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Not Going To Be a G'Day for Credit Cards Down Under

T he Australian government is preparing to make Visa and MasterCard change their operating rules to be more consumer-friendly there, and these changes may have a profound impact on the market globally.

According to the Reserve Bank of Australia, which operates as our Federal Reserve Bank does in the U.S., "the main regulations established by the credit card schemes in Australia do not meet the public-interest test. The regulations suppress or distort the normal market mechanisms in ways that work against, rather than contribute to, the community's welfare. The pricing of credit card services is sending consumers a quite misleading signal about the cost to the community of different payment instruments, while barriers to entry are quarantining the credit card schemes from the competitive pressures that non-financial institutions of substance could bring to bear. Overall, the community is paying a higher cost for its retail payments system than is necessary."¹

While the Australian government is concerned about the cost of bankcards, to some extent it is taking the lead from other countries that are questioning Association rules for credit as well as debit cards.

According to the Reserve Bank, "The credit card network in Australia is extremely well developed, and credit cards are used for a wide variety of transactions. Over the past decade, the number of credit card transactions has risen four-fold; credit cards overtook debit cards (EFT POS) in 1999 as the main non-cash means of payment. Credit cards are now widely used purely as a payment instrument by cardholders who settle their credit card account in full each time and do not use the 'revolving' line of credit."

Someone must ultimately meet these costs. Two groups do so in Australia, at least in the first instance.

One group is composed of cardholders who use the revolving line of credit, who pay interest rates significantly above rates on other forms of unsecured lending. The other group is composed of merchants who pay an average of 1.8 percent of the value of each credit card transaction - and as much as four percent in the case of small merchants - in merchant-service fees to their acquirers.

Like other business inputs, these costs have to be covered by merchants, so they are passed onto all of their customers, not just those who use credit cards, in the form of higher prices for goods and services. In this way, the costs of providing credit card services are ultimately borne by the community as a whole.

Prices paid by users of lower-cost payment instruments are higher than would otherwise be the case, while prices paid by credit cardholders are lower than they would be if cardholders faced the costs of the credit card services they used.

Within the latter group, there is a third group that directly contributes very little to the costs of credit card schemes - these are the cardholders (known as "transactors") who settle their credit card account in full each month. Although they normally pay an annual fee, they pay no transaction fees, enjoy the benefit of an interest-free period and in many cases earn loyalty points for each transaction.

Credit card issuers have a set of regulations in Australia, which their Australian members collectively determine or agree to enforce, that: • (i) set the wholesale fees (known as "interchange fees") that are paid to the issuer by the acquirer whenever a merchant accepts a credit card for payment; • (ii) in the case of MasterCard and Visa, prevent merchants recovering from cardholders the cost of accepting credit cards; and • (iii) restrict membership of the schemes, broadly speaking, to authorized deposit-taking institutions supervised by the Australian Prudential Regulation Authority (APRA).

Given this current set of Association operating rules, and the fact that the Australian government believes "restrictions on merchant pricing are a restraint on trade,"² the Reserve Bank has proposed substantial changes. • (i) an objective, transparent and cost-based methodology for determining interchange fees; • (ii) freedom for merchants to recover from cardholders the costs of accepting credit cards; and • (iii) a more liberal access regime that allows for the entry of specialist credit card service providers, both issuers and acquirers, to be supervised by APRA. So What Does This All Mean? While the Reserve Bank of Australia has not yet enacted the changes noted above (the comment period of any and all concerned ended March 15, 2002), the problem and solutions have been thoroughly researched and discussed before the publication of the "White Paper" in December 2001. It seems clear at this time that changes will be imposed on Visa and MasterCard, which will at a minimum require interchange to be based on verifiable cost criteria that can be clearly understood by retailers. In addition, retailers will be able to pass on the cost of bankcard fees for the first time.

Imagine, for a moment, this new world in which consumers are permitted not only to see the cost difference of their choice of payment method but also, perhaps, to become aware that the fees for payment choices from merchant to merchant are not necessarily the same.

This will permit consumers to make informed choices about how and where they pay and place a lot of work on the acquiring side of the business, to support the programming and services to maintain a system that provides this level of consumer information.

While this might seem like a small change, it could well have a profound impact globally. Australia has led a number of payments initiatives, and other governments are watching this process with interest.

Australia is already looking at taking a similar step for debit cards.³ In fact, "The Reserve Bank has also been in discussion with Visa, and Visa members issuing the Visa-branded debit card, about the current practice under which these issuers earn credit card interchange fees for what are essentially debit card transactions. The Reserve Bank has advised Visa and issuing members that this practice imposes an inappropriate burden of costs on merchants and has no place in the Australian payments system. Issuing members have begun work on an interchange regime to address the issues raised by the Reserve Bank; at the same time, they have expressed concern about the impact on their net revenues if changes to the current practice were to precede reform of the debit card market more generally."

While Australian discussions continue, the U.S. legal system is also trying to come up with a remedy to resolve the debit card pricing dispute between major retailers and Visa and MasterCard, the model for which might well come from the efforts of the Reserve Bank of Australia. Conclusion From the beginning of the credit card era, the majority of the money has always been on the issuing side of the business. Providing the consumer both knowledge and choice could change this dynamic and make acquiring more profitable.

At the very least, should the Australian idea find root in U.S. soil, it could finally provide the reason for a wholesale swap-out of POS equipment in support of more robust consumer information, and with more money (recovery of discount rate expenses) and discloser control moving to retailers, no retailer would avoid making this change.

¹ Reserve Bank of Australia 1A Consultation Document, Page vi, Executive Summary http://www.rba.gov.au/PaymentsSystem/PaymentsPolicy/CreditCardSchemes/ IAConsultationDocument/index.html

² Reserve Bank of Australia 1A Consultation Document, Page v item 17

³ "The Reserve Bank acknowledges that measures to promote efficiency and competition in the credit card market in Australia will have important implications for the pricing of other payment instruments, particularly debit cards. The Joint Study concluded that interchange fees in Australia's debit card system, which are determined bilaterally and flow from card issuers to acquirers, do not have a convincing rationale. Several submissions to the Reserve Bank have argued that debit card interchange fees should be reformed at the same time as those for credit cards, so that consumers and merchants can face more efficient prices for both payment instruments. The Reserve Bank agrees that this is a desirable objective, but it has not been prepared to slow the timetable for reform of the credit card market. In any event, the introduction of more efficient pricing arrangements for debit cards is, in the first instance, a matter for industry participants. The Reserve Bank remains willing to work with participants to this end."

Editor's Note: The 136-page White Paper, "Reform of Credit Card Schemes in Australia," is a very well researched and developed document that illuminates interesting similarities as well as differences to the U.S. market. We have extracted important points from the report and stated clearly the concerns and plans; however, there is a great deal of information for an interested reader. I encourage you to find the report online and read it at http://www.rba.gov.au/PaymentsSystem/PaymentsPolicy/CreditCardSchemes/IAConsultationDocument/index.html