Review of the Reserve Bank of Australia and Payments System Board Annual Reports 2005

In recent times the Reserve Bank of Australia (RBA), in its regulatory role, has been particularly keen to ensure that the payments system is both efficient and competitive. According to Dr Philip Lowe, Assistant Governor (Financial System), the RBA has assessed a number of conditions in pursuing the goals of efficiency and competition:

• relative prices reflect the relative resource costs;
• merchants are free to choose the price they charge for accepting payment instruments and are free to choose which instruments they accept;
• prices are transparent;
• restrictions on access are limited to those strictly necessary for the safe operation of the system; and
• there is competition within and between individual payment systems.¹

Since 2000, the RBA has determined that the Australian payments system does not meet all of these conditions. Therefore, they have embarked on a series of reforms, which aim to rectify the areas of concern. The reforms have generally focussed on two key areas:

• The promotion of price signals to users of payments services that encourage efficient payment choices … [which] has largely, although not exclusively, involved the regulation of interchange fees; and The removal of various restrictions in the payments system that effectively limit entry and stifle competition. ²

2007 review of RBA reforms

The RBA has indicated that it intends to review its payments system reforms in 2007:

When the credit card interchange fee reforms were introduced we indicated we would do a review of how things had gone four or five years afterwards. That is what we are planning to do. ³

Some groups, however, question the appropriateness of the RBA reviewing its own reforms. They instead suggest that the 2007 review should be conducted by an independent body. For example, the Australian Bankers Association stated:

The [banking] industry is advocating that the scheduled 2007 review of payment systems reforms is undertaken by an organisation independent of the reform process so far, such as the Productivity Commission. ⁴

Committee conclusions

Reducing four-party scheme interchange fees

The RBA stated that its interest in the credit card system stems from:

The observation that from a cardholder’s perspective, credit card transactions are typically priced much more attractively than EFTPOS transactions. ⁷

From the RBA’s perspective:

This appeared to be somewhat paradoxical, given that the EFTPOS system has substantially lower costs of operation than the credit card system. ⁸

The RBA also noted that:

Cardholders who use credit cards purely as a payment instrument contribute least to the cost of credit card schemes and, in some cases, are effectively paid to use credit cards. ⁹

The reforms, according to the RBA, have:

• Cut the average interchange fee by around 40 basis points. Now when $100 is spent on a credit card the issuer gets, on average, around 55 cents, rather than around $1. The interchange fee has remained as a percentage of the transaction value.
• Also passed through to merchant service fees. The average fee is now a little under 1 per cent, compared with nearly 1½ per cent in early 2003 and around 1¾ per cent in the late 1990s. ¹³
• Saved merchants and their customers around $580 million. ¹⁴

Arguments against the RBA position

Savings have not been passed on to consumers

The removal of restrictive rules would have been sufficient

Some groups argued that the removal of the no-steering provisions, the honour-all cards rule and the no-surcharge rule would have been a sufficient solution to the RBA’s concerns—in other words, they argue interchange fee reform was unnecessary. The ABA, for example, stated:

If you can improve access so that people can access the system more easily—remove unnecessary restrictions and allow surcharging by merchants—we would ask whether we really need to cost base regulate the interchange fees. ²¹

In response to these claims, the RBA made three points:

The first is that interchange fees are not subject to normal competition, the second is that the EFTPOS system is a lower cost system—yet the configuration of interchange fees discourages the use of EFTPOS—and the third is that surcharging was unlikely to become sufficiently commonplace to send the appropriate price signals to card holders. ²²

The costs included in the cost-based methodology are flawed

The ABA argued that the costs included in the cost-based methodology that the RBA has used to calculate interchange fees are flawed:

The range of eligible costs allowable by the Reserve Bank is arbitrary and excludes costs that would normally be considered legitimate costs, such as the cost of capital … Without a strong academic underpinning, the cost based methodology used by the Reserve Bank will remain vulnerable to arbitrary change. For the banks this means continued uncertainty. ²³

ANZ Bank were equally critical of the eligible components which make up the cost-based formula:

Costs of running the system, including statement production and distribution, operating risk capital, risk assessment, payment processing, card plastic, except for lost or stolen cards, core operating system costs and a return on the cost of capital invested in providing the system and regulatory and compliance costs [are] no longer eligible to be recovered from merchants [through interchange fees]. ²⁵

The effect of the reforms has been ‘neutral’

Prior to the reforms, Professor Joshua Gans argued that the RBA’s interchange fee reform would have a ‘neutral’ effect:

What neutrality means is that even were the interchange fee to change dramatically, other prices in the system would adjust (particularly if surcharging was permitted) so that consumers and merchants faced exactly the same decision regarding whether to make use of credit cards or not. For example, a lower interchange fee would tend to lead to increased card fees for consumers (and lower loyalty rewards). However, it would also lead to a lower merchant service fee. So merchants would be more encouraging of consumers to use cards to offset the direct impact of higher fees on those consumers. In the extreme, these changes would balance out and we would see little change in historic patterns of card use. ²⁷

Three-party schemes have been given a competitive advantage

Interchange fees should be set at zero

Reduced interchange fees result in reduced incentive to invest

Committee conclusions

Non-designation of three-party schemes

As mentioned above, three-party card transactions do not involve interchange fees. Therefore, the three-party schemes have not been subject to the RBA’s reform of interchange fees, nor have they been formally subject to any of the RBA’s recent reforms. There are concerns that because three-party schemes are not subject to fee regulation, they have a competitive advantage. The RBA stated:

The fact that this decline in [three-party schemes’ merchant] fees has been less than that in the credit card schemes has led to periodic calls for the Bank to regulate American Express and Diners Club in the same way as it regulated the other schemes. ³⁰

Furthermore, there has been an evident increase in the three-party schemes’ market share following the reforms of four-party schemes’ interchange fees. Three-party schemes have increased their share from 14.6 per cent to 16.5 per cent.³¹   (see figure 4.1 below)

Source P Lowe, The evolution and regulation of the payments system, Speech to the Payments System Conference 2006, 14 March 2006 .

However, American Express credit cards are now issued by two Australian banks, and therefore some American Express transactions now involve interchange fees. The RBA considered whether these fees should be regulated, but decided that there ‘was not a strong case to do so.’³³ The RBA’s reasoning behind this decision was:

A reduction in these [interchange fees] through regulation would be unlikely to cause a decline in American Express’ merchant fees. This is the contrary of the situation with the credit card schemes where regulation of interchange fees saw merchant fees decline immediately. This difference reflects the fact that … American Express is the sole acquirer of transactions on its cards. This means that unlike in the credit card schemes, the causation runs from merchant service fees to interchange fees, not the other way around. ³⁴

The schemes have, however, agreed to a number of voluntary changes after discussions with the RBA:

In 2002, they agreed to remove the no surcharge clauses from their merchant contracts and in 2005 to remove anti-steering provisions from their contracts. The schemes have also agreed to publish their average merchant fees and their combined market share. ³⁵

The RBA argues that these voluntary reforms have been significant:

As a result of these changes, merchants now have a greater range of options, and better information, when negotiating with American Express and Diners Club. ³⁶

Arguments against the RBA position

Both MasterCard and Visa argued to the committee that the two three-party schemes—American Express and Diners Club—have been advantaged by the regulation of interchange fees. A major concern of the four-party schemes is that three-party schemes’ merchant service fees have fallen by much less than their own. MasterCard highlighted this point, stating:

The average merchant fee payable for a MasterCard or Visa transaction was 0.98% for the December 2005 quarter, down from 1.45% in September 2003 and 1.8% in 1999. In comparison the average merchant fee payable to the unregulated American Express was 2.33% for the same period, down from 2.7% in 1999. The gap between American Express merchant fees and those chargeable for MasterCard, Visa and Bankcard transactions has grown from 0.90% in 1999 to 1.35% in December 2005 or, expressed in a different way, American Express fees are now 138% higher than those applicable to regulated schemes. ³⁷

Visa and MasterCard argued that the three-party schemes’ increase in market share, which some describe as modest, is in fact significant. MasterCard contended:

The combined share of unregulated schemes grew immediately from 13.7% to 16.9%. This represents a shift of more than $4.5 billion in spend from the regulated to the unregulated schemes— costing merchants an additional $63 million in merchant fees per annum. ³⁸

Likewise, Visa asserted:

According to the RBA’s own data, Amex have achieved already around a 20 per cent lift in its market share since the regulations were enacted. Again, a number of submissions presented to the committee identify that this alone is more than a $4.3 billion increase in revenue alone. What is more, it is further $40 million to $50 million increase in merchant service fees, which in some respects are eroding some of the benefits that the merchants have enjoyed from the significantly reduced merchant service fees for Visa and MasterCard. ³⁹

Conversely, the RBA asserted that three-party schemes’ increase in market share has been small, stating:

Our assessment to date—and people present the numbers differently—is that the movements in market share are relatively small. So, despite the more generous reward schemes being offered by some of the cards, there has not been a wholesale migration from the four-party schemes to the three-party schemes. ⁴⁰

The RBA has previously conceded that the reform of four-party schemes’ interchange fees has not necessarily resulted in competitive neutrality:

While in an ideal world regulation would be competitively neutral, designing such regulations is problematic when the various card schemes have different structures and are subject to different competitive dynamics. ⁴²

When asked at what point they would consider that competitive distortions had outweighed the public benefit, the RBA stated:

There is no magic point here. The observation that I would make would be that if the market shares of the three-party schemes were to increase significantly and at the same time … there was no reduction in the average merchant service fee of those schemes, then that would raise the issue of whether the competitive positions of the different schemes were starting to undermine the benefits of the reforms. But you would need to see both of those things, because there is nothing wrong with American Express increasing its market share. That may well be the outcome of a competitive marketplace. It would concern us more if we thought that that outcome was the result of the regulatory reforms, and one sign that that could be occurring is if the average merchant service fee that they charge did not fall any further. ⁴⁵

Overall, the RBA’s approach to the different structures of three- and four-party cards schemes has been:

To focus its efforts on those areas where it has judged that competition is not working appropriately. For the credit card schemes this has primarily involved the regulation of interchange fees, while for American Express and Diners Club it has primarily involved ensuring that merchants are not unnecessarily restricted in their negotiations with the schemes. This approach has delivered significant benefits for consumers, and these benefits are likely to grow through time as merchants use the full range of tools now available to them. ⁴⁶

Committee conclusions

Reducing debit card interchange fees

These arrangements resulted in a 60 cent interchange fee differential between the two systems. The RBA’s concern was:

The structure of [debit card] interchange fees creates a strong incentive for financial institutions to promote the Visa Debit system over the EFTPOS system, despite the EFTPOS system having lower operating costs.

The RBA argued:

If the [debit card] arrangements were to remain unchanged, it is highly likely that the Visa Debit system would grow at the expense of the EFTPOS system, simply because of the structure of interchange fees. ⁴⁸

These reforms will apply to all EFTPOS transactions, except those involving the provision of cash by merchants to cardholders. With respect to this exclusion, the RBA asserted that:

At this stage, the Bank is not convinced that the public interest would be served by regulating these fees, particularly when interchange fees for cash withdrawals through ATMs are not subject to regulation. As a result, issuers and acquirers will be able to negotiate a separate interchange fee for EFTPOS transactions involving the provision of cash. ⁵²

Overall, the RBA argues that the reform of debit card interchange fees:

Will promote competition between the schemes based on the benefits that they offer to cardholders and merchants, rather than on fees that are not subject to normal competitive pressures. ⁵⁴

Arguments against the RBA position

Lower interchange fees for scheme debit will push people to credit cards

The Credit Union Industry Association (CUIA) argued that the imminent reduction in scheme debit interchange fees will push people away from debit cards and toward credit cards:

A cardholder buying a $1000 washing machine with a credit card will earn the card issuer an interchange fee of around $5.50 while a cardholder using a Visa Debit card will earn the card issuer 15 cents.

…

CUIA believes the price signals starkly shown in the above example will push Visa Debit issuers to steer cardholders towards credit cards. ⁵⁵

…

We do not necessarily see that as an efficient outcome for the payment system environment, and we certainly do not see it as being in the interests of the credit union membership in Australia overall. ⁵⁶

In response to these claims, the RBA stated:

One consequence of that narrowing is that, at the margin, building societies and credit unions find it less attractive to issue Visa Debit. At the margin, a few more customers may use credit cards rather than Visa debit as a result of these reforms. But I think the entirety of the package is a set of reforms that will encourage the use of debit relative to credit and it will make sure that the EFTPOS and the Visa Debit systems compete on their merits rather than through interchange fees, which are longstanding and not subject to competitive pressures. ⁵⁸

The costs included in the cost-based methodology are flawed

CUIA agreed that a four-party scheme’s credit and debit transactions should have different interchange fees:

We have agreed from the very beginning that Visa debit should have a distinct interchange fee that should be lower than the credit card interchange fees. ⁵⁹

However, CUIA had concerns as to the level at which the RBA has set scheme debit interchange fees:

We are unhappy, because we think that, if the Reserve Bank has decided that certain costs—which underpin services to merchants which are of some value to merchants, which is what they have done in the credit card area—deserve to be compensated, why would you arbitrarily decide that Visa debit card issuers’ costs do not deserve to be compensated? We think that does not make sense. ⁶⁰

MasterCard shared similar concerns, stating:

By slashing interchange fees on scheme debit cards and not fully recognising the costs associated with issuing such programs, issuers will be forced to charge card holders higher fees for the privilege of accessing their funds while shopping over the internet, over the phone and with more than 24 million merchants. I think the denial of costs related to fraud reduction seem to be counterproductive, particularly in the debit interchange formula that the bank is proposing. ⁶¹

The RBA, in the debit card reforms’ Regulation Impact Statement, defended the level at which scheme debit interchange fees will be set, stating:

The Bank’s approach to interchange fees is not one in which interchange fees are set to recover costs on one side of the system. Rather, the Bank is concerned with the overall effect on the efficiency of the payments system of the configuration of interchange fees across the various individual systems. ⁶²

Interchange fees should be set at zero

Reduced interchange fees result in reduced incentive to invest

Committee conclusions

Are interchange fees unlawful?

The submission of American Express contended:

The multilateral interchange fees (MIF), which are a feature of the MasterCard and Visa card schemes in all countries, have been found by competition regulators in other countries to be unlawful anti-competitive agreements. ⁶³

In rebuttal of this claim, Visa stated:

Regulators in the UK and Australia have expressed concern about the way interchange operates and the level of the interchange fee. They have subsequently either required or negotiated changes to the process of setting interchange fees. However, none of these regulators have found interchange fees to be illegal under any aspect of competition law. ⁶⁴

The Australian Competition and Consumer Commission (ACCC) confirmed to the committee that the setting of four-party schemes’ interchange fees was thought to be in breach of the Trade Practices Act:

The way the fees were set was the issue. ⁶⁶

…

There was a multilateral agreement between banks whereby they would set an interchange fee which had the effect or likely effect of controlling or maintaining the merchant service fee levels. ⁶⁷

However, the ACCC also stated:

We did not have necessarily a problem with the interchange fee system as such and that there were potential public benefits that could result from a proper system being devised. ⁶⁸

Given this statement, the ACCC ‘encouraged the banks to approach [them] for authorisation of an interchange fee system.’ ⁶⁹ However, in 2001 the ACCC concluded that an authorisation was not likely to occur:

It was the Commission’s view that effective and timely reform of the interchange fee system was not occurring. We therefore recommended that the Reserve Bank actually designate and use its powers to reform the system. ⁷⁰

Once the RBA designated under the Payments System (Regulation) Act 1998, the Trade Practices Act 1974 ceased to apply to four-party schemes:

Following the designation of those services by the Reserve Bank, the arrangements behind the interchange regime in relation to both credit and debit card systems fall outside the scope of the competitive provisions of the TPA and, accordingly, fall outside the scope of our enforcement and compliance activities. ⁷²

Committee conclusions

Zero interchange fees

Arguments for zero interchange fees

The AMPF stated that ‘having zero interchange fees would remove any distortion in the payments system and may well avoid a swing to credit cards.’ ⁷³

Mr Peter Mair argued that interchange fees are only necessary in infant systems:

There may be a case for having an interchange fee in the early stages of setting up a payments network but, for a mature payments network like credit cards, BPay or EFTPOS, there is no longer any need for that.⁷⁴

Some of the other proposed benefits of zero interchange fees are:

• Cardholders would be presented with true price signals for each product.
• Zero interchange fees would mean that cardholders are bearing costs, not consumers generally.

The RBA, while not necessarily supporting the concept, commented:

It is an interesting idea and worth further exploration. Of course, we already have zero interchange fees in a number of our payment systems in Australia. In the cheque system there is no interchange fee, in the direct debiting system there is no interchange fee and in exist in some very successful debit card systems around the world. ⁷⁵

Arguments against zero interchange fees

A number of groups were either opposed, or raised arguments against, zero interchange fees. The RBA, for example, stated:

There are solid theoretical arguments as to why non-zero interchange fees might promote the efficiency of the system. There is a large and growing volume of academic literature exploring the rationale for non-zero interchange fees. Many of the points in that literature have merit. ⁷⁷

ANZ Bank commented on the implications of zero interchange fees for cardholders, stating:

Zero interchange would mean credit card holders would likely face increased annual fees, increased interest rates, reduced or no interest-free period (which delivers benefits to card holders and merchants) and curtailed or no loyalty programs. ⁷⁸

CUIA criticised the proposal as an attempt from merchants to escape contributing to the cost of issuing credit cards, asserting:

By seeking zero interchange fees, merchants are asking cardholders to pay for services provided by card issuers that benefit merchants. CUIA believes merchants should pay for services that benefit merchants. ⁷⁹

MasterCard considered that zero interchange would not respect past and future investment in networks, arguing:

I do not believe it respects the investment that has gone into building the network both domestically and globally by MasterCard and our customers. So I think it is highly inappropriate. ⁸⁰

Visa commented on the likely effect of zero interchange on innovation and technology:

If card schemes such as Visa International were compelled to set the interchange fee at zero, they would be prevented from addressing the investment incentive problem on the issuer side. Cardholders would need to pay the full cost of card innovation even though it is clear that many of these innovations in cards provide substantial benefits to merchants, particularly innovations in the area of security and anti-fraud measures. ⁸¹

Visa also commented on the likely effect on its business:

If the current Visa International interchange fee were reduced to 0 while the implicit MIF embodied in the merchant service fee that American Express charges its merchants was unregulated, the potential pool of funds for investing in the cultivation of cardholder membership would be cut by millions of dollars each year. For these issuers the prospect of issuing American Express cards would become relatively more attractive than issuing VISA cards, leading them to promote issuing of American Express payment cards at the expense of Visa International. ⁸²

Committee conclusions

The committee is of the view that while the concept of zero interchange fees is an interesting one, it would require intense examination before being considered in the context of the Australian payments system. Reducing interchange fees to zero would have the greatest impact on four-party scheme credit cards—debit cards interchange fees will be near to zero when the reforms come into effect. If credit card interchange fees were moved to zero, the committee believes that there would be two direct consequences:

• Issuers would need to recoup all of their costs from cardholders. Therefore, the prices paid by cardholders would increase; and
• Merchants’ costs would be reduced because the merchant service fees, which are largely determined by interchange fees, would fall.

Removing the ‘no surcharge’ rule

According to the RBA the no surcharge rule:

Prevents merchants from passing merchant service fees onto customers who choose to use credit cards. Merchants therefore face an ‘all or nothing’ choice—accept credit cards and absorb the merchant service fees into their overall cost structure, or refuse to accept credit cards at all. ⁸³

The RBA argues that:

[Merchants’] ability to resist credit cards has been increasingly eroded as consumers respond to current price incentives by increasing the take-up of credit cards and demanding to make more and more use of them. Merchants have only limited negotiating power to put pressure on merchant service fees and indirectly, interchange fees. ⁸⁴

Therefore, the RBA, as of 1 January 2003, has required that four-party credit card schemes remove the no surcharge rule. Since this change, the RBA notes that:

• There has been charging in a wide range of industries, although the vast majority of merchants still do not charge.
• There have been some high-profile examples of large merchants surcharging, but surcharging has also become quite common amongst small firms operating in very competitive low-margin businesses— computer shops, removalists and carpet layers for example.
• In some cases the ability to levy a charge has actually led merchants to introduce credit cards as a payment option. Previously these cards were simply too expensive, so they were not offered. ⁸⁵

Arguments against the RBA position

Other groups were supportive of the rule’s removal. Diners Club, for example, stated:

We regard surcharging as an issue between the retailer and the customer, not between the retailer and us. If the retailer believes that it is positive for their relationship with their customer to negate and refuse their payment choice, then that is what the retailer should do .⁸⁹

Similarly, CUIA stated:

We have accepted the argument to remove the no-surcharge rule. If retailers want to directly recoup the costs of accepting a particular payment instrument they should be able to. ⁹⁰

However, there was evidence about concerns that the right to surcharge was being abused. For example, Visa asserted:

Merchants are allowed to surcharge whatever amount they want, with no reference to what it costs them to accept the card. There is no cap on surcharging. ⁹¹

A number of groups therefore commented that the surcharge should be capped at the merchants’ costs. MasterCard, for example, stated:

MasterCard believes that these protections should include amongst other things a requirement that any surcharge applied by a merchant should not exceed the actual merchant fee and associated costs incurred by that merchant for accepting a credit card payment. ⁹²

On the possibility of capping surcharges, the RBA stated:

The credit card standard says that the acquirer may come to an agreement that the surcharge is to be no greater than the merchant service fee. The standard specifically allows that possibility. The Reserve Bank, though, does not have the legislative power to say to the merchants of this country, ‘You may not charge more than X for accepting a payment instrument.’ That is beyond the scope of the power that the parliament has given the Reserve Bank. That is not something that the Payments System Board could do. It would have to be an initiative of government to pass relevant legislation. ⁹³

Committee conclusions

Removing the ‘honour all cards rule’

The honour all cards rule imposed by Visa has meant ‘merchants that accept Visa credit cards are also required, by Visa, to accept Visa Debit cards.’ ⁹⁴ The RBA argued that this rule meant that ‘normal competitive pressures [could not] bear upon the price or acceptance of Visa Debit cards.’ ⁹⁵

Therefore, the RBA developed the Honour All Cards standard, which:

Requires that this tying of acceptance of Visa credit and debit cards be removed by Visa. It also requires that Visa Debit cards be identified both visually and electronically to allow merchants to decline acceptance if they so choose .

Arguments against the RBA position

Several groups argued strongly against the removal of this rule. CUIA, for example, stated:

In our view, the removal of ‘honour all cards’ at this stage was unnecessary because of the quite aggressive interchange fee reform that the Standard already proposes and because of the introduction of surcharging on the Visa debit product. Our argument is that those very strong reforms to the Visa debit product and the potential uncertainty around the acceptance of the card place our credit union and the 1.2 million credit union members who have Visa debit cards as their primary access point at risk of a potential threat that is unwarranted at this stage. ⁹⁷

Visa shared similar concerns, asserting:

We believe that this is fundamentally bad policy. It is bad because it gives merchants the right to discriminate and limit consumer choices. It is bad because the people who will be hurt by this proposed new regulation are the four million Visa debit card holders, most of whom are the low- and middle-income earners of today or the children of parents who do not want their kids to have access to credit cards but who recognise there is an increasing need for such cards to be part of their kids’ daily lives. It’s bad also because any harm suffered will fall disproportionately on the smaller financial institutions—the building societies and credit unions, which fundamentally issue the majority of those four million Visa debit cards that are in circulation today.

The AMPF, however, agreed with the RBA’s perspective, stating:

The issue about the honour-all-cards rule is that at least it now allows market forces and the merchants to decide. Until now our hands were tied behind our backs and we had no choice. ⁹⁸

Committee conclusions

Payments system technology

Where has Australia fallen behind? PIN-based credit cards

As outlined in chapter 3, credit card authorisation is signature-based, not PIN-based. It was noted during evidence that many countries around the world have moved to PIN-based authorisation. It was also noted that PIN- based systems are much more resistant to fraud.

Online EFTPOS

In Australia it is not possible to use EFTPOS cards over the internet or phone to make ‘card not present’ transactions. The RBA commented on this issue, stating:

In some other countries you can essentially use your EFTPOS card to do that: you can go in on the website and it will take you back to your bank’s website, where you type in your PIN number, and you can pay for that online transaction through a method other than credit cards.

…

There are many customers who do not like that and, as I said before, only 55 per cent of adult Australians have a credit card, so they are excluded from those sorts of transactions. ¹⁰⁰

Chip technology

According to Visa’s website, chip technology is already in widespread use:

In Asia Pacific there are currently over 32 million Visa chip cards, which can be used in 750,000 chip terminals in 14 countries— Australia, Cambodia, HK, India, Japan, Korea, Malaysia, Maldives, NZ, Pakistan, Taiwan, Thailand, Vietnam, Singapore. Smart cards can be used at merchant locations worldwide and on the Internet.¹⁰³

Why has Australia fallen behind?

The move to new technology is a cost-benefit proposition

During evidence the committee heard on numerous occasions that the move to new technology is a cost-benefit proposition—to justify any upgrade in technology the cost of fraud must be more than the cost of upgrading. Diners Club, for example, stated:

Australia , as part of the wider global organisation, has obviously looked at chip and PIN based systems. The drivers of that are economic and a little bit political. The economics are the point at which your share of the cost to change the terminal fleet is roughly equal to the fraud that you are incurring or avoiding. That is the point at which you start to get interested in bearing, as I say, your share of replacing the terminal fleet. ¹⁰⁴

Similarly, the RBA stated:

When we talked to the banks about why the upgrade to chip and PIN had not occurred in Australia , the answer has been that there is not a business case to do so. The argument has been that Australia already has very low levels of credit card fraud—we heard that again this morning—and there are few cost savings to be gained, at least at the moment, from the introduction of PIN on credit cards. As a result, in terms of fraud reduction, the investment simply did not pass the cost-benefit tests. ¹⁰⁵

Less interchange revenue means less incentive to invest

A number of groups told the committee that because there is less money in the system from the reduction in interchange fees, there is less incentive to invest in new technology. Visa, for example, argued:

That the regulation is also contrary to good policy principles because it dampens incentives to invest by not allowing flexibility or the ability to obtain an adequate return on investment. ¹⁰⁶

Dr Ric Simes agreed that there is a connection between interchange revenue and investment, asserting:

I find it hard to accept that the revenue stream going into a particular activity does not affect the types of innovation or investment decision making on that side of the market. ¹⁰⁷

Conversely, the RBA dismissed the connection between lower interchange fees and the incentive to invest, stating:

The example that is most commonly cited is the lack of PIN and chip functionality on credit cards. In our view this has nothing to do with interchange fees. I note here that this chip and PIN functionality does not exist in the United States, where interchange fees are over three times higher than they are in Australia. In some other countries chip and PIN exist on debit cards where there are no interchange fees at all. I think the relationship between interchange fees and the decision to invest in chip and PIN is very weak. Ultimately, innovation is financed through revenue earned from fees charged to card holders and merchants. The RBA has not regulated these fees at all. ¹⁰⁸

The RBA also asserted:

The RBA over a long period have stated that around 80 per cent of the costs of upgrading to chip and PIN fall on the acquiring side of the market and not on the card-issuing side. This is because most of the main costs in moving to chip and PIN involve the updating of merchants’ terminals rather than the reissue of cards. Given the costs fall mainly on the acquiring side, I find it puzzling that people have argued that reducing interchange fees paid by the acquirer to the issuer has in fact reduced the incentive for acquirers to upgrade their systems. ¹⁰⁹

ANZ Bank agreed that there is not necessarily a connection between investment and interchange fees, stating:

In terms of why Australia has not rolled out chip technology when a number of countries around the world have, I would not say that that is directly related to interchange fees. ¹¹⁰

Committee conclusions

Other reforms

Improving interchange fee transparency

Introducing a standard benchmark for four-party scheme interchange fees

Differences in authorisation and processing costs across issuers as well as differences in the average cost of the interest-free period due to issuers having different portfolios of cardholders. ¹¹⁴

The RBA determined that having a higher interchange fee provided one scheme with a competitive advantage over others. As the RBA noted:

This difference, while small, may be encouraging credit card issuers to issue cards under the scheme with the higher interchange fee simply to receive more interchange revenue for each dollar spent by cardholders. ¹¹⁵

Removing restrictions on access to four-party schemes

The RBA believed that credit card schemes were imposing unnecessary restrictions, which limited new entrants into the schemes. The RBA stated:

Each scheme in Australia imposes minimum entry standards that are intended to ensure the safety of the scheme, but have the effect of unduly limiting competition. ¹¹⁷

In particular, the RBA was concerned that:

• Only authorised deposit-taking institutions supervised by the Australian Prudential Regulation Authority (APRA) were eligible for participation.
• Two of the schemes prohibited their members from acting only as acquirers and two schemes have penalties for members whose business is weighted heavily towards acquiring rather than issuing. ¹¹⁸

The RBA argued that these penalties and restrictions:

Discourage the participation of specialist credit card acquirers which could promote competition in the acquiring market and strengthen the representation of acquiring interests in the process of setting interchange fees. ¹¹⁹

The RBA therefore introduced a new access regime that:

Requires that specialist credit card institutions supervised by the Australian Prudential Regulation Authority (APRA) be eligible to apply for membership in the designated credit card schemes on the same basis as other authorised deposit-taking institutions. It also requires the removal of certain restrictions and penalties on the credit card acquiring activity of members. ¹²⁰

Removing restrictions on access to the EFTPOS network

In 2000 the joint study of the RBA and ACCC determined:

Access to the debit card network through a series of bilateral agreements can put both new issuers and acquirers at a competitive disadvantage, because they may need to use more expensive gateway arrangements. ¹²²

The RBA has also noted Australia’s unique EFTPOS access arrangements:

Typically, in other countries, there is a single point of entry to the system for new participants, who must meet a single set of technical criteria and business requirements. Where there are entry fees, these fees are usually known in advance and, where there are interchange fees, they generally apply uniformly to all participants. In contrast, in Australia , the system is built around a series of bilateral connections and there is much less standardisation of the terms of access. ¹²³

The RBA raised three specific concerns about access to the Australian EFTPOS network:

• A new participant wanting to establish direct connections must separately approach each of the existing eight participants with direct connections to negotiate the technical and business arrangements for exchanging EFTPOS transactions;
• Existing direct connectors have little incentive to facilitate the entry of a new participant, particularly when the entrant is likely to be a direct competitor in at least some business lines; and
• An existing participant might be unwilling to agree to an interchange fee that is similar to the fee paid to, or received from, existing participants. ¹²⁴

As a result of these concerns, the RBA and Australian Payments Clearing Association (APCA) have undertaken a co-regulatory approach to reforming EFTPOS access, through the APCA’s ‘access code’ and the RBA’s ‘access regime’. According to the RBA, the APCA code will:

For the first time, provide new and existing participants the right to establish direct connections with participants in the EFTPOS system, and require that existing participants establish such connections within a specified time frame. ¹²⁵

Further, the RBA states that its own access regime will:

Place a cap on the price that can be charged by existing participants to establish these connections, and it also contains provisions that ensure that negotiations over interchange fees cannot be used to frustrate entry. ¹²⁶

Revoking Bankcard’s designation

The RBA has:

Decided to revoke the designation of the Bankcard scheme, given that the scheme has announced that no new Bankcard cards will be issued and that the scheme will be wound up in first half of 2007. ¹²⁷

The RBA also noted:

While the Bankcard scheme will no longer be subject to regulation under the Payment Systems (Regulation) Act 1998, the Bank expects that the scheme's current interchange fees will be maintained until the scheme is closed. ¹²⁹

Possible reform of ATM transactions

The RBA has stated that it has not yet become involved in regulating ATM transactions because:

Many participants in the ATM industry [want] to pursue voluntary reform, with a view to increasing competition in the charges cardholders pay when using so-called 'foreign' ATMs. ¹³³

The potential advantages of direct charging are:

• Cardholders would know at the time of transaction the fee they are being charged, rather then subsequently being charged a ‘foreign fee’ by their banks;
• ATM owners would be forced to compete for business with their transaction fees, which should reduce prices for cardholders; and
• ATM owners would be encouraged to put machines in remote locations where they could charge higher fees. Currently, interchange fees are the same regardless of the location of an ATM. ¹³⁴

There are also a number of potential concerns:

• It may be difficult for small financial institutions with a limited ATM network of their own to offer their cardholders a widespread network that is free to use; and
• Direct charging meet with consumer opposition, as has been evident in the UK and the US. ¹³⁵

While the direct charging model has come under consideration by the banks and the RBA, there is little prospect of it being implemented in the near future. The RBA has stated:

Despite considerable effort, the various parties have been unable to agree on an alternative set of arrangements to those currently in place and, as a result, the industry reform process has stalled.

…

It [has become] clear that support in the banking industry for a broad-based move to direct charging by ATM owners ha[s] declined. ¹³⁶

Instead, the RBA has focussed on other issues surrounding ATM transactions. The RBA has recently written to the Australian Bankers’ Association asking them to consider two issues:

• The first relates to access to the system. In the [RBA’s} view, current arrangements for access to the ATM system are unnecessarily restrictive. As part of the development of more appropriate arrangements, the [RBA] has also indicated to the Australian Bankers’ Association that it sees merit in ensuring that bilateral negotiations over interchange fees cannot be used in a way that adversely affects access or competition. One way of doing this would be the establishment of a common interchange fee in the ATM system, as exists in many other countries.
• The second relates to the ability of ATM owners to levy a direct charge if they wish to do so. While the [RBA] is not proposing to make such charges mandatory, it is of the view that ATM owners should be able to levy such charges if they see a case for doing so. At present, there are some technical impediments to ATM owners levying such charges, and there is a concern amongst some ATM owners that should they do so, their access to the system may be curtailed. In the [RBA’s] view, there is a strong case for the removal of any technical or business restrictions that limit the ability of ATM owners to impose a direct charge. ¹³⁷

Possible reform of BPAY

As discussed previously, BPAY, like Visa and MasterCard, sets interchange fees centrally and has interchange fees that flow from the biller’s institution to the payer’s institution. Discussing BPAY’s interchange fees, the Reserve Bank stated that:

BPAY is the only system in Australia that currently has an interchange fee that has not been subject to actual or proposed regulation. ¹³⁸

The additional ad valorem fee for credit card transactions ‘has fallen from

0.8 per cent in 2002 to 0.27 per cent in 2005.’ ¹⁴⁰

With regard to possible regulation of these fees, the RBA has stated:

A decline in interchange fees, through regulation, would be likely to lead to a reduction in the price charged to billers for accepting payments through BPAY, but that it would also be likely to lead to an increase in the price charged to consumers for using the BPAY system.

…

One likely effect of such a change in pricing would have been a shift away from BPAY towards other methods of bill payment, including credit card payments directly to billers, cheques and over-the-counter cash payments. Given the current relative prices and resource costs of these alternative payment methods, the Bank’s view is that such a shift could not have been said to be in the public interest. ¹⁴¹

The RBA therefore decided against regulating BPAY’s interchange fees. They did, however, request that BPAY publish their interchange fees. The RBA stated:

If BPAY was unable to agree, then the Bank would consider designating BPAY as a first step to possibly setting a ‘transparency’ standard that would require publication of interchange fees. In response BPAY agreed to publish its interchange fees . ¹⁴²

With regard to possible future regulation, the RBA stated:

In announcing its decision not to regulate BPAY, the Bank noted that it will again review BPAY’s interchange fee arrangements in 2007 as part of its review of all systems with interchange fees. ¹⁴³

The Hon Bruce Baird MP

Chair
22 June 2006

Dr P Lowe, Reform of the Payments System, Speech to Visa International Members Forum, 2 March 2005 . Back

Dr P Lowe, Reform of the payments system, Speech to Visa International Members Forum, 2 March 2005 . Back

Mr J Dimasi, ACCC, Transcript, 15 June 2006 , p. 7. Back

RBA, Standard on merchant pricing, media release, December 2002. Back

RBA, Standard on merchant pricing, media release, December 2002. Back

Dr P Lowe, Reform of the payments system, Speech to Visa International Members Forum, 2 March 2005 . Back

Ms D Karai, Woolworths, Transcript, 15 May 2006 , p. 65. Back

Visa, Chip Technology, viewed 18 June 2006 , <http://www.visa­asia.com/ap/au/cardholders/security/chip_technology.shtml?#What_are_smart_cards>. Back

121 RBA, Payments System Board decisions, media release, 22 August 2005 . Back

RBA and ACCC, Debit and credit card schemes in Australia : A study of interchange fees and access , p. 71. Back

Payments System Board Annual Report 2005, p. 29. Recently, a number of institutions have increased their foreign ATM fee to $2.00. Back

RBA and ACCC, Debit and credit card schemes in Australia : A study of interchange fees and access, p. 42. Back

RBA and ACCC, Debit and credit card schemes in Australia : A study of interchange fees and access , p. 41. Back