Potentially excessive prices and switching costs:
banking cases from Hungary (OTP Bank)
ACE 2007
Bruno Jullien
A case in « Hungarian »
Short but based on economic reasoning (effect based
approach)
I will focus on termination fees (on personal loans) and
ignore « handling fees »
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Summary
OTP former monopoly facing growing competition
The credit market has been growing fast and seems to
stabilize
OTP personal loans : 40-60% contracts (30-40% value)
OTP raises termination fees unilaterally in 2005 (personal
loans, housing loans)
Allowed by regulation, legal requirement fulfilled
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On Banks
Banks are intermediaries that transform deposits into loans
Complex activity: mutualization/ risk management / moral hazard / adverse
selection
Heavy regulation
Contractual relationships
The rates on one side are related to rates on the other side
Deposits and credit rates are jointly determined
There are switching costs
Financial cost
Bundling loans and deposits → transfer costs
Relationship banking based on learning and information : raising competition
may lead to more relationship banking (flight to captivity).
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Termination fees
Early termination is a disruptive action
Profit = flow of interest received on loans - flow of interest paid on deposits
Securing regular flows is important
If a credit R is repaid, the bank will have to lend R again to secure a new flow
r per month → this is costly (direct costs, rate risk due to arbitrage)
If there is an unexpected increase in the flow of termination, the cost
increases, the bank can then
Raise termination fees
Raise interest on loans (risk premium)
Reduce interest on deposits (saving rates)
The bank may rebalance the tariff if the market conditions changes
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Is an increase in termination fee
exploitative ?
Trade-off on the credit market between incentives and insurance
Termination fees induce consumers to internalize the cost of
termination
Risk premium allows to share the risk
If the risk is aggregate (refinancing rates, TF seem appropriate).
The market has a two-sided market characteristic
Effect of termination fees / credit rates on the saving rates should be
assessed
If the retail deposit market is competitive, this is a transfer from
borrowers to depositors but there is no global harm to consumers
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Market assessment
An “effect based” approach
No real assessment of a “relevant market”
Substantial switching costs, high market share for OTP
But evidence of competition on the credit market
Unilateral changes of contract
Lack of information due to inadequate regulation, lack of market transparency,
switching costs
The text establishes that there is
No significant market power on the credit market
But “SMP toward their locked-in consumers….”
No discussion of the saving side
But no assessment of the elasticity of termination to the fee
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Economic theories of abuse
with switching cost
No excessive price (similar to competitors → alignment)
Exclusionary abuse
The firm obtains a large market share during the growth stage (low switching cost
so moderate competition)
Then demand stabilizes, the firm increases switching costs, which prevents
others to “poach”
Here this has been ruled out because there is little market power, small
numbers of contracts
But according to the estimate, 33 to 50 % consumers were prevented from
terminating compared to benchmark
Remark: The TF is waived if refinancing by OTP loan
Presented as a sign of exclusion, but could be simply a simplification for the
procedure because loans are negotiated on individual basis : the TF is irrelevant
for the pair Client-OTP.
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Economic theories of abuse
with switching cost
Exploitative abuse
The firm obtains a large market share during the growth stage
Demand stabilizes → the firm balances captive clients and potential
clients, and decides to increase the price
Here the TF is just one component in the total price
This is the view adopted in the text
The increase in price is not an abuse!
but the unexpected change in the contract is an abuse under some
conditions!
lack of adequate information and transparency
Is it assumed implicitly that consumers are irrational?
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The decision is based on finding little effect of TF on the demand for loans
measurement problem creates an illusion as the ex-post individual cost is
observable but not ex-ante cost
Both the benefits of OTP on captive clients and the cost imposed on new clients
are proportional to the probability of termination
Needs to be quantified ? How was it done ?
In the text, the TF is viewed as another price, not as part of a banking contract
No discussion of rebalancing of the rates / counterfactuals
The main motive for raising TF could be to reduce the amount for termination
Pro-competitive effect if termination is not efficient
Strong elasticity of termination ?
There is a tension between treating the TF as a price and the nature of TF
(hence insistence on information)
Does the same reasoning applies for other fees → handling fees ?
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Abuse ?
Regulation or anti-trust
Here the issue is not the price level but the change in contractual
terms
The abuse is: not informing consumers and not giving them
enough opportunity to react
But there is a regulation for information and the firm followed it
Different from no regulation when there is a regulator
Obligation to act beyond regulation ?
There is the common law for contracts
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Exploitative abuses
Regulation or anti-trust
Can AA intervene if there is a regulator?
Yes for exclusionary practices that cannot be addressed by ex-ante structural remedies
But exploitative abuses ?
Most economists argue that
Exploitative abuses should be the exception
Difficulty in defining “normal prices”
Effects of prices on entry , Motor of innovation and growth
Ex-post monitoring for remedies
Remedies should be structural
When there is a regulator, “excessive prices” should be left to regulators
Little on non-price abuses
Little on how to discipline regulators with different agendas
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Remedies
The remedy has two dimensions
1.
Correct for the “inadequate” regulation by imposing a structural remedy
2.
Compensate the consumers
If the facts are established, the structural remedy seems to generate an
improvement for the sector, but
But the decision creates jurisdiction conflicts
Regulator uncertainty / regulatory squeeze
It would be preferable to convince the regulator to change the rules
There is no fine, but the authority decides on the consumers’ compensation
All the decisions are concentrated in the hand of the same entity
This has a flavor of ex-post price regulation
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Conclusion
The existence of a market failure is not sufficient to establish an
abuse:
How to draw the line with effect based approach?
Outcome would most likely differ with a relevant market
definition and dominance test (compatibility with art. 82?)
Lack of an analysis of financial contracts (including rates, fees,
insurance, …), incentives of OTP, business justification (in the handout).
Abuse reduced to “lack of information”, no excessive price
What to do when the regulator is not doing the job?
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