Proposed Changes to the Credit Card Interchange Standard:
A Consultation Document – July 2005
4. Options

In response to the consultation, the Bank has considered two broad options. The first is to leave the current credit card interchange standard unchanged and the second is to revise the standard to set a common cost-based benchmark for all the designated credit card schemes.

The consultation process confirmed that the current arrangements have created, at the margin, an incentive for issuers to issue credit cards under the scheme with the highest interchange fee. This is despite the difference in interchange fees in the two largest schemes being only two basis points.

A number of issuers noted that cardholders have shown themselves to be quite accepting of changes in the brand of credit card. This means that the cost to issuers of encouraging customers to move from one scheme to another may be minimal in terms of customer loss and, if the scheme pays for reissuing cards, minimal in total. The potential for significant shifts between schemes in these circumstances is therefore quite high because not only new issuers, but also existing issuers, could be encouraged to issue cards under the scheme with the higher interchange fee.

The consultation process also highlighted the fact that there is little competitive discipline on schemes with relatively high interchange fees. While higher interchange fees mean higher costs to acquirers, these higher costs are not transparently passed on to merchants who are invariably offered a bundled price for accepting all three designated credit card schemes. As a result, a scheme with relatively high fees does not find itself at a competitive disadvantage in terms of merchant acceptance. This would likely remain the case even if acquirers charged merchants more for accepting the higher-cost scheme given that merchants have demonstrated that they find it difficult to reject higher-cost cards.

Some submissions argued that the recalculation of the current benchmarks every three years will ameliorate any competitive advantage enjoyed by the scheme with the highest interchange fee. In particular, as lower-cost issuers are attracted to the scheme with the high interchange fee, the benchmark will fall when it is recalculated, offsetting the gain those issuers achieved from switching. However, the offset would not be complete and, thus, an incentive to switch to the scheme with the relatively high benchmark would remain. Even if the offset were complete, some issuers claimed that a year or two of higher interchange fees is of commercial benefit and worth the costs of a switch in brands.

In comparison with the current arrangements, a common interchange fee would provide a stronger incentive towards cost savings (that is technical efficiency) and promote more soundly based competition between the schemes for issuers.

A common benchmark would mean that lower-cost schemes could use their lower costs to attract issuers. Under current arrangements, issuers are not very sensitive to the scheme costs included in eligible costs: if scheme costs are low the interchange fee is low and if scheme costs are high the interchange fee is high. In contrast, under a common benchmark fee, issuers are likely to find it more attractive to issue cards under schemes with the relatively low scheme costs. The result should be a more efficient system.

This analysis also argues for a benchmark based on an average of scheme costs rather than one based on the lowest-cost scheme. If the benchmark is based on the costs of the lowest-cost scheme, there is little incentive for that scheme to lower its costs further as it will lose the benefit of the cost savings when the benchmark is recalculated. If instead the benchmark is based on costs averaged across the schemes, the low-cost scheme will retain a portion of its cost savings even after the benchmark is recalculated – thus providing a stronger incentive to lower costs.

These arguments contrast with those put by MasterCard which emphasised a detrimental effect on competition of a common benchmark.

MasterCard argued that a common benchmark would 'eliminate to a great extent the remaining degree of competition between the credit card schemes in the setting of interchange fees' and that the schemes should be allowed to set interchange fees themselves. In contrast, the Bank's view is that interchange fees are not set under normal competitive conditions, with competitive pressures tending to push interchange fees up not down.

MasterCard also argued that a common benchmark would lead to greater homogeneity in credit card offerings in the Australian market place and increase the attractiveness of the three-party schemes to issuers. The Bank does not accept either of these arguments. There is strong competition amongst issuers of credit cards in terms of both price and product characteristics. In the Bank's opinion, this situation would not be adversely affected by a common benchmark interchange fee. Similarly, a common benchmark fee, at around the current level of interchange fees, is unlikely to increase the attractiveness of the three-party schemes to issuers, since it would not change the average interchange revenue of issuers in the four-party schemes.

Finally, MasterCard argued that a common benchmark would 'under-compensate the issuers in the more expensive scheme(s), and over-compensate the issuers in the lower-costing scheme(s)'. As noted above, the Bank's opinion is that a common benchmark would improve the incentives for the schemes to lower their costs and for issuers to issue under the lower-cost scheme. Also, it is worth noting that under current arrangements the eligible costs of issuers span quite a wide range, with some issuers having lower costs than the relevant benchmark, and others having higher costs than the benchmark.

Taking into account the submissions and consultations and its own analysis, the Payments System Board has reached the preliminary conclusion that the establishment of a common benchmark would be in the public interest.