Fees for Banking Services

Report prepared for the Australian Bankers’ Association

May 2006

Author: Dr Kim Hawtrey Macquarie University Sydney

Contents

Page

Key findings2

Overview of recent trends3

Fee revenue adjusted for changing banking volumes4

Fees and customer circumstances9

Peer comparisons16

Conclusions18

Notes19

Attachment 20

Key findings

This report outlines recent trends in fees for banking services in Australia and discusses the economic impact on bank customers.

The main findings are:

• fee revenue recorded its second successive year of slow growth in 2005, on the back of falling housing loan fee revenue and a minimal rise in fee income from deposit accounts
• in recent years banking service volumes have outpaced banking service fee revenue, meaning the average unit cost to the consumer has fallen
• the user pays approach to fees means customers can make choices about their banking services and the average price is dropping as consumers gravitate toward low-cost options
• access to low-cost banking options offering free transactions is expanding
• besides falling average unit fees and ongoing product rivalry, other evidence of healthy fee competition amongst banks includes the intense discounting war over fees on home loans in 2005 and the quick pass-through to merchants of the reductions in interchange fees in 2004
• customers continue to gain more from reduced loan interest margins than they are paying in account fees
• the proportion of the weekly household budget paid in bank fees is declining
• the incidence of fees between low and high income customers is equitable
• international comparisons show Australian banking fees are around the same level as overseas peers

For further information please contact:

Dr Kim Hawtrey

Department of Economics Macquarie University NSW 2109

Email: khawtrey@efs.mq.edu.au Tel: 0404 476 012

Overview of recent trends

Growth in aggregate fee revenue from domestic banking services remained low for the second successive year in 2005.

Banking service fees grew by 3.7% in 2005, the same pace as the year before (Figure 1). This is well down on the higher rates of growth observed back in the late 1990s.

Growth rates by broad customer segment are provided in Figure 2. To allow comparisons over time, figures back to 1997 are shown.

Figure 1

Figure 2: Banking service fee revenue

$m	1997	1998	1999	2000	2001	2002	2003	2004	2005
Households	1,146	1,514	1,712	2,083	2,233	2,620	3,049	3,419	3,660
% change		32.1%	13.1%	21.7%	7.2%	17.4%	16.4%	12.1%	7.0%
Enterprises	2,764	3,206	3,624	4,164	4,797	5,100	5,558	5,496	5,586
% change		16.0%	13.0%	14.9%	15.2%	6.3%	9.0%	-1.1%	1.6%
Total	3,910	4,721	5,336	6,247	7,029	7,720	8,607	8,916	9,247
% change		20.7%	13.0%	17.1%	12.5%	9.8%	11.5%	3.6%	3.7%

Source: Reserve Bank of Australia . See the Attachment for further detail.

To understand the impact of fees on bank customers, the following sections unpack the figures from various perspectives.

Fee revenue adjusted for changing banking volumes

Overall fee revenue is influenced by several ingredients: growth in the customer base which is usually accompanied by higher transaction numbers, as well as new fees or changes to existing fees.

Even without any change to individual product fees, annual revenue would still increase simply because there are more customers using the system.

Economists use the term ‘volume effect’ to denote increases in turnover or usage. The term ‘value effect’ is used of growth resulting from higher unit prices per transaction. The two effects can be separated.

Figure 3 shows a measure of banking service fee revenue with the volume effect removed: only the estimated value (or price) effect remains. It divides nominal banking fee revenue by an index of transaction activity.

After accounting for underlying growth in transactions by this procedure, we are left with the role played by product pricing. The resulting trend shows an estimated decline of 18.5 percent over the five years.

This tells us growth in banking service revenue has failed to keep pace with banking service volumes in recent years. This implies that the average unit cost of banking services to the consumer has declined.

Figure 3

Sources: Reserve Bank of Australia Bulletin (tables C1, C4, C5) and Australian Bureau of Statistics Housing Finance 5609.0; indices calculated by deflating the dollar value of fee revenue by an unweighted index of transaction numbers in the period. The transactions index sums normalised indices of the number of ATM, EFTPOS, credit card, direct debit and cheque transactions and new housing loans written, plus indices of the value of new personal loans and commercial loans written. The measure excludes some banking transactions such as phone and internet.

The information above means that simple growth in the number of customer transactions is more than enough to explain changes in banking fee revenue during the period. This means the average price of banking services has declined.

Further perspective on fee growth in the context of business volume is found by scaling banking service fee revenue against banks’ assets.

Figure 4 shows the trend in banks’ fee-to-assets ratio in recent years, expressed as a percentage, based on domestic assets only.

The downward trend in the ratio continued in 2005 to 0.73 percent, from 0.78 percent the year before and 0.90 percent a number of years ago.

Figure 4

Source: Reserve Bank of Australia Bulletin table B2; assets defined as residents assets only;

excludes non-resident assets and overseas operations.

Another way to gain perspective is to compare growth in fee revenue against banks’ earnings from other domestic business activities.

Figure 5 shows a measure of this using the ratio of banking fee revenue to bank profits. Profit is on a pre-tax basis, and profits from banks’ foreign operations are excluded so as to enable sensible comparison with the domestic fee data we are working with.

Over the period 2000 to 2005, notwithstanding the usual ups and downs from year to year, the ratio has hovered around the 60 percent mark.

This tells us that revenue from fees has not outpaced revenue from banks’ profits generally. Although not shown here, analysis of the figures further back in time leads to the same conclusion: there has been no change in trend since the mid 1990s.

Figure 5

Source: Fee revenue includes all domestic banking fees, as in Figure 1; profit figures are from banks’ annual reports, defined as earnings from the domestic business of the six largest banks, representing approximately 92% of the industry.

Figures 3, 4 and 5 tell a consistent story, that after adjustment for business volume the average price of banking services in Australia has not grown out of proportion. Indeed it appears to be in decline.

Yet it is common knowledge that certain fees and charges on selected banking products have increased during that time.

How can these two facts be reconciled?

The key is changing patterns of usage by bank customers.

Bank customers have increasingly been shifting away from traditional ways of transacting (cheques, over-the-counter) toward electronic forms (ATMs, EFTPOS). The latter are generally cheaper, and often involve zero fees.

This is illustrated in Figure 6. Since 2000, transactions at ATMs have grown by 13 percent per annum on average. EFTPOS has grown by 20.5 percent a year. By contrast, cheque usage has declined by around 9 percent per annum.

The upshot is that banks are collecting less fee revenue per transaction. As customers substitute low-fee or zero-fee products and services in place of those for which fees have risen, the overall cost of banking to the consumer is falling.

Figure 6

Source: Reserve Bank of Australia

Underpinning the shift in patterns of banking is expanded customer choice.

Innovation by the industry along the lines of product range and pricing has vastly enhanced the ability of customers to manage the average cost of their banking services.

That is, switching between various banking services has become a widespread phenomenon and increasingly customers today are learning to minimise their fees.

In particular, recent years have witnessed significant development of so-called ‘all-you-can-eat’ accounts, a new breed of low-cost transaction accounts that typically carry a flat monthly account-keeping fee of $5 and entitle the customer to multiple free transactions each month.

Proliferation of this type of account has been significant. The number of defined low-cost accounts on offer has grown by 18 percent over the past five years (source: Cannex).

Equally important, the number of inclusive free transactions is steadily rising. The proportion of accounts offering unlimited free transactions (via the host network) is up from 7 to 24 percent over the period, and in cases where monthly limits still apply the average free limit has risen from 5.6 to 7.7 transactions per month (Figure 7).

Figure 7: Expanding choice in banking services

Source: Cannex

The user pays system allows customers to make choices about their banking and the average price of banking is falling as consumers gravitate toward low-cost options.

Expansion in the availability of free transactions, and of accounts offering an unlimited number of such transactions, means that many mainstream customers today pay little or no banking service fees at all because they transact within fee-free limit conditions on their accounts.

Furthermore, around 60 percent of the Australian banking population is eligible for generic ‘basic’ bank accounts. These accounts are generally available to eligible low-income earners such as pensioners or students and provide a basic level of service at minimal or no cost.

Fees and customer circumstances

This section looks at the economic impact of fees on broad customer segments with differing banking needs.

A breakdown of banking fee revenue by broad customer segment is shown in Figure 8. The chart separates household customers from business customers.

More detailed figures for these two broad customer segments are provided in the Attachment.

Figure 8

Both customer segments are sharing in the slowdown in banking service fee growth in recent times (Figure 8).

In 2005 banking service fees paid by households grew by 7 percent, down from 12 percent the previous year.

Business customers saw an increase of 2 percent in 2005, following the drop of 1 percent in 2004.

The different rates of growth between households and enterprises owes in large part to the historic reductions in business merchant fees that occurred in 2004. The reductions explain the dip in the enterprise line observable in that year.

The beneficial effect to merchants who accept credit cards of the Reserve Bank’s interchange reforms is not limited to 2004. The impact is ongoing, in the form of permanently lower fees. Indeed, business merchant fees were down by a further 3.2 percent in 2005, hard on the heels of the 17.0 percent drop in 2004 (Figure 9).

Figure 9

Turning to households, Figure 10 separates fee growth for the three most important household product areas: transaction accounts, loan accounts and credit cards.

Increases in credit card fees are in large part due to factors flowing from the 2004 interchange reforms. The effect of the reforms on households was the reverse of that on merchants, and both effects fed through rapidly. This is evidence of healthy competition amongst banks in fees: the RBA confirmed as much in 2005 in noting that that competition between banks had seen the reductions in interchange fees flow through ‘fairly quickly’.

Figure 10

Household customers are seeing notably slower fee growth for both deposit and loan transactions. Loan fees paid by households grew by 1.6 percent in 2005, the slowest pace in many years, and transaction fee revenue also showed comparatively slow growth at 5.0 percent (Figure 10).

The historically low outcome for loans reflected, in particular, a drop of 1.7 percent in fee revenue for housing loans (Figure 11). Weaker demand in 2005 led to fee waivers and discounting, another indicator that competition between banks is strong.

Figure 11

While these recent gains will be welcomed by household customers, taking a longer telescopic view of fee growth shows households are gaining in other ways in respect to housing loans because of effect of interest rate reductions on offsetting fee increases.

In a Statement on 3 May 2006 concerning interest rates, the Reserve Bank acknowledged the significance of narrowing loan interest margins:

‘A factor that is likely to have contributed to the overall strength of credit growth has been the continuing compression of lending margins by financial intermediaries over recent years, reflecting competition among lenders. As a consequence, although the cash rate has been close to its historical average, interest rates paid by borrowers have remained below average’ (Reserve Bank of Australia)

Figure 12 calculates a measure of the net gain to household customers in terms of lower interest margins on home loans. The margin today between official rates and home loans is almost two and a half (2.45) percent narrower than a decade or so ago.

This tightening in interest margins translates into very significant savings for home buyers, amounting to thousands of dollars on their mortgage each year.

Figure 12: Fall in housing loan margins (%)

	Cost of funds (cash rate)	Housing loan rate (standard)	Difference (‘margin’)	Reduction in margin since early 1990s
Early 1990s	5.25	9.50	4.25	na
2006	5.50	7.30	1.80	-2.45

(Source: RBA Bulletin F1, F5; figures refer to 1993 and April 2006)

To appreciate the impact of this, consider the typical home buyer. The median amount outstanding for owner-occupied housing loans across all borrowers is around $101,000 (source: ABS 4130.0 as at 2003-04). On this basis, the squeeze on bank lending margins as a result of competition over the past decade or so is saving the median home buyer $47.59 per week in mortgage interest repayments.

This saving on interest can be compared with fees paid by the average household. According to ABS data, the typical household pays a total of $4.23 per week in duties, taxes and charges on financial institution accounts (source: 2003-04 ABS Household Expenditure Survey). (This is an over-estimate because it includes all accounts, not only loan accounts, and also includes government taxes.)

Figure 13

In net terms the average Australian household with a home loan and standard deposit banking accounts is better off by at least $43 per week (Figure 13). In the case of new borrowers, the savings are greater still. The average new owner-occupied housing loan taken out in January 2006 was $218,085. The 2.45 percent margin reduction noted in Figure 12 translates into a larger saving of $102.75 per week in mortgage repayments and a net gain after banking fees of $98.

It is clear that customers generally are gaining more from cost reductions on loan interest margins than they are losing from account fee increases.

Notwithstanding the above, there remains a sub-group of consumers who do not hold a home loan account with a bank and therefore have not been the beneficiaries of lower interest margins, yet have faced fee increases on their transaction banking.

In assessing the impact on this group of consumers, perspective is gained by placing their outlays on banking fees in the context of the household budget generally.

The average weekly expenditure by Australian households on financial account duties, taxes and charges of $4.23 represents less than 1 percent (0.48) of the average household weekly budget. This modest proportion can be compared with weekly spending on other staples such as 1.1 percent for local government rates, 2.7 for domestic fuel and power, 12.8 for recreation and 15.7 for transport (Figure 14).

Figure 14

Source: ABS 2003-04 ABS Household Expenditure Survey

Moreover, the proportion of the household budget spent on financial accounts is diminishing with time.

Figure 15 shows the average proportion spent by all households fell from 0.55 percent to 0.48 percent during the latest five year sampling period (source: 1998-99 and 2003-04 ABS Household Expenditure Surveys).

Figure 15

Source: ABS 2003-04 ABS Household Expenditure Survey

These trends, by showing that banking charges are among the very smallest items in household budgets and falling, help place banking service fees in perspective.

A group of consumers warranting particular analysis are those on low incomes. Household customers vary in their capacity to pay, and this raises the issue of fairness across the range of households.

A breakdown of the figures by household income reveals that lower-income households bear a significantly lower share of fees than consumers with higher incomes. Figure 16 shows expenditure on financial accounts across all income quintiles, as a percentage of total weekly spending by the quintile in question.

Figure 16: Average weekly household expenditure on bank accounts

	Gross Household Income Quintile
	Lowest	Second	Third	Fourth	Highest	All
Duties, taxes & charges paid on financial accounts	$1.40	$2.75	$3.92	$5.12	$7.99	$4.23
% of all weekly expenditure by the quintile	0.34%	0.46%	0.46%	0.48%	0.54%	0.48%
% of duties taxes and charges by all households	6.6%	13.0%	18.5%	24.2%	37.8%	100.0%

Source: ABS 2003-04 ABS Household Expenditure Survey

In relative terms, households in the lowest income bracket spend the least on financial account charges (0.34% of their weekly budget), while those in the highest bracket spend the most (0.54%). This ‘sliding scale’ means the incidence of account fees is progressive and thereby satisfies one of the most basic criteria for equity in the application of surcharges.

Figure 17 displays the share of each quintile in total financial fees paid by households. The lowest income group pays the lowest share (6.6%), while the highest share (37.8%) is borne by the high-earning quintile of households.

Figure 17

Source: ABS 2003-04 ABS Household Expenditure Survey

The distribution of fees across the population is generally fair. Low-income earners pay a relatively lower share than high income customers.

Peer comparisons

We can gain further perspective on banking charges by making inter-industry and international comparisons.

Fees for everyday banking versus other daily utilities are shown Figure 18. The monthly cost of fees for everyday banking services is significantly less than basics such as water, power or transport. As shown in Figure 19, banking services on average cost less than other everyday services such as buying a newspaper, renting a telephone line, registering a car and drinking coffee at a café (see endnotes for data sources).

Figure 18

Figure 19

International peer group comparisons are provided in Figure 20.

The chart shows a measure of bank fee revenue, defined as net non-interest income, using OECD data published in 2003.

To allow for comparison across countries with banking systems of differing sizes, the figures are scaled by expressing net non-interest income as a ratio to bank assets in the country concerned. This is a measure of the non-interest income margin (NOM).

Figure 20: International comparison

Source: Organisation for Economic Cooperation and Development (OECD),

Bank Profitability: Financial Statements of Banks, published 2003, latest data 2001.

Australia sits around the middle of other western countries in non-interest margin. At 1.5 percent, Australian banks are equal to the Average across the fourteen banking sectors shown (see last column).

The highest earners of non-interest income are Finland and the United States . The lowest in the sample is Germany . The reliance of United Kingdom banks on non-interest revenue is just below that of Australian banks, at 1.4 percent.

Australian banking fees are generally not out of line with overseas peers.

Conclusions

This paper has outlined recent trends in banking service fees in Australia and discussed the economic impact on bank customers.

Banking service fees need to be seen in context of a number of key facts.

Basic bank accounts are available where eligible low-income earners can access a level of service at minimal or no cost. This applies to around 60 percent of the Australian banking population.

Many remaining bank customers do not pay any fees at all because they transact within fee-free limit conditions on their accounts. The availability of free transactions has expanded significantly, with accounts increasingly offering an unlimited number.

Besides falling average unit fees and ongoing product rivalry, other evidence of healthy fee competition amongst banks includes the fierce discounting war over fees on home loans in 2005 and the quick pass-through to merchants of the 2004 reductions in interchange fees.

The user-pays approach to fees that we have today is a fairer and more transparent system of charging customers for banking services compared with the past when services like cheques were paid for implicitly through higher interest charges.

The user-pays system has allowed banks to reduce interest charges, with customers on average gaining more from cost reductions on loan interest margins than they have paid through account fee increases.

Further, user pays has allowed customers to make choices about their banking and data show the average price of banking is falling as consumers gravitate toward low-cost options.banks to reduce interest charges, and the facts show that customers have gained far more than cost reductions on loan interest margins than they have lost through fee increases. Consumers today are exercising greater choice and responding to transparent fee information by switching products. Banks are collecting less fee revenue per transaction as consumers substitute toward low-fee or zero-fee ways of banking.

In aggregate, after adjusting fee revenue for rising customer volume, the average price of banking to the customer has been falling. Simple growth in banking services volume is more than enough to explain growth in banking fee revenue during the past five years.

As a consequence, the proportion of the weekly household budget spent on banking service fees is declining with time.

The distribution of fees across the population is fair because low-income earners pay a relatively lower share than high income customers.

Overall, banking service fees in Australia are in line with general community benchmarks. The growth in fee income of banks has kept within their asset and profit growth generally. And Australian banking fees are roughly on par with banks in other countries.

Notes

Sources for Figure 18

1. Banking – 2003-04 ABS Household Expenditure Survey
2. Water – Sydney Water Corporation, Hunter Water Corporation, Sydney Catchment Authority Prices of Water Supply, Waste Water and Storm Water Services: Final Determination and Report, NSW Independent Pricing and Regulatory Tribunal (IPART), September 2005, figures for 2005-06 assuming 250 kilolitres (kL)usage per household.
3. Electricity – NSW Electricity Regulated Retail Tariffs 2004/05 to 2006/07: Final Report and Determination, NSW Independent Pricing and Regulatory Tribunal (IPART), Table 5.5, assuming no off-peak.
4. Train – Report on the Determination of Fares for Sydney Metro Train Services, NSW Independent Pricing and Regulatory Tribunal (IPART), March 2006, monthly cost of weekly ‘Travel Ten’ rail ticket from Parramatta to Central station for one adult traveller.
5. Bus – Report on Determination of Fares, NSW Independent Pricing and Regulatory Tribunal (IPART), January 2006, monthly cost of weekly adult bus ticket from Malabar to City.

Sources for Figure 19

1. Banking – 2003-04 ABS Household Expenditure Survey
2. NSW RTA: medium car weighing up to 1504 kg (excludes CTP)
3. The Australian: purchased 5 days a week at newsagent
4. Telstra: standard line rental only under a basic ‘Homeline Plus’ plan (excludes handset rental)
5. Average café price of $2.50 for five days a week

Attachment

Banking fees paid by households

Banking fees $m	2000	2001	2002	2003	2004	2005
Deposit accounts	960	1024	1115	1309	1413	1483
% change	25.0%	6.7%	8.9%	17.4%	7.9%	4.9%
Housing loans	510	495	625	723	785	772
% change	24.3%	-3.1%	26.3%	15.8%	8.5%	-1.6%
Personal loans	208	269	366	357	393	425
% change	44.3%	29.1%	36.2%	-2.4%	10.2%	8.1%
Credit cards	290	337	425	589	761	899
% change	34.0%	16.4%	26.0%	38.8%	29.1%	18.2%
Other	115	108	90	71	68	81
% change	-33.5%	-6.1%	-16.8%	-20.9%	-5.2%	19.3%
Total	2083	2233	2620	3049	3419	3660
% change	21.7%	7.2%	17.4%	16.4%	12.1%	7.0%

Source: Reserve Bank of Australia

Banking fees paid by enterprises

Banking fees $m	2000	2001	2002	2003	2004	2005
Deposit accounts	609	643	681	710	737	754
% change	25.1%	5.6%	5.9%	4.3%	3.8%	2.3%
Loans	1115	1257	1197	1351	1485	1563
% change	14.4%	12.7%	-4.8%	12.9%	9.9%	5.3%
Merchant fees	1164	1383	1622	1826	1516	1468
% change	20.2%	18.8%	17.3%	13.0%	-17.0%	-3.2%
Bank bills	935	1040	1074	1077	1120	1151
% change	5.4%	11.2%	3.3%	0.3%	4.0%	2.8%
Other	340	473	525	594	639	651
% change	10.7%	39.1%	11.0%	13.1%	7.6%	1.9%
Total	4164	4797	5100	5558	5496	5587
% change	14.9%	15.2%	6.3%	9.0%	-1.1%	1.7%

Source: Reserve Bank of Australia