Thank you for the invitation to speak at this annual Credit Law Conference.

I will speak today about some of the changes to the regulatory framework for card payments that the Reserve Bank announced in late May. The changes include three new standards – one dealing with the surcharging of card payments and two dealing with interchange fees on debit and credit cards.

I am going to focus today on the changes to the Bank's surcharging standard which took effect for large merchants on 1 September. The standard will also apply to smaller merchants, but not until 1 September next year. The changes flowing from the new interchange standards largely take effect in mid 2017; I won't address those changes today.

Under the previous regulatory arrangements, merchants had the right to surcharge card payments, while card schemes had the right to limit surcharges to the reasonable cost of card acceptance. Any limits on surcharges were implemented through the membership rules of the card schemes, and the schemes were responsible for enforcing such rules.

Under the Bank's new standard, merchants will retain the right to impose a cost-based surcharge on a card transaction, but any surcharge will be limited to the amount it costs the merchant to accept the particular type of card for that transaction. An important change is that the definition of card acceptance costs is narrower, and therefore clearer, than it was under the previous framework. Another is that recent amendments to the Competition and Consumer Act 2010 give the Australian Competition and Consumer Commission (ACCC) enforcement powers in respect of the new standard.

Background on surcharging

But before I speak about the specifics of the changes, it might be worth revisiting the question of why merchants are allowed to surcharge, or impose an additional fee, for particular payment methods.

One sometimes hears assertions that card payments only involve sending a few simple electronic messages, so surely they must cost merchants no more than a few cents. And one sometimes hears people asserting that the cost to a hotel or an airline for receiving payment for a stay of five nights or a family's five flights is surely no larger than the cost of receiving payment for a one-night stay or just one flight.

It turns out that some of the so-called conventional wisdom is quite incorrect. The fact is that the cost of some payment methods to merchants can be quite high and these costs typically increase in line with the value of the transaction.

Data on average merchant service fees (or MSFs) show that there are very large differences in the cost of different card systems for merchants (Graph 1). These costs ranged from an average of just 0.14 per cent of transaction value for eftpos in the June quarter to about 2 per cent of transaction value for Diners Club. For MasterCard and Visa transactions, the average cost to merchants of debit cards was 0.55 per cent of transaction value, while the average cost of credit card transactions was 0.81 per cent. The average cost of American Express cards was 1.66 per cent of transaction value.^[1]

But these averages mask significant variation across different merchants. Many merchants pay up to 1–1½ per cent on average for MasterCard and Visa credit card transactions. And it is not unusual for merchants to pay 2–3 per cent to receive an American Express card payment.

In addition, just because a merchant has a high volume of card transactions doesn't mean it will necessarily be able to negotiate low card payment costs. Airlines and hotels, for example, receive a high proportion of their payments via American Express and via corporate cards, premium consumer cards and foreign cards from the MasterCard and Visa systems. Reflecting the pricing policies of the card schemes, these are all expensive cards for these merchants, often because they provide corporate or personal cardholders with significant rebates or rewards programs. Someone has to pay for these benefits to the cardholder – and it is typically the merchant accepting the payment who pays the cost, via a high merchant service fee.

The relatively high cost of the international card schemes is also very apparent in environments where merchants or billers have access to some other (non-card) electronic payment methods. The latter include direct debits and payments through providers such as BPAY or POLi. Comprehensive data on costs in these systems are not available, but the Bank has some data from its Payments Cost Study that was published in late 2014 (Graph 2). Based on the data for the billers in that study, the median percentage fee paid to banks or payment providers was just 0.05 per cent of transaction value for direct debit payments and 0.21 per cent for BPAY payments.

One sometimes hears the view that businesses should build the cost of payments into their final prices, as they do with other input costs. This is indeed what many businesses prefer to do. But some others choose to surcharge particular payment methods to signal to customers that some payment methods cost significantly more than others. This reflects a key difference relative to costs like electricity or rent; payments are a cost to the merchant where it is the consumer's choice that determines how much the merchant will pay.

When merchants have the right to apply a surcharge to more expensive payment methods they are able to provide price signals that encourage consumers to use payment methods that are less expensive. That is, the merchant can offer a lower total price to those consumers who choose to use the less expensive payment method. And where customers choose to use a more expensive payment method, which may bring them certain benefits in addition to the basic payments function, they pay for those benefits. In addition, where merchants have the right to surcharge it potentially improves their bargaining position regarding the acceptance of different payment methods, which can help keep downward pressure on merchant service fees.

By helping to hold down payment costs, the right to surcharge helps to hold down the price of goods and services charged to all consumers. It also reduces the extent to which consumers who pay with cheaper payment methods are subsidising others – typically higher-income households – who use more expensive payment methods. For example, the Bank's 2013 Consumer Use Survey shows that consumers in the highest income quartile are far more likely – 6 to 10 times more likely – to hold a premium-status credit card than those in the lowest income quartile.^[2]

Merchants may not, of course, surcharge all payment methods. If they choose to surcharge they must ensure that at least one non-surcharged payment method is also offered. If not, the amount of the surcharge should be built into the base price and not subsequently added on to the price of an item. In addition, consistent with requirements under the Australian Consumer Law, merchants should prominently disclose any surcharge.

Some evidence on surcharging

That is the rationale for allowing merchants to surcharge for more expensive payment methods. So what is the evidence in this regard since 2003 when the Bank introduced its reforms to interchange fees and required the removal of the ‘no-surcharge’ rules of some card systems?

First, as shown in Graph 1, there has been a significant fall in overall payment costs in the economy which will have contributed to downward pressure on the prices of goods and services to consumers and businesses.

Second, at an economy-wide level, there is no evidence to suggest that merchants have taken advantage of the ability to surcharge to recoup an amount in excess of their cost of accepting card payments. The Bank estimates that in 2013 merchants in aggregate recouped approximately one-quarter of the merchant service fees they paid when accepting card transactions.^[3]

Third, while many merchants may surcharge one or more card type, consumers typically choose to use alternative, lower-cost payment methods in order to avoid paying a card surcharge. The evidence in the Bank's 2013 Consumer Use Survey suggests that surcharges are paid on only around 4 per cent of card transactions, or just 1¾ per cent of all transactions that households make.

Fourth, observed surcharging behaviour is generally linked to the cost of card payments.^[4] American Express and Diners Club, the most expensive systems, are the systems that tend to be surcharged at higher rates and to be surcharged most often. Credit cards from MasterCard and Visa are more likely to be surcharged than debit cards from those systems, which tend to be less expensive. And payments via eftpos, the least expensive card system, are least likely to be surcharged. Finally, payments via direct debit and BPAY are essentially never surcharged.

Indeed, unlike the international card systems, BPAY and eftpos are sufficiently low-cost for merchants that they have never sought to implement ‘no-surcharge’ rules or to impose caps on surcharges. Perhaps there is a message from Graph 2: if a payments system is concerned about being surcharged by merchants, the simplest way to avoid that may be ensure it is sufficiently low-cost that merchants do not see any need to surcharge to provide consumers with an incentive to use other payment methods.

While most of the evidence suggests that the surcharging framework has been effective and operating largely as intended, there is no denying that excessive surcharging in a few industries has been a concern for some stakeholders.

A lightning rod here has been the surcharging policies of the domestic airlines. In this case, the companies have argued that their surcharging policies have not resulted in them over-recovering their payment costs in aggregate. But it is clear that they have been over-recovering their costs from some consumers. In particular, given that most of the costs of card acceptance for a merchant vary with transaction values, the flat-rate credit card surcharges of $7-8 per booking that previously applied clearly represented more than the cost of card acceptance for a $100 short-haul, economy-class fare. At the same time, they were far less than the cost of card acceptance for a $4,000 cross-country, return business-class ticket.

Given the concerns of stakeholders and the Bank about excessive surcharging in a few industries, this issue was one of the main ones raised by the Bank in its March 2015 Issues Paper to initiate the Review of Card Payments Regulation.

The new regulatory framework for surcharging

I would now like to touch on five key elements of the new framework contained in the Bank's new surcharging standard and the Government's amendments to the Competition and Consumer Act.

First, the new framework preserves the right of merchants to surcharge for more expensive cards, but it does not require them to do so. Under the framework, a merchant that decides to surcharge a particular type of card may not surcharge above their average cost of acceptance for that card type.

For example, if on average it costs a merchant 1 per cent of the value of a transaction to receive a Visa credit card payment, the merchant may apply a surcharge of up to 1 per cent for that type of card. The merchant would not, however, be able to apply the same 1 per cent surcharge if the customer chose instead to pay with a debit card that was less costly to the merchant.

Second, the definition of card acceptance costs that can be included in a card surcharge has been narrowed. Acceptable costs will be limited to fees paid to the merchant's card acquirer (or other payments facilitator) and a limited number of other documented costs paid to third parties for services directly related to accepting the particular type of card. A merchant's internal costs cannot be included in a surcharge.

Third, a merchant that wishes to surcharge will typically have to do so in percentage terms rather than as a fixed-dollar amount. In the airline industry, this means that surcharges on lower-value airfares have been reduced significantly.

Fourth, the Government has given the ACCC investigation and enforcement powers over cases of possible excessive surcharging.

The Bank's standard and the ACCC's enforcement powers apply to payment surcharges in six card systems that have been designated by the Reserve Bank – eftpos, the MasterCard debit and credit systems, Visa's debit and credit systems, and the American Express companion card system.^[5] However, Reserve Bank staff have been in discussions with other card systems that have not been designated and we expect that those systems will all be including conditions in their merchant agreements that are similar to the limits on surcharges under the Bank's standard. This will mean that merchants that wish to surcharge on payments in these other systems will be contractually bound to similar surcharging caps to those that apply to the regulated systems.

Fifth, surcharging in the taxi industry – which is subject to significant regulation in many other aspects – will remain the responsibility of state taxi regulators. Until recently, surcharges of 10 per cent were typical in that industry. However, authorities in five of the eight states and territories have now taken decisions to limit surcharges to no more than 5 per cent. As new payment methods and technologies emerge, the Bank expects that it will be appropriate for caps on surcharges to be reduced below 5 per cent. The Government and the Bank will continue to monitor developments in the taxi industry with a view to assessing whether further measures are appropriate.

The first stage of implementation of the surcharging reforms took effect on 1 September and covers surcharging of card payments by large merchants. Merchants are defined as large if they meet certain tests in terms of their consolidated turnover, balance-sheet size or number of employees. The framework will take effect for other, smaller merchants in September 2017.

There are a few reasons for the delayed implementation for smaller merchants. Most importantly, these merchants are less likely to have a detailed understanding of their payment costs. Since the new framework involves enforcement by the ACCC, the Bank considered it important to ensure that such merchants have simple, easy-to-understand monthly and annual statements that show their average payment costs for each of the card systems subject to the Bank's standard. Accordingly, as part of the new regulatory framework, acquirers and other payment providers must provide merchants with such statements by mid 2017. All merchants will be required to comply with the new surcharging framework from September 2017 and ACCC enforcement will apply also to smaller merchants from that point.

Given the new framework has only been effective for two weeks, it is too early to be definitive about how the new surcharging regime applying to large merchants has affected the surcharging behaviour of those merchants. However, based on some corporate announcements and an initial survey of some websites, I think it is possible to make six initial observations.

First, and most prominently, the major domestic airlines have moved away from fixed-dollar surcharges to percentage-based surcharging. This will result in a very significant reduction in surcharges payable on lower-value airfares. The two full-service airlines have introduced surcharges for on-line payments of 1.3 per cent for credit cards and 0.6 per cent for debit cards. A passenger wishing to pay for a $100 domestic airfare by card will now pay a surcharge of $1.30 or 60 cents, as opposed to a surcharge of up to $7-8 previously. Surcharges on some high-value airfares may rise with the shift to percentage-based surcharges. However, the airlines have implemented caps on surcharges of $11 for domestic fares and $70 for international fares, indicating that they continue to prefer to not pass on their full payment costs on purchases of more expensive tickets.

Second, there does not appear to have been any increase in the prevalence of surcharging. It remains the case that companies that face relatively low merchant service fees are tending not to surcharge, while those businesses which receive a high proportion of expensive cards are more likely to surcharge.

Third, the surcharge rates for credit cards that have been announced show significant variation, which is consistent with other evidence that there is a lot of variation in the merchant service fees faced by different businesses. In the case of the Qantas group, for example, Qantas is charging a credit card surcharge of 1.3 per cent while Jetstar – which presumably receives fewer high-cost cards – is charging a surcharge of 1.06 per cent.

Fourth, as required by the Australian Consumer Law, merchants that have announced changes to their surcharges are continuing to offer non-surcharged means of payment. In the face-to-face environment, this typically includes cash, eftpos and sometimes MasterCard and Visa debit cards. In the on-line environment, it typically includes payments via BPAY, POLi or direct debit, which – as shown in Graph 2 – are typically low-cost for merchants.

Fifth, while there are still many instances of ‘blended’ credit card surcharges, there are some early signs of greater discrimination in surcharges. Blending refers to the practice of charging the same surcharge across a number of systems regardless of their cost – say across the MasterCard, Visa and American Express credit systems.

The new framework allows merchants to set the same surcharge for a number of different payment systems, provided that the surcharge is no greater than the average cost of acceptance of the lowest-cost of those systems. For example, if a merchant accepts cards from two credit card systems, which have average costs of acceptance of 1 per cent and 1.5 per cent, it can set separate surcharges of up to 1 per cent and 1.5 per cent, respectively. If it wishes to set a single surcharge, it cannot average the costs and set a 1.25 per cent surcharge for both systems, since it would be surcharging one of those systems excessively. In this example, the maximum common surcharge that could be charged would be 1 per cent.

While I think we are already seeing some reduction in the practice of blended surcharging, it is likely that we will see this trend continue from mid 2017 when new rules on the interchange fees exchanged between banks for card transactions take effect. Without wishing to go into details, the Bank will for the first time be placing a cap on the maximum interchange fee that can be paid on any card transaction. This will significantly reduce the cost of MasterCard and Visa payments for those merchants which currently receive a high proportion of high-interchange cards.

The sixth change has been in the event ticketing industry, where it was previously very difficult to avoid a card surcharge in the on-line environment. Given this, the ACCC had already required the major ticketing companies to show their surcharges as a separate component within their headline, up-front pricing. Effective 1 September, the two major companies have now removed their card surcharges and are now quoting a simple, single price for all payment methods.

Conclusion

Whenever it considers regulation, the Bank is required to look carefully at the public interest and its mandate to promote competition and efficiency in the payments system. Accordingly, the changes that the Bank announced in May to the surcharging and interchange standards followed an extended period of consultation with stakeholders including consumer organisations, merchants, financial institutions, card schemes, providers of other payment instruments, and staff from the ACCC and the Treasury. Since the changes were announced, the Bank has been meeting with a wide range of stakeholders to provide guidance and answer any questions on the interpretation of the new standards.

Overall, the Bank expects that the narrower definition of the cost of acceptance, the proposed transparency measures and the ACCC's new powers will result in a framework that is clearer for all parties, with more effective enforcement in any cases where merchants may be surcharging excessively.

While the Bank and the ACCC will continue to watch developments closely with the goal of ensuring that consumers can be confident that any surcharges they face are no more than the costs incurred by merchants in accepting card payments, consumers will also be able to help ensure that we reap the greatest benefits from the new framework.

Where consumers see a surcharge, they should check to see what non-surcharged methods of payment are available. Before paying a surcharge, they should think about whether any benefits from using that payment method outweigh the cost of the surcharge; if not they should consider switching to an alternative payment method. This will not only save them money, it will help keep costs down for businesses and will put pressure on card schemes to keep their charges low.

Finally, in the event that consumers are faced with a situation where the merchant does not offer a non-surcharged payment method or if consumers have concerns that a large merchant may be surcharging excessively, they should contact the ACCC. The ACCC's website provides further guidance on the surcharging framework, along with an online consumer complaint form. It will be investigating surcharging practices where it receives complaints or where it has other reason to believe that merchants may be surcharging excessively.

Endnotes

The data presented here are all for the fees charged to merchants for different payment methods. The Bank's two payment cost studies have also analysed the ‘resource costs’ (the economic resources that are expended by all parties involved to ‘produce’ a payment) of different payment methods which are an important consideration for payments system efficiency. The rankings of the resource costs in the 2014 Study are very similar to the rankings of private costs to merchants shown here. In particular, direct debit, BPAY and eftpos are all relatively low resource cost methods, while credit cards are a high cost method. See C Stewart, I Chan, C Ossolinski, D Halperin and P Ryan (2014), ‘The Evolution of Payment Costs in Australia’, RBA Research Discussion Paper No 2014-14. [1]

See C Ossolinski, T Lam and D Emery (2014), ‘The Changing Way We Pay: Trends in Consumer Payments’, RBA Research Discussion Paper No 2014-05. [2]

This estimate is based primarily on the Bank's 2013 Consumer Use Survey where 1,167 consumers filled in online or paper payments diaries for every transaction undertaken over a week. This resulted in detailed data (including on surcharges paid) on more than 15,500 transactions by households. The estimate of total surcharges paid also includes an estimate of surcharges paid on commercial cards which assumes that transactions on these cards were more likely to be surcharged and were surcharged at higher rates than consumer transactions. This methodology yields an estimate of surcharges paid of around $800 million in 2013, compared with merchant service fees paid of around $3 billion. [3]

For example, the Bank's 2013 Consumer Use Survey indicated that the median surcharge paid for transactions involving American Express cards was 2.0 per cent compared with 1.5 per cent for surcharged MasterCard and Visa transactions. Survey data from the Bank and the NSW Business Chamber for over 700 small and medium-sized businesses indicate that 30 per cent of merchants accepting American Express applied a surcharge, compared with 12 per cent for MasterCard and Visa credit cards, 5 per cent for MasterCard and Visa debit cards and 3 per cent for eftpos. [4]

References to the eftpos, MasterCard and Visa debit systems here encompass both their debit and prepaid systems. [5]