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This story appears in the November 2008 issue of Cards&Payments.
As the global debate intensifies about how best to determine credit and debit card interchange rates, many eyes are trained on Australia as a laboratory of the market effects of interchange-rate regulation.
Interchange, an important element of payment card issuers' revenue, comprises a large portion of the discount rate merchants pay their acquiring banks. Acquirers pay interchange to card issuers for a variety of services, including covering the cost of providing card programs. Interchange rates have risen in many countries in recent years, causing merchants in some regions to call for government intervention and rate caps.
Authorities in about two dozen countries have moved to regulate interchange or have considered doing so. In the United States, where merchants ultimately pay credit card issuers up to 2% of transaction value, lawmakers are considering interchange legislation that would force card networks and issuers to negotiate new credit and debit card interchange rates with retailers. The European Commission also has been scrutinizing interchange rates for cross-border credit and debit card transactions with an eye toward the Single Euro Payments Area initiative.
Australia pops up in many analyses of interchange-rate regulations because the Reserve Bank of Australia capped credit card interchange rates at 0.55% of the sale beginning in 2003. That year the bank also prohibited card networks from establishing no-surcharge rules, and in 2006 it adjusted the interchange rate to 0.5% of the sale.
Last month, the bank proposed removing interchange regulation altogether next year if the card industry meets certain conditions.
The conditions present steep challenges for issuers. If they are unable to comply by August 2009, the central bank says it will cut credit card interchange rates further, to 0.3% of the sale. The bank proposed an alternative: if card issuers could guarantee that interchange rates will not rise above present levels, it will not cut interchange rates further.
When Australia implemented interchange-rate caps, card issuers protested vigorously. MasterCard predicted the country's card industry would go into a "death spiral." On the contrary, a spokesperson for the central bank says, the credit card industry has thrived since the new rules kicked in, and interchange regulation has "significantly improved" competition.
The central bank arrived at its proposal to lift interchange-rate regulation after outlining several options in a preliminary report last April and weighing input from merchants, consumer groups, card-industry groups and issuers. "Few, if any, parties were completely satisfied with any of the options presented," the bank wrote. "Issuers and card schemes wanted (no regulation), and merchants wanted interchange removed altogether."
A spokesperson for the Reserve Bank's payment policy division tells Cards&Payments that if interchange regulation is lifted, the bank wants to ensure that merchants are given the power of refusing to accept cards with unacceptably high interchange rates.
Analysts say Australia's experience with interchange regulation could shed light on some other countries' similar efforts, but they caution against making too many direct comparisons.
Nearly every adult among Australia's population of 21.3 million has a credit card, according to the Australia-based financial research and consulting firm Cannex. At the end of July, some 12.9 million credit card accounts existed in Australia, and total outstanding credit card balances stood at $40.4 billion, according to the central bank.
By comparison, some 80% of adults among 300 million Americans have credit cards, according to industry estimates. Approximately 640 million credit cards are in circulation in the U.S., and total outstanding balances range from $750 billion to $800 billion, according to the Federal Reserve.
"We're going to hear a lot more about interchange regulation next year, and a lot of people are looking at Australia," says Bruce Cundiff, a senior analyst with U.S.-based Javelin Strategy & Research. "There are parallels to be drawn with Australia, but we have to be careful to not superimpose the facts directly."
Australia's recent proposal to drop interchange-rate regulation was the culmination of several years of close examination by the central bank of interchange rates and card-acceptance policies. The bank says it originally intervened in interchange rates because studies showed inefficiencies in the payments system.
Initially, the central bank capped credit card interchange at 0.55% of the sale, compared with 0.95% previously. In 2006, the bank reduced the rate further, to 0.5%, where it stands today. The central bank also overhauled debit card interchange rates (
In 2003 the bank prohibited no-surcharge rules, enabling merchants to impose surcharges on credit card transactions. It also modified its honor-all-cards rule so a card scheme no longer could require merchants to accept debit cards as a condition of accepting credit cards.
American Express Co. and Diners Club both agreed to remove their no-surcharge rules under the bank's rules, but they were not directly affected by bankcard interchange-rate regulation. Both issuers have smaller market shares than bankcard competitors in Australia and tend to target upscale customers.
On The Rise
Supporters and opponents of interchange-rate reform agree that credit and debit card programs are on the rise in Australia. Full-service revolving-credit card products have increased by 56% in five years, to 271 different cards currently from 174 offered in 2003, according to Cannex.
The central bank says so far it can only estimate the impact of its interchange rules. If interchange-rate caps and new card-acceptance rules shifted about 5% of costlier credit card transactions to more-efficient debit transactions, it says, Australians would have saved a collective $AU100 million (US$69 million) to $AU150 million (US$103.5 million) annually.
Card issuers and networks dispute these potential cost-savings. They say the forced reduction on interchange has stifled industry profits and innovation, while forcing a weakening of cardholder benefits and rewards.
The Australian Bankers' Association declined to comment on whether the card industry will succeed in achieving the central bank's conditions for eliminating interchange-rate regulation. But Nicholas Hossack, a director of payments and competition policy for the association, tells Cards&Payments that since the central bank began regulating interchange, the fees consumers pay for credit cards "have increased markedly." The association does not formally track merchant surcharges or average annual credit card fees.
The central bank concedes that not all cardholders have benefited equally from interchange regulation. Its data show that a MasterCard or Visa cardholder in June 2007 was required to spend about $16,300 (US$11,185) on a credit card to earn a $100 (US$69) shopping voucher, a 24% decline from the $12,400 in card spending needed in 2003 to earn a $100 voucher. Some issuers also have capped the amount of rewards cardholders can earn during various periods, analysts say.
Two Card Types Prevail
According to Cannex analyst Frank Lopez, the average credit card annual fee has increased by about 50% since interchange regulation began. In September 2003, 28.2% of Australia's credit cards carried no annual fee; a year later, only 10.3% did. The average annual fee for credit cards in Australia as of last month is $69.50 (US$44.75), he says.
Lopez says credit card offerings have split into basic cards targeting those who tend to revolve a balance each month and premium cards targeting those who tend to pay off their balances in full each month.
Basic cards carry annual percentage rates of 12% to 14% and annual fees of $30 to $50 (although some are free). Premium card annual percentage rates average between 18% and 20%, have annual fees of about $100 (with some fees as high as $395), and benefits include rewards, concierge services and travel insurance.
A typical premium card is the BP Citibank MasterCard, introduced last year, which carries a $79 annual fee (US$54.19), and an annual percentage rate of 19.89%. The card enables cardholders to earn 1% cash back for up to $60,000 worth of annual spending anywhere and 5% cash back on the first $300 spent at BP fueling locations each month.
One casualty of interchange-rate caps is the Australia and New Zealand Banking Group's Qantas ANZ card, which was "hugely popular" before 2003, when cardholders earned points at a brisk rate, says Jonathan Sinton, strategy director at Australia-based Research International Inc., which recently conducted a survey to gauge Aussies' card preferences. When ANZ raised fees and capped the number of points cardholders could earn annually, cardholders left in droves, Sinton says.
"For a variety of reasons, Australians are shifting their credit card behavior, ... either opting for a budget credit card (with fewer rewards) or upgrading to a premium card," Sinton say. AmEx and Diners Club have retained their market share among upscale customers willing to pay a higher annual fee for richer rewards, he notes.
The upshot of interchange regulation for consumers is fewer freebies, says Duncan Douglass, a partner with the U.S.-based law firm of Alston & Bird, who studies interchange rate-regulation. "Since Australia instituted its new interchange rules, in some ways it appears that consumers are now funding their own rewards programs by paying higher annual fees."
Interest-Free Days Rise
On the other hand, interchange regulation brought Australia's credit cardholders more interest-free days, meaning cardholders who pay their card off every month owe no interest during those days, Lopez says. Since 2003, the interest-free days available on credit cards have almost tripled. According to Cannex data, in 2003 the average number of interest-free days on credit cards was 17.79; in September it was 49.26 days.
Merchant surcharges on credit card transactions also have increased sharply. A survey of 2,500 merchants conducted earlier this year by Australia-based financial-services consultancy East & Partners found that 26% were imposing surcharges on credit card purchases, and another 39% planned to do so in the near future. The average surcharge was about 1% at the end of last year, according to the survey.
One of the biggest debates about the benefits of Australia's interchange regulation is whether merchants have passed on their interchange-fee savings to consumers.
A report by UK-based CRA International that MasterCard funded asserts that the central bank's interchange regulations "have clearly harmed consumers by causing higher cardholder fees and less-valuable reward programs (
The central bank disagrees. A spokesperson there says it is difficult to measure any broad reduction in consumer prices due to interchange regulation because interchange fees account for about 0.1% of the Australian Consumer Price Index.
Any drop in prices would have been slight, and it would not have happened instantaneously, the spokesperson says.
For the central bank to lift interchange regulation, the card industry would need to develop and promote a domestic debit card system to compete more effectively with open-loop debit systems such as Visa's and MasterCard's. The card industry also would need to allow merchants to refuse any card if they deem the interchange tied to it is too high, and it would have to improve transparency of open-loop debit fees and average interchange rates.
Several card networks and issuers said in comments responding to the bank's preliminary report that they supported the lifting of interchange regulations. But they found many of the conditions to be impractical.
David Bell, CEO of the Australian Bankers' Association, wrote that any scenario allowing merchants to refuse to accept certain cards would undermine the brand promise of international card networks, which guarantee acceptance everywhere. He noted the existing no-surcharge rule gives merchants plenty of bargaining power over interchange fees.
"The freedom of a merchant to apply a very high surcharge to a transaction will generate downward pressure on interchange fees," he said.
Issuer Profitability
Bell also objected to fixing interchange rates permanently, saying "the incentives for developing new payment products would be diminished, particularly given there appears little in the way of an objective formula or rationale cited to arrive at the 0.3% (interchange-rate cap) figure."
CRA International says its research also shows that interchange regulation has hurt issuer profitability. In 2006, Australia's card issuers increased their revenue collectively by $480 million by raising annual fees, but their interchange revenues collectively fell by $647 million because of interchange regulation, according to researchers at the company.
William M. Sheedy, who recently was named president of Visa's North America region, wrote that the central bank's interchange-rate regulations were overwhelmingly negative and had produced "less incentive for financial institutions to enter Australia as issuers or acquirers, as well as reduced resources for those already participating to continue to invest valuable and scarce capital in new products, faster processing capabilities, and increased system security."
Dhun Karai, head of group financial services for supermarket retailer Woolworths Ltd., wrote that she opposes deregulating the card market. She said card-industry players are self-interested, and lifting interchange regulation "could result in the payments system reverting towards its preregulatory climate."
The central bank says it will monitor the card industry until next August. If its conditions are met, the bank will remove its interchange-rate regulations, "probably in November 2009," with draft standards to be released late next year and final regulations released in the first quarter of 2010.
The card industry may opt to guarantee that interchange rates will not rise above present levels. In that case, the bank proposed in its report that each card issuer would sign an agreement, to be revisited every three years, stating that credit card interchange fees in Australia will not exceed 0.5%.
Australia's experience in regulating credit and debit card interchange has produced little consensus between merchants and card issuers. It is too early to tell whether card issuers can meet the conditions needed to achieve deregulation, but other countries watching Australia's payments industry over the next several months may gain insight into the pros and cons of government intervention in setting interchange rates. CP
