RDP 2014-14: The Evolution of Payment Costs in Australia 1. Introduction

This study provides comprehensive estimates of the costs borne by merchants, financial institutions and individuals in the use of different retail payment methods. The absolute and relative costs involved in making and receiving payments are important as they influence the decisions of these sectors and, therefore, the mix of payments in the economy. They are also important considerations for policymakers when trying to understand the efficiency of the payments system. These costs are typically not transparent to policymakers or end users of payment systems.

This study follows earlier work on payments costs by the Reserve Bank and the Australian Competition and Consumer Commission (Schwartz et al 2008; RBA and ACCC 2000). These studies helped to inform subsequent policy deliberations, although it should be kept in mind that policy deliberations take into account a wider range of considerations than just costs as measured by these types of studies.

Given the significant changes in technology, payment functionality, issuing arrangements, pricing and payment use patterns that have occurred in recent years it is timely to refresh this work with new cost data. This study extends the earlier work in a number of directions. In particular, it:

• explores both the resources used (resource costs) and the fees and other transfers (which contribute to private costs) associated with different payment instruments ^[1]
• captures the payments costs of a wider range of merchants, including small businesses
• collects information on a wider range of payment instruments, for example so-called ‘companion credit cards’ (American Express credit cards issued by the major banks to customers alongside a MasterCard or Visa credit card)
• separately identifies the costs of contactless card transactions given their rapid growth and implications for tender times and other costs.

As with the earlier Reserve Bank work, the study has benefited from close cooperation with a wide range of financial institutions and merchants. These entities helped determine what information could be reliably obtained, provided a large amount of data to the Reserve Bank for analysis, and worked with the Reserve Bank to improve the accuracy and consistency of these data.

The key findings of the study include:

• The aggregate resource cost incurred by merchants and financial institutions in receiving payments from consumers is estimated to be about $8.4 billion in 2013, or about 0.54 per cent of GDP. Financial institutions incur the majority of these costs. Around one-third of costs are incurred by merchants, with tender time (the time taken at the till to process the payment) being the most significant component.
• The aggregate costs associated with consumer-to-business payments are estimated to have changed little in nominal terms since the 2007 study, and to have fallen as a per cent of GDP. The fall primarily reflects that per transaction costs have fallen across most instruments. Marginally offsetting the fall, the shift towards greater use of more expensive instruments has worked to raise the cost of the payments system.
• To conduct a comparison of the cost across instruments, the cost of maintaining accounts (which may facilitate payments made with multiple instruments) is excluded and only the direct cost of making a payment using that method is considered. On this basis, cash, eftpos and contactless MasterCard & Visa debit transactions have broadly similar resource costs for transactions of under about $20. Above $20, eftpos is the lowest-cost payment method. At the average transaction size for each instrument, MasterCard & Visa debit card payments are more resource intensive than eftpos, while credit card transactions are the most resource-intensive card payment method even when excluding the costs of credit and rewards (Figure 1). Of all methods considered in the study, direct debit remains the lowest cost, while cheques remain the most expensive.

• The aggregate and relative costs associated with card payments are changing considerably with the advent of contactless payments. Contactless card payments are estimated to incur 10 to 20 per cent lower resource costs than a comparable contact-based card transaction.
• Once fees and other transfers between sectors are included, the burden of private costs across sectors differs from that of resource costs and varies significantly across instruments. The majority of private costs are incurred by merchants and consumers who typically pay a net transfer to the financial sector to use payment services, although merchants may pass these costs on to consumers in general via the prices on their goods and services. Across instruments, the private cost to consumers is relatively similar despite large differences in resource costs. On average, the private cost to consumers of using a credit card is similar to that for a debit card despite the higher resource costs incurred for credit card transactions. Although consumers pay fees to hold credit cards, they also receive significant incentives to use them to make purchases, due to rewards points and the interest-free period.
• Results from a survey of small and medium enterprises (SMEs) suggest that while the ranking of the private costs of instruments is similar to that for large businesses, the private costs faced by SMEs are higher. In part, this is because SMEs do not benefit from the economies of scale that can be achieved by large merchants due to their larger payment volumes. In addition, merchant service fees are higher for small businesses.

The rest of this paper proceeds as follows. Section 2 discusses the literature on payment costs. Section 3 outlines the scope of this study and details the estimation methodology. Section 4 presents resource costs of payments in Australia, both in aggregate and by instrument. This is supplemented in Section 5 by a discussion of how these costs are borne by different sectors. Section 6 examines how resource costs vary at different transaction sizes and Section 7 focuses on the private (gross) costs to SMEs of accepting payments. Section 8 concludes.

Footnote

The distinction between resource costs (the economic resources that are expended to ‘produce’ a payment, see Schwartz et al (2008)) and private costs (the combination of resource costs plus the transfer payments paid or received by parties) is discussed in more detail in Section 2. [1]