Short-term gain only in removing exit fees

THE removal of exit fees may turn out to be only a short-term benefit to customers, as it will hurt smaller lenders over the medium term.

Dr Henry Ergas said removal of exit fees may mean all banks need to offer higher up-front fees to guard against risks / File

THE removal of exit fees may bring short-term advantage to customers who want to change banks, but is likely to make banking less competitive over the medium term.

The Australian Centre for Financial Studies says the decision to place strict limits on exit fees is the latest of a series of regulatory decisions by the Labor Government that has made life harder for smaller financial institutions.

Small financial institutions, which have to invest much more than big banks in winning each customer, rely on keeping them for years to break even, reported The Australian.

The centre's director, Professor Deborah Ralston, said the clampdown on exit fees followed a series of regulatory interventions that hurt smaller institutions, including the bank guarantees, the collapse of securitisation markets and the banning of ATM interchange fees.

"The major banks grew from strength to strength through the global financial crisis just as the position of their competitors, the second-tier banks, building societies, credit unions and mortgage companies weakened," she said.

Professor Ralston noted that the Government had only charged the major banks 70 basis points to use its guarantee to raise funds, while smaller banks had been charged 150 basis points.

The Reserve Bank's payments reforms, which require that operators show the cost of using a card at the ATM of another issuer, had similarly given customers an incentive to move to larger banks with more ATM outlets.

Deloitte economic adviser, Dr Henry Ergas, said yesterday that exit fees had been introduced into the Australian market by new entrants so that they could eliminate up-front payments and offer a better deal over all.

He said exit fees boosted competition by increasing the value to institutions of acquiring a customer.

Exit fees also reduce the risk that an institution will lose its good customers, but be left with the bad ones.

"At the outset, when a bank takes on a customer, there is some uncertainty about the customer's future income trajectory and what the future value of the asset against which they are lending," Dr Ergas said.

"The lower the switching cost to good customers, the greater the risk that the bank will be stuck with the lemons."

The result would be that everyone has to offer higher up-front fees to guard against this risk, he said.

"Eliminating exit fees is a two-edged sword," he said.

Read more about small lenders at The Australian.