Reasons for the Decision to Designate the EFTPOS Payment System

14 October 2004

Introduction

  1. This statement provides the reasons for the decision of the Payments System Board to designate the Electronic Funds Transfer at Point Of Sale (EFTPOS) debit card payment system as a payment system under Section 11 of the Payment Systems (Regulation) Act 1998.
  2. The Reserve Bank Act 1959 establishes the Payments System Board. Section 10B(3) of the Act states:
    1. 'It is the duty of the Payments System Board to ensure, within the limits of its powers, that:
      1. the Bank's payments system policy is directed to the greatest advantage of the people of Australia; and
      2. the powers of the Bank under the Payment Systems (Regulation) Act 1998 and the Payment Systems and Netting Act 1998 are exercised in a way that, in the Board's opinion, will best contribute to:
        1. controlling risk in the financial system; and
        2. promoting the efficiency of the payments system; and
        3. promoting competition in the market for payment services, consistent with the overall stability of the financial system…'.
  1. The authority to designate a payment system is conferred on the Bank by Section 11 of the Payment Systems (Regulation) Act 1998. The Act states that 'The Reserve Bank may designate a payment system if it considers that designating the system is in the public interest'. Section 8 of the Act defines the meaning of public interest:

    1. 'In determining, for the purposes of this Act, if particular action is or would be in, or contrary to, the public interest, the Reserve Bank is to have regard to the desirability of payment systems:
      1. being (in its opinion):
        1. financially safe for use by participants; and
        2. efficient; and
        3. competitive; and
      2. not (in its opinion) materially causing or contributing to increased risk to the financial system.

        The Reserve Bank may have regard to other matters that it considers are relevant, but is not required to do so.'
  1. Having designated a payment system, the Bank may impose an access regime on participants in the system (Section 12), and/or determine standards to be complied with by participants in the system (Section 18).
  2. In determining whether designation of the EFTPOS system was in the public interest, the Board took account of analysis by the Bank staff, international experience, written and oral submissions to the Bank by industry participants and interested parties, submissions to the Australian Competition and Consumer Commission (ACCC) and the Australian Competition Tribunal (ACT) and the decisions by those bodies, and drew on the collective knowledge and experience of the members of the Board, who are listed in the Board's Annual Report. Schedule A identifies the principal material taken into account by the Board.
  3. In assessing whether to designate the EFTPOS system, the Board recognised its obligation to consider the overall payments system, and not just the EFTPOS system. It paid particular attention to the possible interactions between the EFTPOS system and the credit card and Visa Debit payment systems (as well as other prospective scheme-based debit cards).
  4. The decision to designate was taken at a meeting of the Payments System Board on 3 September 2004 and was announced via a notice in the Gazette and a Reserve Bank of Australia Media Release on 9 September 2004.
  5. The remainder of this statement sets out the major findings, considerations and conclusions that underpinned the Board's decision to designate the EFTPOS payment system.

The payments system

  1. The Australian non-cash payments system is made up of a number of separate payment systems. These include:

    • the debit and credit card payment systems predominantly used for retail payments by consumers;
    • the direct credit and debit payment systems used by both consumers and businesses;
    • the cheque payment system that, today, is mainly used by businesses; and
    • the RTGS system primarily used by banks for settlement of money market and foreign exchange transactions.
  1. Over time, the use of these different payment systems has changed substantially. The use of credit cards has grown particularly strongly, as has the use of EFTPOS, albeit less rapidly than that of credit cards. In contrast, the use of cheques has declined; in the case of bill payments, cheques have been displaced by direct credits, direct debits, credit cards and BPAY.
Graph 1: Non-cash Payments per Capita

Graph 1 [D]

  1. For many payments, individuals clearly have a choice about which payment method to use. For instance, to pay for a trolley of groceries at a supermarket checkout, credit cards and debit cards can be used along with cash, more or less interchangeably. Similarly, cheques, credit cards, direct debits, direct credits and BPAY can all be used to pay most household bills.

Card payment systems

  1. The EFTPOS debit card payment system allows cardholders to make payments at merchants accepting the card and, in some cases, to also obtain cash. Transactions are debited electronically to cardholders' accounts at authorised deposit-taking institutions (ADIs). The cardholder authorises the transaction by entering a personal identification number (PIN) into a terminal at the point of sale.
  2. The system was built as a series of bilateral linkages between institutions that issue EFTPOS cards (issuers) and institutions that provide payment services to merchants (acquirers). The first cards were issued in the early 1980s and could be used by cardholders for transactions at merchants serviced by their bank as well as to withdraw cash from their bank's ATMs. As the number of bilateral linkages grew, cardholders gained access to a large number of merchants, and merchants were able to accept cards from more issuers. By 2004, there were 465,000 EFTPOS terminals in Australia, with over 980 million transactions being processed per year.
  3. Currently, there are around ten financial institutions offering EFTPOS acquiring services to merchants, with one merchant acting as its own acquirer (known as a merchant principal). There are many more banks, building societies and credit unions which issue debit cards that can be used in the EFTPOS system.
  4. Each time a cardholder makes a payment to a merchant using the EFTPOS system, an interchange fee averaging around $0.20 (with a range of $0.18 to over $0.30) is paid by the institution issuing the card to the acquirer. The large number of agreements between issuers and acquirers that were provided to the Bank on a confidential basis in mid 2004 showed little evidence of any material changes in interchange fees since the system was established.
  5. In addition to EFTPOS, there are a number of other widely accepted card payment systems in Australia. They are credit cards, charge cards and Visa Debit cards. In contrast to the EFTPOS system, the Bankcard, MasterCard and Visa credit card systems have interchange fees that flow from acquirers to issuers. These fees are calculated as a percentage of the amount spent. While they vary across the three credit card schemes, the average fee is a little less than 0.55 per cent of the transaction value.[1] This figure is down from around 0.95 per cent in 2000. The interchange fee applying to Visa Debit transactions is the same as that applying to Visa credit card transactions.
  6. In terms of access to the EFTPOS system, new entrants wishing to participate as issuers or acquirers on the same basis as the existing players must arrange bilateral links with around eight other participants. Alternatively, they can enter by establishing gateway arrangements with existing participants. A number of submissions to the Bank argued that these arrangements were not conducive to competition in the acquiring business. The Board was of the opinion that improved access to the EFTPOS payment system would promote competition and would be in the public interest. The Australian Payments Clearing Association is currently reviewing the arrangements with the aim of developing a regime to improve access.[2] The Bank has indicated that it is closely monitoring this work.

The Board's decision-making framework

  1. In reaching its decision to designate the EFTPOS system, the Board considered that, in order to allow it to form the opinions required under the relevant Acts, the appropriate framework in which to consider the issues was one based on micro economic principles regarding the relationship between prices and resource costs. This is the same framework that the Board has used in making other decisions, including the decisions to designate the credit card payment systems and to set standards and impose an access regime on those systems. The framework was first set out in detail in a paper for the Board's second meeting dated November 1998. In order to assess efficiency under the framework, it is not necessary to explicitly calculate the benefits accruing to cardholders.
  2. The Board considered, in the context of the payments system as a whole, the extent to which the relative prices that individuals face when choosing among payment methods reflect the relative costs to society of using those methods. When prices do not reflect costs it is often a sign that competitive forces are not working adequately or that, at least, analysis is needed to clarify whether the system is working competitively and efficiently. If the price charged is below the cost to society of providing a particular method of payment, that method is likely to be overused. Similarly, if the price is above cost, the payment method is likely to be underused.
  3. In making its assessment, there were six primary issues that the Board took into account:
  • the effective prices charged to cardholders for the different card-based payment systems;
  • the relative cost of the resources needed to make a payment through the various card-based payment systems;
  • the relationship between interchange fees and prices faced by cardholders and merchants;
  • the competitive forces working on interchange fees;
  • the impact of prices on cardholders' choice about which payment method to use (i.e. substitutability); and
  • evidence on the use of debit cards in other countries.

The Board's findings on each of these issues is discussed below.

Effective prices to cardholders

  1. Cardholders using the EFTPOS system face either a zero or positive price for each transaction.
  2. As noted above, an EFTPOS card is linked to an account at a financial institution. An ADI typically charges a fixed monthly fee for this account, although the fee is sometimes waived for relationship or other reasons. Typically, the account offers a certain number of transactions, including EFTPOS transactions, for no charge (other than the fixed monthly fee) but then a per transaction fee is imposed once that number has been exceeded. In 2003, this charge averaged 45 cents for an EFTPOS transaction for the four largest banks.[3] One of the Commonwealth Bank's main transaction accounts, for example, provides 15 fee-free electronic transactions per month, and then charges a fee of 30 cents for each EFTPOS transaction, while Westpac has an account that allows 8 fee-free transactions (of any type) and then charges 50 cents per transaction. In contrast, ANZ has for some time offered accounts with unlimited free electronic transactions for a fixed monthly fee and NAB has recently done likewise.
  3. Confidential data supplied to the Reserve Bank by the five largest banks in mid 2004 showed that, with the exception of ANZ, around 28 per cent of EFTPOS transactions incur transaction fees. ANZ's unlimited free electronic transactions account means that a smaller proportion of its EFTPOS transactions incur fees. Overall, on an annual basis EFTPOS transaction fees total around $70 million for the five banks whose accounts were covered by the Reserve Bank's survey.
  4. In contrast to EFTPOS, users of the credit card system typically face either a zero or negative effective price for each transaction.
  5. Credit card accounts, like deposit transaction accounts, typically have a fixed fee, but it is levied annually, not monthly. However, unlike EFTPOS, no Australian credit card issuer currently levies a per transaction charge. Indeed, for many cardholders, the effective per-transaction price is negative. This reflects the fact that issuers provide cardholders with the possibility of interest-free credit and reward points.
  6. According to data collected by the Bank, around 30 per cent of credit card balances do not attract interest, with survey data from Roy Morgan indicating that around 60-65 per cent of credit cardholders pay off their balances each month.[4] These cardholders receive the benefit of an interest-free loan from the issuing institution. On an account that offers up to 55 days free credit and where the cardholder spends evenly across the month, this benefit is equivalent to over half a per cent of the amount spent (at current interest rates).
  7. In addition, reward points can be exchanged for a range of goods, services and shopping vouchers. Taking the Commonwealth Bank's standard rewards program as a guide, a $100 shopping voucher can be obtained after spending $14,000. This amounts to a benefit of around 0.7 per cent of the amount spent. While the exact value of the reward points depends upon how they are redeemed, this figure is reasonably representative of their value.
  8. While not all cardholders receive interest-free credit and earn reward points, for the many that do, the effective price of using a credit card to pay for a transaction can be minus 1.2 per cent, or even lower.
  9. Like users of credit cards, cardholders using a Visa Debit card face no per transaction charge. They do not, however, receive an interest-free period and there are currently no reward schemes attached to the use of these cards. Whether a monthly account keeping charge applies depends on the features of the account to which the Visa Debit card is attached.

Resource Costs

  1. The available data indicate that the resource costs associated with a credit card (or scheme debit card) payment exceed those associated with an EFTPOS payment. This reflects at least two factors.
  2. The first is that payments made using four-party credit card and scheme debit cards are processed through the relevant proprietary infrastructure set up by the individual credit card systems to ensure worldwide acceptance of their cards. The global nature of this infrastructure means that there are additional expenses, relative to the domestically based EFTPOS system. Data collected by the Bank and the Australian Competition and Consumer Commission and published in Debit and Credit Card Schemes in Australia: Study of Interchange Fees and Access (the Joint Study) in 2000 show that the cost of acquiring a credit card transaction was $0.43 while for debit cards the acquiring cost was $0.26. The processing and authorisation costs on the issuing side were $0.21 for credit cards and $0.06 per transaction for debit cards.
  3. The second is that the costs of fraud and fraud control are considerably higher for credit card and Visa Debit transactions due to the fact that they are signature based and can be used in situations where the merchant cannot check the signature. EFTPOS transactions, on the other hand, have low fraud costs due to the EFTPOS system being PIN based.
  4. Data on the fraud costs of the systems can be found in Tables 5.1 and 6.1 of the Joint Study. In the credit card system these data show that fraud losses amount to around 0.07 per cent of the amount spent. Subsequent confidential data provided to the Bank by independent experts appointed by Bankcard, MasterCard and Visa in the course of implementing the interchange standard for credit cards show that once explicit account is taken of both fraud losses and the costs of preventing fraud, the figure for total fraud-related costs is around double this. By way of contrast, the Joint Study reported that fraud costs in the EFTPOS system were around 0.01 per cent of the amount spent. Confidential data from the Australian Payments Clearing Association confirm that fraud in the EFTPOS debit card system remains of this order.
  5. The Board considered the Australian Merchant Payments Forum's (AMPF) criticism, and the view of the ACT, that the data in the Joint Study cannot be relied upon because they do not include merchants' costs and are out of date. The Board gave this view little weight for two primary reasons.
  6. First, the Board recognised that in considering whether an interchange fee was necessary to make a payment system viable, it was widely accepted that it was the costs of issuers and acquirers that were relevant, not the costs of end users. This argument has been set out by the Bank publicly in a number of places, including its Consultation Document on credit card reforms in 2001 and its submission to the ACT in April 2004.
  7. Second, the Board judged that it was unlikely that acquirers' and issuers' costs had changed so much since the Joint Study that an interchange fee was now necessary to make the EFTPOS system viable. While it recognised that costs may have changed somewhat over recent years, the data obtained during finalisation and implementation of the credit card standard on interchange fees show that, at least on the issuing side, any changes have been small. Accordingly, the Board concluded that it had sufficient information to reach a judgement on whether designation was in the public interest.

Interchange fees and prices charged to merchants and cardholders

  1. Interchange fees affect merchants' costs of accepting the various cards and the costs that cardholders face for using different cards.
  2. These points are well illustrated by the effects of the recent changes to merchant service fees and credit card pricing following the Bank's reforms of the credit card schemes. As noted above, these reforms have seen the average interchange fee across the Bankcard, MasterCard and Visa schemes fall by around 40 basis points to a little under 0.55 per cent.[5] At current levels of credit card spending this represents a fall in acquirers' annual costs of around $500 million and a reduction in issuers' revenue of the same amount. Data collected by the Bank show that this fall in interchange fees was almost fully and immediately passed through into lower merchant service fees. As yet unpublished data suggest that, by the June quarter this year, merchant service fees had fallen by the full amount of the reduction in the average interchange fee.
  3. There have also been changes on the issuing side. Most major banks have reduced the attractiveness of their reward schemes by increasing the amount that must be spent to achieve a given reward. The most recent example is Westpac, which increased the spending required to earn a $100 David Jones voucher from $12,500 to $14,000. It had earlier halved the conversion rate for frequent flyer points from $1 spent = 1 point to $2 spent = 1 point. Most banks have also introduced caps on the accumulation of reward points. ANZ, for example, has capped points accumulation at 3,250 points per month with a halved accrual rate for expenditure between $1,500 and $5,000 per month and no accrual above $5,000 per month on its Frequent Flyer Visa card. There have also been increases in annual fees and fees for being a member of a reward scheme.
  4. The recent experience in the United States, where both PIN-based systems and signature-based debit card systems operated by MasterCard and Visa exist, provides further evidence. Interchange fees for the PIN-based system flow from acquirers to issuers (the opposite to Australia) but are flat fees and are relatively small. In contrast, interchange fees for the scheme debit cards are value based and, on average, provide the issuing bank with higher interchange revenue per transaction than the PIN-based system. This has had two effects on prices. First, some banks have offered rewards to customers using scheme debit cards, effectively making the price for using these cards negative. Second, an increasing number of banks are charging customers who make PIN-based transactions, encouraging them to use the system that provides the issuing banks with higher fees; in some cases the fees charged to cardholders are as high as US$1.50 per transaction. As a result, the scheme based debit card systems have grown more quickly than the PIN-based systems.
  5. In Australia, as noted above, institutions offering Visa Debit do not impose a per transaction charge, while charges are imposed on some users of EFTPOS. In the Board's view, an important reason for this is the difference in interchange fees in the two systems. When a cardholder spends $100 on a Visa Debit card, their financial institution receives around 50 cents from the merchant's financial institution. If the same purchase is made by EFTPOS, the cardholder's financial institution does not receive a payment, but instead has to make a payment of around 20 cents to the merchant's acquirer. Given this difference in the issuers' costs, it is not surprising that there is a difference in pricing.
  6. In the Board's view, lower interchange fees in the EFTPOS system would be likely to have two effects on prices.
  7. First, acquirers would increase their merchant service fees on EFTPOS transactions to offset the reduction in their revenue.
  8. Second, issuers of EFTPOS cards would offer cardholders lower prices, or more fee-free transactions, because lower interchange fees would reduce their costs of offering EFTPOS cards. In their submissions to the ACCC and ACT a number of banks indicated that they expected to reassess their pricing if interchange fees fell to zero, although they did not specify what changes would take place.
  9. The Board considered the views of the AMPF and the ACT that 'the vast majority of cardholders will not receive any reduction in EFTPOS transaction fees from lower interchange fees'.[6] In considering this argument, the Board took account two factors. The first was that, as noted above, a significant number of EFTPOS transactions incur fees. The second was the more general developments in the Australian financial system over the past two decades. In particular, where institutions have offered services for less than the cost of providing those services, competition has, in many cases, forced a rationalisation of pricing.[7] Again, overseas experience reinforces this assessment. In Europe, the viability of domestic EFTPOS systems is reported to be under pressure from scheme-based debit systems which yield higher revenue to issuers.[8]
  10. In the Board's view, in the medium term, it is unlikely to be sustainable for financial institutions to offer a large number of free EFTPOS transactions while having to pay an interchange fee of around 20 cents on each of these transactions. Current products are likely to come under pressure to be restructured and/or issuers will face a strong incentive to steer customers to payment methods that are less costly for issuers. In particular, given the large difference in interchange fees, issuers will be encouraged to steer customers towards using Visa Debit, rather than EFTPOS. As discussed below, this currently occurs with those institutions that offer both products.
  11. Accordingly, the Board concluded that lower EFTPOS interchange fees would not only lead to cardholders facing lower prices and/or higher fee-free limits, but also issuers being more likely than at present to encourage the use of EFTPOS.

Competition over interchange fees

  1. Given the importance of interchange fees in determining prices, a relevant issue is whether these fees are subject to competitive pressure.
  2. The Board's judgement was that these fees are subject to little competitive pressure. When they are set multilaterally, as is the case with credit cards, all issuers in the scheme pay the same interchange fees and this is reflected in the fees that merchants face. Merchants cannot force interchange fees lower by the threat of moving from one bank to another for supply of the scheme's credit card services. When the fees are bilaterally set, as is the case in the EFTPOS system, the dynamics of competition are different, but again, normal competitive forces tend to be weak. In general, neither acquirers nor issuers are willing, or able, to initiate a process of competition over interchange fees.
  3. In the bilateral case, the main reason for little competition emanating from the issuing side is that in any negotiation with an acquirer over the interchange fee, an issuer cannot credibly threaten to end the current agreement if a lower fee is not agreed to. Ending the agreement would mean that the issuer's cardholders were not able to use their cards at merchants serviced by the acquirer. For most issuers, this would be seen as unacceptable as it would effectively mean that they could not offer a full-service transaction account and would therefore hurt their competitive position. Similarly, an acquirer attempting to expand its business would have difficulty doing so if it were to offer, or agree to, a lower interchange fee. If the acquirer were receiving less revenue from interchange payments than its competitors, it would be unlikely to be able to offer merchants as competitive pricing as other acquirers. Accepting a lower fee can hurt, not improve, the competitive position of acquirers.
  4. The one qualification to this arises from the possibility of large merchants bypassing their acquirers and connecting directly to issuers. Under such an arrangement both issuer and merchant can be better off by sharing any margin earned by the merchant's existing acquirer. However, the gains to be achieved from this source are limited. Once the merchant has established a direct connection with the issuers, there is likely to be little further competitive pressure on interchange fees. Only one large merchant has been able to undertake such negotiations and smaller merchants are not in a position to do so.
  5. These considerations suggested that bilaterally set interchange fees do not reflect normal competitive pressures. The rigidity of interchange fees in the EFTPOS payment system since the 1980s and 1990s supports this assessment.

Prices and the choice of payment method

  1. A number of factors influence the choice of payment method. These include the convenience and security of the method, as well as whether a receipt is required. Another important factor is the price. If cardholders face a reduction in the price of a particular payment method, relative to other methods, they are likely to substitute that method for other means of payment and use that method more often. This assessment is supported by a number of developments in the Australian payments system over recent years.
  2. The first is the growth of credit cards. Throughout much of the 1990s, spending on credit cards grew rapidly, outpacing that on debit cards. The Board recognised that one of the widely accepted explanations for this is that the spread of reward schemes effectively reduced the per transaction price of using a credit card, with cardholders responding by purchasing a much wider range of goods and services on their credit cards.[9]
  3. A second example is that of cheque usage. Since 1997, the number of cheques written in Australia per person has halved. An important reason for this is that financial institutions have increased the price they charge their customers for writing cheques.
  4. A third example relates to EFTPOS and Visa Debit. Holders of Visa Debit cards can choose to have the transaction processed though the EFTPOS debit card system by pressing the 'cheque' or 'savings' button on the terminal. If they make this choice, they may be charged by their financial institution. Alternatively, if the 'credit' button is pressed, the payment goes through the Visa system, and no charge is applied. In addition to the price incentive to use the Visa Debit system, many issuers of Visa Debit cards actively encourage cardholders to press the 'credit' button in their promotional material (see, for example, the website of St George Bank).[10]
  5. Overseas experience was also seen to be instructive. In the United States, the relatively attractive pricing of signature based debit cards (discussed above) has resulted in a switch to these cards and away from PIN-based cards. Between 1993 and 2003, the share of PIN-based debit cards in total debit card transactions fell from 61 per cent to 40 per cent.[11]
  6. The AMPF and its members argued before the ACT that the fact that many cardholders did not pay transaction fees meant that a reduction in EFTPOS fees would not lead to an increase in EFTPOS use.
  7. The Board gave little weight to this argument for the following reasons. First, a significant number of transactions do attract fees, and, based on the experience above, cardholders would be expected to adjust their behaviour in response to lower fees. Also, a lowering of fees, or an increase in the number of fee-free transactions, is likely to encourage those that do not currently use EFTPOS to do so. A second reason relates to the long-term viability of bundled transaction products with unlimited EFTPOS transactions. If interchange fees continue as they are, such products are ultimately likely to be relatively unattractive for issuers unless they are able to switch customers away from EFTPOS and towards other means of payment where interchange fees are either not paid or are paid to issuers. A reduction in interchange fees would likely lessen the eventual pressure on these products and see greater use of EFTPOS than would otherwise be the case.
  8. On the basis of the available evidence, the Board concluded that debit cards and credit cards are economic substitutes.

International Evidence

  1. In assessing the possible effect of reform on the payments system, the Board found that overseas experience provides a valuable benchmark. This experience allows the Board to view the outcomes of 'experiments' which cannot be undertaken domestically. While these experiments are not perfect, they do provide a rich source of empirical evidence. Although the ACT was of the view that there is not 'a great deal of value in overseas comparisons', the Board judged that the Bank's extensive experience in policy making and its long-standing involvement in international policy debates and fora has shown such comparisons to be extremely valuable. Some examples where this evidence has been informative are noted above.
  2. Most overseas EFTPOS systems have interchange fees that flow, as in credit card systems, from acquirer to issuer.
  3. The Board considered that experience in two of the most widely used EFTPOS systems – those in Canada and the Netherlands – which have no interchange fees at all, was relevant. This can be seen in Graph 2 which shows the number of debit card transactions per inhabitant in 2002 against the average EFTPOS interchange fee in a number of countries. Australia, with an interchange fee that flows from issuer to acquirer is on the left side of the chart and the US, where interchange fees (averaging around $0.30[12]) flow from acquirer to issuer, is on the right side of the chart. Australia's average interchange fee is -$0.20 and there were a little over 40 debit card transactions per inhabitant in 2002. The Canadian system has an interchange fee of $0 (or equivalently no interchange fee) and had over 70 debit card transactions per inhabitant in 2002.
  4. The graph shows that the countries with a relatively high number of debit card transactions per inhabitant (the Netherlands and Canada) are those countries with a zero interchange fee. Not surprisingly, the zero fee is reflected in the price structures. In the Netherlands there are no per transaction fees for the use of debit cards while in Canada the 'fee-free' limits are generally much higher than in Australia.[13] [14] Australia, with an interchange fee that flows from issuer to acquirer, has higher fees, lower fee-free limits and lower usage.
Graph 2: Debit Card Transactions (per inhabitant, 2002)

Graph 2 [D]

  1. Not surprisingly given the direction that interchange fees flow in Australia, there is a very high merchant acceptance of EFTPOS. Australia has a relatively high number of terminals per inhabitant; in 2002 there were over 20,000 POS terminals per million inhabitants, compared with 12,000 in the United States (and most of these do not accept PIN based debit cards).
  2. These two observations – relatively low use per capita and high merchant acceptance – are consistent with the direction of interchange fees in Australia. Merchants are strongly encouraged to accept EFTPOS transactions while consumers have less incentive to use the system than is the case in a number of other countries.
  3. Another way of looking at these facts is that there are a relatively low number of transactions per terminal in Australia. Graph 3 shows transactions per terminal against the average interchange fee for a number of countries. While there are a large number of terminals installed in Australia, by international standards, each terminal processes relatively few EFTPOS transactions.
Graph 3: Debit Card Transactions (Per terminal, 2002)

Graph 3 [D]

  1. The Board's view was that the relatively high price (compared with credit cards) of using EFTPOS, rather than the lack of merchant acceptance or merchant investment in terminals, is the main reason that EFTPOS is not more heavily used in Australia. There are around 2,000 transactions per terminal in Australia while in Canada and the Netherlands, the countries with zero interchange fees, there are around 5,000 to 6,000 transactions per terminal. In the UK and the US, which have interchange fees that flow from acquirers to issuers, there are around 4,000 transactions per terminal.

The decision to designate

  1. In deciding whether designation of the EFTPOS system was in the public interest, the Board's primary focus was on promoting the efficiency of the payments system and competition in the market for payment services in the context of Section 10B of the Reserve Bank Act and Section 11 of the Payment Systems (Regulation) Act. At an early stage in its deliberations, the Board judged that designation would have few, if any, implications for whether the payment system is financially safe for use by participants. None of the submissions received by the Bank argued otherwise. The Board also judged that the decision to designate would not contribute to risk in the financial system. Again, no submission argued otherwise.
  2. In considering whether designation would promote efficiency in payment systems, the Board was of the view that it was necessary to take a system-wide perspective and consider efficiency in the payments system as a whole. As set out in paragraphs 9 to 11, the payments system is made up of a number of different payment systems. The Board therefore focussed on whether the prices that cardholders face in these different payment systems promote choices that are efficient from the perspective of the overall payments system.
  3. As noted earlier, as a general proposition of economics, efficient outcomes are achieved when the relative prices that individuals face for goods and services reflect the relative (marginal) costs of producing those goods and services. On the available evidence, the Board concluded that this condition is not satisfied in the case of card payment systems in Australia. As discussed above, cardholders, on average, face higher prices for EFTPOS transactions than for credit card and Visa Debit transactions, while the costs of processing an EFTPOS transaction are lower than the costs of processing transactions through the other systems.
  4. There may, of course, be exceptions to the above general principle. One of these could arise in payment systems in which acquiring or issuing institutions are not able to recover their costs through pricing to cardholders and merchants. In such situations the payment of an interchange fee – with the result that prices deviate from underlying costs – can make an otherwise unviable system, viable. In some, but not necessarily all, such situations the payment of this fee can enhance the overall efficiency of the payments system. As noted earlier, this rationale for interchange fees has been set out by the Bank in a number of publications.
  5. The available data do not suggest that costs and revenues of EFTPOS issuers and acquirers are so out of balance that both issuing and acquiring would not be viable without an interchange fee.[15] A comparison of the data in Tables 5.1 and 6.1 of the Joint Study shows that compared to credit cards, issuers' and acquirers' costs and revenues are relatively balanced. That both issuers and acquirers have sought to set interchange fees to zero is further evidence of this. International evidence cited above indicates that similar systems operate with larger transaction volumes per capita than in Australia with no interchange fee.
  6. Accordingly, the Board found that the current arrangements are not conducive to the efficiency of the system, particularly given that they have led to EFTPOS being a relatively expensive payment option for a significant number of cardholders despite it having relatively low costs.
  7. The designation of the EFTPOS and Visa Debit systems – and any consequent setting of standards to narrow the difference between the interchange fees in these two systems – could be expected to lead to a repricing of these products. As discussed above, there are a number of examples in which changes in interchange fees have affected the pricing of services by financial institutions to both merchants and cardholders. The Board expects that were the Bank to take action that led to a lowering of interchange fees, the same would apply in this case, with the average cost of EFTPOS transactions being lower than is now the case.
  8. Given the evidence, discussed above, that cardholders respond to changes in relative prices, the Board's opinion was that, were there to be a change in interchange arrangements, some substitution towards EFTPOS and away from the other forms of card based payments would take place. A consequence of this change would likely be a reduction in the overall cost of making card-based payments in Australia. It is important to note, however, that this is not an objective in itself. In the Board's framework, as discussed earlier, an efficient system is not necessarily one in which cardholders use the lowest cost payment method. Instead, an efficient outcome can be one in which the high cost method is used extensively, provided that those using this method are paying a price consistent with the method's high costs.
  9. In making the above judgements, the Board took account not only of current pricing arrangements, but also of how these arrangements are likely to evolve over the medium term. This reflects the Board's view that in assessing the efficiency of the system it is important to take a medium-term perspective – in particular, to take into account how the system is likely to evolve over coming years in response to the existing incentives facing cardholders and financial institutions. In the Board's judgement, a continuation of current interchange arrangements would mean that over time financial institutions would face pressure to increase their per transaction EFTPOS fees and/or to steer customers away from EFTPOS towards other forms of payment. This outcome would be harmful to the efficiency of the overall payment system.
  10. The Board also considered whether designation would promote competition in the market for payment services. On the basis of the evidence available to it outlined in paragraph 17, the Board was of the view that improvements in access to the EFTPOS system could be beneficial for competition in the payments system. The Bank continues to closely monitor work being undertaken by the Australian Payments Clearing Association to improve access arrangements. Designation provides the Bank with the option of considering whether to impose an access regime if that work were to falter.
  11. In addition to the analysis above, the Board considered a number of other issues.
  12. The first was the claim that a fall in interchange fees would result in reduced investment in the EFTPOS system, reducing its efficiency and security. In the Board's opinion this argument warranted little weight. A change in interchange fees may well affect who pays for any investment, but it is unlikely to lead to degradation in the system over time. As noted above, internationally, EFTPOS debit card systems operate successfully without interchange fees and with fees flowing from acquirers to issuers.
  13. The second was the claim that higher merchant service fees resulting from lower interchange fees would cause an increase in prices for goods and services. To the extent that cardholders substitute away from credit cards and Visa Debit cards to EFTPOS, merchants could actually face lower costs, even with higher merchant service costs for EFTPOS. Currently, the merchant service fee on a typical credit card payment is higher than the merchant service fee on an EFTPOS payment of the same value, and is likely to remain so. Any shift towards EFTPOS and away from credit cards will reduce the initial effect on merchants' costs. The Board considered that, in the event that overall merchants' costs increase as a result of lower EFTPOS interchange fees, this needs to be viewed in the context of the overall reform process. The earlier reforms to credit card interchange arrangements have seen a fall in merchants' costs by an amount considerably in excess of any likely increase in their costs of accepting EFTPOS.
  14. The third issue was the possibility that in the event that an interchange standard is determined, there may be less potential competition over interchange fees. The Board's view was that this argument had little weight. As discussed above, interchange fees are currently subject to very little competition and there has been little change in them for over a decade.
  15. A fourth issue was the claim that the credit card reform process has remedied any misalignment of costs and prices and that further changes are unnecessary. The reasoning set out above makes it clear that the Board does not share this view.
  16. A fifth issue was the suggestion that merchants who provide banking services, in particular cash distribution, should be rewarded for doing so. Such an argument is not relevant to whether an interchange fee is needed to balance issuers' and acquirers' costs and revenues. In any case, data published in the Reserve Bank Bulletin[16] show that: most cash dispensed by merchants is in conjunction with a purchase; that only 1.5 per cent of EFTPOS transactions are solely 'cash out' transactions; and that EFTPOS accounts for less than 6 per cent of the value of cash obtained by cardholders using electronic means.
  17. Finally, the Board took into account the findings, comments and implications of the decision by the ACT. In considering them, the Board was guided by papers written by Bank staff dated 11 August 2004 and 1 September 2004, as well as some data that were not available to the ACT because they were either protected under the Reserve Bank Act or collected after the ACT's decision. In particular, the Board noted a number of areas in which its views differed from those of the ACT including:

    • data collected from major banks after the ACT's decision showed that the proportion of EFTPOS transactions incurring fees was not insignificant (paragraph 23);
    • the available data on the costs of EFTPOS and credit card transactions indicated that credit card transactions are more costly than EFTPOS transactions because of differences in processing and fraud-related costs (paragraphs 30 to 36);
    • data collected since the Joint Study gave the Board confidence that the data from the Joint Study were sufficiently reliable to form the basis of a decision to designate (paragraphs 33 to 36);
    • overseas comparisons are valuable as they provide “experimental evidence” that is unavailable from domestic sources. Economic agencies involved in applied economics, including the Bank, place considerable weight on such comparisons (paragraphs 61 to 68);
    • the Board concluded that there is little effective competition in the setting of interchange fees in the Australian EFTPOS system (paragraphs 48 to 52);
    • a reduction in the interchange fee paid by issuers would be likely to lead to a reduction in the price faced by EFTPOS users and will reduce the incentive for financial institutions to encourage the use of alternative payment instruments. The Board concluded that a reduction is issuers' costs would be likely to be passed through to cardholders in some form (paragraphs 37 to 47);
    • the Board concluded that credit and debit cards are substitutes for many transactions (paragraphs 53 to 60); and
    • a shift by cardholders towards EFTPOS and away from credit cards will offset to some extent the rise in merchants' costs due to higher merchant service fees on EFTPOS transactions. To the extent that an increase in merchants' costs did occur it would be much smaller than the fall in merchants' costs that has already occurred as a result of lower interchange fees for credit cards (paragraph 81).
  1. Having regard to all of the above, the Board formed the opinion that, pursuant to Section 10B(3) of the Reserve Bank Act 1959 and Section 8 of the Payment Systems (Regulation) Act 1998, it considered it in the public interest that the EFTPOS payment system be designated as a payment system under Section 11 of the Payment Systems (Regulation) Act 1998.

Schedule A

References

Confidential monthly transaction card statistics provided by financial institutions, published in aggregate form in Reserve Bank of Australia Bulletin 1994–2003
Papers and presentations for the Payments System Board on card payment systems and other relevant topics August 1998–September 2004
Payments System Board Annual Reports 1999–2003
Committee on Payment and Settlement Systems, Retail payments in selected countries: a comparative study, Bank for International Settlements, Basel September 1999
Committee on Payment and Settlement Systems, Clearing and settlement arrangements for retail payments in selected countries, Bank for International Settlements, Basel September 2000
Australian Competition and Consumer Commission and Reserve Bank of Australia, Debit and credit card schemes in Australia: A study of interchange fees and access October 2000
Confidential submissions received in response to the Joint Study November 2000–November 2001
Confidential monthly retail payment statistics provided by individual financial institutions, published in aggregate form in Reserve Bank of Australia Bulletin 2001–August 2004
Reserve Bank of Australia, Reform of credit card schemes in Australia I A consultation document December 2001
Reserve Bank of Australia, Reform of credit card schemes in Australia II Commissioned report December 2001
Reserve Bank of Australia, Reform of credit card schemes in Australia III Submissions received, Volumes 1 and 2 December 2001
Submissions received in response to the Consultation Document January–August 2002
EFTPOS Industry Working Group, Discussion paper: Options for interchange fee reform July 2002
Reserve Bank of Australia, Reform of credit card schemes in Australia IV Final reforms and regulation impact statement August 2002
Responses listed on the Reserve Bank's website to 'EFTPOS Industry Working Group, Discussion paper: Options for interchange fee reform' by various parties September 2002
Evidence admitted in the proceedings Visa International Service Association v Reserve Bank of Australia N973 of 2002 and MasterCard International Incorporated v Reserve Bank of Australia N987 of 2002 (other than evidence admitted subject to confidentiality orders) and the decision of Tamberlin J. 2002–2003
Various confidential Memoranda of the Australian Payments Clearing Association - Board, MC3, EFTPOS Access Working Group, Fraud Committee 2002–2004
EFTPOS Industry Working Group, Application for authorisation to reduce EFTPOS interchange fees to zero 21 February 2003
Submissions to the ACCC in response to application to set interchange fees to zero March–July 2003
Australian Competition and Consumer Commission, Draft determination in respect of Applications for authorisation Nos A30224 and A30225 in relation to EFTPOS interchange fees 8 August 2003
Submissions to the ACCC in response to the draft determination, including the pre-decision conference August–December 2003
Australian Competition and Consumer Commission, Determination in respect of Applications for authorisation Nos A30224 and A30225 in relation to EFTPOS interchange fees 11 December 2003
Responses, both written and oral, to letter of 19 December 2003 calling for views on the designation of Visa Debit January–February 2004
Responses, written and oral, to letter of 23 December 2003 calling for views on the designation of EFTPOS January–February 2004
Submission by the Reserve Bank of Australia to the Australian Competition Tribunal April 2004
Submissions of parties, and evidence admitted in proceedings before the Australian Competition Tribunal (other than confidential information that the Bank was not entitled to use) April 2004
Australian Competition Tribunal re EFTPOS Interchange Fees Agreement [2004] ACompT 7 25 May 2004
Reserve Bank of Australia Media Release, Reform of card payment systems (Possible designation of the EFTPOS system) 11 June 2004
Submissions, both formal and informal, to the Reserve Bank on designation of the EFTPOS payment system July–August 2004
Confidential data provided by ANZ, Commonwealth Bank, National Australia Bank, St George Bank and Westpac on EFTPOS transactions attracting fees July–August 2004
How Australians Withdraw Cash’, Reserve Bank of Australia Bulletin July 2004
Confidential quarterly data on merchant service fees for credit and debit cards provided by ANZ, CBA, NAB, St George, Westpac, American Express and Diners Club, 2003 - August 2004, published in aggregate form in 'Merchant service fees for credit cards', Reserve Bank of Australia Bulletin July 2004
Confidential bilateral interchange agreements between participants in the EFTPOS payment system August 2004
Confidential information provided in consultations and subsequent to those consultations August 2004
Consultations with interested parties on designation of the EFTPOS payment system August 2004
Data on payments systems in other countries from the Bank for International Settlements and country sources. Various years
Reports, working papers and media articles on relevant experience in payment systems in other countries Various years
Relevant academic articles on payment systems Various years
Information from various bank websites on product offerings Various years
Data from Bankchoice and Cannex on product offerings by financial institutions Various years

Footnotes

See card scheme websites and ‘Merchant Service Fees for Credit Cards’, Reserve Bank of Australia Bulletin, July 2004. [1]

Australian Payments Clearing Association, Annual Report, 2004. [2]

Banking Fees in Australia’, Reserve Bank of Australia Bulletin, May 2004. [3]

The changing Australian retail payments landscape’, Reserve Bank of Australia Bulletin, July 2003. [4]

Reform of Credit Card Schemes in Australia IV: Final Reforms and Regulation Impact Statement, Reserve Bank of Australia, Sydney, 2002 and ‘ Merchant Service Fees for Credit Cards’, Reserve Bank of Australia Bulletin, July 2004. [5]

‘Submission to the RBA re EFTPOS designation’, Australian Merchant Payments Forum, 9 July 2004, p12. [6]

Gizycki, M and Lowe, P (2000), ‘The Australian Financial System in the 1990s’ in The Australian Economy in the 1990s, Reserve Bank of Australia. [7]

'The rise and rise of debit', Electronic Payments International, July 2004. [8]

Australian Retailers Association, Submissions to the Reserve Bank of Australia, 2001 reprinted in Reserve Bank of Australia Reform of Credit Card Schemes in Australia III: Submissions Received, Pages H1 and H2. [9]

See Avoid EFTPOS fees with St. George <https://www.stgeorge.com.au/media/news/archive.asp?id=11> [10]

Nilson Report, No 809, April 2004. [11]

Bank for International Settlements (2003), Payment and settlement systems in selected countries, Basel, and EFTPOS Industry Working Group (2002), Discussion Paper: Options for EFTPOS interchange reform, July. [12]

Bolt, W (2003), Retail payments in the Netherlands: Some facts and some theory, Research Memorandum WO no. 772, De Nederlandsche Bank, p. 17. [13]

For example, Scotia Bank, one of the large Canadian banks, offers an account with 50 ‘fee-free’ transactions for $5.50 per month. [14]

See paragraphs 67 to 82 of the Reserve Bank's submission to the Australian Competition Tribunal, April 2004. [15]

How Australians Withdraw Cash’, Reserve Bank of Australia Bulletin, July 2004. [16]