Reform of Australia's Payments System 4. The Process of the Review

The current review originated from a commitment made by the Payments System Board when it released its final reforms for the credit card systems in 2002. At that time, it said it would review the reforms in five years time. As things have transpired, the Review has been much more wide ranging than was originally envisaged, and has covered all the reforms in card payment systems introduced since 2002. This reflects the Board's view that the various reforms are interconnected and are, therefore, best assessed as part of a package, rather than on a stand-alone basis. Throughout the reform process, the Board's focus has very much been on the payments system as a whole, rather than on the operation of individual payment systems within the overall system.

The first step in the review process was taken in September 2006, with the Bank seeking submissions from interested parties on the scope and content of the Review. Most submissions called for the Review to be broad in nature and to cover all the Bank's reforms, not just those relating to the credit card system.

The second step was the publication of an issues paper in May 2007 (Reform of Australia's Payments System: Issues for the 2007/08 Review). This paper provided a summary of recent developments in card payment systems and sought industry feedback on three interrelated questions:

1. what have been the effects of the reforms to date?
2. what is the case for ongoing regulation of interchange fees, access arrangements and scheme rules, and what are the practical alternatives to the current regulatory approach? and
3. if the current regulatory approach is retained, what changes, if any, should be made to the standards and access regimes?

In total, 27 submissions were received, and 20 parties took up the invitation to discuss their submission with the Bank. The Bank also held a number of other related meetings with industry participants, including consumer groups. Appendix 1 lists the parties who made a submission on the Issues Paper.

The third step was the holding of an industry-wide conference in November 2007 to discuss the reforms. This conference was jointly organised by the Bank and the Centre for Business and Public Policy at the Melbourne Business School. Around 90 participants were invited, representing financial institutions, merchants, card schemes, industry associations, consultants and academia. All members of the Payments System Board attended. The first part of the conference involved a discussion of two commissioned papers and the results of the Reserve Bank's studies of the use and cost of payment instruments. The second part took the form of an open forum discussing the reforms to the card payment systems, particularly the issues of interchange fee regulation, innovation and access. The conference proceedings were published separately and are available on the Bank's website (www.rba.gov.au).

The fourth step was the release of the Board's Preliminary Conclusions in April 2008 (Reform of Australia's Payments System: Preliminary Conclusions of the 2007/08 Review). This document set out the Board's views on the effects of the reforms to date and some possible ways forward for regulation of interchange fees.

On the reforms to date, the Board concluded that they have met their main objectives of: improving price signals in the Australian payments system; increasing transparency; improving access; and creating a more soundly based competitive environment. It was acknowledged, however, that the reforms have not affected all parties equally. In particular, those individuals who use EFTPOS and cash are more likely to have been made better off than those who use credit cards extensively and pay their balances off by the due date.

On the regulation of interchange fees going forward, the Board presented three broad options.

The first option was to retain the current credit and debit card interchange Standards, largely unchanged. This would mean that:

• the weighted-average interchange fee in the MasterCard and Visa credit card systems would continue to be capped at around 0.5 per cent;
• the weighted-average interchange fee in the MasterCard and Visa debit systems would continue to be capped at around 12 cents; and
• interchange fees in the EFTPOS system (paid to the acquirer) would continue to be between 4 and 5 cents.

The second option was to retain interchange regulation, but to reduce the benchmark applying to the credit card systems to around 0.3 per cent and to establish a common benchmark of, perhaps, 5 cents (paid to the issuer) for all debit card systems.

The third option was to step back from interchange regulation on the condition that industry took a number of steps to strengthen the competitive environment. These included: changes to the EFTPOS system; further modifications to honour-all-cards rules to allow merchants to make independent acceptance decisions for each type of card for which a separate interchange fee applies; and increased transparency of scheme fees and average interchange fees, as well as the fees and procedures that apply if an acquirer wishes to bypass scheme switches. In terms of the EFTPOS system, the Board identified a number of potential changes that might improve the competitive environment. These included:

1. the introduction of a scheme to replace the existing bilateral contracts, with the scheme able to make binding decisions about interchange fees;
2. the creation of effective arrangements to promote the development of the system;
3. reform of current access arrangements; and
4. the development of alternative payment instruments for use in online payments (either by the EFTPOS scheme or through another channel).

The Board concluded that, while the costs and benefits of options 2 and 3 were finely balanced, its preferred approach was option 3. Despite its preference for this option, the Board noted that there was some probability that, even if it were implemented, the resulting competitive forces may still not be sufficient to constrain interchange fees. Reflecting this concern, the Board concluded that if average interchange fees in the credit card systems were to increase materially after the implementation of this option, it would consider the reimposition of interchange regulation. The Board also indicated that if the necessary steps were not taken by industry participants to improve the competitive environment, then it would consider the implementation of option 2.

In addition to the Board's conclusions on interchange fees, its other key preliminary conclusions can be summarised as follows.

• There was no case for allowing schemes to reimpose their no-surcharge rules or their earlier honour-all-cards rules. Some consideration was given to allowing schemes to impose a restriction on merchants that limited the size of any surcharge, but it was concluded that such a restriction could limit the competitive pressure on interchange fees.
• Merchants should be able to make independent acceptance decisions about pre-paid cards. Furthermore, merchants should not be penalised with higher interchange fees if they do not accept all card types within a scheme.
• The various access regimes should be retained, although further improvements in access arrangements were necessary, particularly to those systems based on bilateral contracts. The industry was encouraged, as a matter of priority, to examine alternative approaches that would address this issue and possibly allow entry without the need to establish a multitude of bilateral connections.