RDP 2014-14: The Evolution of Payment Costs in Australia 4. Resource Costs of Payments

4.1 Overall Resource Costs

The aggregate resource costs incurred by large merchants, financial institutions and the public sector in facilitating consumer-to-business payments are estimated to have been about $8.4 billion per annum in 2013, or about 0.54 per cent of GDP (Table 1). Payment resource costs of consumers are estimated at an additional $2.6 billion, the equivalent of about 0.17 per cent of GDP or 0.41 per cent of household expenditure; these are not included in the estimate of aggregate costs as they are considerably less reliable than costs for merchants and financial institutions.^[7] Detailed results for the resource costs associated with each payment instrument can be found in Appendix A.

The results suggest that the aggregate resource cost of the payments system is little changed in nominal terms since 2006, although it has fallen as a share of GDP (Schwartz et al 2008). The per transaction cost of almost all instruments has fallen since 2006, which has worked to reduce the overall resource cost. At the same time, however, a change in the mix of payments since 2006 has worked to increase costs. In particular, the share of payments made using cash has fallen, while the share of payments made using cards, which typically require more resources per payment, has increased. Furthermore, growth in the total number of payments in the economy is estimated to have been slightly slower than growth in real GDP.^[8]

It is worth noting that these estimates are likely to be somewhat sensitive to sample coverage. While, as noted above, the coverage of financial institutions is very good, the coverage of merchants is narrower, with detailed information focused on larger merchants that are likely to experience lower costs per transaction for payment services. Augmenting these results with indicative cost numbers from the small business survey (see Section 7) would increase the total costs to the economy to around $10 billion or 0.64 per cent of GDP.^[9] Such an augmentation is, however, imprecise.^[10] Regardless of whether the base or augmented measure of aggregate cost is considered, these aggregate estimates suggest that the cost of ‘producing’ a payment in the Australian payments system is towards the lower end of estimates for other economies for which studies have been undertaken.^[11]

The per transaction resource costs presented in Table 1 are the sum of both the direct costs of each payment and the costs of managing the accounts from which payments are made or received; Table 2 shows these costs separately. In this paper, the comparison of costs across instruments focuses on differences in direct costs because these costs are incurred in the chain of events required to make a payment; the costs of maintaining accounts are excluded because these costs can be common costs across a number of payment instruments. Account keeping costs are discussed separately to direct costs in more detail in Section 4.2.

Focusing on total direct costs, the least costly options that are typically available at the point of sale are cash and eftpos at $0.48 and $0.45 per transaction (Table 2). MasterCard & Visa debit and credit cards use around 1½ to 2 times the level of resources per transaction than either cash or eftpos. Of the remote payment options, direct debit is considerably less resource intensive than BPAY, debit and credit cards. Finally, cheques are the most resource intensive of the payment methods considered by the study by a considerable margin, costing over $5 per transaction. These rankings of cash, debit cards, credit cards and cheques are broadly consistent with overseas studies and the 2007 study.

A number of factors are relevant when considering the relative resource costs of these instruments. First, for the purpose of comparing the overall resource intensity of different instruments it is relevant to consider how they are actually used in the economy, and so the costs are measured at the average transaction size for each instrument. Section 6 explores in more detail how transaction size and cost are related. One implication of that analysis is that while cash is reasonably cheap for the small-value payments for which it is used ($26 on average, based on data from the RBA's 2013 Survey of Consumers' Use of Payment Methods), it is not necessarily a low-cost instrument at larger transaction sizes.^[12]

Second, relative resource costs also reflect the features of the different products. For example, the fact that eftpos did not offer card-not-present or international payments at the time of the study is likely to be one reason why the average resource cost per transaction is estimated to be significantly lower for eftpos transactions than for MasterCard & Visa debit card transactions or credit card transactions. It is also important to restate that the costs of credit provision and rewards, the differentiating features of credit cards, are not included in the payment costs calculated above. Including the cost of resources used for these functions and the transfers to consumers, the average total private cost of a credit card payment for financial institutions is estimated to be $2.95 per average transaction (Figure 2). The effects of fees and transfers are discussed in Section 5.

Third, economies of scale in the provision of payment services also influence costs per transaction. The ranking of cash and debit card costs in overseas studies provides some support to the idea that there are economies of scale. Countries with high cash use relative to debit card use (like Hungary and Portugal) report that cash is cheaper than debit cards on a per transaction basis, while studies for those countries which make greater use of debit cards (Denmark, Norway and Sweden) report that debit cards are cheaper (Schmiedel et al 2012). However, the costs per transaction across countries may also reflect greater use of lower-cost instruments within countries.

Fourth, differences in tender time – the time between the customer being informed of the transaction amount and the time the payment is completed – can play an important role in determining costs per transaction.^[13] For point-of-sale payments, figures obtained from a number of large merchants suggest, for example, that tender time for a cash transaction is about 25 seconds (Figure 3). Overseas research suggests broadly similar times, of about 20–30 seconds per cash payment (Bradford 2005; Borzekowski and Kiser 2008). Cheque transactions are found to be the slowest, taking somewhere between one and two minutes. Signature- and PIN-based card transactions are reported by merchants to be slower than cash but considerably quicker than cheques. Contactless card transactions are estimated to be slightly quicker than cash transactions, although different merchants in our sample reported contrasting experiences.^[14] Polasik et al (2013) report broadly similar transaction times between cash and contactless transactions in Poland. The difference in tender time between contactless and contact transactions does not affect the ranking of instruments at their average transaction sizes, but can affect the ranking of instruments at low transaction values (see Section 6).

Most resource costs are incurred by financial institutions ($5.4 billion), although sizeable costs are also incurred by merchants ($2.9 billion).^[15] Financial institutions' costs largely consist of the costs incurred to directly support payments being made, in particular the costs of building and maintaining information technology (IT) networks, the cost of processing payments (particularly the manually intensive processes surrounding cash processing and distribution) and customer service costs. In addition, the costs associated with running transaction and credit card accounts, which provide the capacity to make payments, are considerable.

The overall resource cost to financial institutions is estimated to be little changed since 2006, reflecting a range of developments that have affected resource costs in offsetting ways. On a per transaction basis, costs of running accounts are lower for all payment methods. In part, this reflects the fact that the intervening years have seen efficiency gains, such as those associated with the greater use of the internet to offer services. It also reflects the fact that the fixed costs are now spread across a greater number of electronic payments. Costs directly related to payment activities are also lower, with the exception of MasterCard & Visa credit cards. Investment in payment infrastructure by the financial and public sectors since 2006 is another factor that has reduced per transaction costs for many instruments in 2013.^[16] Offsetting these cost savings, consumers have been making greater use of more expensive instruments.

Since 2006, merchant resource costs are largely unchanged in aggregate, although there have been changes in some cost components. For example, costs have been lowered by initiatives that speed up tender time (including the move from signature to PIN verification and the introduction of contactless payments). Concurrently, costs have been boosted by higher staff wages and investment expenditure associated with terminal upgrades in order to process chip-and-PIN and contactless transactions.

4.2 Account Maintenance Costs

With the exception of cash transactions, all payment options covered in this study require a consumer to establish a transaction or credit card account at a financial institution. The establishment and maintenance of these accounts involves a number of costs for financial institutions. Examples include the cost of staff time used in processing applications and customer requests, the building and upkeep of IT systems and the marketing of new products.

Annual costs per account are estimated to have fallen since the 2007 study. Part of the decline in the per account costs can be explained by economies of scale. However, there has also been a broad-based decrease in the costs of many different components – such as systems and IT, application processing, general customer service and statement production costs (Table 3). This is likely to reflect both changes in the way that customers interact with their financial institutions as well as operational efficiencies from previous upgrades to core banking and customer systems (Stewart, Robertson and Heath 2013). That is, customers are undertaking more of their banking business through relatively inexpensive online channels, rather than through bank branches or telephone banking, while the costs associated with online channels have also fallen. For example, in 2006, respondents reported that telephone banking calls – often answered by staff – comprised close to 30 per cent of telephone- and internet-based connections. By 2013, telephone banking calls comprised only 5 per cent of these connections and rarely involved staff interaction.

Sections 4.3 to 4.6 cover the costs of each instrument excluding these account maintenance costs.

4.3 Cash

While cash is the most widely used payment method in Australia for consumer transactions there are some challenges in measuring the costs of cash payments. Its widespread use means that measuring the ‘end-to-end’ cost of a cash payment involves estimating the costs incurred by a large number of entities, including financial institutions, merchants, consumers and the public sector. For example, financial institutions incur costs running branch and ATM networks that allow customers to withdraw and deposit cash; merchants incur costs in handling cash, both at the point of sale and during the performance of back-office functions; the public sector incurs costs producing the physical notes and coins; and consumers incur costs – mainly their time – in obtaining and using cash. Furthermore, some of cash's characteristics – such as the ability to withdraw a large amount to make multiple payments and the absence of a centralised ledger or record keeping – mean that estimating the total number of cash transactions in the economy, and hence costs per transaction, is particularly difficult.

Addressing these issues in a broadly similar fashion as Schwartz et al (2008), this study estimates the total resource costs (excluding consumer costs) associated with cash payments to be $2.9 billion in 2013. The resource cost of cash transactions arise almost entirely from the costs associated with withdrawing and accepting cash, with little cost incurred in its production or in other activities, such as maintaining accounts to support cash transactions. Based on an estimated 6.1 billion consumer-to-business cash transactions per annum, the average direct cost of using cash is about $0.48 per transaction (Table 2).^[17] This is somewhat higher than estimated at the time of the 2007 study.^[18]

In regards to cash withdrawals, financial institutions are estimated to incur costs of about $0.91 (the average value of a personal cash withdrawal is about $280). The majority of cash withdrawals occur through ATMs, which involve an average cost of $0.85 per transaction (Figure 4). Costs associated with the maintenance of branches – including their staffing and location rental – mean that withdrawals through this channel are particularly costly, at around $6.00. This difference has become increasingly stark since 2006 as a diminishing number of withdrawals at branches has reduced the scope to spread the fixed cost of branches.^[19] The total resource cost of a debit cash-out withdrawal – whether a stand-alone transaction or combined with the purchase of goods or services – is estimated to be about $0.44 per withdrawal. Merchants incur the majority of this cost, about $0.30 per withdrawal, mainly in tender time, with financial institutions incurring the remaining costs.^[20]

It is also worth noting that the costs of ATM withdrawals differ markedly across ATM owners. For example, while the average ATM-based cash withdrawal is estimated to cost ATM owners about $0.77 (with card issuers incurring the extra $0.08 per transaction), a few entities reported average costs of between $1 and $2.50. This is potentially a function of the ATM owner's size and is heavily influenced by whether the entity's ATM locations are owned or rented from other parties. In the latter case, for example, the ATM owner often pays high rent to the site owner to install and run a machine in a ‘convenience’ location (such as a store, petrol station or licensed venue).

Overall, the average cost of a cash payment is estimated to be around $0.48 (Table 4). Around $0.20 of these costs are incurred by financial institutions and merchants in the course of distributing cash (given the cost per withdrawal discussed above is spread over multiple transactions). Merchants incur costs per transaction of approximately $0.27 in accepting cash, with the largest single component – about two-thirds – being tender time. The cost of tender time has increased somewhat since 2006, reflecting higher staff wages. To some degree tender time costs will have been reduced as more retailers offer self-serve checkouts. This has, however, shifted some of the costs to consumers and increased merchants' spending on point-of-sale equipment.

The cost of cash and coin production for the public sector is estimated to be less than $0.01 per transaction. This includes the costs associated with the production process (including equipment, materials and labour), research and development, the distribution of the currency (including storage and security), and note quality testing and counterfeit prevention. The low cost of cash production is consistent with a range of international evidence. For example, for Canada, Switzerland and the United States, banknote costs were below $0.36 cents per banknote^[21] (Williams and Anderson 2007), with a banknote only having to be used around 20 times for its costs to average around $0.01 per payment.

4.4 Personal Cheques

The total resource costs associated with cheque payments by consumers are estimated to be $0.3 billion (Table 1), lower than in 2006. Each cheque is estimated to impose resource costs of $5.12 per transaction, making cheques the most expensive retail payment method covered by the study (for more detail, see Table A6).

The change in the cost per transaction of cheques over the past decade is uncertain. Schwartz et al (2008) estimated total resource costs of about $5.30 per transaction, but noted that this might be overstated given alternative estimates (Centre for International Economics and Edgar, Dunn and Company 2006) and that estimating these costs was particularly challenging. The difficulty in estimating cheque costs remains, especially given these instruments now make up less than 1 per cent of consumer payments. Again, difficulties in separating cheque and cash costs might potentially result in some overstatement of the costs of cash transactions and an understatement of the costs of cheque transactions.

Notwithstanding these difficulties, there are a number of reasons why the costs for financial institutions' of cheques may have fallen since 2006, with the point estimates suggesting a fall from $4.22 to $3.26 per transaction. These include the major banks outsourcing their cheque processing arrangements around the time of the earlier study, reorganising and consolidating the processing of cheques, and investing in systems that image cheques to help reduce costs associated with customer inquiries (and in the future, the transporting of cheques).

The cost of cheque usage varies significantly for merchants across and within sectors (Figure 5). This is influenced by a number of operational differences across merchants. For example, billers bear no tender time costs as they do not have a physical presence. Also, the ability to attach additional information to a cheque payment (e.g. stapling a cheque to the bill and sending them together in the post) means that these payments remain more prevalent for billers than retailers, and hence billers can still benefit from some economies of scale. Although a private cost and not a resource cost, retailers can also pay a fee of up to 10 per cent to guarantee receipt of funds even if the cheque bounces. Given the high cost, a number of larger merchants noted during the study that they have now stopped accepting cheques.

4.5 Credit and Debit Cards

Both credit and debit cards offer consumers the ability to pay electronically for goods and services as well as to obtain cash using either cash-out or cash advance facilities. As well as enabling consumers to pay at the point of sale, credit and debit cards allow transactions to be conducted over the internet and phone.

A number of credit card networks operate in Australia – most notably American Express, MasterCard and Visa – allowing cardholders to undertake transactions using funds borrowed from their financial institution. Beyond offering cardholders the use of these funds – often on an interest-free basis for up to 60 days – these cards often also provide rewards on amounts spent. The three debit card networks operating in Australia – eftpos, MasterCard and Visa – offer cardholders similar payment functionality; consumers pay using their own funds and generally do not receive any rewards. Different credit and debit card networks can incur different costs, potentially reflecting differences in the efficiency of parties in the transaction and the features offered by the networks.

In aggregate, the study indicates that consumers' use of the credit and debit card systems for payment-related purposes (as opposed to credit and rewards functions) consumed resources of about $3.0 billion (excluding account overheads), with the majority of this comprised of resources used in credit card transactions (Table 1). On a per transaction basis, both eftpos and MasterCard & Visa debit card transactions continue to involve lower resource costs than credit card transactions (Tables 5 and 6).

The lower resource costs of debit card transactions for financial institutions partially arise from differences in scheme fees – which are used as a proxy for the resource costs incurred by the schemes (Table 5).^[22] Scheme fees within the eftpos network average only $0.02 per transaction, well below the $0.19 average for MasterCard & Visa debit transactions and the $0.32 average for MasterCard & Visa credit transactions.^[23] Other costs of eftpos cards – including card production, transaction processing and fraud prevention – are also lower than the equivalent costs for the MasterCard & Visa debit and credit networks. These differences in cost are, in turn, partially influenced by differences in card characteristics. At the time of the study, for example, eftpos transactions could only be authorised with the use of a PIN while other debit and credit cards allowed both PIN and signature authorisation at retailers and could be used online, resulting in higher fraud-related costs.^[24] Likewise, eftpos cards had lower costs of production than contactless-enabled MasterCard & Visa debit and credit cards as they did not have chip or contactless functionality.

For merchants, the lower resource costs of debit card transactions largely reflect differences in tender times (Table 6). In particular, credit card transactions generally have higher transaction amounts than debit cards – making it more likely that the consumer will have to use a slower signature or PIN authorisation rather than being able to use contactless functionality. Indeed, the study suggests that tender time costs for a contact transaction are about $0.20 per transaction, relative to $0.11 per transaction for a contactless payment. (This also explains why contact-only eftpos transactions involve more resource costs for merchants than MasterCard & Visa debit transactions, which include a significant proportion of contactless transactions).

Since 2006, the resource costs associated with eftpos transactions have fallen on a per transaction basis, reflecting lower costs to merchants (Table A5).^[25] The largest contributing factor is that the reported tender time cost of eftpos transactions has fallen; although eftpos did not offer contactless transactions in 2013, merchants reported that processing speeds have increased. Other costs of eftpos transactions have also fallen, presumably driven by economies of scale as the number of eftpos transactions has doubled.

In contrast, the costs of credit cards have increased slightly since the previous study (Table A3). The small increase primarily arises from higher scheme fees. Furthermore, the costs of ‘acquiring’ credit card transactions have also increased marginally for financial institutions, as more advanced terminals have needed to be installed at merchants to take advantage of contactless cards. These implementation costs have only been partially offset by lower fraud losses from the improved security.^[26]

Resource costs of credit cards faced by point-of-sale merchants have fallen, reflecting a decrease in tender time costs and other point-of-sale transaction costs (Table A4). However, the resource costs faced by merchants accepting card-not-present transactions have increased, driven by spending on scheme initiatives to improve the security of customer card details.

Finally, within credit cards, the resource costs of transactions using American Express and MasterCard or Visa cards are similar where data are available (Tables A3 and A4; note that acquiring data for American Express are excluded to maintain confidentiality). Regardless of which card network is used, credit cards are more resource intensive than debit card transactions.

4.6 Direct Debit and BPAY

Direct debit payments involve the automatic debiting of funds from a customer's transaction or savings account. These are initiated by merchants who have obtained prior authorisation from their customer.^[27] There is no scheme involved in direct debit payments; direct debits are facilitated by the set of bilateral relationships between financial institutions.^[28] BPAY, in contrast, is a scheme that financial institutions can join. BPAY allows a customer to pay a bill or invoice using the biller's unique BPAY identifier and the customer's unique customer number (generated by the merchant).

Both direct debits and BPAY have relatively low resource costs. They involve the lowest resource cost to merchants of all the payment methods considered, primarily because both are remote electronic payment options involving no tender time and few manual processing tasks. As for other instruments, the per transaction costs associated with these payments have fallen since 2006 (Tables A6 and A7); the economies of scale generated by continued growth in transaction volumes have more than offset an increase in the aggregate costs incurred by merchants and financial institutions.

Merchants incur higher back-office costs for direct debits than for BPAY; the authorisation process can involve manual processes and merchants may incur costs chasing failed payments as there is no guarantee that funds are available in the customer's account at the due date of the automated payment. In contrast, financial institutions incur higher costs for BPAY transactions than direct debits; financial institutions incur costs setting up and servicing BPAY biller accounts (which offer billers more services than are built into direct entry payments) and pay scheme fees to BPAY for clearing, marketing, centralised governance and product development services.^[29] In total, direct debit payments involve the least resource cost across all payment methods, reflecting the very simple service they provide, which uses the long-standing direct entry system with no other built-in features.

Footnotes

Consumer costs are discussed in more detail in Appendix C. [7]

The number of electronic transactions is measured directly from the population of financial institutions through the Retail Payments Statistics, while the number of cash transactions is estimated from survey data and is subject to a margin of error. Details of the preferred estimate of cash transactions are in Appendix B. If the higher estimate of cash transactions in Appendix B is used, the aggregate cost increases by 0.03 percentage points of GDP. [8]

Australian Taxation Office data for sole traders, partnerships, and small- and micro-sized companies in consumer-facing industries suggest that they account for around $177 billion in sales, or 29 per cent of total sales in these industries. The costs incurred by SMEs was not estimated in the 2007 study. [9]

There are a number of caveats: the SME cost estimates primarily focused on private costs (resource cost estimations are inferred); a much smaller share of SMEs responded to the survey; the industry coverage may not be representative; it was not possible to implement the same quality assurance processes around data from these institutions; and the scaling of payments made to SMEs is less certain. [10]

A thirteen country study of payment costs in Europe found that resource costs associated with payments accounted for an average of about 1 per cent of GDP, with results for individual countries ranging from 0.42 per cent to 1.35 per cent of GDP (Schmiedel et al 2012). A recent estimate for Norway suggests costs of about 0.48 per cent of GDP (Norges Bank 2014). The extent to which international studies have been able to incorporate small business costs is not entirely clear, but the results of these studies are likely to reflect the costs of large businesses which are better able to provide accurate data on costs and payment volumes (Scheimdel et al 2012, p 12). [11]

Some indicative transaction sizes for consumer-to-business payments are: eftpos $52, MasterCard & Visa debit cards $69, credit cards $128, cheques $3,533, direct debit $510 and BPAY from a transaction account $540 (Table B1). [12]

Some studies define tender time more broadly, potentially including the time taken in queuing at the point of sale or the time taken to ‘ring up’ the total sale price from individual items. Such costs are not, however, explicitly estimated in this study. In the first case, queuing time will be influenced by a range of factors beyond the payment method choice. In the second case, the time taken to ‘ring up’ sales is not a time cost that arises from a particular payment method but rather part of the wider sales and inventory management process. [13]

For the purposes of this study, ‘contactless card payments’ refers to transactions using contactless technology and which are under $100 (and hence do not need a PIN). Contactless card payments can be made for values over $100 with the use of a PIN, at which point tender time could be assumed to be the same as a contact-based card transaction. A few factors seem to influence whether cash or contactless card transactions are reported to be quicker. These include such factors as the technology in the PIN pad used by the merchant, the transaction size (with payments around the same size as currency denominations more likely to be made with cash), whether the contactless transaction can be processed ‘offline’, etc. A number of merchants also noted that the occasional failure of a contactless transaction increases tender time as the consumer has to retry their card or switch payment types. [14]

Resource costs are also incurred by the public sector, which produces and distributes notes and coins, and runs some of the centralised components of the payments system. However, these are very small on a per transaction basis. [15]

For example, the Community of Interest Network (COIN) has worked to reduce the number of physical network connections in the direct entry, eftpos and ATM systems. The Reserve Bank has also overseen the linking of the COIN and the SWIFT network for the exchange of bulk files, thereby simplifying the process of sending settlement instructions. Developments specific to each instrument are discussed further below. [16]

Information on the methodology used to calculate the number of cash transactions can be found in Appendix B. [17]

The approach to cash in the 2014 study is slightly different to the 2007 study. In line with the approach taken for other payment instruments, the costs of cash considered in this study include only costs directly relevant to consumer payments to businesses: the costs of consumers withdrawing cash, and the cost to merchants of accepting cash payments and making deposits. In contrast to the 2007 study, the costs to financial institutions of consumer cash deposits and business cash withdrawals have been excluded, as the majority of these costs are likely to relate to transactions outside the scope of this study, such as person-to-person, business-to-consumer or business-to-business payments. The total cost of cash for 2006 in Table 4 is calculated using the 2014 methodology and so differs from the number presented in the 2007 report ($0.44 per transaction). [18]

Discussions with some banks suggest that the diminishing number of cheque transactions has made it harder to accurately measure the separate costs of cash and cheque acceptance at branches, implying that the estimate of the costs of branch cash withdrawals are potentially overstated while financial institutions' costs of cheques may be understated. [19]

Resource costs associated with purchase-only eftpos transactions are discussed in Section 4.5. [20]

Range calculated from local currency estimates converted to Australian dollars on 11 August 2014. [21]

For example, schemes may incur costs of clearing, marketing and centralised governance and product development. [22]

Interchange fees are not a resource cost and are excluded from this calculation; see Section 5 for private cost calculations. [23]

Signature authorisation was phased out subsequent to the study period. [24]

The evolution of MasterCard & Visa debit card costs is not presented owing to the small number of entities able to provide costs on this item in the 2007 study. [25]

The majority of fraud costs now arise from card-not-present (online) transactions (APCA 2014). Discussions at the time that the scope of this study was being determined indicated that financial institutions did not consider there to be a significant difference in fraud losses between contact and contactless transactions. [26]

Authorisation may also be obtained by the merchant to debit payments from the customer's credit card account. These are processed and settled through the relevant credit card network and so treated as a credit card payment in this report. [27]

Clearing rules have been established by the Australian Payments Clearing Association. [28]

Costs relating to BPAY View were excluded as this is an invoicing function of BPAY, not a payment function (although it may lower costs relating to exceptions management). [29]