Reform of Credit Card Schemes in Australia: II Commissioned Report 1. Introduction

1. This report analyses the economic effects of several practices of Australian credit and charge card systems. Specifically, it looks at the use of so-called no-surcharge rules and the setting of interchange fees.^[1] Under no-surcharge rules imposed by MasterCard and Visa, a merchant accepting a given credit card agrees not to charge its customers any more for using that card than any other non-cash means of payment.^[2],^[3] The interchange fee is an amount collected from the relevant financial institution serving a merchant at which a payment card is used and transferred to the institution that issued the card.
2. These practices have been subject to an enquiry by the Reserve Bank of Australia and the Australian Competition and Consumer Commission. In October 2000, the Bank and Commission published a study (the Joint Study) stating their initial findings.^[4] Industry participants were given the opportunity to comment on the study and offer support for, or objections to, its findings. The present report, commissioned by the Reserve Bank of Australia, analyses economic issues raised by the Joint Study and the responses to it.
3. The report is organized as follows. Sections II through IV set the stage for the later analysis. Section II provides an overview of the credit and charge card industry. Section III identifies benefits potentially enjoyed by consumers and merchants from the use of credit and charge cards. As discussed in Section IV, these benefits give rise to network effects. Moreover, because a card-based transaction affects both consumers and merchants, actions by one side of the transaction can affect the economic welfare of the other side. This fact raises the possibility of externalities, which also are defined in Section IV.
4. Sections V through VII analyse the effects of no-surcharge rules and interchange fees. Section V examines the market outcome when merchants can freely engage in surcharging. Section VI then examines the market outcome when merchants must set retail prices that are invariant with respect to the payment mechanism used. Section VII compares the market outcomes with and without surcharging to identify the net effects of no-surcharge rules on economic welfare.
5. After a brief concluding section, a technical appendix surveys several economic models that have been developed to shed light on interchange rate setting and no-surcharge rules. A second appendix discusses the definition of a relevant market and notes that there is no contradiction between the finding that credit and charge cards constitute a relevant market and the finding that distortions in credit and charge card prices can lead to excessive card use.