Be careful what you wish for on exit fees
|Terry McCrann | Herald Sun | November 09, 2010
It looks so obvious. And easy. Abolish, reduce or limit so-called ‘exit fees’. What you pay to terminate your mortgage early. But usually payable, only very early, like in the first four years of a mortgage.
It might appear to get to the heart of the problem. You are unhappy with Bank A putting up its mortgage interest rate; you want to move to Bank B; but that exit charge might wipe out the benefit.
So if there’s only a low exit fee, or better still no exit fee, people will be — literally — free to move.
To, as the prime minister creatively put it, take their money and go elsewhere. Actually with a loan, it’s not your money.
First little problem. If there are no longer exit fees, there will be — or should be — entry fees. Because that’s exactly what an exit fee is — a deferred entry fee.
In the good old days, you paid up-front when you got your home loan for the costs of establishing — and yes, there are costs to a bank in agreeing to a home loan and setting up — a mortgage.
Then along came the non-banks, and as a competitive lure, they offered low or zero establishment charges, which would be recouped in the interest paid each year over the life of the loan.
Except if a borrower paid the loan out early: hence very big exit fees. Which the banks then followed in order to remain competitive.
You think a $900 exit fee from a bank is outrageous? What about a $12,000 one — which featured prominently in a case a few years ago involving a non-bank? Just to be clear, a non-bank.
So if you abolish exit fees, you might well undermine the very competition that this whole exercise is supposed to be trying to achieve.
There’s not much point doing it, if you enable people to switch from one big bank only to another big bank.
This leads to two other big if less obvious problems with this ‘solution’.
First, switching involves real costs. So the more switching that’s encouraged, the more the cost of banking increases. Somebody has to pay it; and ultimately it has to be the customer — more accurately, some customer, not necessarily the switcher.
More generally, instead of having exit fees paid only by a switcher, you go back to all customers paying it in their establishment charges. Even if most never ‘use it’.
Yes, the payment would be much lower, but why should one customer pay for a service they don’t receive.
In the good old days, banks operated on much fatter interest margins between what they charged home loan borrowers and what they paid on deposits. They covered all the costs of banking in that margin.
We’ve — partly — moved to a fee-for-service model; where a customer pays a specific fee for a specific service.
Which in broad terms is better for the customer and better for the system. And which saw a big drop in those interest margins.
The second concern about abolishing exit fees is the incentive it gives borrowers to chase seemingly low interest rates which might prove to be costly to that customer. Especially if there are entry fees.
You’re unhappy with the CBA’s new rate? You switch to, say, Westpac, and find yourself in a year paying more than the-then CBA rate.
It’s not quite as a dangerous but it’s similar to superannuation portability. You decide to switch from Super Fund A to Super Fund B because it has superior performance numbers.
But they were both yesterday performances. You might switch just as Fund A starts to generate higher returns than B. You could end up continually chasing higher performance only to actually get lower performance.
The critical bottom line in all this is the misperception about bank profits. That they are gougingly high. That the banks can afford to give something back to one set or all of their customers and not aim to recoup the money somewhere else.
While in a perfect world they could give something back, and still generate reasonable returns for shareholders and still be safe, that figure is not huge.
Yes the CBA has just made $6 billion. But that’s on $666 billion of assets. It and indeed all the banks make less than 1 of profit on every dollar of assets.
They don’t have a lot of margin for error. The one thing worse than a bank making too much profit is one making not enough.
Crucially, it’s not just about the banks. The tougher we make it for the banks, the even tougher we would make it for the non-banks.
So the tougher we make it for the big banks, we are likely to create less competition from the non-banks and even the few remaining smaller banks.
This is a much bigger and more complicated issue than simply attacking bank fees and charges. Which is why we need a much broader inquiry into banks and the financial system.
In particular, how to take costs out of the system. How to create real competition.