Common Benchmark for the Setting of Credit Card Interchange Fees – November 2005 5. Analysis of Issues

The consultation process confirmed that the current arrangements have created, at the margin, an incentive for issuers to issue credit cards under the scheme with the highest interchange fees. This is despite the difference in interchange fees in the two largest schemes being only two basis points.

The consultation process also highlighted the fact that there is little competitive discipline on schemes with relatively high interchange fees. While higher interchange fees mean higher costs to acquirers, these higher costs are not transparently passed on to merchants who are offered a bundled price for accepting cards of all three designated credit card schemes. As a result, a scheme with relatively high fees does not find itself at a competitive disadvantage in terms of merchant acceptance. This would likely remain the case even if acquirers charged merchants more for accepting cards issued under the higher-cost scheme given that many merchants currently accept higher-cost cards.

Some submissions argued that the recalculation of the current benchmarks every three years will ameliorate any competitive advantage enjoyed by the scheme with the highest interchange fee. In particular, if it were the case that it was predominantly issuers with lower costs that are attracted to the scheme with the high interchange fee, the benchmark would fall when it was recalculated, offsetting the gain those issuers achieved from switching. However, the offset would not be complete and, thus, an incentive to switch to the scheme with the relatively high benchmark would remain. Even if the offset were complete, a year or two of higher interchange fees may still be of commercial benefit and worth the costs of a switch in scheme.

MasterCard argued that a common benchmark would ‘eliminate to a great extent the remaining degree of competition between the credit card schemes in the setting of interchange fees’ and that the schemes should be allowed to set interchange fees themselves. In contrast, the Bank's view is that interchange fees are not set under normal competitive conditions, with competitive pressures tending to push intercharge fees up not down.

MasterCard also argued that a common benchmark would lead to greater homogeneity in credit card offerings in the Australian market place and increase the attractiveness of the three-party schemes to issuers. The Bank does not accept either of these arguments. There is strong competition amongst issuers of credit cards in terms of both price and product characteristics. In the Bank's opinion, this situation would not be adversely affected by a common benchmark. Similarly, a common benchmark, which results in interchange fees at around the current level, is unlikely to increase the attractiveness of the three-party schemes to issuers, since it would not change the average interchange revenue of issuers in the four-party schemes.

Finally, MasterCard argued that a common benchmark would ‘under-compensate the issuers in the more expensive scheme(s), and over-compensate the issuers in the lower-costing scheme(s)’. As noted above, the Bank's opinion is that a common benchmark would improve the incentives for the schemes to lower their costs and for issuers to issue under the lower-cost scheme. Also, it is worth noting that under current arrangements the eligible costs of issuers span quite a wide range, with some issuers having lower costs than the relevant benchmark, and others having higher costs than the benchmark.

Regulatory action

Given the above considerations the Bank considered whether a change to a common benchmark would meet the public interest test set out in the Payment Systems (Regulation) Act 1998. The Bank came to the conclusion that a common benchmark would provide a stronger incentive towards cost savings (that is, both technical and dynamic efficiency) and promote more-soundly based competition between the schemes for issuers. As such, the Bank determined that such a change would be in the public interest as it promoted both efficiency and competition in the designated credit card systems.

The Bank determined that a common benchmark calculated as a weighted average across the schemes is likely to promote efficiency and competition in two main ways. First, all else constant, it is likely to make schemes with lower costs more attractive to issuers. Second, it provides stronger incentives for issuers and schemes to pursue cost reductions over time. Under the current arrangements, any cost reductions that a scheme achieves lead to a reduction in the scheme's benchmark when it is recalculated, reducing the incentive to reduce costs. In contrast, under the new standard, the benchmark, because of the averaging across schemes, is only reduced by a fraction of any cost saving when it is recalculated.

The Bank also considered whether to base a common benchmark on a weighted average of costs, or whether to use the costs of the scheme with the lowest costs. The Bank has decided to use the weighted average of costs, refl ecting the view that this amendment to the standard is designed to improve the operation of the existing Standard, rather than to further lower the average level of interchange fees in the credit card systems. The Bank has previously indicated that it will conduct a major review of the regulations in 2007, and at that time it will consider the broader question of whether the level of the benchmark continues to be appropriate.

As noted above, the draft Standard also proposed selecting nominated scheme participants in a way that would remove any discretion from the scheme in selecting which issuers were to be included in the benchmark calculations. This is in contrast to the current standard, where the schemes have some limited discretion as to which issuers are to be included. Visa has argued that the revised approach could create considerable practical problems, particularly where it was not clear at an early stage which participants would be included. While the Bank was not convinced that the problems were significant, it nonetheless decided that there was not a strong case for change at this time. As such, it has decided not to change the method of selecting the nominated scheme participants.