ACE 2007

1. Potentially excessive prices and switching costs: banking cases from Hungary (OTP Bank) ACE 2007 Bruno Jullien

2. 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 »

3. 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

4. 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).

5. 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

6. Is an increase in termination feeexploitative ? • 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

7. 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

8. 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 increasesswitching 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.

9. 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?

10. 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 ?

11. 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

12. Exploitative abusesRegulation 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

13. Remedies • The remedy has two dimensions • Correct for the “inadequate” regulation by imposing a structural remedy • 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

14. 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 hand-out). • Abuse reduced to “lack of information”, no excessive price • What to do when the regulator is not doing the job?