Thursday, April 19, 2007

Dutch Competition authority moving in on large banks lending... but does so with an completely outdatet mindset

This week the Dutch competition authority has entered the larger banks (without notice) to demand information and archives on price setting in lending for business customers. See the FD-articles (login required; in Dutch). But it is an interesting case they're after. Let me try to explain why.

In older days (more than 20 years ago) the banks used to work with the so-called PD-system. PD stands for Promesse Disconto (Interest Rate for Promissory Notes) and that was an interest rate set by the central bank. Banks would determine the rates on commercial loans by means of a surplus percentage on the PD. So they would agree on an interest rate of PD+1 for example (meaning that if the PD changed, the interest rate for the customer would also). And in this old situation (with no Basle II, with little computing power at hand and little market segmentation), it was not uncommon that for certain classes of companies, a bank would use a similar surplus-rate. So companies would generally face quite similar loan levels. And you could indeed consider the market to be quite homogenous.

Now, today, having had the monetary changes in Europe towards the Euro, there is now mainly the European central bank rates that can be used as a reference rate. And since the changeover to Euro most large banks have devised a system where their local treasuries determine and set a so-called basis-interest rate for their own bank. This rate setting is done based on the ECB interest rate and the liquidity portfolio. So generally, when the ECB moves, the basis-interest rates of large banks are also bound to move (one a bit earlier than the other, but just as with the rain: after it starts, everyone will at some point in time unfold the umbrella).

Now it looks as if the Dutch competition authority has so little understanding of the loans market that they mistakenly still think the old system of 20 years ago is still in place. They appear to be looking at the moves in basic interest rates of banks (set by individual treasuries) and see this as an indication of no competition in the market for loans to businesses.

What are they obviously missing....?
- they think the interest rates displayed by banks (whether basic bank rate or rates for specific loans) are the final ones ; effectively those rates are merely the starting point for negotiations with the companies,
- they forget that we now have something as the internet and a large liquidity in the market, with a lot of banks all competing for the companies;
- they overlook the advances in technology leading to a more differentiated bank assessment of companies
- they forget that banks individual liquidity/risk profiles may be different due to the Basle II implementations chosen, as a result of which it is impossible to assume that as a starting point the cost of capital is equal for all banks
- Bizzner; the new internet based bank from Rabobank; is an initiative that by its sheer existence does not allow banks to extract margins out of this market. Likewise, they overlook the availability of private equity and other sources of funds for companies.

So here we see a nice example of policy intervention and policy analysis based on dogma's from the old world and from the academic books of quite some years ago. And I would personally be quite surprised if they find anything wrong. They didn't find problems in the area of savings (as reported a month ago). And they won't for lending.

What's interesting is that if indeed the basic banking knowledge of our competition authority is as outdated as it seems, they will also be unable to properly assess todays market practices and reality. So they'll spend our tax payers money to discover that they miss the proper expertise and really can't come to terms with the facts they find. I image they will then device a tactical retreat like: stuff was wrong at several banks, but we are going to be so kind not to pursue the matter any further, now that banks have explained what they did and made some adaptations.

And my take on this... ?

Considering that reputation and money are earned slowly and lost quickly (as they say in Spain I believe), it would be best if, at the end of the factfinding, the competition authority would also have the decency to spend a considerable amount of money reparing the damage they do to the image of the banks involved.