We’ve ourselves to blame for paying banks too much

No one is forcing borrowers to be gouged. There are plenty of alternatives.

Loyalty to the big four banks is a tax on our stupidity, writes Adam Creighton. Picture: AAP

The ritual flaying of the big four banks following a Reserve Bank decision to cut interest rates is tiresome. Sure, they have market power and still manage outsized profits even after paying out many millions in bonuses. But no one is ­forcing borrowers, new or existing, to be gouged. There are plenty of alternatives.

The “loyalty tax” really is a laziness tax or, if we’re completely honest, a tax on our stupidity.

The banks passed on about half the RBA’s latest 0.25 percentage point cut in the ­official interest, prompting condemnation from the Prime Minister down.

But if people don’t like it, they can change lenders. For what is the biggest expense of most households’ lives, a few phone calls shouldn’t be such a huge barrier to savings thousands of dollars.

Moreover, if we’re going to maintain the pretence of a free market, banks are perfectly entitled to pass on as much as they want of any rate cut. There’s no law that says they must follow the RBA, which is one of many influences on their cost of funds.

The stupidity tax is a substantial impost on economic efficiency, though. On home loans alone it raises $6.3bn a year, given the ­Reserve Bank and Australian Competition & Consumer Commission reckon existing borrowers pay 0.35 percentage points more on their loans compared with new borrowers. More than $1.8 trillion in home loans are outstanding.

That’s a lot of money that could be spent instead on goods and services people really want.

According to the Productivity Commission’s inquiry last year into the financial system, 28 per cent of borrowers are paying the standard variable home loan rate — 4.94 per cent — or even more, despite the fact numerous lenders are offering rates below 3 per cent. Even on a $500,000 home loan, that’s a $1200 a month potential saving.

Remarkably, about 2 per cent of new borrowers were paying more than the standard variable rate. Who are these people? They were unlikely doctors and lawyers, who paid about 0.20 percentage points less on their mortgage than widows for the same loan, on the commission’s figures.

Consumers search for the cheapest petrol, understandably complain about power costs, and cut back on coffees but ignore enormous potential savings on their biggest outgoing. Penny proud, pound foolish, my grandmother said.

Last week I pointed out the big four banks were charging between 1000 per cent and 2000 per cent more for retail foreign currency exchanges than their smaller rivals, amounting to between $500m and $1bn a year in “stupidity tax”. They make a lot more out of credit cards. If you put all your ­expenses on credit cards to accrue frequent flyer points and avoid paying a cent of interest, spare a thought for your benefactors: the 1.9 million people regularly paying credit card interest.

For all the chatter about “zero interest rates”, average credit card rates have increased to an average of 19.94 per cent in recent months. Paying interest on credit cards must rank among the most stupid financial acts. Balances totalling $32bn were incurring interest as of July — about $500m a month in stupidity tax. The tax looms even larger in superannuation, where it raises more than $10bn a year, given $2.8 trillion in super assets are being managed at an annual cost of more than 1 per cent.

During a speech I gave on superannuation at a large fund manager recently, I asked the ­financially savvy audience to raise their hands if they knew, within plus or minus 10 basis points, how much they were paying in super fees. Only one put her hand up. Most people at least know what their monthly mortgage ­payment is.

While banks are the biggest beneficiary of the stupidity tax, it is levied heavily throughout the economy. Consider over-the-counter medicines. Status-conscious headache sufferers who buy Panadol ($3.70 for 20 tablets), rather than Coles paracetamol (70c) pay 430 per cent more for products with the same ­active ingredient: 500m of paracetamol.

Throughout the supermarket, home-brand groceries are typically little different from branded alternatives despite significant price differences.

The assumption consumers are rational underpins economic theory. But the presence of large numbers of unsophisticated consumers means prices often don’t reflect costs, according to Harvard economists David Laibson and Xavier Gabaix. And it creates a permanent subsidy to the smart from the not so smart, as businesses take ­advantage of customers’ laziness and ignorance.

“Competition will not induce firms to reveal information that would improve market efficiency. Firms will not educate the public,” they write in their famous 2006 ­article on the pervasiveness of “shrouded prices” in the Quarterly Journal of Economics.

They use the example of hotels, which routinely set room rates below the cost of supplying them in the knowledge travellers will be stung by their startlingly high “shrouded” prices for add-ons (minibar, laundry and so on). But sophisticated consumers avoid such add-ons, enjoying a lower room rate.

Distorted prices that fleece the less intelligent become the norm. “ ‘Debiasing’ a consumer improves consumer welfare, but no firm can capture or even partially share these benefits,” they write.

“Educated consumers prefer to stick with the firms that feature high add-on prices, since these firms have loss-leader base-good prices, and the educated consumer can partially substitute away from the overpriced add-ons,” they conclude. Anyone who has bought $2 milk at Coles or Woolworths and the rest of their groceries at Aldi understands the point.

Parliaments can’t legislate for the smarts but they should require transparent pricing or provide benchmarks to help customers choose. In the new year the average mortgage rates actually being charged will be unveiled, sliced and diced by type and size of loan, by the Australian Securities & Investments Commission in new data that should prompt many borrowers to refinance.

In the meantime, do your bit for economic theory and shop around. As a rule of thumb, if you’re the customer of a big bank, telco, supermarket, you’re paying more than you could be. They are big for a reason.