Payments System Board Annual Report – 2005 Debit Cards

During the year, the Bank released three draft standards applying to the debit card systems operating in Australia, and imposed an access regime on the Visa Debit system. As with the credit card reforms, the proposed standards and the access regime are aimed at promoting both more appropriate price signals and competition in the Australian payments system.

Improving Price Signals

As discussed in the introductory chapter, for many people the effective per-transaction price of using the EFTPOS system is higher than that for using either the credit card system or the Visa Debit system. In large part, this reflects the interchange fees in these systems. In the EFTPOS system, these fees are paid by the cardholder's bank to the merchant's bank. In contrast, a transaction on the same deposit account, but routed through the Visa Debit system, results in a payment by the merchant's bank to the cardholder's bank. The same is true for credit card transactions.

The result of these fees is that the net cost to issuers of an EFTPOS transaction is higher than that for a Visa Debit transaction, even though the funds may have been drawn from the same deposit account. For an EFTPOS transaction, the issuer bears its own resource costs plus an average interchange fee of around 20 cents paid to the merchant's bank. In the case of Visa Debit, the issuer bears its own resource costs but receives a payment, equivalent on average, to around 0.55 per cent of the transaction value. This difference in fees can make it more attractive to financial institutions to issue and promote Visa Debit cards rather than EFTPOS cards. Those institutions that currently offer both products typically offer more attractive pricing to cardholders for Visa Debit transactions than for EFTPOS transactions, and they also encourage cardholders to push the ‘credit' button at the point of sale (and so route the transaction through the Visa Debit system) rather than press the ‘cheque’ or ‘savings’ button (and thus route the transaction through the EFTPOS system).

While currently only a relatively limited number of financial institutions issue Visa Debit cards, the Board has been concerned that, should regulatory certainty be given to the current arrangements, the Visa Debit system could grow considerably at the expense of the EFTPOS system. The experience in the United States is consistent with this concern. There, higher interchange fees and the honour all cards rule have enabled Visa Debit and the similar MasterCard product to significantly increase their market shares at the expense of alternative PIN-based debit products (similar to the Australian EFTPOS system). A significant spur to this was the higher revenue banks could earn by issuing scheme-based debit cards over other debit cards. Eventually, the PIN-based networks were forced to increase their interchange fees to counter the loss of market share to the scheme-based systems with higher interchange fees (Graph 5). The net result was that these higher interchange fees were passed on to merchants accepting the cards. If the same outcome were to occur in Australia, merchants' total costs of accepting debit cards would be considerably higher than is now the case.

The Bank has also been concerned that the interchange fee on Visa Debit transactions is the same as that on Visa credit transactions. It sees no justification for this, given that issuers of Visa Debit cards do not offer cardholders interest-free credit.

Designation of EFTPOS and Visa Debit

The process of improving price signals in the EFTPOS and Visa Debit systems has been protracted. Following the publication of the Joint Study in 2000, the Bank pursued voluntary reform of the Visa Debit system with Visa and the institutions that issue the cards. Much of the discussion took place between Visa and the Bank, with Visa making a number of submissions on voluntary reforms it was prepared to implement and putting arguments in defence of its existing arrangements. Although some progress was made, discussions were complicated by the fact that issuing institutions could not discuss what would amount to the collective setting of interchange fees and the discussions were not transparent. Furthermore, there remained a number of areas where the Bank and Visa could not reach agreement. The Bank ultimately reached the conclusion that designation of the Visa Debit system was in the public interest. This decision was influenced, in part, by the fact that designation would allow for transparent and broadly based consultation on possible reforms – a situation that had been difficult to achieve previously. In February 2004, the Bank designated the Visa Debit system.

Similarly, the Bank had encouraged the industry to examine options for reform of EFTPOS interchange fees. An industry group was set up in 2002 and developed a proposal to set these fees to zero. This proposal was put to the Australian Competition and Consumer Commission (ACCC) for authorisation in February 2003, and the ACCC authorised the application in December 2003. This decision was, however, overturned by the Australian Competition Tribunal (ACT) in May 2004 after an appeal by a number of merchants.

Following the ACT's decision, the Bank invited submissions from interested parties on whether it would be in the public interest for it to designate the EFTPOS payment system under the Payment Systems (Regulation) Act 1998. Following that process, the Board concluded that designation was in the public interest, and on 9 September 2004 the Bank designated the EFTPOS system. A group of retailers then challenged the legality of the designation decision, with the case being heard in the Federal Court during May and June 2005. At the time of writing, a decision was pending.

Draft standards for EFTPOS and Visa Debit

The Board has been of the view that the reform process should not stop completely while legal challenges were being decided. Accordingly, it released a consultation document in February 2005, setting out draft standards that would constrain interchange fees in the EFTPOS and Visa Debit systems. In releasing this document, however, the Board indicated that it would not finalise any standards before the outcome of the court case was known and would consult further if the court's decision warranted doing so.

The draft standards recognise that establishing a consistent and rational set of interchange fees is complicated by two factors. The first is the starting point – interchange fees that flow in opposite directions in the EFTPOS and Visa Debit systems. The second is that substantive businesses have been built around now longstanding interchange revenue flows and that changing their direction could be very disruptive. Accordingly, as a step towards more consistent and rational interchange fees in these systems, the draft standards propose moving interchange fees closer together, while leaving their directions of flow unchanged.

The proposed standard for EFTPOS interchange fees would limit these fees on the basis of eligible costs incurred by specified acquirers. These eligible costs are limited to the processing and switching costs of acquirers. The standard requires EFTPOS acquirers accounting for 90 per cent of EFTPOS transactions to provide the Bank with data on these costs, and proposes that the costs of the three most efficient acquirers be used to calculate the cap. Provided the interchange fee remains below the cap, individual issuers and acquirers would be free to negotiate bilaterally the interchange fee they pay or receive – just as they may do now. Based on data currently available to the Bank, this would be likely to result in an initial cap on interchange fees paid by an issuer to an acquirer of around five cents per transaction.

The proposed standard for Visa Debit interchange fees would limit these fees based on eligible costs of nominated issuers in the Visa system. The draft methodology proposes that the cap be based on the issuers' costs of processing and authorising transactions. It also proposed that there be a flat fee rather than an ad valorem fee (as is currently the case), reflecting the fact that the costs of processing and authorising debit card transactions are unrelated to the size of the transaction. Unlike the credit card interchange fee standard, the list of eligible costs does not include fraud costs or the cost of funding the interest-free period.

The draft methodology also proposes calculating the benchmark fee for Visa Debit using data collected for the calculation of the credit card benchmark fee, rather than conducting another survey to collect data on the costs of current issuers of Visa Debit cards. This approach would place less burden on issuers of Visa Debit cards and recognises that future issuers of Visa Debit cards may have different costs than the mostly small institutions that currently issue these cards. Based on data currently available to the Bank, the proposed methodology would result in a cap on interchange fees for Visa Debit of around 15 cents per transaction paid by an acquirer to an issuer.

Taken together, the draft standards would narrow the current differential in the interchange fees in the two systems on a transaction of average size from 60 cents to around 20 cents (Table 4).

Submissions on the draft standards were invited by 29 April 2005. The Bank received 14 submissions by 29 April; a further 4 submissions have been received since then. The Bank has held consultations with those making submissions who wished to do so and is currently considering the submissions.


The Bank has also worked to increase competition in the EFTPOS and Visa Debit systems by making it easier for new issuers and acquirers to enter the market, and by removing restrictions imposed on merchants by the schemes.

Access to EFTPOS

Access to the EFTPOS system is complicated by the need for a new entrant who wishes to establish direct connections to bilaterally negotiate connections with other direct connectors. Under current arrangements there is no obligation on existing participants to connect to new entrants, and even if existing participants agree to connect, there is no standard time frame or charge for doing so. The Bank has been of the view for some time that these arrangements are unsatisfactory and that changes to access provisions are required to promote competition in the system. As with other aspects of the reform process, the Bank has had a preference for industry to develop more appropriate arrangements, rather than to have a regulatory solution imposed.

The industry has been working on developing an access code since 2003, when the ACCC approved the proposal to set interchange fees in the EFTPOS system at zero, conditional on improved access arrangements being put in place. This work has been undertaken by major participants in the EFTPOS system and co-ordinated by APCA. In January 2005, a draft EFTPOS access code was distributed by APCA to its members, including the Bank. The Bank then indicated that the code was unsatisfactory in a number of respects. Subsequently, the code has been amended and is now broadly acceptable to the Bank. When implemented, it will give certainty to new entrants regarding both the cost and timing of accessing the EFTPOS system.

Access to Visa Debit

There has also been a need to address technical aspects of access to the Visa Debit system. Prior to the creation of SCCIs and the Bank's access regime for the credit card schemes coming into force, Visa's rules had the effect of limiting membership in Australia to those institutions that were authorised by APRA to accept demand deposits. The Bank's credit card access regime had the effect of overriding these rules in Australia, allowing SCCIs to join the Visa system.

At the time this access regime was being developed, the Bank expected that an SCCI joining the Visa credit card system with the intention of acquiring credit card transactions would also be able to acquire Visa Debit transactions. Visa indicated, however, that since the access regime strictly applies only to the credit card system, its own rules may still preclude an SCCI from acquiring debit card transactions given that an SCCI cannot accept deposits.

The Bank formed the opinion that the current arrangements in the Visa Debit system were not in the public interest. If an SCCI is not able to acquire both Visa credit and debit card transactions, it may find it difficult to provide commercially competitive acquiring services. To rectify this situation the Bank proposed imposing an access regime on the Visa Debit system that was practically identical to the one already applying to the Visa credit card system. This proposal was released for public comment in July 2005. The Bank received three submissions, including one from Visa which supported the access regime. After considering the submissions, the Bank imposed the Access Regime in August 2005.

Removing restrictions on merchants

The Bank has also sought the removal of restrictions on merchants that limit competition and impair the efficiency of the payments system. While the Bank is not aware of any such restrictions in the EFTPOS system, such restrictions still exist in the Visa Debit system. In particular, merchants are not permitted to impose a surcharge on a cardholder who uses a Visa Debit card (the no surcharge rule) and must accept all Visa branded cards if they accept Visa credit cards (the honour all cards rule).

As part of the credit card reform process, the Bank required the credit card schemes to remove the no surcharge rule applying to credit card transactions. The Bank has now proposed a standard that would require that this restriction also be removed for Visa Debit transactions. As with the other reforms to the Visa Debit and EFTPOS systems, a final decision will not be made until after the outcome of the current case in the Federal Court is known.

The second restriction – the honour all cards rule – has two relevant aspects. The first is that it requires merchants to accept Visa cards regardless of which bank or financial institution issued the card. This might be best thought of as an ‘honour all issuers’ rule. The second is that it requires merchants to accept all products issued under the Visa brand. This might be best thought of as an ‘honour all products’ rule.

The Bank accepts that the honour all issuers aspect of the rule is in the public interest. By insisting that merchants who accept Visa credit cards accept Visa-branded credit cards regardless of the issuer, the value of the network to cardholders and issuers is maximised. If merchants were allowed to selectively refuse cards issued by particular institutions, this could generate a need for bilateral negotiation between issuers and acquirers and, potentially, merchants. This would raise the costs of participating in the system and generally impair efficiency. Cardholders could also be directly disadvantaged by not knowing whether cards issued by their financial institution would be accepted at any given merchant.

In contrast to the honour all issuers aspect of the rule, the Bank has formed the preliminary view that the honour all products aspect is not in the public interest. Accordingly, in February 2005 it released a draft standard which would have the effect of requiring the removal of this rule.

Those industry participants who support the rule have advanced two main arguments. The first is that it can provide a cost-effective way for the schemes to offer multiple card products and the second is that it encourages the development of new products by ensuring a ready-made acceptance network. In contrast, merchants, who oppose the rule, have indicated to the Bank that they would rather not accept the Visa Debit card on its current terms, yet they are forced to accept it as a condition of accepting Visa credit cards. A consequence of the forced acceptance is that competitive forces cannot bear independently upon the price of, or acceptance of, the product. In particular, merchants currently pay the same fees for transactions using Visa Debit cards as they do for Visa credit cards. This is despite Visa Debit not offering interest-free credit to the cardholder.

In the Bank's view, the tying of Visa credit and debit cards has diminished normal competitive forces, and distorted the competitive positions of the Visa Debit and EFTPOS systems. For domestic point-of-sale transactions, which represent the largest segment of card-based transactions, the Visa Debit and EFTPOS system are interchangeable – all that is required is the pressing of a different button at the terminal. Visa Debit, however, has a competitive advantage over EFTPOS because merchants are forced to accept the card when they make the decision to accept Visa credit cards and the interchange fee arrangements mean that issuers have an incentive to issue and promote Visa Debit over EFTPOS. In the Bank's view, the efficiency of the overall Australian payments system is likely to be enhanced if cardholders and merchants are in a position to evaluate freely the benefits provided by Visa Debit against the costs and make acceptance decisions based upon that evaluation. The honour all products rule significantly restricts this possibility.