RDP 2009-04: Price Incentives and Consumer Payment Behaviour 2. The Australian Payments Landscape

The main payment instruments available to Australian consumers are similar to those in other industrialised countries.[1] One unusual feature of Australian payment patterns until quite recently, however, has been the strong growth in credit card use, relative to debit card use (Figure 2).[2]

Figure 2: Card Payments per Capita

One factor that is likely to have contributed to this trend in Australia was the pricing structure of the credit card and domestic debit card (EFTPOS) systems which differs somewhat from many other countries. For many Australian consumers, the effective price of using a credit card to make payments was less than that of using EFTPOS.[3] For example, at the time of the Reserve Bank's initial investigation of credit and debit card systems in 2000, an EFTPOS transaction often incurred a cost of around $0.50 once a certain number of fee-free transactions had been made each month. In contrast, some consumers were effectively paid to use their credit card via the interest-free period and loyalty program rewards. These loyalty program rewards were quite generous; an average expenditure of around $12,400 earnt a $100 shopping voucher in June 2003.[4] Hence, combined with an interest-free period (typically up to 55 days), the effective price for a $100 credit card transaction for a transactor with a loyalty program, prior to the reforms, was around −$1.30.[5],[6] Average annual fees, which can also have some influence on a consumer's choice of holding and, hence, use of a particular payment instrument, were $61 on a standard rewards card and $98 on a gold rewards card in June 2002.[7]

One important factor affecting the pricing of these two systems is interchange fees – the fees paid between the merchant's and cardholder's financial institutions (the issuers) each time a transaction is made. In Australia, the average interchange fee in the credit card system has been, and continues to be, substantially higher than the interchange fee in the EFTPOS system. Prior to the reforms, the average interchange fee in the MasterCard and Visa credit card schemes was around 0.95 per cent of the transaction value (paid to the issuer). Similar interchange fees also applied for the Visa Debit system (the only scheme debit system then in operation).[8] In contrast to most other countries, in Australia the interchange fee in the EFTPOS system flows in the opposite direction – from the cardholder's financial institution to the merchant's financial institution – and was around $0.20 per transaction prior to the reforms. Not surprisingly, this structure of fees provided little incentive for issuers to promote or price the domestic EFTPOS system attractively to cardholders.

The Reserve Bank was concerned that the relative levels of interchange fees between credit and debit cards was not contributing to an efficient payments system. Some particular concerns were that the relative prices to cardholders for card payments did not generally reflect relative costs and interchange fees were not subject to the normal forces of competition. In addition, price signals to cardholders were distorted by credit card schemes imposing rules that did not allow merchants to surcharge at the point of sale. Hence, based on its legislative mandate to promote efficiency and competition in the payments system, the Reserve Bank's Payments System Board introduced a number of reforms to debit and credit card arrangements, beginning from the start of 2003. These included setting interchange fee benchmarks for the credit card, debit card and EFTPOS systems, and removing scheme rules that prevented merchants from surcharging.[9] Figure 3 shows the extent to which the reforms have lowered interchange fees in the respective systems, as well as narrowed the difference in fees between the systems.

Figure 3: Interchange Fees on a $100 Payment

These reforms have contributed to changes in effective prices facing card users. For credit cards, the reforms have had a number of effects, including: a reduction in the generosity of loyalty program rewards, with an average spend of $16,700 now required to obtain a $100 shopping voucher compared with $12,400 in 2003; an increase in average annual fees of around 40 per cent to be currently $85 for a standard rewards card and $140 for a gold rewards card; and a gradual increase in the prevalence of surcharging at the point of sale.[10] In addition, the reforms have also contributed to changes in the types of credit card products offered. With issuers receiving lower interchange-fee revenue, competition has partly focused on interest rates, rather than reward programs, and has led to a proliferation in the number of low-rate cards. These low-rate cards generally do not offer reward points but have both an interest-free period and lower annual fees than do the higher interest rate cards. For the EFTPOS system, the opposite has occurred, with most financial institutions now offering unlimited fee-free transactions for a small fixed monthly account-keeping fee.

Figure 4 shows growth in credit and debit card payments during this period of significant payments system change. Although some slowing in credit card payment growth was inevitable from the rapid pace experienced over the late 1990s, what is interesting is that there appears to have been a shift in the relative growth in the two card payment instruments. Further, this shift appears to have coincided with the shift in relative prices resulting from the reforms. This issue is explored in further detail later in the paper, using transaction-level data.

Figure 4: Number of Card Payments


Further details on these payment instruments and their uses can be found in Emery, West and Massey (2008). [1]

Unless otherwise separately identified, in this paper credit cards include credit/charge cards from the MasterCard, Visa, American Express and Diners Club schemes, and debit cards include cards from the domestic EFTPOS system and the MasterCard and Visa debit schemes. [2]

RBA and Australian Competition and Consumer Commission (2000). [3]

See RBA (2008b) for further details of reward program benefits to cardholders. These are the earliest data available and are sourced from bank websites for the following cards: ANZ Telstra Rewards Visa card; Commonwealth Bank MasterCard Awards card; National Australia Bank Visa Gold card; and Westpac Altitude MasterCard. [4]

RBA (2008c). The effective, or marginal, price takes into account the interest-free period and the value of loyalty program rewards. The annual fee is not accounted for in this calculation. [5]

A transactor is a credit card holder who pays their bill in full each month and, thus, has access to an interest-free period. In contrast, a revolver is a credit card holder who uses the credit facility of a credit card and incurs an interest charge for each transaction made on the credit card. Revolvers likely faced a positive price for using their credit card because of interest charges. [6]

Averages for credit cards with an interest-free period issued by major banks. RBA (2008a) provides additional detail. [7]

MasterCard's debit product was not launched in Australia until November 2005. [8]

See RBA (2008c) for a detailed discussion of the reforms. [9]

RBA (2008b) and RBA (2009). [10]