How Australia could be the first country to abolish interchange
The Australian government is evaluating a set of proposals to radically reform its payments industry, including abolishing interchange and opening up access for new entrants to core infrastructure.
Separately, Australia’s competition watchdog is investigating whether FX fees charged for overseas transactions should be reduced. Concurrently, Australia’s four top banks, which dominate the country's banking industry, have experienced heavy criticism from a government inquiry into allegations of misconduct.
All of this adds pressure to interchange revenue, which has been heavily sliced and scrutinized in recent years. Australia is already well on its way toward creating an interchange-free environment.
Beyond Visa and Mastercard
Australia's past efforts to reduce or eliminate interchange have focused primarily on Visa and Mastercard. In 2003, Australia became the first country to reduce interchange, under a reform implemented by the Reserve Bank of Australia (RBA). The reform, which also banned the card schemes’ no-surcharge rule, saw Visa and Mastercard credit card interchange fall by around 50 percent from 0.95 percent.
However, the RBA didn’t tackle merchant fees charged by the three-party card schemes, American Express and Diners.
In August, the Australian Government’s Productivity Commission published its final report on Competition in the Australian Financial System. It made several recommendations, not just to break up the dominance of the top four Australian banks, but also to abolish Mastercard and Visa interchange, introduce merchant choice over payment networks, and ensure open access to the New Payments Platform, Australia’s faster payments system.
The report also says the power to dictate who is liable for online and digital fraud should be taken from FIs and given to the Australian Securities and Investments Commission (ASIC).
The Productivity Commission report calls on the RBA’s regulatory body, the Payments System Board (PSB), to ban interchange fees by the end of 2019 as a way to reduce distortions in payment choices and the flow-on costs of these distortions to merchants. “Any other (card) fees should be made transparent and published,” the report says.
“Card payments and bank transfers have grown in Australia and are dominated by Visa, MasterCard and the major banks (which enable over 80 percent of credit card payments),” the report adds. It asks that the Australian Competition and Consumer Commission (ACCC) investigate whether existing interchange fee regulation favours three-party card schemes, and, if distortion exists, provide pricing controls on three-party fees.
“Given the potential for three-party card schemes to avoid such regulation and further distort the mix of payment instruments, the ACCC should investigate whether further intervention — such as the direct regulation of merchant service fees — is necessary,” it says.
The PSB’s response to the Productivity Commission report appeared to rule out eliminating interchange. In August 2018 the PSB said that the RBA’s interchange reforms since the early 2000s have improved competition and efficiency.
“The Productivity Commission advises the government on economic policy,” said Brad Pragnell, an Australian banking consultant. “However, government and regulators aren’t bound to accepts its recommendations, and often don't. I suspect this might be the case with its call to ban interchange by end-2019."
Other factors will come into play by that time, Pragnell said.
"The government is expected to respond to the Productivity Commission Report at the same time as it responds to the Royal Commission on Banking," he said. "The Royal Commission final report is expected in February 2019, so we shouldn’t expect anything in respect to the Productivity Commission report before then. Regardless, interchange fee regulation decisions rest with the Payments System Board, which is independent of the federal government. New interchange fee standards came into effect in July 2017, and it’s unlikely the Payments System Board would review its own decisions so soon."
Grant Halverson, CEO of Australian payments consultancy McLean Roche, said the Productivity Commission’s proposal to zero-rate interchange would be terminal for Australia’s credit card frequent-flier programs.
“The credit/charge card firms depend on interchange to fund their entire frequent-flier programs,” he said. “The airlines’ card issuing programs are also at risk, as credit/charge cards provide the majority of their non-airline revenue.”
Halverson estimated, based on AU$173 billion in domestic Australian Mastercard and Visa credit card spending in the year to May 31, 2018, that banning interchange would lead to issuers losing AU$2 billion, or 22 percent of their revenue.
When the RBA cut interchange in 2003, this led to card companies introducing new fees or increasing existing fees to recoup their losses, Halverson said. “If interchange is abolished, card frequent-flier programs would be forced to increase their membership fees again and reduce benefits, so that might be terminal,” he said.
“It’s a battle between the RBA, which wants to keep credit card interchange at 50 basis points, and the Productivity Commission, which wants to abolish it,” Halverson said. “The Productivity Commission report is very critical of the RBA/Payments System Board, so it may appeal to the politicians. The other regulators, ACCC and ASIC, also have a role, so that makes it even more complex. At this point, probably the RBA will win, but I'm not sure.”
A tough market
"Australia has seen significant growth in card transactions over recent years,” said Pragnell. “We've seen stronger growth in debit cards compared to credit cards. Debit card transactions have had an average annual growth rate of 14 percent over the past decade, compared to 7 percent for credit cards. However, debit card share has been shifting from Australian domestic debit scheme eftpos to Visa and Mastercard debit, much of this due to the earlier deployment of contactless by the international card schemes."
Pragnell said that, while rewards-based credit cards remain important, Australia's strict interchange fee regulation has made this a tough market.
“The RBA monitors credit card rewards, and sees high rewards for cardholders as part of the problem it’s trying to address through its regulation,” he said. “Many cards in Australia carry comparatively high annual fees, often in the hundreds of dollars, and the rewards provided appear quite modest when compared to similar programs offered in North America."
The Productivity Commission report says low-cost routing of dual-network cards (carrying both an international and the domestic eftpos brand) should be provided for merchants. The Payments System Board should bring the regulatory standard for least-cost routing into force by Jan. 1, 2019, it says.
“Australia has the highest level of contactless card use in the world and the fourth highest number of non-cash payments per person, with non-cash payments growing at about 10 percent per year,” the report says. “Currently, contactless transactions using dual network cards (such as ‘tap and go’ at the point of sale) are mainly processed through the generally higher-cost Visa or MasterCard networks by default, rather than through eftpos.”
The Productivity Commission report recommends an open access regime for critical shared infrastructure such as Australia’s New Payment Platform, to ensure there continues to be opportunity for new entrants to join.
The report says the government should make Australia’s electronic payments regulations, the ePayments Code, mandatory, given the significant rise in CNP payments fraud in Australia. The code, which is governed by the ASIC, sets out basic rules for who pays for unauthorized transactions, and establishes a regime for recovering unauthorized payments.
“To ensure positive consumer outcomes are maintained as innovative products and services expand in the payment system, subscription to the ePayments Code … should be made mandatory for any organization that sends or receives electronic payments, with more clearly defined liability provisions,” the report says.
It says the ASIC should “review the ePayments Code and update it to reflect changes in technology, innovative business models and developments in open banking. ASIC should more clearly define the liability provisions for unauthorised transactions when third parties are involved, including participation in financial dispute resolution schemes.” The update should happen by the end of 2019 and the ePayments Code should undergo one review every three years, the report says.