Review of Card Payments Regulation 2. Introduction

This document represents the Board's conclusions and includes final standards that have been registered on the Federal Register of Legislation concurrent with publication of this document. This chapter outlines the background and process for the Review, in the context of the Board's mandate and competition and efficiency considerations. Chapters 3, 4 and 5 cover the key issues for the Review: efficiency issues related to interchange fees and the transparency of card payments; competitive neutrality of card payments regulation; and excessive surcharging. Each chapter describes the key issues, stakeholders' views, the Boards's assessment and any significant changes to the regulatory framework. Chapter 6 describes the final standards in more detail and highlights the main changes relative to the draft standards that were released for consultation in December 2015.

2.1 Background to the Review

Following the Wallis Inquiry in 1997, the Bank was assigned a number of responsibilities and powers in relation to the payments system and the Board was established to oversee this mandate.[3] The Board is required to exercise its responsibilities in a way that promotes a safe, efficient and competitive payments system (section 2.3).

In the early 2000s, the Bank began implementing a series of reforms to card payments regulation. These reforms included measures that changed the relative prices cardholders faced when using debit and credit cards, reducing the incentives to use higher-cost payment methods. The Bank's reforms also required changes to certain restrictive rules in card systems, including to allow merchants to apply surcharges on card transactions so that cardholders were more likely to face prices that reflected the cost of the card they were using. The Bank also took steps that reduced the barriers to entry for entities wishing to issue cards or provide card payment services to merchants.

In 2007–08, the Board conducted a review of the Bank's reforms. The review concluded that the reforms had improved access, increased transparency and had led to more appropriate price signals to consumers. This review also explored a number of options for possible changes to the regulatory framework, including stepping back from formal regulation and relying on industry undertakings. However, the industry was unable to arrive at suitable undertakings, so in August 2009 the Board decided against stepping back from interchange regulation and noted that the regulatory framework would remain under review.

The first major review of the financial system since the Wallis Inquiry was announced by the Government in 2013. The Final Report of the Financial System Inquiry (FSI), released in December 2014, endorsed the reforms undertaken by the Board since it was established.[4] It also recommended that the Bank further consider elements of card payments regulation, particularly in relation to interchange fees and surcharging. The Bank had also raised concerns about aspects of the interchange fee system and merchant surcharging practices in its submission to the FSI, including a decline in transparency for some end users, perceptions of excessive surcharging in some industries, and questions around whether existing regulation was fully competitively neutral.

2.2 The Review process

The Bank's Review of Card Payments Regulation commenced in March 2015 with the publication of an Issues Paper that sought the views of stakeholders and interested parties on the regulatory framework, including on issues that the Bank had raised in its March 2014 submission to the FSI (RBA 2014) and on issues that the FSI had identified in its Interim and Final Reports (see Box A). The Bank received over 40 written submissions in response to the Paper and also considered submissions on card payments regulation to the FSI. Some submissions raised issues that had not been canvassed in the Issues Paper, particularly with regard to the coverage of interchange caps. Consultations were conducted both individually, and collectively, when the Bank hosted a roundtable discussion that brought together stakeholders from the payments industry, end users of payments services and government.

In August 2015, the Board asked Bank staff to liaise with industry participants on the possible designation of the bank-issued American Express companion card system, the Debit MasterCard system and the eftpos, MasterCard and Visa prepaid card systems. The Bank determined that it would be in the public interest to designate these systems and, following a resolution of the Board, did so in October. The designation of a system is the first of a number of steps that the Bank must take to exercise any of its powers, such as imposing an access regime or setting standards.

The Bank released draft standards for card payments regulation for public consultation on 3 December 2015. Over 40 organisations and individuals made written submissions; the majority of these were published on the Bank's website, while some were submitted in confidence. The Bank also received a significant number of emails on surcharging and on interchange as part of two coordinated campaigns on these issues. The Bank conducted around 50 consultation meetings with interested parties, including a range of stakeholders that had not provided written submissions, as well as those that did.

The release of the Bank's draft standards coincided with the Government introducing legislation to ban excessive surcharges on card payments, which was subsequently passed by Parliament on 22 February 2016 (see Box B). Under the new law, the ACCC will enforce a ban on excessive surcharging and will, in the case of card payments, rely on the Bank's surcharging standard to determine the level of surcharge that is permitted. The Bank has been working closely with Treasury and the ACCC to ensure that the surcharging regime is as clear as possible for the industry, merchants, consumers and regulators.

The conclusions presented in this document address most of the matters raised in the Bank's March 2015 Issues Paper. One matter not specifically addressed is issues arising with respect to competing payment options on a single device – this includes both issues that have arisen in the case of dual-network debit cards and those that may arise in the case of electronic wallets. Newer form factors, such as electronic wallets, potentially allow a consumer to access a wider range of different cards (or other means of payment) for a given transaction than in the past. This gives rise to a number of regulatory issues, including the possibility that technology, telecommunications or payment providers may seek to restrict the choice of options available to end users and financial institutions. Innovations in the payment process, such as tokenisation, might also be used in ways that restrict competition, for example, where a network requires that a transaction be processed via a particular tokenisation service. The Review has not focused on policy responses in this area given that they are largely separate from the main public-interest issues addressed here and involve some complex issues arising from developments in technology. The Bank will, however, continue to monitor developments in this area and will consider the appropriate response where significant issues arise.

2.3 The Payments System Board's mandate

The responsibilities of the Payments System Board of the Reserve Bank are set out in the Reserve Bank Act 1959, which requires the Board to determine the Bank's payments system policy so as to best contribute to: controlling risk in the financial system; promoting the efficiency of the payments system; and promoting competition in the market for payment services, consistent with the overall stability of the financial system.

The most relevant powers for the current review are those provided to the Reserve Bank under the Payment Systems (Regulation) Act 1998 (the PSRA). Under the PSRA, the Bank has the power to designate payment systems, and to set standards and access regimes in designated systems. The PSRA also sets out the matters that the Bank must take into account when using these powers.

Under section 18 of the PSRA, the Reserve Bank may impose standards to be complied with by participants in a designated payment system if it considers it to be in the public interest. Section 8 states that in determining whether a particular action is in the public interest, the Bank is to have regard to the desirability of payment systems:

  1. being (in its opinion):
    1. financially safe to 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 Bank may have regard to other matters that it considers are relevant, but is not required to do so.

2.4 Competition and efficiency in the cards market

This Review has focused on a number of quite different elements of the payments card market in Australia, including: interchange fee levels and regulatory compliance methodologies; the treatment of bank-issued American Express companion cards; transparency of card acceptance costs to merchants; and allowable card surcharges. While quite different in nature, these areas relate in one way or another to the Bank's mandate for competition and efficiency in the payments system.

Consistent with the Bank's earlier analysis, a number of principles underlie the approach taken to the promotion of competition and efficiency in this paper:

  • Accurate price signals promote the efficient use of the payments system and the efficient allocation of resources. Distortions to price signals may lead to overuse of some payment methods.
  • Relative prices that do not reflect the relative resource costs of different payment systems (i.e. the relative costs to society) are likely to lead to a higher-cost payments system overall.
  • In the absence of market failures, effective competition could be relied upon to provide efficient outcomes. Where market failures exist, regulatory options may be appropriate.
  • Transparency measures should be preferred to more intrusive regulatory measures where there is confidence that they can be applied effectively.
  • Any regulatory intervention should seek to be enforceable, while minimising compliance costs and seeking to be competitively neutral for functionally equivalent systems.

While the Bank's mandate does not include equity considerations, to the extent that improved equity can be achieved through policies that improve competition and efficiency in the payments system, the Bank will seek to do so in the public interest.

Much of the Bank's intervention in the cards market is based on an assessment that there is a market failure that prevents competition from working effectively in this market. In fact, competition between card schemes acts to push prices up, rather than down.

Cards markets are two-sided markets whereby both merchants and cardholders must have an incentive to participate for a system to be successful. However, in a mature cards market like Australia's, many merchants feel they have little choice but to accept a range of cards with little regard to cost, otherwise they will lose business to a competitor. This allows competition between card schemes to focus on the ‘issuing side’ of the market – that is, competition seeks to influence card issuance by financial institutions, cardholding by individuals and businesses, and the choice of payment method made by the cardholder when making a purchase. Incentives in the system therefore flow towards issuers, in turn funding rewards and interest-free periods for personal cardholders, and reconciliation and expenditure management services for commercial cardholders. Because many merchants feel obliged to accept cards and are relatively insensitive to price, the cost of cardholder benefits can be readily passed through to merchants. Interchange fees (paid from the merchant's bank to the issuer's bank) are central to this incentive framework, placing a floor under the fees that a merchant is charged and supporting the benefits to issuers and cardholders.

The framework put forward in this paper is founded in the Board's earlier decisions to constrain interchange fees through regulation in order to reduce the distorted price signals provided by interchange fees that differed from system to system. It proposes to limit the very high interchange fees that have emerged for some transactions within the existing framework and modestly reduces interchange fee levels overall through a revised compliance framework and a lower debit card benchmark. It also seeks to apply a comparable framework to two products – prepaid cards and American Express companion cards (where a fee similar in form and effect to an interchange fee is paid from American Express to the issuing bank) – that are functionally similar to other, currently regulated products. This will reduce the capacity of interchange fees and interchange-like fees to influence the payment choices of cardholders. The framework also recognises that the economic effect of interchange fees can be replicated through other payments that do not take the exact form of interchange fees and therefore seeks to bring these within regulation.

As noted, approaches that can achieve regulatory objectives through transparency rather than more direct regulation are generally preferred. The principal tool for transparency in card markets is card surcharging. Notionally, concerns about distortions to price signals arising from interchange fees would be reduced if all merchants were to surcharge in a way that accurately reflected the difference in acceptance costs for different methods. Cardholders would make payment choices based on the relative attributes of those methods, rather than in response to interchange fee effects. However, in practice many merchants do not surcharge, either because they feel unable to as their competitors do not, or because they simply do not understand their payment costs. Where they do surcharge, the differentiation between different card products is often limited. In some other cases, particularly where there is an expectation that payments will be made by card, merchants may have an incentive to surcharge more than their acceptance costs so as to keep their advertised prices lower.

These patterns mean that the Bank has little choice but to rely on direct regulation of interchange fees in order to promote an efficient card payments market. Nonetheless, the Bank's view is that surcharging continues to improve payment choices and is targeting measures in this Review to improve the effectiveness of surcharging. Together with the Government's complementary reforms with a consumer protection focus and new enforcement powers for the ACCC, the Bank's new standard is aimed at preventing excessive surcharging and providing merchants with more easily understandable information on their card acceptance costs.

2.5 The effects of the Bank's previous reforms

The decisions taken in this Review have been influenced by the experience since the initial round of reforms in the early 2000s. More than a decade on, the Bank's view remains that the reforms have been in the public interest; they have contributed to a more efficient and competitive payments system. In some cases it is difficult to precisely quantify the effects of the earlier reforms but there is clear evidence of some very positive trends in the payments system over the period of the Bank's reforms.[5]

The reforms improved access to the cards system, increased transparency and led to more appropriate price signals to consumers. Significantly, the reforms to interchange fees and various measures to strengthen the rights of merchants have combined to place downward pressure on the cost of payment services to merchants. Average merchant service fees for MasterCard and Visa transactions have fallen by 68 basis points relative to their levels prior to the reforms (Graph 1).

Graph 1
Merchant Service Fees
Per cent of transaction values acquired
Graph 1: Merchant Service Fees

Source: RBA

The cost savings have been significant – for example, merchants' payments costs are estimated to have been reduced by $15 billion relative to the amount they would have paid since 2004 if merchant service fees had remained at pre-reform levels.[6] To the extent that interchange fees might have risen significantly in the absence of the Bank's reforms, any estimate of these savings to merchants would be far higher. Indeed, if average merchant service fees on card payments in Australia had instead risen to the levels seen in the absence of interchange regulation in the United States, annual costs to Australian merchants would now be around $5 billion higher than current levels.[7] Just as other types of input costs feed through to final prices faced by consumers, the reduction in payment costs resulting from Australia's reforms will have fed through into lower prices for all consumers, regardless of what payment method they use.

Looking at payment costs more broadly – and including other payment methods in addition to cards – data on aggregate resource costs incurred in producing payments suggest Australia has benefited from a more efficient, lower cost payments system. The results of the Bank's two comprehensive cost studies indicate that the aggregate resource costs incurred by financial institutions and merchants in accepting consumer payments have fallen from 0.8 per cent of GDP in 2006 to 0.54 per cent of GDP in 2013.[8] Based on the most recent estimate, it appears that Australia now has a relatively low cost payments system by international standards.

These falls in the cost of payments in Australia have not, however, been associated with any decline in the quality of services offered to end users. The absolute and relative use of debit and credit/charge cards in Australia has continued to increase strongly (Graph 2). The value of card transactions has grown at an average annual rate of 8.7 per cent since 2002, which is above the average annual growth of around 6 per cent in household consumption over this period. The dire predictions of some observers for the future of the cards market at time of the initial reforms have not come to pass. Participants in the cards market have continued to innovate, with the implementation of EMV chip cards, the introduction of contactless payments, and mobile payment technology. In particular, the adoption of contactless payments in Australia has been among the highest in the world.

Graph 2
Non-cash Payments per Capita*
Year to date
Graph 2: Merchant Service Fees

* A series break occured in January 2004; prior to 2004 debit cash-outs were included in the number of debit card payments, and credit card cash advances were included in the number of credit card payments



See Financial System Inquiry (1997). [3]

See Financial System Inquiry (2014). [4]

A more detailed analysis of developments in the cards market is provided in the Issues Paper (RBA 2015a). [5]

This estimate is based on data for schemes' average merchant service fees with an assumption about the evolution of schemes' market shares over this period. Similar estimates are obtained if it is assumed that market shares were the same as actually occurred, or if it is assumed that schemes' market shares remained at their starting levels. [6]

The calculation takes the number and value of card transactions acquired in Australia and applies US merchant service fees. The US merchant service fee data are from The Nilson Report (2015) for the latest available year (2014) except in the case of debit cards, where pre-Durbin Amendment merchant service fees (2010) are assumed (The Nilson Report 2011). The implied average of merchant service fees for the United States is 1.7 per cent, compared with the actual average for Australia of 0.72 per cent. [7]

See Schwartz et al (2008) and Stewart et al (2014). [8]