Comment: ATM Surcharges Raise Broad Antitrust Issues

The most interesting yet unexplored competition issue arising from automated teller machine surcharging has to do with how financial institutions compete.

ATMs are an important form of competition between institutions. Consumers who desire a surcharge-free ATM network, absent a shared one, would place their accounts with the bank with the largest internal network of ATMs. In earlier days, such large banks with sizable in-house networks had a significant competitive advantage over smaller rivals.

This dynamic began to change in the 1970s as banks formed shared networks. These actually enhanced competition between banks by letting small and large banks share in a large number of ATM locations. In essence, a shared ATM network created a level playing field enabling both small and large institutions to focus on other factors in retail competition, including interest rates and fees.

Surcharges changed those procompetitive aspects of sharing, as large banks can impose higher costs on the customers of small banks and credit unions. In turn, the large banks can try to induce customers to defect from the smaller institutions. In essence, ATM surcharges return the competitive dynamic to that which existed before shared networks were formed.

Moreover, surcharges present a perverse form of price competition where firms can actually gain customers by raising prices (and the costs of their rivals). As the economist Paul Horvitz has observed, "there is little downside to such a strategy-either you gain substantial market share or earn substantial fee income."

It is important to recognize that small banks and credit unions often can be of far greater competitive significance than their size suggests. Recent studies by the Federal Reserve Board and consumer groups have shown that credit unions and small banks on average offer higher interest rates on deposits and charge lower account fees. They are often the leaders in providing the most efficient, consumer-friendly level of service. Losing, or even hobbling, these efficient, low-cost rivals would harm all consumers.

Therefore, preserving a level playing field may be important to preserving a competitive retail banking market.

ATM surcharges, especially those imposed by the larger banks, could hamper smaller institutions' ability to compete. Because they cannot offer as large a network of surcharge-free ATMs, their depositors may defect. As competition becomes focused on the size of a bank's ATM network, interest rates and fees become lesser factors, putting small financial institutions at a competitive disadvantage.

This, in turn, would weaken the ability of small institutions to compete for deposits. And in the overall market, competition will be dampened, leading to lower interest rates and higher fees. The elimination of competition may be of particular concern where a retail banking market is concentrated among relatively few firms. Although consumers may benefit from some increase in the number of ATMs, they may ultimately lose as competition for deposits is weakened.

The role of antitrust? Unfortunately, antitrust laws have made it difficult to address surcharges. These laws require intense scrutiny of price fixing by competitors. But after several years of surcharge controversy, the courts and an arbitrator have been inconsistent in their pronouncements.

For instance, banks that wish to form no-surcharge alliances as a competitive alternative may also fear that they may be subjects of antitrust suits. A group of surcharge-hungry ATM deployers might claim that a no-surcharge agreement is price fixing.

Antitrust enforcers could help unmuddy the waters by offering clear guidance that an agreement not to surcharge is not an antitrust violation. This would be well supported by the Alabama decision won by Plus System Inc. in 1995.

Although surcharge prohibitions by these new networks do not pose antitrust problems, surcharges in dominant networks pose a larger set of issues.

Are interchange fees necessary? Before surcharges, ATM owners already received compensation-in the form of per-transaction interchange fees paid by the cardholders' banks to the ATM owners. These fees, typically 35 cents to 50 cents a transaction, have avoided condemnation under the antitrust laws in part because they were necessary to compensate ATM owners for their deployment costs. Now that the vast majority of ATM owners receive surcharges, does this justification still stand?

Moreover, ATM interchange fees appear inefficient and the fee-setting mechanism is paralyzed. Although the costs of ATM deployment-hardware, communications, etc.-have decreased over the past decade, interchange fees have not changed. While ATM networks have passed on their lower costs by decreasing switch fees about 18% over the last four years, the fact that ATM interchange fees have not decreased seems a disturbing anomaly.

The threat of antitrust litigation may be one reason the ATM networks are reluctant to cut interchange fees. The last time an ATM network attempted to do so it was hit with an antitrust suit. Now that the number of nonbank ATM deployers has proliferated, so has the pool of potential plaintiffs.

From a commonsense perspective, interchange and surcharge fees are a "double charge," a label applied by Sen. Alfonse D'Amato of New York and consumer advocates. But charging both surcharges and interchange fees poses an even greater problem from an economic perspective.

As a recent study by the New York Fed discussed, when two firms set a price, both try to secure as high a margin as possible. Typically the combined price will be higher than if only one firm had set it. It is called "double marginalization" when two firms try to secure the same margin.

The most efficient economic result is for one firm-either the ATM owner or the network-to set the price.

Probably the most prudent move for ATM networks, from both a practical and antitrust-risk perspective, would be to adopt a rule that prevents the ATM owner from collecting both the surcharge and the interchange fee. The Independent Bankers Association of America and consumer groups have called for this alternative. In this fashion, at least the costs of the card- issuing bank will be reduced, and perhaps these cost savings will be passed on to consumers in lower "foreign fees" that stem from the interchange fee.

Interestingly, the Plus board of directors adopted this proposal around 1995, but it was not enacted by the parent Visa board. Representatives of both Plus and MasterCard's Cirrus network have said there are no technical obstacles to this approach.

ATM networks might argue that one reason not to adopt such a rule is that they could be sued for price fixing in eliminating the interchange fee. But such claims should fail, because consumers are not harmed. In addition, it would be difficult for the ATM owner to demonstrate harm, since it still collects compensation in the form of surcharges.

Networks could avoid that problem by letting the card-issuing banks, rather than ATM owners, control the routing of transactions. Having the card issuer control routing would be more efficient, as it will choose the lowest-cost available method.

Three other areas of ATM competition are probably worth continued and careful antitrust scrutiny:

Do network nondiscrimination rules inhibit the development of alternative networks?

ATM networks would be wise to eliminate these rules. They may inhibit the development of lower-cost, no-surcharge alternatives. Nondiscrimination rules have been attacked by both the Justice Department and the Federal Trade Commission where they have inhibited the development of alternative networks, as in the FTC's 1995 challenge to a pharmacy network in Tennessee that kept its members from joining alternative networks that offered consumers lower prices.

Are ATM networks dominated by large banks that can disadvantage their smaller rivals?

The networks generally have avoided much antitrust scrutiny because they were established as not-for-profit entities with governance spread over a large number of institutions. Yet that structure is quickly changing, especially at the largest ATM networks. They are increasingly converting to a for-profit basis, and ownership is in some cases increasingly concentrated because of bank mergers, with some banks having as much as a 30% share of the network.

Taking on more of a proprietary character with fewer owners, they may be used by larger banks to disadvantage smaller rivals. This was the basis of the one ATM case brought by the Justice Department's antitrust division- against the MAC network in 1994 - for effectively prohibiting smaller banks from seeking ATM-driving services from lower-cost alternatives.

Notably the networks that have tried to facilitate the development of no-surcharge alliances are generally not-for-profit, broad-based membership organizations such as Magic Line in Michigan and Shazam in Iowa.

Can large banks use surcharges to harm smaller rivals?

Predation by large banks raises the most significant and troubling competitive problem. Usually firms try to attract customers from rivals by lowering prices. The surcharging effectively turns competition on its head. Surcharges are particularly attractive because they involve gaining customers by raising prices.

Banks will argue that relatively few consumers have switched banks to avoid surcharges. That may be due to the fact that surcharges are still in their infancy. In an unconcentrated banking market such as Texas, a predatory strategy may not appear likely to succeed.

But where banking is more concentrated, this threat is great. In Massachusetts, where two banks have over 65% of the ATMs, a survey has shown 33% of cardholders of small banks might defect to these dominant banks in response to surcharges.

The Clinton administration is beginning to take a new look at predatory conduct. The Transportation Department recently issued draft guidelines on pricing by dominant airlines. ATM surcharges as a form of predation should be on the radar screen of the antitrust enforcers.

Amid the public and congressional outcry over ATM surcharges, the banking regulatory agencies have been strangely silent. In fact, when ATM surcharge bans were being lifted, the Fed actually weakened the consumer disclosure provisions for surcharges.

The Fed has also been silent on the role of ATMs in its bank merger analysis. Although they are an important element of retail competition and arguably substitute for branches, the Fed has never discussed the impact of bank mergers on ATM competition. It is a major issue when a bank through merger gains a dominant share of the ATM market, such as the BankBoston- BayBanks merger.

The Fed has uniformly approved every ATM network merger presented, on the theory that bigger is better. (These decisions are inconsistent with enforcement actions by the Justice Department and the FTC to block other types of network mergers.)

Moreover, these decisions have never analyzed the impact of ATM surcharges on bank or ATM network competition. More important, the decisions have not analyzed the role of other network rules, such as nondiscrimination provisions, that might inhibit the formation of competing networks.

The impacts of surcharges on small banks, on retail banking competition generally, and their possibly leading to more concentrated banking markets requires more comprehensive study by the banking agencies.

Markets work most effectively when consumers are fully informed of the costs of a service and its alternatives. Yet the current consumer disclosure requirements are weaker than those adopted by the national ATM networks, which require that a consumer be notified of the fee both on the computer screen and on a sign on the ATM. The Fed should strengthen the consumer disclosure provisions and then actively enforce them. Recent studies by consumer groups show that as many as 20% of ATMs lack the proper disclosure.

ATM surcharges pose critical challenges to ATM networks, small banks, antitrust enforcers, and bank regulators. Whether each of these groups can meet the challenge will dictate the likelihood of legislative action in the states or on Capitol Hill. As consumers are increasingly realizing, surcharges are a "double charge" -and a "free market" is not one where prices only go up.

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