The Financial System Inquiry interim report describes Australia's banking market as relatively concentrated by international standards, with the level of concentration increasing since the GFC.The major banks' share of total authorised deposit-taking institutions' assets increased to 78.5 per cent in March 2014, from 65.4 per cent in September 2007. One suggested reason for the increased concentration is that, since the GFC, the major banks have benefited from better access to funds and lower funding costs than their competitors. These two advantages have allowed the major banks to grow faster.Nevertheless, the FSI finds that the banking sector is competitive. The net interest margins of the major banks are mid-range by world standards and return on equity is comparable with that of other large Australian companies.In addition, customer satisfaction with the major banks has increased since 2001 and is now at record highs. Total fee income has also fallen since 2000 but while households are paying less, businesses are paying more. But what about the competitors of the major banks, the smaller ADIs? The FSI doesn't say much about them.The Customer Owned Banking Association said it welcomed aspects of the interim report but that it fell short on competition in banking. "Fair and sustainable competition in the banking market is not possible when the regulatory framework advantages only the biggest players," COBA saidThe FSI acknowledges that "the application of capital requirements is not competitively neutral. Banks that use IRB [internal ratings-based] risk weights have lower risk weights for mortgage lending than smaller ADIs that use standardised risk weights, giving the IRB banks a cost advantage." Indeed, the average risk weight for residential mortgages under the IRB approach earlier this year was just 18 per cent. For other ADIs that must use the standardised risk weight, the weighting was 39 per cent.The FSI estimates that all else being equal, this amounts to a cost of capital advantage of 23 basis points for the major banks. The FSI goes on to say that it considers smaller ADIs most likely face a disadvantage due to the differences between standardised risk weights and risk weights determined by IRB models. However, the extent of the disadvantage would be difficult to determine and would vary between ADIs over time, depending on the riskiness of their assets.The FSI asks whether the following changes should be considered as policy options:•    No change to current arrangements.•    Assist ADIs that are not accredited to use IRB models in attaining IRB accreditation•    Increase minimum IRB risk weights•    Introduce a tiered system of standardised risk weights•    Lower standardised risk weights for mortgages•    Allow smaller ADIs to adopt IRB modelling for mortgages onlyAs for the cost of debt, the FSI states that "the major banks have lower wholesale funding costs than their smaller competitors".  This funding advantage could be a natural consequence of their size and a perception that the major banks are too big to fail.The FSI believes that it is difficult to estimate the size of any funding cost advantage that the perception of being