Competition Assessment Guidelines for Prudential Policy

Competition Assessment Guidelines For Prudential Policy October 2025

1 Competition Assessment Guidelines for Prudential Policy Contents Introduction and purpose _____________________________________________________________________ 2 Why the RBNZ thinks about competition_____________________________________________________ 3 When should competition be a factor in decision making ___________________________________ 8 The ability of businesses to enter, exit and expand into markets 8 The ability and incentives of businesses to compete 9 The ability of consumers to choose 10 Competitive neutrality in markets 10 Considering competition should occur early in the process ________________________________ 11 Other useful concepts ________________________________________________________________________ 14 Fundamentals of competition analysis 14 Appendix A: Questions to consider __________________________________________________________ 16

2 Competition Assessment Guidelines for Prudential Policy Introduction and purpose1 Competition creates incentives for businesses to reduce costs and prices, improve the quality of goods and services and develop and introduce new products, services and technologies. Competition in markets, including banking, insurance and financial market infrastructures, is a key driver for greater value, innovation and productivity, and therefore of better outcomes for New Zealanders.2 Government, through policy, regulation and other actions, can affect the level of competition in markets, and in some regulatory regimes such as that tied to the market for financial services and products, deliberately so. However, while intervention is often motivated by important goals other than the promotion and/or protection of competition, the incentives or ability of businesses to compete may nonetheless be affected with potential consequences for consumers, productivity, growth, efficiency and innovation. Indeed, sometimes it may be necessary to reduce competition to implement a particular policy. This can create a tension between meeting policy goals and maintaining competition in markets. In the case of the Reserve Bank of New Zealand (the ‘RBNZ’) and prudential regulation, while our primary purpose is financial stability, our work may sometimes be to the benefit, or detriment, of competition in the markets we regulate. This can occur through, for example, the licensing hurdles that we impose that permit financial institutions to operate, the standards and other requirements we set, or decisions we take which impinge on the allocation of resources across and within economic agents, sectors and the economy more generally. Our empowering legislation recognises this and requires us to consider other factors (including the desirability of maintaining competition) that may have the effect of acting as a legislative counterbalance to the RBNZ adopting an overly conservative approach to regulation. These guidelines are intended to help those working in prudential policy to factor competition into their analysis from the outset. Early identification of potential competition issues may, where appropriate, allow consideration of alternative approaches to policy and regulatory problems that achieve similar goals but deliver better outcomes in terms of competition. Although developed primarily with prudential policy in mind, much of the analytical framework, principles and process discussed in this document has wider applicability across the work and decisions that the RBNZ makes as well as public policy and regulation more generally. The remainder of these guidelines begin by discussing the importance of competition and its relevance to the RBNZ. Four scenarios where factoring competition into decision making is likely to be particularly beneficial, together with RBNZ specific examples and a potential process, are outlined. The guidelines conclude by introducing some concepts that are fundamental to competition analysis.

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1 This note draws heavily from the Competition Assessment Guidelines produced jointly by the Commerce Commission and the Ministry for Business, Innovation and Employment available here: Competition-Assessment-Guidelines-January-2023.pdf and benefits from discussions with Commerce Commission staff. 2 In the presence of market failures regulation may improve welfare as unregulated markets or competition can lead to inefficient outcomes.

3 Competition Assessment Guidelines for Prudential Policy Why the RBNZ thinks about competition Competition is a means to an end. It is an important process of rivalry that drives efficiencies, delivering improvements in economic welfare over time (Figure 1). There are different types of efficiency (allocative, productive and dynamic) that relate to the process of getting prices closer to costs, lowering costs, and innovation, respectively. Over time these efficiencies increase the benefits (economic welfare) that specific markets deliver for consumers and producers. The RBNZ’s empowering legislation recognises the importance of competition and allows for its consideration as we undertake prudential regulation. The industries we regulate, including deposit taking, insurance and financial market infrastructures, are vital to the prosperity of New Zealanders, with competition in personal ‘banking’ services of particular interest recently. Figure 1: The competitive process

Competition is typically one of the key drivers of well-functioning markets and can contribute to the wellbeing of New Zealanders and the economy by: • encouraging businesses to lower costs and prices and provide a better range of quality products and services to their customers • encouraging businesses to invest efficiently and innovate • empowering consumers by increasing their choice of products and services and encouraging businesses to provide information for consumers to make good purchasing choices • contributing to New Zealand’s economic growth and international competitiveness by encouraging New Zealand’s resources to be used in the most valuable way • constraining market power which can lead to unreasonably high profits for businesses and less choice for consumers • encouraging businesses to invest in sustainable inputs and employ environmentally friendly production methods if they can gain a competitive advantage by doing so, for example to meet consumer demand for environmentally-friendly products or services or to cut costs • encouraging a range of businesses to thrive, including those that meet the needs of new or different consumer groups, for example, Māori, Pacific and other ethnic communities, improving efficiency and leading to increased economic welfare.

4 Competition Assessment Guidelines for Prudential Policy The Commerce Commission recently concluded a market study into personal banking services in New Zealand.3 The study highlighted a number of competition concerns and made specific recommendations to improve competition. Findings of note included that: • the four major banks do not face strong competition and Kiwibank is not of sufficient scale to consistently act as a competitive constraint (not withstanding that, in addition to licensed deposit takers there are many other banks also operating in New Zealand, to varying degrees, that are not required to be licensed/registered) • banks’ customers appear to be sticky, being more likely to add new products and renew services with their existing provider, and face barriers to switching • there is limited investment in innovation by the major banks plus Kiwibank • some groups find it difficult to access personal banking services • the overall regulatory burden on providers of personal banking services is high and is a constraint on growing competition • regulatory requirements impose substantial fixed costs, limiting the ability of the smaller banks, non-bank deposit takers (NBDTs) and fintechs to compete due to lack of scale. Prudential policy and regulation has the potential to influence outcomes such as these. As well as other specific measures, the Commerce Commission therefore recommended that the RBNZ broaden the way it undertakes competition assessments under the Deposit Takers Act 2023 (DTA) and place more focus on reducing barriers to entry and expansion in the banking sector. In addition, the Commission recommended the RBNZ place greater emphasis on competition in specific upcoming decisions. The RBNZ’s powers, duties and functions are governed by relevant legislation, while the Financial Policy Remit, issued by the Minister of Finance, specifies or provides for matters that the Minister considers are desirable for the RBNZ to have regard to in relation to our financial stability objective. This legislation does indeed allow, and in fact requires, consideration of competition together with other important issues which may not always complement each other. One of the purposes of the Reserve Bank of New Zealand Act (RBNZ 2021 Act), outlined in section 3(b) is to promote the prosperity and well-being of New Zealanders and contribute to a sustainable and productive economy with a financial stability objective, outlined in section 9(1)(b), of protecting and promoting the stability of New Zealand’s financial system which sits across all our sectoral legislation. For instance, while the primary purpose of the DTA, outlined in section 3(1), is to

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3 Further details are available at: Commerce Commission - Market study into personal banking services

5 Competition Assessment Guidelines for Prudential Policy promote the prosperity and well-being of New Zealanders and contribute to a sustainable and productive economy by protecting and promoting the stability of the financial system one of the principles to be taken into account, outlined in section 4(b) is the need to maintain competition within the deposit-taking sector. The DTA includes a number of other principles. These principles may, or may not, complement competition or indeed each other, depending on policy objectives, time-horizons and other factors. The other principles are the desirability of: • section 4(a)(i): taking a proportionate approach to regulation and supervision • section 4(a)(ii): consistency in the treatment of similar institutions • section 4(b)(iii): the deposit-taking sector comprising a diversity of institutions to provide access to financial products and services to a diverse range of New Zealanders • section 4(c): the need to avoid unnecessary compliance costs. Similarly, the Insurance (Prudential Supervision) Act 2010 (IPSA) and the Financial Market Infrastructures Act 2021 (FMIA) contain the following relevant purposes and principles respectively. IPSA: • section 3(1)(a) statutory purpose: promote the maintenance of a sound and efficient insurance sector • section 4(g) statutory principle: the need to maintain competition within the insurance sector • section 4(f) statutory principle: the desirability of consistency in the treatment of similar institutions (while recognising that the New Zealand insurance market comprises a diversity of institutions) • section 4(h) statutory principle: the need to avoid unnecessary compliance costs. FMIA: • section 3(1)(a) statutory purpose: promote the maintenance of a sound and efficient financial system • section 3(1)(d) statutory purpose: promote and facilitate the development of fair, efficient, and transparent financial markets • section 13(2)(a) statutory principle: the importance of recognising that FMIs can have a key role in maintaining a sound and efficient financial system • section 13(2)(e) statutory principle: the importance of recognising the diversity of FMIs and of taking into account the circumstances of particular FMIs (while recognising the importance of consistency in the treatment of similar FMIs) • section 13(2)(f) statutory principle: the need to avoid unnecessary compliance costs and unnecessary constraints on innovation. Finally, the 2024 Financial Policy Remit discusses the desirability of the Reserve Bank having regard to competition: The Government regards competition in the financial system as a key priority to deliver better customer outcomes. As part of promoting this objective, the Reserve Bank should ensure that prudential regulation and supervision do not impede effective competition and facilitates the goal of improving competition, while remaining consistent with the financial stability objective.

6 Competition Assessment Guidelines for Prudential Policy In taking account of competition within the context of the legislative framework, the Reserve Bank should consider how its regulations can be used to reduce barriers to entry and exit. Regulatory settings should enable competition from growth of smaller players by seeking a proportionate approach to regulation. On the face of it, one might consider that having regard to various other statutory purposes and principles that sit across our suite of sectoral legislation, such as efficiency and competition, could reduce financial stability. Given financial stability is our primary purpose, and appropriately so for a prudential regulator, this may nevertheless risk competition and related considerations being underweighted during the policy process. However, in many situations this outcome is by no means clear, and complementarities between financial stability and competition can exist. For instance, while on the one hand we may consider that greater competition in banking might lower profits and the ability of banks to weather shocks (therefore diminishing financial stability), lower associated interest rates that typically accompany a negative economic shock may reduce default risk.4 A financial stability frontier provides a framework for thinking about the relationship between two important enablers of prosperity and wellbeing – financial stability (resilience) and competition and is illustrated in Figure 2. Figure 2: Financial stability frontier Resilience and competition are shown on the vertical and horizontal axis respectively. Both resilience and competition are enablers of a productive and sustainable economy, and so we prefer to have more of both factors, all else equal. The thick dark line represents the financial stability frontier, which are the limits of what our financial policy can achieve at a given point in time (though over time it is optimal that the frontier shifts outward, allowing better outcomes for both resilience and

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4 For more on the relationship between financial stability and competition see, for example, OECD (2011) “Bank Competition and Financial Stability”.

7 Competition Assessment Guidelines for Prudential Policy competition). When on the financial stability frontier, gaining either more resilience or more competition involves accepting a lower amount of the other. However, when inside the frontier it may be possible to achieve more competition without sacrificing resilience, and vice versa. Three examples illustrate the potential substitutability and complementarities of differing financial policy settings. Moving from point A (a point inside the financial stability frontier) to point B (a point on the financial stability frontier) is a situation where our financial policy can improve both resilience and competition. Moving from point C to point D involves giving up a lot of resilience in the financial system for a small amount of additional competition, which may be considered unattractive to accept. Moving from point E to point F involves gaining a small amount of additional resilience in the financial system but results in an unacceptably low amount of competition. A recent example of where we were able to improve both competition and resilience relates to the activation a new macroprudential tool, Debt-to-Income (DTI) restrictions, as a guardrail to reduce boom-bust cycles in mortgage lending and asset prices. Having both DTI restrictions and Loan-to￾Value (LVR) restrictions means that we can better focus each tool on the risk it was designed to manage. Activating the DTI tool enabled us to ease LVR settings, resulting in more efficient use of these tools while retaining a similar amount of system resilience.

8 Competition Assessment Guidelines for Prudential Policy When should competition be a factor in decision making Competition assessment is complex. However, initiatives that may affect competition and which warrant close consideration of their competitive effects are those likely to affect businesses and consumers in one of four ways (Figure 3). A particular policy or regulatory initiative may affect competition through a single channel or influence competition through multiple mechanisms. Impacts may differ in the short versus long run, with policies sometimes resulting in a deterioration in competition initially to improve the competitive landscape going forward. The remainder of this section discusses in more detail the types of initiatives that may impact competition. These include initiatives that could impact the ability of businesses to enter, expand and exit from markets, the ability and incentive to compete, the ability of consumers to choose and competitive neutrality in markets. Figure 3: When policy or regulation may warrant closer consideration of competitive effects

The ability of businesses to enter, exit and expand into markets In competitive markets businesses can easily enter, expand, or exit. Businesses have incentives to earn profits by winning and retaining customers. Competitive markets retain these incentives but ensure that businesses cannot earn sustained levels of high profits unless they continue to meet consumer needs. This is because the profits create incentives for other businesses to enter and expand to win their share of the profits and for inefficient businesses to leave the market. Many restrictions on entry, expansion, and exit may fall outside our control, such as requirements for certain types of expensive capital (plant, machinery, buildings, intellectual property etc), the importance of economies of scale, or access issues, for example. Other barriers, however, are more

9 Competition Assessment Guidelines for Prudential Policy likely to be influenced by policy and regulatory decisions and actions such as establishing licence requirements, setting standards or limiting access to necessary inputs and may well be legitimate and imposed for important policy reasons. However, if more stringent than needed to achieve a particular policy goal, these may unnecessarily reduce consumer choice or create artificial scarcity that raises prices. In the case of the RBNZ, many regulatory settings and policy choices have the potential to create unnecessary barriers to entry, exit and expansion. For example, in the pursuit of financial stability, if we impose minimum capital requirements on regulated entities that are too ‘high’ or otherwise stringent or set unnecessarily strict licensing requirements it may be difficult for potential new entrants to meet these. To mitigate possible issues such as this, our proportionality framework attempts to relate regulatory measures to the level of systemic risk that various participants impart on the financial system. With respect to exit and the sectors the RBNZ regulate, there can be substantial negative externalities involved in a firm exiting the market, although we do not run a zero-failure regime. Indeed, some orderly exits from the market are undoubtedly a good thing for both financial stability and competition, if managed well. Here, an effective crisis management framework can help to support competition in the deposit taking sector. By helping to facilitate the orderly exit of failing deposit takers, it can support a more efficient and dynamic sector, where deposit takers can enter and exit the market in a timely and efficient manner and without significant damage to the financial system. Further, well designed licensing processes and requirements can limit the extent to which any crisis management framework may need to be drawn upon. The ability and incentives of businesses to compete Policies and regulations may affect the ability of businesses to compete vigorously in a market and may reduce their incentives and ability to lower prices, increase quality, choice and innovation, or to become more productive. Examples include policies and regulations that specify a minimum quality of goods or standard of service that all businesses must meet. Minimum standards can protect consumers from poor quality goods and services. However, if standards are set too high, they may create barriers for entry, raise production costs or advantage some businesses over others. Other policies may make it easier for businesses to accommodate each other’s behaviour and facilitate conduct such as leader-follower pricing, while some regulatory regimes may impose unnecessarily strict qualification/standards/testing requirements. Such regimes may reduce the ability of businesses to enter or expand in a market and unfairly advantage some businesses over others. The Commerce Commission’s market study highlighted examples from the RBNZ here as well which may act not only as barriers to entry but also limit the ability of some financial institutions to compete on an ongoing basis. One relates to the restrictions that we place on the use of the word bank and how this can make it harder for some to compete. Another is limitations on accessing the Exchange Settlement Account System (ESAS). However, following recent review, revised access criteria has opened ESAS eligibility to more non-bank entities. In terms of incentives to compete, decisions around disclosure regimes and what we do with the information we collect may have the potential to facilitate accommodative behaviour between market participants resulting in worse outcomes for consumers, if not designed well.

10 Competition Assessment Guidelines for Prudential Policy The ability of consumers to choose Well informed consumers, who can easily choose between different options, play a large part in making sure markets are competitive. Consumer choice can provide incentives for businesses to win and retain market share by lowering price and increasing choice, quality, innovation and productivity. Switching barriers can restrict consumer choice by causing consumers to stay with existing businesses even if others are offering better products or services at lower prices. Switching barriers may be due to information asymmetries or complicated, time-consuming and expensive processes for consumers to switch between businesses, such as lengthy contract terms, high cancellation fees and lack of individual data portability. Switching barriers may also discourage new businesses from entering the market, because it is difficult to win customers from existing businesses. In the case of the RBNZ’s role as prudential regulator there are again examples of how our work might influence consumers ability to choose. For instance, decisions around disclosure regimes and what we do with the information we collect can help ensure consumers have the information they need to make informed decisions on their choice of deposit taker, insurer and related products and services. Another example is settings for loan-to-value (LVR) and debt-to-income (DTI) ratios. Depending on how these are implemented they may make some customers looking to switch mortgage providers more or less desirable from a competitor’s perspective, thus affecting their options. High LVR or DTI customers may encounter difficulties in switching relative to their low LVR/DTI counterparts. Policy features that mitigate the impacts on high-LVR/high-DTI customers trying to switch providers include speed limits (these allow a percentage of lending to be above high-LVR and/or high-DTI thresholds), various exemptions, and that LVR and DTI restrictions do not apply to non-bank deposit takers. Competitive neutrality in markets Competitive neutrality means that businesses should be able to compete on their merits without competitive advantages from regulation or government ownership. Policies that favour a particular type of business may reinforce or create advantages for some businesses over others, leading to an unequal playing field for businesses, distorted competition in markets or barriers to new entrants. Each of the DTA, IPSA and FMIA respectively contain principles related to competitive neutrality. Competitive neutrality may be distorted by regulations, such as “grandparent” clauses or subsidies that assist some businesses more than others. Cost advantages to some businesses over others may support businesses that are relatively inefficient to remain in the market and cause otherwise efficient businesses to exit, unless a cost advantage is the deliberate and legitimate intent. A potential example of how the RBNZ might affect competitive neutrality comes from our new depositor compensation scheme (DCS) and the way it is funded by participants. To be competitively neutral, policy and/or regulation should be agnostic with respect to differing business models. With respect to the DCS for example, if levies for participants were set in a way that deviated too far from the expected costs that each participant were likely to impose on the scheme, this could effectively subsidise one business model over another giving a competitive advantage to some businesses over others. Another example could relate to the application of our proportionality framework. If taken too far a ‘proportionate’ approach to regulation, say for example by lowering various requirements and standards for Group 3 deposit takers because of limited systemic importance, may act as a subsidy to this group, providing a competitive advantage.

11 Competition Assessment Guidelines for Prudential Policy Considering competition should occur early in the process The process illustrated in Figure 4 and described below may assist in the consideration of competition early in the development and review of policy and regulatory initiatives and actions with the potential to materially change markets. Appendix A provides a list of questions to consider which may prove useful when undertaking analysis. Figure 4: A process for considering the competition effects of prudential policy

Step 1: Identify the policy goals Identify the policy goals to be achieved to inform the assessment process. In some cases, a policy project will be looking at fundamental issues of existing legislation (or, rarely, proposing new legislation). However, they are often more targeted in their nature and seek to address specific concerns that have been identified with existing primary or secondary legislation. In either case, there will likely be clear policy goals behind the proposal. Earlier in this document we discussed the overarching purposes of the DTA, IPSA and FMIA and various principles that might be taken into account as part of this process. Step 2: Assess the impact of the policy options on competition The next step is to identify if, and how, the policy options or regulatory initiatives are likely to affect competition, including through analysis as well as consultation on potential competition implications of policy proposals. If any competition issues are identified, further analysis may be required.

12 Competition Assessment Guidelines for Prudential Policy All our sectoral prudential legislation requires the RBNZ to consult with affected parties. Feedback from stakeholder engagement is a valuable input into this assessment of any policy initiative’s impact on competition, so long as the consultation document is written in a way that best supports this feedback. The DTA also requires us to specifically consult CoFR agencies, placing an explicit obligation on the RBNZ to engage with New Zealand’s competition authority, the Commerce Commission. This engagement, alongside the feedback from other CoFR members provides another opportunity to test our assumptions and analysis of the impact on competition arising from any regulatory initiative. The RBNZ is also required to produce an assessment of the regulatory impact of any prudential policy under section 255 of the RBNZ Act. As part of these impact statements, the RBNZ must summarise how competition (and other considerations) has been taken into account in the finalised policy or regulatory initiative. Section 256 details the specific requirements of a regulatory impact assessment. It is therefore important that competition analysis is conducted early to help inform this cost-benefit analysis. Step 3: Identify alternative approaches to address policy goals, if necessary If no material negative effects on competition are identified the process can conclude here. However, if any parts of the initiative are likely to negatively impact competition, consider whether there are less restrictive alternatives or other mitigating measures that could be put in place. Further consultation may be required, which could include an indication of the potential magnitude of any adverse competitive effects (e.g. a sense of the magnitude of an additional cost relative to business size for different types of deposit takers). If it is not possible to achieve the policy or regulatory goal (or tangible outcome) without some restriction or distortion to competition, it might be possible to adopt feasible alternatives that reduce and minimise the identified negative impact on competition. The Commerce Commission provides examples of less restrictive alternatives for a general suite of policy and regulatory goals affecting competition.5 With respect to competitive neutrality for instance, the Commerce Commission gives the example of ‘grandparent’ clauses that reward existing businesses, by allowing them to operate under old rules, at the expense of new entrants. The Commission suggests that any ‘grandparent’ clauses should be time limited, or better still, that transition periods requiring ‘grandparent’ clauses be avoided. Step 4: Implement the best alternative Where possible, adopt the option that achieves the policy goal while minimising negative competition impacts or distortions, where it is feasible. This should be done in a way that is consistent with the relevant statutory purposes and principles of the RBNZ Act, DTA, IPSA and FMIA. Consistency with these purposes and principles may sometimes mean that the original option must be implemented over alternatives, even if competition is negatively affected. Where this happens, the regulatory impact analysis should make these trade-offs transparent. Step 5: Monitor and review Once implemented, monitor the initiative to understand the intended and unintended effects on competition in the relevant markets. Consider whether amendments should be made. A review may also be necessary to consider new technological or economic developments.

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5 Competition-Assessment-Guidelines-January-2023.pdf

13 Competition Assessment Guidelines for Prudential Policy Note under section 255(1)(b) of the RBNZ Act the RBNZ must assess the regulatory impacts of the policies adopted and applied under prudential legislation at intervals appropriate to the nature of the policy being assessed.

14 Competition Assessment Guidelines for Prudential Policy Other useful concepts Competition analysis is highly complex. Policy can affect competition through multiple channels, often simultaneously, and those effects can be different in the short versus long run. To complicate matters further, there is no one single measure of competition, such as the number of firms operating in a market. Similarly, there are many ways competition may be enhanced, notwithstanding that the overarching reason competition is desirable is to drive efficiency to increase economic welfare and promote better outcomes for consumers over time. Although by no means exhaustive, to help navigate this complexity, some concepts and measures that are fundamental to competition analysis are outlined below. Depending on the issue being considered some of these will be more relevant than others to any competition analysis undertaken. Similarly, different measures and outcomes may be more amenable than others to influence by the RBNZ as regulator. Fundamentals of competition analysis The factual and counterfactual - at its core, competition analysis is forward looking and entails comparing the likely state of competition between two future states of the world. These are known as the ‘factual’ and ‘counterfactual’. In terms of analysing the competition effects of a particular policy or regulatory initiative, the ‘factual’ is the future state where that policy or regulatory initiative goes ahead. The ‘counterfactual’ is the future state of the world where it does not. Market power and profitability – the ability to raise price above the price that would exist in a competitive market (the ‘competitive price’) or reduce non-price factors such as quality or service below competitive levels. Firms that possess market power consequently earn significant profits (or above-normal economic profits), potentially exhibiting relatively high price-cost margins and returns on equity or assets. Market definition – relevant markets for competition analysis can be much narrower or broader than the ordinary use of the term “market”. A market is defined in the Commerce Act as a market in New Zealand for goods or services as well as other goods or services that are substitutable for them as a matter of “fact and commercial common sense”. In general, the more closely substitutable two products or services are, the closer the competition and the greater the competitive constraint between those products. Identifying products and services in a relevant market can be complex, potentially involving the assessment of substitution possibilities by both customers and suppliers across up to five different dimensions. These include the products or services supplied, geographic area, position in the supply chain, customer type and time period within which the market operates. The Commerce Commission uses something called a SSNIP test to aid in market definition, where SSNIP refers to a small, but significant, non-transitory increase in price – generally 5%. Across the above dimensions, one considers if prices increased, whether: • customers would switch sufficient purchases to alternative products, services or locations (customer or demand-side substitution) • firms would easily, profitably and quickly (generally within one year) switch production to the products, services or locations in question without significant cost (supplier or supply-side substitution)

15 Competition Assessment Guidelines for Prudential Policy If the answer is yes, then the products, services, firms etc in question are likely to be considered as belonging to the same market and any change to that market that leads to a SSNIP would constitute a substantial lessoning of competition. Concentration and market structure - once the relevant (or affected) market has been clearly defined, we can look at variables that describe the structure of this market. For example: • Number of firms: In general, the larger the number of firms in the relevant market, the lower the concerns about market power. However, a small number of firms (or high concentration) is not necessarily bad for competition and depends on the magnitude of the barriers-to￾entry, contestability and the type of competition that prevails. • Size distribution of firms: Compared to markets populated by relatively equal sized firms, a highly skewed size distribution, has potential implications for the market’s competitiveness. It may well be the case that a dominant firm that faces no effective competition from the firms at the fringe wields significant market power. • Concentration of output: This measures the extent to which production is concentrated in the hands of a few firms in the market. Higher concentration of output, in general, is expected to lead to a greater likelihood of market power with implications for higher prices paid by consumers. A simple measure, for example, is the share of total sales that is accounted for by the 3 or 4 largest firms in the market (known as a CR3 or CR4 ratio). The measure that is typically used by competition policy authorities, is the Herfindahl-Hirschman Index (HHI). A larger HHI indicates greater concentration of sales (or production capacity) in the hands of a few firms. In combination, these variables can be used to get a broad picture of the structure of relevant markets, allowing judgments about relative competitiveness.

16 Competition Assessment Guidelines for Prudential Policy Appendix A: Questions to consider

1. What are the goals of the proposed policy / regulation?
2. What is the likelihood that intervention will achieve those goals and over what time horizon?
3. What markets might be impacted?
4. What is the state of competition in the future likely to look like in these markets if the proposed policy / regulation is implemented (the factual)? How does this compare to the likely future state of competition where the policy / regulation is not implemented (the counterfactual).
5. Is the proposed policy / regulation likely to affect the ability of businesses to enter, exit or expand into markets? If so, in what way?
6. Is the proposed policy / regulation likely to affect the ability and incentives of businesses to compete? If so, in what way?
7. Is the proposed policy / regulation likely to affect the ability of consumers to choose? If so, in what way?
8. Is the proposed policy / regulation likely to affect competitive neutrality in markets? If so, in what way?
9. What is the likely magnitude of any competition effects? How might these be measured?
10. If competition is impacted in one or more ways, do the effects differ in the short vs long run?
11. Are other regulatory principles, besides those related to competition, affected by the proposed policy / regulation? If so, how should these effects be weighed against competition?
12. Are there alternative policy or regulatory tools that could be implemented to mitigate any negative impacts on competition? To what extent will the effects on competition be reduced?
13. Do the alternative policy or regulatory tools risk the effectiveness and / or timeliness of achievement of policy goals?