The Reserve Bank of Australia's (RBA's) decision to radically overhaul credit card schemes provoked mixed reactions among the various groups affected by the changes. Stuart Finlayson examines what the changes mean for retailers, banks, card companies and consumers.
Changes to credit card systems, imposed by the Reserve Bank of Australia (RBA) in August, have been a long time in the making.
The seeds were sown as far back as 1997, when in its Final Report, the Financial Systems Inquiry highlighted interchange fee arrangements and restrictions on access to credit card schemes as areas of policy concern. However, it wasn't until October 2000 – when a joint study published by the RBA and the Australian Competition and Consumer Commission (ACCC) identified the case for reform – that the momentum for change really gathered pace.
The study found that issuing credit cards to consumers and providing merchants with the capacity to accept credit card payments generates revenues well in excess of the average cost to the banks of providing such services. It also found that interchange fees, where the cardholder's issuer charges the merchant's bank for each credit card transaction accepted by the merchant, should be much lower.
The interchange fee applies when a customer pays for products using a credit card issued by a different institution to the one the merchant uses to process its card payments. Not surprising then that the country's leading banks, while broadly supporting change in the credit card industry, have taken umbrage with the proposed changes to interchange fees.
This is because the RBA's proposal to put a ceiling on average interchange fees and make them cost-based will lead to a significant dip in profits for those banks. So, essentially, it would be like the proverbial turkeys voting for Christmas if they endorsed the RBA's proposals in a wholesale fashion.
In its study into debit and credit card schemes in Australia, published in October 2000, the RBA found the average interchange fee was $0.95. This figure was based on data received from the four major banks and some smaller institutions – which together account for about 95 percent of credit card transactions in Australia – for the year 1999.
Since the average credit card payment is about $100, this per transaction figure can also be interpreted as a percentage (0.95 percent), reflecting the inclusion of electronic transactions normally at 0.8 percent and other transactions at 1.2 percent. Acquirers pass this fee on in full to their merchants with a margin on top, which is also typically calculated as a percentage of the value of the transaction, to cover the cost of providing acquiring services. The resulting merchant service fee averages $1.78 per transaction (1.78 percent). Now interchange fees are to be calculated on the basis of 'eligible costs'.
In its Final Reforms and Regulation Impact Statement, the RBA stated one important reason for implementing the changes was "to address the anomaly in current arrangements for 'card not present' transactions in Australia, where merchants [such as internet merchants] bear the cost of fraud – because they cannot meet scheme requirements for payment guarantee – but nonetheless incur the higher interchange rate on such transactions".
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Good News
A fair indication of how the changes will affect Australia's leading banks came in the shape of a statement issued by ANZ following the release of the RBA's proposed reforms. In it, the bank claimed the reduction in interchange revenue, coupled with recent increases in the cost of frequent flyer points, was likely to reduce ANZ's Australian credit card annual after tax profit by approximately $40 million by the 2004 financial year.
ANZ managing director of consumer finance, Brian Hartzer says: "The reduction in interchange announced by the Reserve Bank was disappointing but is now a reality. The unfortunate result of the reduction in interchange and the increasing cost of reward programs will be difficult but were necessary decisions in restructuring credit card programs. The changes will aim to ensure that credit cards remain economically viable while maintaining their value to customers."
Interestingly, the bank also says "the current competitive environment and its responsibilities to its customers would not permit full recovery of the shortfall". Assuming the other banks share ANZ's assessment of the current financial climate, this spells good news for the consumer, as they won't face increased charges such as interest rate hikes to make up for the banks' lost interchange fee revenues.
Another interesting aside, though we won't go into too much detail here for fear of digressing, is the view expressed by the banks on EFTPOS interchange fees. Here, leading banks such as National and Westpac have issued statements approving a zero EFTPOS interchange fee in order to ensure the future viability of the payment system. No such statements have been made in favour of reducing credit card interchange fees among the leading banks, a move which has been met with almost universal resistance from said group.
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Retail Reaction
So what do retailers make of all this? Well, if the thoughts of the Australian Retailers Association (ARA) are anything to go by, there won't be many gripes from merchants. This will undoubtedly be welcome news for the RBA, given it already has the banks on its case and is under fire from credit card giants Visa and MasterCard who have vowed to take legal action against the RBA.
The ARA's policy director, Stan Moore, says the reforms proposed by the RBA should reduce the cost of doing business for all retailers, large and small, and would ultimately benefit all customers. "The ARA supports the Reserve Bank's findings which show that:
– The current credit card interchange fees in Australia are too high and not determined by a competitive market.
– There are unnecessary restrictions on access to the credit card schemes.
– Restrictions on merchant pricing are inappropriate."
The only bone of contention the ARA seems to have with the RBA's reforms is the cost of interest-free periods were not included in the interchange fee, as was originally proposed by the RBA. However, even this only met passive resistance, with the ARA welcoming the RBA's commitment to review interest-free periods in 2005.
Similarly, the Australian Competition and Consumer Commission (ACCC) gave the reforms the thumbs up. ACCC chairman Professor Allan Fels detailed how the reforms would benefit both merchants and consumers. "The ACCC has worked closely with the Reserve Bank since the designation of the credit card network in April 2001 and strongly believes that the reforms will lead to a more competitive and efficient credit card network in Australia.
"Increased competition and efficiency will be to the benefit of both Australian businesses and consumers."
Fels identified the three principal measures proposed by the RBA and described why the ACCC was in favour of each. On the opening up of the market to allow new entrants to issue credit cards or provide merchant services: "The access reforms will open up the 'closed shop' credit card market while at the same time ensuring, through the Australian Prudential Regulation Authority, the safety of the market for all participants.
"Importantly, the opening up of the credit card market has the potential to lower prices overall for credit card services, in a manner similar to the way in which new entry into the mortgage market by non-banks pushed down the interest margins on home mortgages. This will be of significant benefit to both consumers and business."
Fels also commented on the RBA's decision to establish a cost-based methodology for the calculation of interchange fees: "Interchange fees in Australia have traditionally been set without any external scrutiny or public accountability. The Reserve Bank interchange fee reforms will break open these closed doors and replace them with a process that is both transparent and open to public scrutiny.
"The regulated reduction in interchange fees should also lead to a reduction in the burden of bank fees paid by retailers, particularly small business. Competition in the retail market should ensure that businesses pass on the benefit to customers."
Finally, and arguably most importantly for retailers, Fels revealed what the ending of restrictions imposed by credit card schemes, which prevent merchants from recovering from cardholders the costs of accepting credit cards, will mean to both retailers and consumers. "Merchant pricing restrictions currently prevent businesses from recovering the cost of accepting credit card payments directly from consumers who pay for goods or services by credit card. This means that businesses have no choice but to pass the cost of accepting credit card payments through to all consumers in the price of retail goods and services.
"[At present], consumers using credit cards are not necessarily those who ultimately bear the cost of their credit card transaction and that consumers who do not use credit cards may be subsidising those who do.
"While overseas experience suggests that a majority of merchants may not choose to impose a credit card fee, businesses that do elect to charge such a fee must ensure that they do not breach their statutory competition and consumer responsibilities. Consumer protection responsibilities for such transactions are vested in the Australian Securities and Investments Commission."
It seems then the credit card reforms will be good news for both retailers and consumers. However, with the RBA's standard on merchant pricing coming into force on January 1 and its standard on interchange fees not coming into force until July 1, it is unlikely to be any earlier than the end of 2003 before the impact of the changes can be fully assessed.
Seconds Out for the Credit Card Heavyweights Versus RBA
To suggest that credit card giants Visa and MasterCard were somewhat miffed at the RBA's proposals for credit card reform would be to understate the case slightly.
The RBA's proposals, primarily the slashing of interchange fees – which net banks about $900 million annually – by 40 percent, has prompted the pair to challenge the RBA to a court battle.
A further directions hearing, which took place in the Federal Court of Australia, set a tentative start date of May 5 next year for what is expected to be a complicated hearing that is likely to take four to six weeks and involve expert finance witnesses.
While Visa, the RBA and MasterCard agreed on potential directions and hearing dates, it is still to be decided whether the Visa and MasterCard actions would be heard together, consecutively or in tandem.
RBA counsel Tom Bathurst QC says some of the regime surrounding the reforms would still come into effect in December and July next year, with the central bank wanting the new reforms in place by October 2003.
"As we see it, it would be important that the matter be completed by October [2003] and hopefully by a period before then."
MasterCard argues the RBA has not complied with its legislative obligations in developing the proposals, while Visa says it regards the RBA's reforms as "misconceived regulatory intervention" into its credit card business.
