on market July 2015 Total products listed Total institutions % Banks %Credit Unions and Building Society Credit Cards % non-adis Source: Canstar July Ease of entry for new players Barriers to entry in the Credit Card market are relatively low and have not inhibited new entrants. Media reports suggest the Commonwealth Treasury supports this conclusion. Low barriers to entry are evidenced by an increase in the number of providers and products in the market. Recent new entrants included Woolworths, Coles, ME Bank, Myer and re-entry by Virgin. The amendments to the Banking Amendment (Credit Card) Regulation 2014, which commenced on 1 January 2015, further reduced barriers to entry for non-bank Credit Card providers and as such we expect the number of market participants and products to continue to increase over time. Consumer behaviour and preferences Customers in Australia are sophisticated users of banking services and have become accustomed to products tailored to their particular needs. There is a high level of differentiation in the price and features of cards on the market. Across the industry, interest rates on purchases range from 8% to 23.50% for unsecured products and as low as 5% for secured Credit Cards. This caters to different consumer needs, from rich-benefit cards, with rates around the 20% mark, to low-feature, lower rate cards. Customers are increasingly choosing low feature, lower rate cards. This is reflected in Figure 2 below.

4 Figure 2: Low rate cards penetration of product for sale in the market Source: Canstar Data July 2015 Credit Card market participants compete on all aspects of the product including: 1. Acquisition offers: A wide range of offers including balance transfers with zero rate for a fixed period on the transferred balance, waived annual fees, bonus rewards points and interest free purchases. Competition is driving better offers, for example, longer balance transfer periods which now range between 18 and 24 months. 2. Product pricing: More products offer 0% foreign transaction fees as a standard product feature. $0 annual fee is a popular feature. The Argus 2014 Benchmarking Study showed these products represent 24% of new account openings. 3. Product benefits: A wide range of product benefits including rewards, complimentary insurances, shopping discounts, concierge services and free airport lounge passes. Upgrades to higher benefit tiers (i.e. Gold to Platinum), often at no additional cost to the customer. 4. Service experience: These are all designed to create customer ease, control and comfort. Examples that banks use to differentiate include fraud protection, ability to shop with rewards points, card locking and ease of account opening and servicing.

5 Low barriers to switching The ease with which customers can switch products in a market is another key indicator of competition. The Westpac Group considers there are minimal barriers to switching in the Credit Card market. While some commentators have suggested that recurring payments on Credit Cards create inertia against switching, this does not appear to be reflected by the data. The Argus 2014 Benchmarking Study estimates that approximately 1.4 million to 1.5 million new Credit Card accounts are opened each year in Australia. This represents around 9% of the 15.7 million accounts currently in the market. Given net account growth is approximately 2% 3 this demonstrates a churn rate of 7% per annum. This data provides strong evidence that consumers are willing to shop around and that switching Credit Card type and providers is relatively easy. Indeed, media reports suggest the Commonwealth Treasury agrees there are minimal barriers to consumers switching in the Credit Card market. Section 2: Consumers have a wide choice of payment and borrowing options In addition to Credit Cards, consumers are able to choose from a suite of products to meet their payment and borrowing needs. Examples include overdrafts, Personal Loans and Debit Cards. These products can be substitutes for Credit Cards. Alternative borrowing options: The majority of consumers use Credit Cards to meet short to medium term borrowing needs. Other products available for short to long-term borrowing include overdrafts and Personal Loans. Unsecured low rate and low feature Credit Cards and Unsecured Personal Loans meet similar needs and have similar rates at around 13%. Credit Cards offer customers the choice of a flexible line of credit with a payment mechanism whereas Personal Loans provide a structured payment plan and may be more appropriate for medium-term borrowing. There is evidence that consumers are selecting the right product for their medium-term borrowing needs with Personal Loans growing faster than Credit Cards over the last few years (as reflected in Figure 3 below). 3 Source: RBA data

6 Figure 3: Personal Loan versus Credit Card Balance Growth Indexed 140 Personal Loans continue to rise faster than Credit Cards PL 105 Credit Cards Nov-08 Mar-09 Jul-09 Nov-09 Mar-10 Jul-10 Nov-10 Mar-11 Jul-11 Nov-11 Mar-12 Jul-12 Nov-12 Mar-13 Jul-13 Nov-13 Mar-14 Jul-14 Nov-14 Mar-15 Source: RFI monthly report (PL data) and APRA data for Credit Cards Alternative payment tools Debit Cards 4 continue to increase in popularity as a payment tool. Over the last 12 months spending on Debit Cards has grown faster than spending on Credit Cards (12.0% and 8.6% respectively). This is shown in Figure 4 below. 4 Debit Cards includes scheme cards and Eftpos.

7 Figure 4: Growth in purchases- Debit and Credit Cards Count Aug-02 Jul-03 Jun-04 May-05 Apr-06 Mar-07 Feb-08 Jan-09 Dec-09 Nov-10 Oct-11 Sep-12 Aug-13 Jul-14 Debit Card Credit Card Source: RBA Payment System statistics The combination of these factors shows consumers are being more prudent with Credit Cards and using them more as a payment mechanism than a borrowing tool. This trend is reflected by the average Australian credit card payments to balance ratio lifting since 2011 (from 38% to 48%). This is demonstrated in Figure 5 below.

8 Figure 5: Australian Credit Card average payments to balance ratio (%) 60% 55% 50% 45% 40% 35% 30% May-1994 Aug-1995 Nov-1996 Feb-1998 May-1999 Aug-2000 Nov-2001 Feb-2003 May-2004 Aug-2005 Nov-2006 Feb-2008 May-2009 Aug-2010 Nov-2011 Feb-2013 May-2014 Source: RBA Payment System statistics Section 3: Westpac s Credit Card book Meeting our customers needs The Westpac Group offers a range of Credit Cards in three categories: 1. Low/no fee; 2. Low rate; and 3. Rewards. Each product type is designed to address different customer needs, including those who are more sensitive to interest rates or fees. In addition to the headline interest rate, many customers will take into account the range of features and benefits available on the card such as complimentary insurances, concierge service, free lounge passes and access to multiple loyalty programs. These benefits are normally available on premium products, and customers make a decision based on the value of rewards, annual fee, interest free period and interest rate. The benefit a customer can derive from these premium products may be greater than the cost of annual

9 fees. For example, a similar stand-alone travel insurance policy from the same under-writer can cost in excess of $500 (versus an annual fee of up to $395). Changing customer needs Over 30% of total customer credit card balances across the Westpac Group are held in low rate accounts. This has increased from 23% in In the last two years, low rate cards have accounted for over 50% of all new sales. We have also seen increased demand for low or no fee cards. This is shown in Figure 6. Annual fees range from $0 to $395 (for our most premium product, which also provides access to a wide range of other features and benefits). Figure 6: Low Fee Cards popularity Source: Market Data Argus 2014 Benchmarking. Managing particular customer segments needs There are quite a number of unique customer behavior segments within a Credit Card portfolio. We believe the majority of Westpac Group customers are managing their debt prudently, including the segment of customers that revolve continuously over a 12 month period. Significantly, only 4% of our customers make the minimum payment continuously over a 12- month period. The majority of these revolvers make full use of their product features and pay off far more than the minimum repayment required on a monthly basis. Only 0.9% of

10 revolvers who consistently pay the minimum repayment amount over a 12-month period are not on a low rate product. For the majority of these revolvers their existing credit card product meets their borrowing and payment needs. Nevertheless, the Westpac Group actively offers revolvers a Personal Loan should they wish to pay down in a more structured manner. 277,000 proactive offers were made in the last 12 months. Section 4: Consumer protection regime The Westpac Group supports a strong consumer credit protection regime and we consider that the current regulatory framework governing Credit Cards in Australia is appropriate. The National Consumer Credit Protection Act 2009 ( the Act ) requires the bank to comply with responsible lending conduct obligations. These require us to determine that a Credit Card is not unsuitable for the customer based on their financial situation, requirements and objectives. We are also required to take reasonable steps to verify the customer s financial situation and determine they can make repayments without substantial hardship. In the Westpac Group, less than 60 % of applications for new Credit Card accounts are approved and less than 15% of accounts are eligible for credit limit increases at any point in time. Credit Cards were also subject to additional reforms under the National Consumer Credit Protection Amendment (Home Loan and Credit Cards) Act 2011 including: Introduction of a Key Fact Sheet to help customers understand Credit Card product; a change in the Order of Payments (with the higher interest rate balances required to be paid off first); the obligation to obtain a customer s consent to provide credit limit increase invitations; greater consumer control of credit limits by requiring that customers are provided with the choice to select their own limit; and a Minimum Repayment Warning table in all Credit Card statements showing the number of years it would take to pay off the account balance if the customer made only the minimum repayments and the monthly repayment required to pay off the balance within 2 years.

11 Since these legislative changes, we have seen the following changes in customer behavior: On average 60% of all applicants are selecting a limit specific to their requirements; Revolve rates have declined (shown in Figure 7 below); and Monthly repayments are higher. Figure 7: Interest Bearing Balances as a % of outstanding balances Source: RBA Data The Westpac Group has our own Principles of Responsible Lending through which we recognise our obligations to market our products responsibly and have established productbased standards for lending to individuals, with key controls including minimum serviceability standards. In addition to complying with our legal and regulatory requirements, the Westpac Group supports customers to make appropriate financial decisions through a range of tools, including: An interactive guide to assist customers select a product based on their spending and repayment habits and the importance they place on product features and benefits. Online information to help customers manage their card and avoid unnecessary fees and charges such as overlimit fees 5. 5 NB: Under the enhancements to the National Consumer Credit Protection Act 2009 overlimit fees have not been charged on credit contracts entered into after 4 June 2012.

12 Promotion of Personal Loans to Credit Card customers with revolving balances. We have contacted over 277,000 Credit Card customers over the last 12 months to see whether a Personal Loan would better meet their needs. Balance transfer offers that give customers interest holidays allowing them a period of up to 20 months to pay the balance down. The Westpac Group therefore does not consider that a compelling case exists for any new regulatory changes to the operation of the consumer credit protection regime. Section 5: The relationship between official interest rates and Credit Card interest rates A key area of consideration for the Inquiry is why headline interest rates on Credit Cards have been unresponsive to changes in official interest rates. Figure 8: Credit Card Interest Rates Source: RBA The link between Credit Card headline (advertised) rates and the official cash rate is low. There are a range of factors which are all important in determining Credit Card pricing including: Expected losses (and provisioning) i.e. Probability of default (PD) and loss given default (LGD); Capital required to be held against the loan; Costs of origination, servicing and value-added benefits (such as rewards);

13 Cost of funding any borrowing; and Customer behaviours. The RBA s discussion paper, The Evolution of Payment Costs in Australia, confirms that funding costs are a low component of overall Credit Card issuing costs and consequently the official cash rate has a negligible impact on card economics. Rather, the highest Credit Card costs are associated high operational costs, payments functionality (such as real-time systems) and the rich bundle of benefits associated with Credit Card products. Risk characteristics One driver of pricing for Credit Cards is the risk characteristics of the product. Credit Card portfolios are by comparison relatively higher risk than secured loan (i.e. residential mortgage) portfolios. For example, the annual level of credit losses for Credit Cards is around 2.52% of outstanding balances compared to around 0.02% for secured home loans. Table 2: Summary of Westpac Group Credit Risk Disclosure 6 Risk Weight Actual Losses (6m) ($ millions) Annualised Losses % Mortgages 16% % Cards 31% % Pricing needs to take account of risk over the economic cycle, rather than at a point-in-time. For example, economic conditions for consumer lending remain somewhat weaker than a few years ago. Unemployment is a key factor for this portfolio and, while this has improved more recently, unemployment rates remain higher than in This reinforces the need to base pricing decisions on longer term portfolio trends. Costs associated with Credit Cards Another cost driver is innovation. There has been a high level of innovation in the Credit Cards market including the introduction of contactless payments, mobile payments, chip and PIN 6 Source: (page 23)

14 authorisation, anti-fraud measures and digitisation of services. We expect this area of banking will continue to be highly innovative. In practice, Credit Cards are complex products. The cost structure of Credit Cards is fundamentally different to other lending products such as home loans. Credit Cards have a number of materially higher costs including: Higher fraud costs; Higher ongoing servicing costs driven by the need for real time systems, disputed transactions, more frequent statements and higher contact centre activity; Scheme fees; Costs of benefits offered to consumers such as rewards, insurances and concierge services; and Costs of regulatory and compliance changes. The advertised headline rate does not reflect portfolio margins Net margin on a Credit Card portfolio is determined by the effective interest rate 7 less funding costs. The portfolio effective interest rate varies from the advertised headline rate because it reflects the combination of promotional rates, mix of products held and the percentage of customers that revolve or pay interest. The Westpac Group s current net margin for Credit Cards is in line with 2010, with small movements up and down over the period. Therefore, while funding costs have declined the overall profitability of the product has not improved as funding costs reductions have been offset by declining revolve rates, higher promotional rates and changes in product mix. For example, since January 2013 the market balance revolve rate has declined by 963 basis points (from 73.7% to 64.1%), which has had a far bigger impact on margins than the official cash rate reductions of 0.75% over the same period. 7 Effective interest rate is weighted rates of purchase, cash, balance transfer and other promotional rates (based on outstanding balances) multiplied by the revolve rate.

15 Figure 9: RBA Cash Rate and Market Revolve Rates Source: RBA Data In summary, the link between Credit Card pricing and movements in official interest rates is not strong. Credit Card pricing movements are dependent on changes to a broad range of factors that also includes capital requirements, changes to consumer benefits offered, loss rate trends, revolve rate trends and other expense drivers. This broad range of factors move both positively and adversely over time and that is why Credit Card pricing adjustments reflect broad changes over an economic cycle rather than as a frequent, point-in-time response to individual movements such as changes in the official cash rate. Section 6 ATM Fees The Westpac Group ATM Direct Charge fees have remained at the same level since the RBA s mandate to introduce Direct Charging at ATMs in March ($2 for withdrawal and balance enquiry).

16 The Direct Charge fee is only applied to customers who choose to access cash from our network with a card not linked to an account with any of the Westpac, St.George, BankSA or the Bank of Melbourne brands. These transactions make up approximately 15% of all transactions across the network. Of the remaining transactions on the network, 80% are Westpac Group cardholders or cardholders associated with our wholesale partners (5%), where no fees are directly charged to the cardholder at the ATM. The channel has a net negative contribution, with cash servicing, maintenance and security costs increasing annually and transaction usage is declining (at ~10% per annum). Declining transaction usage has been driven by changes in customers' payment behaviours, with alternative channels, for example, tap & go and EFTPOS cash out transactions providing alternative convenient payment methods. The combination of increasing costs and lower usage has resulted in the cost per transaction on an ATM increasing, with a high component of fixed costs associated with the deployment and operation of ATMs. The annual investment required to continue to maintain and operate the channel is significant. Total operating costs are in excess of $100 million each year to support the 31,000 ATMs connected to the network. In addition to this ongoing significant investment, approximately $50 million in new capital is invested on ATMs annually to ensure the network coverage continues to meet our customers expectations, is appropriately maintained, safe and secure, and remains a compliant participant in the global payments system. These capital reinvestments include: Replacement programs - replacing older ATMs with new generation devices; Expansion Programs - deployment of new more sophisticated ATMs in new locations, expanding network coverage to avoid our customers paying direct charges; Product development - Introducing new functionality; Compliance programs - Ensuring network compliance is maintained and satisfies local and international compliance standards; and Risk mitigation against skimming and other fraud. Section 7 Conclusion The Financial System Inquiry final report notes that Competition remains the cornerstone of a well-functioning financial system and is generally preferred to government intervention. Competition drives efficient outcomes for price, quality and innovation 8. Various indicators demonstrate that the Credit Card market in Australia is highly competitive. These include the 8 Financial System Inquiry Final Report, November 2014, page 9.

17 levels of innovation, the number of Credit Card providers and wide range of product offerings which suit the needs and behaviours of different customers, low barriers to entry and consumer switching. Trends in Credit Card portfolios across the market suggest that consumers are making appropriate financial decisions based on their individual needs. Changes in consumer behaviour have been supported by changes to the regulatory environment governing consumer credit in Australia. We do not consider there is a compelling case for regulatory changes to the existing consumer protection regime. Nevertheless, the Westpac Group continually looks to improve the manner in which we support customers to make the most appropriate financial decisions, including the use of customer data and offering alternate products to meet the changing borrowing and payment needs of our customers. When examining the advertised headline rates of Credit Cards, one price component, such as the interest rate, and one cost component, such as the funding costs, cannot be considered in isolation of all movements in other revenue and cost lines. Furthermore, pricing decisions on headline interest rates are determined by a combination of factors. As a result there is not a close linkage between funding costs, total costs and headline rates. Overall margins in the Credit Card portfolio have not increased despite funding costs falling. We strongly support the conclusion of the Financial System Inquiry report that prudential supervision and conduct regulation remain the preferred approach over direct Government control of prices and quantities in the financial system 9. 9 Financial System Inquiry Interim Report, July 2014, page 1-1.