Industry calls on the RBA to keep payment system regulation flexible

The payments industry has urged the Reserve Bank not to reduce the level of regulated interchange fees for credit and debit cards but has conceded that the rules could be tightened to improve transparency.

The Payments System Board of the Reserve Bank is reviewing regulatory arrangements applying to the payment card system. In March it published an issues paper and earlier this month released industry submissions.

Since 2003 the RBA has set benchmarks for credit card interchange (the fees that banks charge each other for handling card transactions) and it extended interchange regulation to debit cards in 2006.

In its issues paper it asked whether it was time to bring the interchange benchmarks down. It said it was possible that interchange fees continued to distort payment decisions.

It also asked whether it should change the way it set fee caps, moving from a weighted average to a "hard cap". And it asked whether it should broaden interchange fee caps to include payments between schemes and issuers that are not currently captured.

The standard on interchange fees for the MasterCard and Visa systems sets benchmarks for the average interchange fee that can be paid in those systems. For credit cards the benchmark is 50 basis points.

Every three years the benchmark is reviewed and the weighted average fee must not exceed the benchmark.

One of the RBA's concerns is that, given this backward-looking compliance calculation, the weighted average fees have followed a sawtooth pattern, with fees drifting above the benchmark after each review and then dropping back at review periods.

Another concern is that the schemes have responded to the introduction of the benchmarks by expanding the range of categories of interchange fees. For credit cards the number has risen from three to 19 for MasterCard and from five to 23 for Visa since 2003. There has been a significant widening of the range of interchange rates. For MasterCard the range has gone from 66 bps to 177 bps and for Visa from 48 bps to 180 bps.

In the case of debit cards the number of categories and the ranges have also increased but not as much as for credit cards.

The RBA's concern is that this process has reduced transparency in the system. The issues paper said: "Merchants are unable to see the cost of different cards and the cost of individual transactions, and this affects their ability to control their costs."

The RBA asked whether applying a hard cap would solve the problem.

The industry's overwhelming response was that the RBA needed to leave some flexibility in the system, to allow for competition between providers and to create incentives for innovation and product development.

The industry's peak body, the Australian Payments Clearing Association, agreed that there was a problem with a lack of transparency.

"The weighted average provides flexibility in interchange rates and ensures some level of competitiveness between schemes. A more frequent calculation of the weighted average may help manage outcomes," APCA said.

Commonwealth Bank agreed that a more frequent interchange reset period would address the drift problem. It also recommended introducing caps and collars to establish a band around the weighted average.

American Express said: "Manage upward drift in average interchange rates during the current cycle by reducing the length of the testing cycle to quarterly, or at least no less than annually."

Westpac argued that the RBA should maintain the existing weighted average cap. It said the way to deal with the breadth of interchange fees, "which can have an impact on efficiency", was to apply a maximum interchange fee level and move to annual re-setting.

MasterCard said hard caps would represent a form of price setting and would remove the flexibility from the system that was required to create incentives for innovation and investment.

Not surprisingly, the RBA got almost no support from industry for the suggestion that the interchange fee benchmarks should come down.

APCA said: "The level of interchange fees is already among the lowest in the world. The Australian industry is exhibiting high levels of competition and innovation. Drastic change to regulation will have unintended consequences."

A number of submissions argued that the RBA had not demonstrated that the regulation of interchange fees had led to lower consumer prices, and without evidence of consumer benefit there no was justification for cutting them further.

American Express said: "Lowering interchange will tend to drive retail profits up rather than retail prices down and will extract more revenue from schemes that could have been used for investment in technology and innovation. Card issuers would raise fees for consumers and/or interest rates.

"Economic theory suggests that a reduction in interchange fees will drive down fees paid by merchants to acquirers, which in turn should lead to lower retail prices. This remains a purely theoretical scenario."

The Customer Owned Banking Association agreed: "COBA members rely on the current level of interchange fees to cover the cost of issuance and to offer low rates. Transaction processing and authorisation, fraud prevention and the provision of an interest-free period are significant costs."

Westpac said: "The service provided to merchants, consisting of real-time authorisation of cards from anywhere in the world, credit offered to customers in real time without the risk of credit default, no cost of carrying cash and ongoing innovation, is compelling. The cost to create such value is substantial.

"From a practical perspective, lowering existing interchange fee caps is likely to lead to lower costs for merchants being fully offset by higher costs to cardholders."

But the RBA might be hard to convince. Its view is that there has been a significant increase is card payment volumes in recent years, resulting in a fall in "average resource costs". This fall in costs has not been reflected in a fall in interchange fees.