Submission to the Productivity Commission Inquiry into Competition in the Financial System 6. Competition in the Payments System

The Reserve Bank is the primary regulator of the payments system and competition is a key part of its regulatory mandate. The Bank has taken a number of actions since the early 2000s to enhance competition and efficiency in the payments system, mostly in relation to card schemes. While the nature of competition in payment systems can be complex due to the structure of the industry and the role played by network effects, the Bank's overall assessment is that competition in retail payment systems is reasonably strong at present. The Bank, nevertheless, continues to monitor competitive conditions in the payments system and is prepared to take action, where it is in the public interest, to address any competition concerns that arise.

The role of the Payments System Board

The promotion of competition in the payments system is a key part of the mandate of the Payments System Board (PSB) of the Reserve Bank. The PSB is responsible for the Reserve Bank's payments system policy, including in relation to clearing and settlement facilities. The PSB is required to exercise its responsibilities in a way that best contributes to:

• controlling risk in the financial system
• promoting the efficiency of the payments system
• promoting competition in the market for payment services, consistent with the overall stability of the financial system.

In practice, most of the competition issues that the PSB has dealt with relate to retail payment systems, where matters of competition and efficiency are key, compared with high-value payment systems and clearing and settlement facilities, where safety and stability are more critical.^[11] This section therefore focuses on the work of the Bank and the PSB in promoting competition in the retail payments system.

The approach of the PSB has been to encourage the industry to undertake reform on its own where possible, with the PSB using its powers only when it considers this to be in the public interest to do so to help manage risk and promote efficiency, competition and stability in the payments system. As a result, the PSB has made only limited use of its formal regulatory powers over the past two decades.

In discharging its responsibilities, the PSB is mindful of the responsibilities of other regulators. The Australian Competition and Consumer Commission (ACCC) has broad responsibility for competition and access issues in all industries under the Competition and Consumer Act 2010. The Bank and the ACCC have entered into a Memorandum of Understanding to ensure appropriate coordination between the two agencies in relation to competition issues in the payments system.

The Bank's regulatory reforms in the card payments market

From the early 2000s, the Bank began implementing a series of reforms in the payment cards market as part of its mandate to promote competition and efficiency in the payments system. These reforms included the introduction of benchmarks for interchange fees, which are fees paid by the merchant's financial institution (the acquirer) to the cardholder's financial institution (the issuer) every time a card payment is made. The benchmarks were aimed at increasing the transparency of interchange fees and limiting their tendency to rise. The reforms also involved changes to certain restrictive rules in card networks to provide merchants with the freedom to choose which cards they would accept and to apply surcharges on card transactions. By choosing to not accept a particular card type or to surcharge more expensive cards, merchants are able to provide signals to cardholders to choose less costly payment methods, and to schemes and acquirers to ensure that merchant service fees are competitive.

The Bank has also implemented access regimes for various card schemes aimed at reducing barriers to entry for entities wishing to issue cards or provide acquiring services to merchants.^[12] For instance, in 2006 the Bank introduced an access regime for the eftpos network to facilitate entry given that new participants had to undertake bilateral negotiations with multiple incumbents who had little incentive to assist them.^[13] The Bank has subsequently revised or revoked many of these access regimes when it was satisfied the card schemes had put in place improved access arrangements for new entrants.^[14]

In 2015–16, the Bank undertook a comprehensive review of its card payments regulation, which resulted in several changes to the interchange and surcharging regulations (RBA 2016b). These included the introduction of ceilings on individual interchange fees as a supplement to the existing weighted-average benchmarks, a more tightly defined limit on the maximum surcharges that merchants can impose, and requirements for acquirers to provide merchants with greater transparency over their payment costs. The review also prompted additional reforms to enhance competitive neutrality in the payments card market by extending interchange fee regulation to American Express companion cards issued by banks. Though these cards do not involve interchange fees, they incorporate payments that are economically equivalent to interchange fees.

In recent years, the Bank has negotiated voluntary undertakings to deal with competition concerns in relation to dual-network debit cards, which are ATM/debit cards with point-of-sale debit functionality from two payment networks (eftpos and one of either MasterCard or Visa). The PSB was concerned that actions by particular networks with respect to these cards had the potential to inhibit competition, limit consumer choice and increase payment costs. Accordingly, in 2013, the Bank secured voluntary undertakings from the relevant schemes in which they agreed not to prevent issuers from including contactless applications of other schemes on debit cards and to not stand in the way of merchants exercising choice in the networks they accept and in how their contactless transactions are routed (RBA 2013). In 2016–17, the Bank undertook a public consultation in response to concerns about possible restrictions by schemes on the use of dual-network cards in mobile wallets (RBA 2016a). Following discussions with industry participants, the Bank received voluntary commitments from relevant participants that addressed these concerns without the need for regulatory intervention (RBA 2017).

Competition in the payments market

Competition in payment systems is complex and multifaceted as it occurs at different levels and between different participants in those systems. At the broadest level, there is competition between different payment methods, such as credit and debit cards, bank transfers, cheques and cash. Payment methods have varying levels of convenience, cost and other attributes that make them more or less appealing to users. These differences have contributed to some noticeable shifts in consumer payment preferences, which the Bank has documented in its triennial Consumer Payments Surveys (Doyle et al 2017). One consistent trend over the past decade has been a shift away from paper-based payment methods, such as cash and cheques, and towards electronic methods, such as credit and debit cards.

Within the payment cards market there is competition between different card schemes and also between the participants within those schemes, namely card issuers and acquirers.^[15] The card schemes, such as Visa, MasterCard, and eftpos, compete to increase the issuance, acceptance and use of cards that utilise their payment networks. This competition can be reflected in the fees schemes charge and in the incentives and other benefits they provide to issuers, acquirers and/or merchants. Separately, there is competition between card issuers and between acquirers. In card issuance, competition is reflected in the pricing, rewards and other product features that apply to different types of cards. Acquirers mostly compete over the payment services and products they provide to merchants and the fees they charge (merchant service fees).

As the Bank has discussed elsewhere, the structure and competitive dynamics of card schemes can result in pricing outcomes that are economically counterintuitive.^[16] Where the market structure is such that there are multiple schemes whose cards are widely accepted and where consumers may hold one scheme's cards but not the other, competition tends to involve offering incentives to a consumer to use a particular scheme's cards (Guthrie and Wright 2007). In four-party card schemes, interchange fees are typically paid by the merchant's financial institution (the acquirer) to the cardholder's financial institution (the issuer) every time a payment is made. Therefore, a scheme that increases its interchange fees enables the card issuer to offer more generous incentives to cardholders, which can increase use of its cards. Competition between well-established payment card schemes can therefore lead to the perverse result of increasing the price of payment services to merchants (thereby leading to higher retail prices for consumers). This dynamic was evident in Australia before the Bank's regulation of interchange fees and is observable today in markets such as the United States where credit card interchange fees are not regulated.

Card schemes

Payment cards (debit, credit and charge cards) are the most frequently used retail payment method in Australia. The Bank's Consumer Payments Survey showed that 52 per cent of consumer payments were made with payment cards in 2016, compared with 26 per cent in 2007 (Doyle et al 2017).

MasterCard and Visa are the two largest credit card schemes in Australia, with a combined market share of a little over 80 per cent of the value of credit and charge card transactions (Graph 30). They operate as four-party arrangements, relying on banks and other financial institutions to separately issue their cards and provide acquiring services. In contrast, American Express and Diners Club operate as three-party arrangements, where they act as the card issuer and acquirer themselves. Some banks also issue American Express companion cards for which American Express remains the sole acquirer. The introduction of companion cards by the major banks in 2004 and 2009 coincided with visible increases in American Express' market share.

MasterCard, Visa and eftpos compete in the debit card market (the American Express and Diners Club schemes do not include debit cards). MasterCard and Visa debit card transactions have generally grown at a faster rate than eftpos transactions over the past decade, with their combined market share rising to a little over 60 per cent. This largely reflects MasterCard and Visa's relatively early introduction of contactless and online payments functionality, whereas eftpos only recently began offering contactless functionality and is still developing online payments functionality.

A high degree of concentration in a few card schemes is a characteristic of many payments markets. Payment systems have strong network effects that can make it difficult for new schemes to develop or enter the market. Consumers tend to only want to hold a card if there are many merchants that accept it, while merchants tend to only accept a brand of card as a means of payment if many potential customers hold it. UnionPay, which is one of the largest card schemes globally by virtue of its dominance in China, has been gradually building merchant acceptance in Australia by focusing on merchant segments with heavy exposure to inbound Chinese tourism. However, few UnionPay-branded credit cards have been issued locally, which is indicative of the challenges of establishing a new card scheme in the presence of these strong network effects.

Card issuing^[17]

As in the broader banking market, the major banks are the largest card issuers in Australia. Spending on credit and debit cards issued by the major banks accounts for nearly 80 per cent of the value of card transactions, with this share remaining fairly stable over the past decade (Graph 31). Credit and charge card issuance is slightly less concentrated than the overall card market, partly reflecting the presence of American Express and Diners Club, which, as mentioned before, typically issue credit and charge cards directly to cardholders (rather than through a financial institution).

Credit card issuers compete for cardholders in various ways, including in relation to fees, reward points and other product benefits (e.g. travel insurance). Strong competition is evident in the frequency and range of offers that, for instance, waive annual fees for the first year or give sign-on bonuses in the form of frequent flyer points. Most notably, many credit card issuers offer a zero per cent (or significantly reduced) interest rate for balances transferred from another credit card for a set period of time. Around 70 per cent of the consumer credit cards that the Bank monitors have some form of active balance transfer offer.

Debit card issuance is a little more concentrated than the overall card market. This partly reflects that debit cards are issued as part of a bundle of transactional account services and are not offered or priced as standalone products like credit and charge cards. Accordingly, switching debit cards usually involves changing to a new transaction account, which can be inconvenient in terms of re-establishing direct debits and credits. While the industry has introduced arrangements to facilitate account switching, use of these arrangements is reportedly quite low. This could indicate a lack of customer awareness or a perception that the benefits from switching are not that significant. Looking forward, the New Payments Platform (NPP) and the introduction of an open banking regime may facilitate the development of services that make account switching easier (see below).^[18]

Credit card interest rates

The Reserve Bank's primary responsibilities with respect to credit cards relate to the payment, rather than lending, function of these cards. Nonetheless, it is worth making a few observations regarding interest rates on credit cards.^[19]

There is significant variation in the advertised interest rates on credit cards, reflecting the wide range of products offered, with some bunching of the rates on standard cards around 20 per cent and around 13 per cent for lower-rate cards. These rates have changed very little since 2010, despite a fall of over 3 percentage points in the cash rate over this period. The actual interest rates paid on credit cards will be lower than advertised rates to the extent that cardholders switch cards to take advantage of low- or zero-rate balance transfer offers or pay their balances in full every month. On average, the outstanding rate on the entire credit card portfolio is around 11 per cent (or about 18 per cent for those cardholders who pay interest).

While issuers compete actively for new customers, credit card interest rates are relatively sticky and do not follow changes in issuers' funding costs as closely as other lending rates. This is consistent with international experience and has been studied before (Ausubel 1991). A likely reason is the existence of a significant number of consumers who are either not well informed of the credit card options available to them or are reluctant to switch providers to seek a lower rate. While there are numerous credit card comparison websites, many consumers may be more focused on accumulating rewards, frequent flyer points or other benefits from card use. Issuers therefore have little incentive to compete on interest rates given that rates are not a determining factor in choosing a credit card for many individuals who (possibly mistakenly) do not expect to build up significant interest-accruing balances.

Card acquiring

The major banks are also the largest card acquirers in Australia, but their share of this market – at about 75 per cent of the value of card transactions – is a bit lower than their share of the card-issuing market, and has declined over the past decade (Graph 32). The decline in the major banks' share partly reflects growth in the market share of American Express cards, which are acquired directly by American Express. In addition, two large Australian retailers have implemented payment-switching capability that allows them to ‘self-acquire’ transactions. A specialist acquirer, Tyro, also entered the market following the Bank's initial access reforms in the early 2000s, and has since obtained a banking licence and is now offering a wider range of business banking products. Other specialist acquirers have entered the market more recently, notably Adyen and First Data, although their market shares are still small.

One indicator of competition in the card-acquiring market is the level of merchant service fees, which acquirers charge to merchants for every card payment they process. Since the Bank started regulating MasterCard and Visa interchange fees in the early 2000s, average (credit and debit) merchant service fees for these networks have roughly halved, to around 70 basis points (Graph 33). Most of this decline occurred in the years immediately following the reforms and was larger than the decline in interchange fees, suggesting strong competition between acquirers. Furthermore, average merchant service fees for American Express and Diners Club have also fallen since the reforms, by around 90 and 60 basis points, respectively, despite them not being directly regulated.

Besides lower merchant fees, competition in card acquiring is also apparent in the increasing range of products and services being made available to merchants. For example, recently some acquirers have been offering more innovative options for accepting card payments at the point of sale or online, such as mobile card readers and online invoicing and payments solutions. Acquirers also commonly compete by offering discounted ‘bundled’ pricing on payment and non-payment services, such as a package that combines acquiring services, terminal rental, a business loan and insurance. While these packages provide additional convenience, and possibly better overall pricing, they may also act as an impediment to merchants switching to a different acquirer. A merchant will be less inclined to look for a better deal on its acquiring services if that would mean that it also has to renegotiate a number of other banking services at the same time.

One area where competition is yet to emerge is in the provision of least-cost transaction routing to merchants. Different card transactions have different costs for merchants, with debit cards usually having lower merchant service fees than credit cards. In addition, debit transactions that are processed through the domestic eftpos system are on average less expensive than transactions processed through the international MasterCard and Visa systems, reflecting both lower interchange fees and lower scheme fees (the fee that the merchant's bank pays to the payment network). In ‘contact’ or ‘dip and PIN’ transactions involving dual-network debit cards, the cardholder chooses whether the transaction goes via eftpos (if they push CHQ or SAV) or the international network (if they push CR). However, with the introduction of contactless cards, the cardholder and merchant no longer influence the routing of the transaction – it is determined by the network priority that is preset by the card-issuing bank when it sends the card out. Initially, the international schemes were the only networks with contactless functionality, so a contactless debit transaction could only go via their networks. However, eftpos has now rolled out contactless functionality on almost all debit cards and almost all terminals are now enabled for eftpos contactless transactions. With international scheme transactions typically being more expensive for merchants, merchants report that the shift from contact to contactless transactions has resulted in a significant increase in payment costs for debit transactions and many merchants are now increasingly interested in their banks providing them with the ability to send debit transactions via the lower-cost network even if that network is not the first-priority contactless network on the card. The Bank understands that a number of acquirers are currently considering providing least-cost routing to merchants, a development which would contribute to a more competitive and efficient payments system. As noted above, one element of the undertakings provided by the three debit card networks in 2013 in relation to dual-network debit cards was that schemes would not prevent merchants from exercising choice in routing contactless transactions.

Competition in the ATM system

The ATM system is another part of the payments system where the Bank has intervened to address competition concerns. In 2009, the Bank put in place an ATM access regime aimed at making it easier for new participants to join the system and introducing greater competition in fees by allowing ATM owners to charge cardholders directly for using their ATMs (and at the same time removing hidden interchange fees that were passed on to the cardholder in a non-transparent way). One outcome of these reforms was an increase in the number of ATMs as participants took advantage of the new pricing flexibility to place them in locations where they would not previously have been commercially viable. The number of ATMs in Australia has increased by about 25 per cent since 2008, to around 33,000 at end 2016 (Graph 34, left panel).

While the number of ATMs is still close to its peak, the use of ATMs has been declining rapidly in recent years reflecting a broader decline in the use of cash for transactions as consumers increasingly opt to use electronic means of payment (Graph 34, right panel) (Doyle et al 2017). The structure of the ATM industry has also changed since the original reforms were introduced, with the development of switches and other hub-based infrastructure making it easier for new entrants to join the ATM system without having to establish direct bilateral connections with all other participants. These changes mean that facilitating access for new participants has become less of an issue and so the Bank has recently been in discussions with the industry about the future of the ATM access framework, including exploring the scope to transition to a self-regulatory model in the future.

Technology and innovation

Driven by advances in information and communications technology, the payments market has been going through a period of rapid innovation and technology evolution in recent years. Competition is increasingly being reflected in new customer-facing product innovations and technologies, introduced both by existing participants and challengers that are seeking either to gain a foothold in existing payment systems or attract business away from those systems. For example, among incumbents there has been a focus on the deployment of contactless ‘tap and go’ and mobile payments functionality in recent years.

The number of contactless card payments has increased strongly in recent years, largely because of the growing use of contactless cards for lower-value payments. The 2016 Consumer Payments Survey showed that nearly two-thirds of all point-of-sale card payments were contactless. Similarly, mobile payments technology has attracted significant investment in recent years. Almost all financial institutions in Australia have internet banking mobile apps, which facilitate mobile payments. Third-party mobile wallet apps, such as Apple Pay, Android Pay and Samsung Pay, have all been recently launched in Australia, although they are not available across all banks or card schemes.

New entrants into the payments market have also been driving innovation in retail payments. Firms such as PayPal and POLi, which offer customers new ways to make online payments that may be more convenient, have experienced strong growth over recent years, although from a low base. In addition to online payments, new entrants are active in other parts of the payment system, including merchant services and card payments processing (such as Square), card acquiring (such as Tyro) and remittances (such as OFX and TransferWise). As would be expected, however, the types of innovations that are succeeding in Australia reflect the initial structure of, and gaps in, our payments system. For example, with almost all Australians having bank accounts and payment cards, services similar to Kenya's M-Pesa system, where customers' funds are held by a mobile phone operator, have gained little traction here. Furthermore, given the high use of cards and high penetration of payment card terminals in even the smallest retailers, it remains to be seen whether there will be demand for QR-based payments which have grown rapidly in China where card terminals are much less ubiquitous.

Digital currencies are another area of innovation in retail payments, although their use and merchant acceptance is extremely limited at present in Australia. Digital currencies have displayed high levels of price volatility and some security issues that are likely to make them unappealing for many consumers. Nonetheless, as technology improves and industry practices evolve, it is possible that they may become more widely used, providing competition to other payment methods; this is more likely for cross-border payments than for domestic use. Recent changes in some policy settings, such as the removal of the double incidence of GST on digital currency transactions, may encourage the development of more products and services related to digital currencies (ATO 2017).

Looking forward, the Australian Government has recently announced that it intends to introduce an open banking regime in Australia (The Treasury 2017). Allowing consumers to securely share their personal banking data with other service providers could facilitate the development of innovative services and promote the entry of new players into the payments market. Fintech firms, for example, could develop services that provide personalised product comparisons, facilitate account switching, or allow customers to securely make online payments direct from their bank account as an alternative to other payment methods. Given the potential benefits for innovation, competition and efficiency in the payments system, the Bank is strongly supportive of an open banking regime.

Despite these positive developments, there are some challenges. Some fintech firms have suggested that access to banking services is difficult where the firm's business model relates to payments. Partly, this may be the natural response of incumbents, which, in any industry, generally have little incentive to cooperate with new competitors. In addition, some banks have indicated that they are reluctant to deal with bitcoin-related start-ups due to the risks arising from AML/CTF regulation and international enforcement.

Innovation in payments networks and the New Payments Platform

Some innovations in the payments market, such as a new wireless card acquiring terminal, can be characterised as proprietary in nature. The decision to innovate is largely based on the expected benefit to the innovator, for example lower costs or greater revenue to the participant that introduces the new type of terminal (RBA 2011). Since the innovator can implement the technology and receive the benefits without coordinating with many other participants in the system, competitive pressures are likely to encourage proprietary innovation.

In contrast, innovations in the cooperative systems and arrangements that underlie most payment systems are more difficult to achieve since they require agreements across many participants. An investment in cooperative infrastructure might not align with individual banks' investment cycles or banks may have concerns that investing in a standardised technology could give competitors an advantage. The need to coordinate can result in innovation being slower than desirable and, in some cases, new technologies may not be implemented at all.

To encourage greater cooperation in payments innovation, in 2012 the Bank published a set of high-level strategic objectives for the payments industry following a Strategic Review of Innovation in the Payments System.^[20] These objectives addressed a number of gaps in the payments system, including the ability to make real-time payments on a 24/7 basis with simpler addressing and richer data.

The NPP, currently under development by a group of 13 financial institutions, is the industry's main vehicle for addressing the Bank's initial set of strategic objectives. One of the ‘core criteria’ that the Bank specified for the NPP was that it ‘should be based on efficient, secure and open hub-type architecture, capable of supporting fair and open access’. Accordingly, it has been designed to provide a platform for the development of innovative payment services over coming years. In particular, it will be capable of supporting specialised overlay services, tailored to meet the specific payment needs of different groups of users.

The governance of the NPP – including an independent chair and representation of industry stakeholders catering for the interests of large, medium and smaller institutions – will support open access and competition from various payment system participants to utilise the platform. The Bank, which is also represented on the Board of the NPP, will continue to monitor the progress of the platform, including its arrangements around access and support for competition. At some point after the NPP is operational, it will be appropriate for the Bank to assess how well the NPP has met the initial set of strategic objectives and whether there are other areas where cooperative industry approaches to innovation in the payments system are needed.

Footnotes

Competition issues do, however, periodically arise in other parts of the system, including in relation to the clearing and settlement of Australian cash equities. [11]

An access regime is a regulation that seeks to ensure that new participants are able to access a payment system on fair and reasonable terms. [12]

In the early 2000s, the Bank also implemented access regimes for the credit card networks with the aim of removing some restrictions on participation imposed by the credit card networks that unnecessarily inhibited competition and could not be justified as protecting the safety of the system. These access regimes involved the creation of a special class of financial institutions, to be authorised by APRA, to conduct only credit card activities. [13]

The eftpos access regime was revoked in September 2015. Access regimes for the credit card networks were varied, effective January 2015, giving the card networks more flexibility to establish their own access eligibility and assessment criteria. [14]

Acquirers are institutions that provide merchants with facilities to accept card payments. The biggest participants in the cards market are both card issuers and acquirers, but there are some institutions that are only involved in card issuing or acquiring. [15]

For a more detailed description of the competitive implications of interchange fees, see ‘Box A: Interchange Fees’ in (RBA 2015b). [16]

The Bank provided detailed information and observations about competition in the credit card market in its ‘2015 Submission to the Senate Inquiry into Matters Relating to Credit Card Interest Rates’ (RBA 2015c). [17]

Recently, the House of Representatives Standing Committee on Economics recommended that the government, following the introduction of the NPP, consider whether additional account-switching tools are required to improve competition in the banking sector (House of Representatives 2016). [18]

For more detail about credit card interest rates, see (RBA 2015c). [19]

See ‘Box E: Initial Strategic Objectives’ in (RBA 2012). [20]