Payment cards

Phil Alves15 October 2010

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Outline

1. The credit card market in South Africa2. What is interchange?3. What are the concerns?4. The Enquiry Panel’s view5. What can be done?6. Conclusion

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Credit card market by card schemeOctober 2006, Submission to the Banking Enquiry

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Credit card market by issuing bankApril 2007, Submission to the Banking Enquiry

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What is interchange?

• Two-sided platforms/markets– Newspapers, shopping malls, video gaming platforms,

payment cards• Interchange balances demand on either side • Aim: to optimise total demand for network usage

– And to overcome chicken and egg problem (usage and acceptance)

• Not necessarily to redistribute costs between issuers and acquirers, although issuing is more expensive

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Three-party scheme

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Merchant Cardholder

Good/services at price P

P plus card usage fee (or minus rebate)

P minus merchant service charge

AmEX

Four-party scheme

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IssuerAcquirer

Merchant Cardholder

Good/services at price P

P plus card usage fee (or minus rebate)

P

P minus merchant service charge

VISANetwork feeNetwork fee

Interchange

Concern 1 – consumer welfare

• Central concern of the European Commission and UK’s OFT

• Merchants pay merchant service fees– Interchange sets the floor of merchant service fees– Multilateral interchange may restrict competition among

acquirers– Merchants are also consumers themselves

• Merchants pass on higher costs through retail prices• Issuing banks with market power do not pass on

interchange receipts sufficiently to cardholders• Inter-platform competition drives up interchange

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Concern 2 – payment efficiency

• Stated concern of the Reserve Bank of Australia (RBA)

• (Social) efficiency related to the payment system• High interchange on credit cards encourage

‘excessive’ usage • Credit cards are more costly than debit cards to the

society (but not to the cardholder) – but credit cards are far more prevalent

• Market failure: competition leads to inefficiency

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Concern 3 – cashless society?• What are the relevant policy priorities here?• Card penetration (debit and credit) is low in SA• Less cash is good for just about everyone

– Consumers (security)– Merchants– Banks– Non-bank payment firms– SARB– SARS and Treasury

• Can interchange influence this situation?

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CC’s view since Enquiry

• Action on interchange must include policy input from NT and SARB, because financial inclusion and payment system efficiency are important considerations

• But the options still boil down to:– Regulation– Competition law enforcement

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Regulation• Can be tailored to a sector• Can be forward looking and flexible• But must be clearly justified (cumulative):

– Clear policy objectives– Identification of market failure with theory supported by

empirical evidence– Benefits outweighs potential distortions– Implementable with low information requirement– Vision of the likely, not desired outcome

• In a sense, burden of proof lies with the authority

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Competition law enforcement

• Market definition is crucial (two-sidedness)– EC cases looked at the acquiring side only

• Backward-looking in nature• Remedy (cartel fine, cessation of price-fixing)

may not actually address the concerns• As in EU, inability to shoulder the burden of

proof may determine the outcome, which may then be arbitrary

• Constant litigation or monitoring is required – competition agencies are not regulators

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Regulation - lessons from RBA• RBA is the pioneer of interchange regulation

– Statutory power given by Payment System Act• RBA has a very clear objective

– Payment system efficiency– Death of EFTPOS?

• Anticipated outcome– Reduced credit card usage relative to debit card– Lower merchant fees; merchants start to surcharge– Credit card holders should pay more for usage

• RBA proposes stepped back from regulation in late 2009

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Enquiry Panel’s view• Multilateral interchange is probably necessary for

cards, maybe necessary for non-card electronic payment streams, especially at startup

• But subject to abuse by banks and card schemes• Current methodology is unsatisfactory• Interchange needs to be kept ‘as low as is reasonably

possible’• Adopt (Australian-type) regulation• If regulation is not adopted, may initiate an

investigation under sections 4(1)(a) or 4(1)(b)

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The Panel’s recommendations

• Devise an independent, objective and transparent interchange-setting mechanism

• Determine necessity of interchange in each stream• Set up Interchange Forum to regulate payment

streams in which interchange is deemed necessary– South African Reserve Bank– Banks and payment schemes– Merchant and consumer groups– Third-party cost and demand studies

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CC’s response (1)

• On pure competition grounds, the CC argued for the following changes1. Interchange must not be set collectively by

issuers – this is a cartel2. Card schemes to take interchange decisions

independently3. Authorities must devise rules of engagement

such that inter-scheme competition doesn’t perpetually drive up interchange

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CC response (2)

• Interchange Forum not practical– Information requirement is enormous– Consensus nature means that the final decisions are likely to be

arbitrary– Regulator would have no vision of the outcome– Results would not improve consumer welfare, and may even

harm efficiency• CC concluded that an authority must either:

– Regulate outright, or– Devise suitable rules

• And at the same time all efforts must be made to intensify competition on both sides of the market

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Conclusion1. Payment card systems operate in two-sided markets and

interchange is a necessary balancing mechanism

2. Competition law enforcement on two-sided markets as if they are normal markets may lead to undesirable outcomes

3. Regulation is difficult, and unlikely to improve consumer welfare if banks retain market power, especially in issuing

4. Regulation is nevertheless ‘easier’ than competition law enforcement, and carries fewer risks

5. At the very least, we must and have ensured the independence of card schemes from issuing banks

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