A Revised Interchange Standard for the EFTPOS System – November 2009 3. Background
The Australian debit card systems
Two types of debit card systems operate in Australia to allow cardholders to make purchases with funds drawn from a deposit account. The EFTPOS system allows cardholders to swipe their card through a terminal at the point of sale and verify the transaction using a personal identification number (PIN). EFTPOS payments are processed through bilateral links between customers' and merchants' financial institutions, with each link governed by one of the many bilateral agreements between financial institutions. It is common practice for financial institutions to issue cards providing EFTPOS and ATM access when deposit accounts are established. As a result EFTPOS cards are ubiquitous. EFTPOS is currently the dominant debit card system in Australia, accounting for 85 per cent of debit card payments in 2008/09.
Scheme debit systems can be used to make payments at point-of-sale terminals, using either signature or (since June 2008) PIN verification, but can also be used remotely (for example, over the internet or the telephone) by quoting the card number and other details. Payments are processed via the networks of the international card schemes. Visa Debit cards have been offered in Australia for many years. Debit MasterCard was launched in Australia in 2005. Like EFTPOS cards, scheme debit cards are issued by financial institutions. They carry branding of both the issuing institution and the scheme. In recent years scheme debit has been actively promoted, including by the major banks, resulting in rapid growth in its use. In the year to the September quarter of 2009, scheme debit transactions increased by 37 per cent.
In nearly all cases scheme debit cards are multi-function, providing point-of-sale access to the cardholder's funds via the EFTPOS system as well as through the scheme. The system utilised is determined by whether the ‘cheque/savings’ or ‘credit’ button is pressed at the terminal. In the former case, the transaction is processed through the EFTPOS system and in the latter case through the relevant international scheme.
Public policy concerns
A critical difference between the EFTPOS and scheme debit systems is the operation of interchange fees. In line with the bilateral nature of the EFTPOS system, EFTPOS interchange fees are bilaterally negotiated and paid by card issuers to transaction acquirers. Scheme debit interchange fees, in contrast, are centrally set by the scheme operator and flow from the acquirer to the issuer. This difference was discussed by the Reserve Bank and the Australian Competition and Consumer Commission (ACCC) in Debit and Credit Card Schemes in Australia: A Study of Interchange Fees and Access (the Joint Study), published in October 2000. At the time of the Joint Study, EFTPOS interchange fees averaged around 20 cents per transaction, flowing to the acquirer, while Visa Debit interchange fees were around 0.95 per cent of the transaction value, flowing to the issuer – the same as credit card interchange fees. The Joint Study noted the significantly different interchange fees in the two systems, concluding that there did not seem to be a convincing case for an interchange fee in either direction in the case of the EFTPOS system and that there was no case for applying credit card interchange fees to debit cards.
The Board's main concerns with interchange fees in the EFTPOS and scheme debit systems at this time were that they were subject to limited competition and that the large discrepancy between fees provided issuers with an incentive to promote scheme debit (or credit), even though the resource costs of those systems were higher than for the EFTPOS system. Interchange fees in the scheme debit systems were set in the same way as for credit cards. In these systems, there was limited competitive pressure from merchants for lower interchange fees while cardholders were quite sensitive to the relative prices they faced for using different payment mechanisms. Competitive pressures therefore tended to raise interchange fees above efficient levels.[1] Similarly, normal competitive pressures did not act on EFTPOS interchange fees – once the bilateral fees were set, it was very difficult, if not impossible, to renegotiate them.
The end result was that, due to the limited competitive pressure and the history of the two types of systems, the difference in interchange fees was entrenched. This meant that prices to cardholders did not reflect the relative resource costs of the different systems. As a consequence, there was potential for the higher-cost systems to grow at the expense of the lower-cost EFTPOS system and for merchants' payment costs to rise, along with the overall level of goods and services prices in Australia. The Board was therefore of the view that competition and efficiency would be promoted if the interchange fees in the two types of debit systems were closer together.
Regulatory response
While the industry was initially willing to address the Board's concerns about EFTPOS interchange fees, a self-regulatory solution proved impossible and the Bank ultimately regulated to address the difference in EFTPOS and scheme debit interchange fees.[2] A standard was introduced to constrain EFTPOS interchange fees for purchase transactions to between 4 and 5 cents paid to the acquirer. Unlike other interchange fee caps determined by the Bank, a cap and floor were established for EFTPOS interchange fees reflecting concerns that, in a system relying on bilateral negotiation, unfavourable interchange fees could be used by incumbents as a means of restricting new entrants' access to the system. At the same time, the Bank set a standard on Visa Debit interchange fees, capping the weighted-average interchange fee at 12 cents per transaction paid to the issuer. MasterCard provided a voluntary undertaking to adhere to the Visa Debit Standard in respect of its debit card system. These changes meant that for a $100 transaction the differential between EFTPOS and scheme debit interchange fees was reduced by around 58 cents – from around 75 cents to 17 cents. The fall from prior to the credit card interchange Standard was even greater, at around 98 cents.[3]
While the reduction in the interchange fee differential addressed the Board's concerns to some extent, the Board remained of the view that, as long as a differential remained, there may have been an incentive for issuers to promote scheme debit, not on its merits, but on the basis of the more favourable interchange fees. The relative competitive positions of the EFTPOS and scheme debit systems were therefore revisited during the recent review of the Board's payments system reforms. At the conclusion of the Review, the Payments System Board indicated that it would be prepared to remove explicit credit and debit card interchange fee regulation if the industry took sufficient steps to improve the competitive environment.
Some of the key elements the Board identified as providing such an improved environment were related to the EFTPOS system's capacity to compete with the schemes by actively developing and marketing its products and setting previously inflexible interchange fees in a way that best advantaged the system. Central to this was the formation of an EFTPOS scheme with the ability to make decisions about the system. With improved governance and the removal of interchange restrictions, the Board was of the view that the EFTPOS system would be placed on a level playing field with scheme debit and would be in a much improved position to compete effectively.
If improvements to the competitive environment proved not to be achievable, the Board expressed a preference for further lowering interchange fees and applying a common treatment to both EFTPOS and the scheme debit systems. It concluded after consultation that this common regime would constrain interchange fees in the EFTPOS and scheme debit systems to between five cents paid to the issuer and five cents paid to the acquirer.
The current issue
The Board considered the future of interchange regulation at its August 2009 meeting. It concluded that progress on improving the competitive environment was not sufficient to provide it with confidence that interchange fees would not rise if interchange regulation were removed. Nonetheless, in recognition of the progress that had been made by the industry, including the formation of an EFTPOS scheme, the Board decided that it would not be appropriate at that time to lower interchange fees further. Instead, the Board decided to defer consideration of any further reduction in interchange fees. It indicated that it would keep matters under review, and would be prepared to re-open consideration of the regulations in light of industry developments.[4]
A consequence of that decision was that, in the absence of any other action by the Bank, the different regulatory standards applying to the EFTPOS system and the scheme debit systems would continue, to the potential detriment of the efficiency of the payments system. In particular, under the current regulatory regimes, the EFTPOS system is more constrained in its ability to set interchange fees than are the scheme debit systems. While the EFTPOS system continued to operate as a series of bilateral relationships this may not have mattered, as it was not possible for the system as a whole to set interchange fees in its best interests. But with the formation of the EFTPOS scheme earlier this year, there is the possibility of more active competition between the two types of debit card systems. While EFTPOS Payments Australia Limited (EPAL) is not yet fully operational, its formation provides the potential for more active promotion of the system and for decisions to be made about interchange fees in the interests of the system. But without some flexibility in setting its interchange fees, EPAL's ability to compete is likely to be hampered.
Leaving EFTPOS interchange regulation unchanged until the Board made a final decision about the future of interchange regulation more generally was an option. However, it was the Board's view that there could be material market changes resulting from the disparate regulatory treatment during this transitional period that might affect the ultimate competitive outcome, regardless of any final decision that was made. It was also the Board's view that providing decision-making flexibility was important during the formative stages of the EFTPOS scheme to facilitate its growth and allow it to demonstrate the competitive pressure it could bring to the market. For this reason, the Board indicated that it was considering amending the interchange Standard for the EFTPOS system to make it consistent with the Visa Debit interchange Standard and invited submissions on the proposal.[5] This amended EFTPOS interchange Standard would remain in force until such time that the Board made a final decision on interchange regulation.
Footnotes
See Reserve Bank of Australia (2005), Reform of the EFTPOS and Visa Debit Systems in Australia: A Consultation Document, February, pp19–26. [1]
An industry proposal to reduce interchange fees in the EFTPOS system to zero was approved by the ACCC in 2003 but it was subsequently challenged by a group of merchants in the Australian Competition Tribunal and the decision was overturned. With little prospect remaining of an industry-initiated solution, the Bank, after reviewing the Tribunal decision and undertaking public consultation, designated the EFTPOS system in September 2004 with a view to establishing lower interchange fees via a standard under the Payment Systems (Regulation) Act. After delays related to further legal action and the development of an industry access code for the EFTPOS system, the EFTPOS interchange fee Standard was finally released as part of a regulatory package for the debit card systems in April 2006 and came into force from July that year. See Reserve Bank of Australia (2006), Reform of the EFTPOS and Visa Debit Systems in Australia: Final Reforms and Regulation Impact Statement, April, for more details of the process leading up to the regulation of the EFTPOS and scheme debit systems. [2]
Since scheme debit interchange fees were initially the same as those for credit cards, scheme debit interchange fees were lowered from around 0.95 per cent to around 0.55 per cent in November 2003 as a result of the introduction of the credit card interchange Standard. [3]
Reserve Bank of Australia (2009), Media Release No. 2009-18, ‘Payments System Reform’, 26 August <https://www.rba.gov.au/media-releases/2009/mr-09-18.html>. [4]
Reserve Bank of Australia (2009), Media Release No. 2009-20, ‘Payments System Issues’, 22 September <https://www.rba.gov.au/media-releases/2009/mr-09-20.html>. [5]