catallaxy files

catallaxy in technical exile

Regulation and the future of payment cards

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The House of Representatives Economics Committee has been conducting an inquiry into the Reserve Bank’s recent and proposed reforms to the payments system with particular reference to credit cards, debit cards and ATM fees. This is a big and complex issue (or rather, set of issues, with its own set of terminology) and rather than write a detailed post on it, I’ll give some guides to reading. Economist-blogger Joshua Gans has been testifying at the inquiry. Here is his take on the reforms, and here is the RBA’s specific page devoted to documenting the reforms to date.

Two of the foremost economic theorists in the world today, Rochet and Tirole have contributed a paper to the online Review of Network Economics journal here which explores the theoretical issues in greater depth. The introduction and conclusion to their paper has a nice summary of some of the concrete implications involved for those who don’t want to follow up on all those links which gives a flavour of the kinds of reforms that have been implemented by the RBA and what their future consequences may be:

Multi-party card payment systems such as Visa and MasterCard set interchange fees, which are transaction-based payments from the merchant’s bank, the acquirer, to the cardholder’s bank, the issuer. The magnitude and sometimes even the very legitimacy of these interchange fees have been repeatedly questioned either directly (the focus of this paper), or indirectly in cases involving tying between debit and credit, the no-surcharge rule, system duality, and the collective determination of its level. These challenges have occurred both in courts of law (as for example the Wal-Mart case and the ongoing class action suits in the U.S.) or through regulatory decisions to constrain interchange fees (as for example by the European Commission, the UK Office of Fair Trading, and the Reserve Bank of Australia) …

Setting up a regulation requires having a vision as to what is likely to happen in the presence or absence of regulation. Such analysis is lacking and developing such scenarios lies way beyond the scope of this paper. Let us therefore content ourselves with stating a couple of relevant questions: i) If Visa’s interchange fee is reduced by regulation, will issuers gradually move their business to alternative platforms (in particular, by switching new customers as well as existing ones at card renewal)? ii) Will large issuers such as Citigroup or Bank of America start their own proprietary systems (with or without integrating into acquiring)? iii) How will new payment platforms such as Pay Pal take advantage of the consumer demand for attractive payment systems if offers by incumbents (Visa, MasterCard, American Express, and Discover) are constrained by regulation?

Should we expect merchant discount regulation to spread to the entire payment industry and how effective would such a regulation be? Existing regulations and their likely near future variants are intrinsically asymmetric ones, and one should ponder over their likely impact on the future of the industry.

Finally, if we decide that regulation is warranted, we ought to devise, like for telecoms, innovative forms of regulation. The cost-based approach currently used in several countries is well-known to lack intellectual foundations and therefore to be rather arbitrary.


Written by Admin

May 20, 2006 at 12:35 am

Posted in Uncategorized

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