Big Trouble Down Under

  Over the past two years, Australia has seen some major changes that promise to transform its payment card industry.
  In August 2002, in its role as regulator of the payment systems, the Reserve Bank of Australia (RBA) announced the results of its investigation into the country's credit card schemes, setting in motion a set of reforms that are having global ramifications.
  The RBA intervened in part because "the use of credit and debit cards as a proportion of all non-cash retail payments has increased significantly" and "credit card growth in Australia has significantly outstripped debit card growth." Debit cards are preferred for cash access, while credit and charge cards are the instrument of choice for purchases (table, page 47).
  There are a number of reasons why purchases are skewed toward credit cards, rather than balanced between debit and credit, as in the United Kingdom and many other countries. One is the proliferation since the mid-1990s of loyalty programs attached to Australian credit cards. As elsewhere in the world, these have been partly funded from the interchange element of the merchant service charge (MSC), paid by the merchant to the card issuer, through the merchant acquirer.
  One of RBA's goals as a regulator is to promote efficiency in the Australian payments system and competition in the market for payment services. The reforms to the credit card market in August 2002 were an attempt to encourage cardholders to use debit cards instead of credit cards. The reforms also sought to introduce transparency into the MSCs associated with credit card payments.
  The reforms essentially were threefold. First, the interchange element of the MSC was halved, reducing the fees merchants pay in Australia. MasterCard and Visa fought a rearguard legal action to delay implementation of these reductions by challenging the RBA's power to regulate on these matters. But by June 2004, the reforms had seen the average MasterCard and Visa interchange fee fall to 0.55% of the purchase transaction.
  RBA data suggest that MSCs subsequently have fallen by the full amount of the reduction in interchange and that this represents an annual savings to merchants of around A$500 million.
  The results of this intervention have been manifold, and the reverberations still are resounding through the system in Australia, and, indeed, throughout the world. Of the major stakeholders involved, to date, the regulators and the merchants are the winners, while card schemes, banks and cardholders are the losers.
  The regulators have won because they have imposed their will and delivered what they see as one of their duties, which is to direct payment-system policy to the greatest advantage of Australian consumers. The merchants have won because they have materially reduced their costs associated with credit card acceptance.
  The card schemes have lost the legal battles with the RBA and have seen one of their founding principles, interchange, severely damaged.
  They also have lost market share in Australia to their payment card rivals, American Express Co. and Diners Club, as card issuers have moved to regain MSC income by encouraging their customers to switch to cards cobranded with these marks. But overall, the banks have not recouped lost MSC income.
  Paradoxically, despite the RBA's goals, cardholders also have lost because of the reforms. Little, if any, of the reduction in interchange has been passed on by the merchants to the cardholders in the form of lower prices. And, to add insult to injury, the second element of the RBA's reforms has enabled merchants to surcharge cardholders for credit card payments.
  Some merchants, particularly those with a dominant market position, have chosen to do this. Qantas and Virgin Blue, the duopoly in domestic air travel, both add a surcharge to all payments made with a credit card (including Internet bookings), while Telstra, the minority state-owned telecommunications provider, surcharges at 0.63% of the sale for MasterCard and Visa, and 1.68% for American Express and Diners Club.
  If we presume that these costs were previously included in the prices charged by these suppliers, then the imposition of surcharges would appear to be an opportunistic way of taking more money from cardholders without providing any extra benefit.
  The third element of the RBA reforms also was aimed at helping cardholders by encouraging new issuers to enter the Australian credit card market. On the issuer side, superficially this appears to have worked with, for example, new card programs from Virgin Money and GE Money.
  However, the former is really a cobrand with an existing issuer, Westpac, while in the case of GE Money, the store card conversion of the Coles Myer base merely enables it to be a new issuer of MasterCard in Australia. From the cardholder's perspective, the reforms have not, as yet, produced any real new entrants, although the market is rife with rumors about U.S. monolines and U.K. majors applying for issuer status under the new RBA access guidelines.
  So after a year of reduced interchange and nine months of surcharging, where has the payments market gone? Michael Ebstein, of MWE Consulting, releases a user-friendly version of the RBA's monthly statistics on card payments. His analysis of the September 2004 figures shows that the most striking feature of the movement in annual growth rates over the last nine months has been the resurgence of charge cards.
  Though their growth in purchase value at the beginning of 2004 was half that of personal credit cards, the annual growth of charge cards now exceeds credit cards. During the nine months ended September 2004, the growth rate of credit card transaction values was flat at around 12%, while the growth in charge card purchases went to 13.6% from 6.1% (table, page 47).
  The obvious conclusion is that Australian issuers have been trying to minimize the impact of the reduction in interchange on credit card transactions by switching their cardholders (particularly the transactors) to their cobranded AmEx and Diners Club card products, and that this is now having an impact in the market. ANZ has a cobranded card with Diners Club, while both Westpac and NAB have AmEx cobranded cards, the latter a credit card, instead of a charge card.
  However, the RBA's figures also show (table, page 47) that the debit card market still is heavily dominated by cash withdrawals and that while there is some growth in total purchases, either solo or combined with a cash-out/cash-back, this is hardly the realignment of the payments market it hoped to promote.
  Regulatory Dilemma
  So the regulatory dilemma is: Having regulated part of the market for payment systems, do you now leave it alone, even if you have not achieved your aims? Or do you further regulate to push through additional changes in the hope of eventually achieving them?
  The RBA has decided to push on as a regulator. In October, it gave its rationale for the EFTPOS payment system, as the debit card is known in Australia, as being within its power to regulate. Part of the RBA's rationale is that use of debit cards for purchases is inhibited by the fees issuers charge for these transactions.
  Confidential data supplied to the RBA by the five largest Australian banks in mid-2004 showed that, with the exception of ANZ, debit cardholders face paying fees for about 28% of EFTPOS transactions.
  The EFTPOS system was built as a series of linkages between banks that issue debit cards and the acquirers that provide payment services to merchants. The first cards were issued in the early 1980s and, according to the RBA, there has been little, if any, alteration in interchange fees since the system was established.
  EFTPOS interchange fees average about A20 cents (with a range of A18 cents to over A30 cents) and are paid by the issuer to the acquirer. This, of course, is in contrast to most other countries, where EFTPOS interchange fees flow, as in credit card systems, from acquirer to issuer.
  Large merchants in Australia have negotiating muscle and investments in their own POS terminal networks. They earn a fee from their acquirer for each EFTPOS transaction. This fee is then indirectly linked to the interchange fee paid by the issuer to the acquirer.
  A recent research note from Macquarie Equities speculated that Coles Myer, Australia's largest retailer, received EFTPOS acquirer fees of around A$94 million, paid by the major debit card issuers. Coles Myer is becoming a self-acquirer of the merchant's own debit card transactions.
  As such, it will have bilateral agreements with all key card issuers. It already has negotiated reduced interchange on some of its EFTPOS transactions in exchange for direct switching of its acquired transactions to these major issuers (thought to be about A15 cents per transaction).
  Zero Interchange
  The RBA would like to set the debit card interchange fee at zero, but this would reduce the income large merchants such as Coles Myer earn from debit transactions. Naturally they are resisting this and are engaging in the same delaying tactics used by MasterCard and Visa over the credit card interchange, namely challenging the RBA's powers to designate the debit card system.
  In giving its reasons for a zero interchange fee, RBA offers some overseas comparisons. While there is a large number of EFTPOS terminals installed in Australia (in 2002, there were over 20,000 per million inhabitants), each terminal processes relatively few EFTPOS transactions (2,000 per terminal).
  The RBA compares this to the U.K., where the interchange flows from acquirer to card issuer and there are around 4,000 annual transactions per terminal, or to the Netherlands, where the interchange fee is zero and there are around 6,000 annual transactions per terminal.
  Price Reduction
  In defending its decision to designate the debit card system, the RBA states that a reduction in the interchange fee paid by the issuers would tend to reduce the prices paid by their cardholders, and this would encourage more debit card use at the POS. Any loss of income to the merchants as a result of reduced debit interchange would, the RBA argues, be smaller than their existing gains from the reduction in credit card interchange.
  The process of the merchants' challenge, the submission of evidence to any subsequent inquiry and the likely appeals of whatever the result, mean that it will be some time before the shape of the future EFTPOS system in Australia emerges.
  But whatever the legal nuances, payment matters have entered the political arena. The regulator, having given the merchant community a windfall by reducing the interchange on credit card transactions, is now trying to be even-handed by reducing the interchange on debit card transactions, to the financial detriment of the larger merchants. In the same way, while American Express and Diners Club fell outside the RBA's original actions, it has since moved to designate them and make them subject to its regulation.
  Regulators, of course, do not live in isolation. They meet, exchange views and experiences, and provide each other with a sort of case law of judgments they have made. No one in the card-payment business, in whatever country, should be surprised if their regulator is not following events in Australia, nor if over time they choose to imitate the RBA's interventions.
  Steve Worthington, former professor of financial services marketing at Staffordshire University in the U.K., is now professor at Monash University in Melbourne.