An Access Regime for the ATM System – February 2009 2. The ATM System and the Need for Reform

2.1 The ATM system in Australia

The Australian ATM system is comprised of a number of ATM ‘networks’, linked together through a series of bilateral agreements. Most of these individual networks are owned by large banks and were established to provide customers of those institutions with access to cash withdrawals and some account management functionality. There are also two ‘sub-networks’, which were set up to serve the building societies and credit unions, although these days their membership is wider. These sub-networks effectively link together ATMs of a large number of smaller institutions so that they can provide their customers with access to a larger network of ATMs. In addition, in recent years, a large number of ATMs have been deployed by owners that are not financial institutions. In total, these ‘independent deployers’ currently own around half of the 26,500 ATMs in Australia.

The interconnection of ATM networks is facilitated through bilateral agreements between network owners that allow each institution's cardholders to use the other institution's ATMs. Among other things, these bilateral agreements have provided for the payment of ‘interchange fees’, averaging around $1.00 per transaction, from the card issuer to the ATM owner in compensation for the service that the ATM owner is providing to the cardholder.

As interchange fees are a cost to the card issuer, many financial institutions have charged their customers a ‘foreign fee’ when they use an ATM belonging to another financial institution. These fees are typically significantly higher than interchange fees. In recent times the four largest banks have charged $2.00 a transaction, while some smaller financial institutions have chosen to absorb the cost of the interchange fee for their customers, effectively providing them with fee-free access to a large number of ATMs.

Further details of the ATM system are provided in Access Regime for the ATM System: A Consultation Document released on 10 December 2008.

2.2 The need for reform

The issues addressed in the Access Regime are part of a broader set of reforms to the ATM system being implemented by the industry, with the support of the Reserve Bank. In its entirety the reform package seeks to address two main issues that have been a cause for concern for both the Reserve Bank and industry for a number of years. These are the lack of competitive pressure on interchange fees and the access difficulties facing potential new participants.

2.2.1 Lack of competitive pressure on interchange fees

As noted above, an important feature of the current arrangements is the existence of bilateral interchange fees between the major participants. When the Bank studied these fees in 2000, it made two main observations.^[1]

The first was that these fees had remained fixed for many years at the levels agreed when the links were first established and that it was very difficult for existing ATM owners and card issuers to negotiate different rates. The second was that, although interchange fees were paid to ATM owners as recompense for providing a service, the fees bore little relationship to the cost of providing an ATM withdrawal. The Bank found that while interchange fees averaged around $1.00, the average cost of providing a cash withdrawal at an ATM was around $0.50 and there appeared to be no competitive pressures to reduce interchange fees. In addition, the foreign fees being paid by cardholders for a cash withdrawal were substantially higher than the cost of providing the service and there seemed to be only limited competitive pressures to reduce that margin.

One reason why ATM interchange fees are not subject to the normal forces of competition is that bilateral interchange agreements are not easy to renegotiate. The potential loser out of any renegotiation naturally prefers the status quo, so unless the potential winner is prepared to walk away from the agreement – which may be difficult if its cardholders have become used to the convenience of access to a wider ATM network – the interchange fee is likely to remain unchanged. Experience suggests that such ‘sticky’ interchange fees are a common feature of bilateral payment systems.

A second reason is that cardholders have no influence over these fees. Although interchange fees have a bearing on foreign fees, customers face the same foreign fee from their financial institution regardless of the interchange fee paid. They therefore have no incentive to favour ATMs with lower interchange fees. This in turn means that there is no incentive for ATM owners to lower their interchange fees to promote use by cardholders. More generally, the uniformity of foreign fees reinforces the observation that the relationship between interchange fees and the costs of providing ATM withdrawals is weak.

This weak relationship between fees and costs raises a potentially important issue going forward. Because of the difficulties with renegotiating bilateral interchange fees, these fees may remain at their current levels even if costs rise. As a result, there is a risk that many ATMs will become uneconomic over time. Indeed, the Bank estimated in 2007 that the average cost to an ATM owner of providing the service of a cash withdrawal was around $0.75, up from $0.50 in 2000. As costs continue to rise, it is likely that the number of ATMs – particularly those operated by the independent deployers – will decline if interchange fees are not renegotiated. This would result in less convenience for consumers and reduced public benefit from the ATM system.

2.2.2 Access difficulties

The second issue with the current bilateral arrangements is the difficulties faced by new entrants in gaining access to the system. These difficulties are similar to those identified by the Bank with respect to the EFTPOS system and which were addressed in a co-regulatory framework by the Bank and the Australian Payments Clearing Association (APCA) in 2006.

The bilateral arrangements in the ATM system make access complicated in three main ways. First, any potential new provider of ATM services that wants to be a direct participant in the system must separately approach existing participants to negotiate agreements to establish connections. Each individual agreement tends to be different with respect to technical and business requirements, further complicating the negotiation process and increasing costs.

Second, existing direct connectors have little incentive to facilitate entry since the prospective entrant is likely to be a competitor in at least some aspects of the participant's business and, in the case of smaller new entrants, might offer existing participants only limited benefit in terms of network expansion. This means that participants may either refuse to negotiate or delay the process. Even if an in-principle agreement to connect is reached, there are no standardised procedures around testing or guidelines around timing. As a consequence, the incumbent may effectively hold up entry by delaying the technical work required. In addition, there is no standard cost of connection nor is the cost of connection known in advance, so new entrants may find it difficult to build a robust business case.

Third, in a bilateral system, the need to negotiate the interchange fee to be paid can also act as a barrier to entry. At its most prohibitive, the inability of a new entrant to negotiate an interchange fee would prevent it from participating in the system. But even if the other participants are prepared to negotiate an agreement, the new entrant may find that the only interchange fee the incumbents are prepared to consider is at a level that would render the new entrant uncompetitive. If, for example, the owner of a new ATM network found that other participants were only prepared to pay it $0.50 for use of its ATMs by cardholders when other ATM owners were receiving $1.00, it would immediately be at a competitive disadvantage to other participants. Bilateral interchange fees therefore effectively act as a price of access.

Footnote

Reserve Bank of Australia and Australian Competition and Consumer Commission (2000), Debit and Credit Card Schemes in Australia: A Study of Interchange Fees and Access, October. [1]