BACKGROUND ON REPORTS FROM LEADING ECONOMISTS RAISE CONCERNS ABOUT RBA/ACCC JOINT INTERCHANGE FEE STUDY

MEDIA BACKGROUNDER 

The RBA/ACCC Joint Study into Interchange Fees and Card Schemes has been used to justify regulatory intervention in the current competitive arrangements for provision of credit card services. Despite the role of the Joint Study in justifying intervention, leading economists have raised concerns about its analysis and findings.

OVERALL VIEW OF THE RBA/ACCC JOINT STUDY

• An extensive study by the Network Economic Consulting Group (NECG) commissioned by Visa International concluded that "The Joint Study seems to favour regulation, but the arguments it puts do not resist scrutiny….The RBA and the ACCC should carefully reconsider the views they have put."
• Analysis by 'The Allens Consulting Group' has highlighted a range of inadequacies in the RBA/ACCC Joint Study, including, the failure of the Study to recognise financial risks in credit card acquiring and warns against lowering prudential standards when there is a high degree of economic participation in card schemes already which acts to overcomes many efficiency concerns.
• Professors Gans and King conclude in their paper ‘The Role of Interchange Fees in Credit Card Associations: Competitive Analysis and Regulatory Issues’ (April 2001) that "…a number of its (Joint Study) conclusions are poorly founded."
• And, international interchange experts, Edgar Dunn, have expressed verbally to the ABA that the failure of the Joint Study to fully recognise and examine the competitive impact of regulating ‘open’ card schemes, but not ‘closed’ schemes like American Express, was a major shortcoming.

SPECIFIC ISSUES RAISED

‘Closed’ credit card schemes, such as American Express, are not investigated (and are not now to be included in the RBA designation)

• Visa’s NECG study warns that: ‘The exclusion of closed credit card networks (e.g American Express and Diners Club) from the scope of the Joint Study is also a matter for serious concern. Any moves to regulate interchange for open card systems such as VISA would provide a significant competitive advantage for closed credit card networks such as American Express. Indeed, there is a strong argument that if the interchange fees set by the open systems are regulated, then there is a clear need for final price regulation of closed systems’ (Exec. Summary).
• International interchange experts, Edgar Dunn, have expressed verbally to the ABA that the failure of the Joint Study to fully recognise and examine the competitive impact of regulating ‘open’ card schemes, but not ‘closed’ schemes like American Express, was a major shortcoming.

• Frontier Economics states that ‘If a regulator were to insist that the cost of loyalty programs could not be taken into account when setting an interchange fee, then a mechanism would need to be found that created a level playing field between open and closed systems. The only feasible way that this could be achieved would be to regulate cardholder benefits and/or charges offered by closed card systems. That is, a regulator would need to ensure that closed card systems were not able to offer generous loyalty program/low cardholder fee packages that open system credit card issuers were unable to provide.’ (p.52)

The full marketing costs of credit card schemes are not accepted

• "In the case of credit card systems, the Joint Study appears to define the product quite narrowly. For example, the cost of loyalty program points awarded to cardholders is apparently not regarded as part of the product, since it is explicitly excluded from the resource cost of card issuers…From an economic point of view, this approach is entirely arbitrary." (NECG, p.24)
• "Another major source of issuer costs is loyalty programs. Loyalty programs are a means by which issuers can differentiate their cards." (Frontier Economics, p.57)
• "An appropriate application of the Joint Study’s own methodology (regardless of approach) should take into account the payments made by financial institutions for loyalty schemes. These should be either added to the costs or removed from revenues…remembering that the Study’s second methodology sets the minimum viable interchange fee for issuers, once loyalty scheme costs are included it appears that, if anything, interchange fees should rise." (Gans and King, p.114)

Network benefits (to merchants) are not properly understood

• "…the ACCC/RBA position appears to be that the network effects in credit card systems diminish as the system ‘matures’. It is difficult to see how the incremental external value to the system of an additional telephone subscriber, or a credit card customer could decline as the system grows." (Frontier Economics, p.81)
• "There is no reason to suppose that these effects (network externalities) vanish as network membership increases" (NECG, p.7)
• "..it (Joint Study) takes the view that the interchange fee is a means of allowing those who are earning profits in a card scheme to compensate other participants who face a shortfall between their revenue and costs…The approach ignores any impact of the interchange fee on the overall operation of a card system." (Gans and King, p.112)

The cost to merchants of accepting cash and cheques (as opposed to credit cards) not considered

• "It is assumed by the RBA and ACCC that other forms of payment are cheaper than credit cards…(but)…the costs of accepting other forms of payment are not zero, and differ between merchants." (Frontier Economics, p.80 (footnote)).
• "To see the importance of market definition and the failure of the Joint Study to consider substitute payment instruments, recall that credit and debit cards represent only two of the types of payment instruments available to consumers. They also have available cash, cheques, direct account transfers and cards from closed associations such as American Express and Diners Club." (Gans and King, p.111)

The risks carried by acquiring banks on behalf of merchants are fundamental, but overlooked

• "…acquirers guarantee financial compensation to cardholders in the event of failure of a merchant who sells goods or services for future delivery (e.g an airline or direct marketer). The failure of Compass Airlines, acquired by ANZ, is the obvious Australian example. It is noted that the authors of the Joint Study did not acknowledge any settlement risk associated with acquiring." ('The Allens Consulting Group', p.19)
• "Acquirers are required to monitor merchants to ensure that they are unlikely to create risks for the scheme, such as selling goods that cardholders never receive, or fraudulently using credit card numbers for their own purposes. The concern associated with having a merchant acquire its own transactions is the risk that the acquirer monitoring function is compromised by a conflict of interest." (Frontier Economics, p. 43)

The assumption that Australia’s credit card schemes are ‘mature’ is not supported

• The NECG study concludes in relation to the Joint Study that "…there is no evidence to suggest that credit card networks in Australia are mature. Even if card networks were now mature in the sense described in the Joint Study, the established theory of interchange does not support the proposition that interchange fees should now be reduced." (p.15)

International evidence on the impact of abolishing the ‘No Surcharge’ rule is not considered

• "In Britain, despite the complete prohibition of "No-Surcharging" and related rules (such as the "no-discount for cash purchases" rule) the practice of surcharging is not widespread. (NECG, p.36)

BIBLIOGRAPHY

1. ‘Credit Card Schemes in Australia ­ A response to the Reserve Bank of Australia and Australian Competition and Consumer Commission Joint Study’, Prepared by Network Economic Consulting Group for VISA International Service Association, January 2001.
2. ‘Economic Review of Credit Card Scheme Membership Rules’, Report to ‘The Review Banks’, 'The Allens Consulting Group', January 2001.
3. ‘Role of Interchange Fees in Credit Card Associations: Competitive Analysis and Regulatory Issues’, Joshua S. Gans and Stephen P. King, University of Melbourne, April 2001, (published in The Australian Business Law Review)
4. ‘Joint Bank Review of Credit Card Membership and Interchange Fees ­ Report on Credit Card Interchange Fees to Review Banks’, Frontier Economics, January 2001.
5. Edgar Dunn, (verbal correspondence)

(These documents are available on the ABA Web Site: www.bankers.asn.au)