if Kiwibank is part of the competitive fringe of an oligopoly made up of the 4 Australian banks, it is not very profitable for a competitive fringe of a cartel as the chart below shows. The other New Zealand owned small banks in that competitive fringe are not that profitable at all. Undercutting an oligopoly and its high prices and above-average cost and above marginal cost pricing is not what it used to be for the competitive fringe in New Zealand banking, if there ever was a cartel.

Source: G1 Summary information for locally incorporated banks – Reserve Bank of New Zealand.

Bank customers can choose between four major banks and a competitive fringe. If those major banks are indeed overcharging because of price-fixing by a cartel or an oligopoly, that competitive fringe which includes Kiwibank has a real opportunity to expand profitably and with little risk.

The prospect of expansion by the competitive fringe that includes Kiwibank only increases the incentives on each of the four big banks to cheat on the cartel price. The first bank to cheat on the cartel will profit the most; the other banks who are colluding know this. As George Stigler concluded in his 1964 paper “The Theory of Oligopoly” as Peltzman and Carlton explain:

…once a price is somehow agreed upon, there will be incentives for individual rivals to cheat on the [collusive] agreement. Whether cheating occurs depends on weighing the profits from not cheating against the profits from cheating and then being detected and having competition break out…

any agreement among sellers cannot ignore the incentives to cheat provided by lags in detection. So understanding when a price elevated above the competitive level can be an equilibrium requires an analysis of the dynamic consequences of cheating versus not cheating…

Collusion over retail banking services and prices faces major hurdles that will lead to most attempts at price-fixing having a short life. These barriers to successful collusion include:

• numerous competitors,
• expansion by the smaller banks were not part of the cartel or cheat on the cartel
• the entry and expansion of new banks,
• the lack of a standard product,  and
• a rapidly changing business environment.

Implicit understandings among the colluding banks may break down owing to conflicts over the most suitable price, the complexities of co-ordinating pricing across a diverse range of banking products, or the simple presence of a maverick bank.

As time passes, destabilising pressures within a banking cartel or oligopoly will build due to long-run substitution and the threat or actuality of entry by new banks and expansion by banks In the competitive fringe, which includes Kiwibank.

The first firm in any market may charge a high price relative to costs, but the entry of one or two more firms usually results in effective competition. Once there are three to five suppliers in a market, an additional entrant has little impact on prices because pricing is already as competitive as it can be.

When ANZ sought to acquire the National Bank of New Zealand in 2003, the Commerce Commission did not oppose this merger. The Commission did not consider that a substantial lessening of competition would follow this merger. The Commission said:

…the merger is unlikely to increase the likelihood of co-ordinated market power in the supply of transaction accounts because the fringe players are likely to provide some competition, the banks have different strengths and weaknesses and in particular ASB is unlikely to have the incentive to participate in co-ordinated power at the expense of its recent growth and customer satisfaction levels.

This analysis of co-ordinated market power applies to each of the relevant markets. Therefore the Commission concludes that the merger is unlikely to result in a substantial lessening of competition in the supply of transaction accounts.

In the supply of mortgages, savings accounts and credit cards the merger is unlikely to lead to a substantial lessening of competition, as in each of these markets, ASB, Westpac and BNZ are likely to provide sufficient competition to the combined entity.

An important driver of a competition in the mortgage market in 2003 was a high incidence of fixed-rate mortgages and the tendency of these fixed rate mortgagees to reconsider all their options at the end of each fixed rate term.

The Commission Commission noted that there was a large re-mortgaging market in New Zealand. Banks offer to do all the work for customers  wishing to switch over bank accounts and direct debit arrangements.

In a very atypical move for a purported cartel, in 2010 the bank owned Payments New Zealand agreed to change over direct debits over automatically when a customer switched banks, which made switching banks even more easier.

At the time of the ANZ and National Bank merger, the Commerce Commission noted that Kiwibank was offering lower rates on its mortgages as a way of gaining a foothold in the market.

The Commerce Commission could not have been more right about the vigour in competition in retail banking with regard to re-mortgaging and switching between fixed and floating mortgages in New Zealand.

As the chart below  of fixed and floating mortgage shares  a New Zealand bank balance sheets shows, there is a rapid exodus from fixed rate mortgages at the time of the Global Financial Crisis.

Source: S8 Banks: Mortgage lending ($m) – Reserve Bank of New Zealand.

I cannot see how any cartel or oligopoly could sustain price-fixing against such dynamic changes in market shares and product switching.

Cartels are is much more difficult to agree when there are many products about which to fix prices and market shares. At a minimum, this rapid movement of customers between mortgage products will sow suspicions that one or more rival banks is stealing customers thereby cheating on the cartel agreement. Not surprisingly, the history of cartels is a history of double-crossing. Banking is no exception.