The Role of Interchange Fees in Credit CardAssociations: Competitive Analysis and RegulatoryIssues
by
Joshua S. Gans
and
Stephen P. King
*
University of Melbourne29
th
November, 2000
This paper reviews and develops the economics associated withinterchange fees in credit card associations. These fees have beensubject to legal action in the US and recent reports in both the UK andAustralia have called for regulation of these fees. These reports haveargued that interchange fees can be used to support collusivearrangements or to force cash customers to ‘cross subsidise’ credit cardcustomers. We show that interchange fees have an important role in anefficient credit card scheme and that the anti-competitive fearsassociated with these fees are overstated. In particular, interchange feesare only a concern for competition authorities if retail level competitionis relatively weak. We then review the recent joint report by the RBAand the ACCC and argue that a number of its conclusions are poorlyfounded.
*
Melbourne Business School and the Department of Economics, respectively. Funding for thisresearch came from Arthur Robinson and Hedderwicks on behalf of their clients the NationalAustralia Bank. All views in this paper are our own and should not be held as stating or reflectingthose of either of the above organisations. All correspondence to Professor Joshua Gans, MelbourneBusiness School, 200 Leicester Street, Carlton, Victoria 3053; E-mail: J.Gans@unimelb.edu.au.
Section
1
Introduction
December00 1
1 Introduction
Credit card associations, such as MasterCard, Visa andBankcard, set interchange fees for transactions between members of theassociation. These same members often compete with each other onvarious aspects of a credit card transaction. The fact that interchangefees are the outcome of cooperation among firms that otherwisecompete with each other, raises suspicion as to their efficiency andpotential anti-competitive impact.In the United States, several anti-trust actions have involvedcredit card interchange fees. For example, NaBanco, a potentialmerchant acquirer, brought an action against the Visa associationalleging that the interchange fee was set prohibitively high.
1
NaBancoclaimed that the fee effectively excluded entrant acquirers andfavoured incumbents who operated as both issuers and acquirers.
2
That suit was dismissed but controversy remains with the U.S.Department of Justice, in 2000, initiating proceedings againstMasterCard and Visa relating to dual membership by various banks inthese associations.In the United Kingdom, the Cruickshank report expressedconcern that interchange fees were set too high.
3
The report argued thathigh interchange fees reduce the efficiency of the payments system andthat the interchange fee and other aspects of card associations shouldbe subject to tighter regulation.Interchange arrangements in Australia are similar to elsewhere.and concerns have been raised about their efficiency and whether theyfacilitate competition or collusion. The 1998 Wallis report into the
1
To clarify the terminology used by credit card associations,
acquirers
are members of theassociation who provide services to (retail) merchants.
Issuers
provide services to customerswho hold the card. The same financial institution can operate as both an issuer and an acquirerin one association. Interchange fees are paid between separate issuers and acquirers whofacilitate a particular credit card transaction.
2
National Bankcard Corp (NaBanco) v Visa USA
, 779 F.2d 592 (11
th
Cir. 1986).
3
D. Cruickshank, (2000),
Competition in U.K. Banking: A Report to the Chancellor of the Exchequer
,The Stationary Office: London.
Section
1
Introduction
December00 2
financial system recommended further investigation. The Reserve Bankof Australia (RBA) and the Australian Competition and ConsumerCommission (ACCC) began jointly investigating these issues in 1999.They have recently reported findings that essentially mirror those ofCruickshank.
4
In addition, the ACCC has alleged that the currentcentralised determination of interchange fees represents potential pricefixing by leading banks.The aim of this paper is to investigate the role of interchangefees and any potential inefficiencies and anti-competitive detrimentsthat might arise from these fees. The academic literature on this topic islimited. We draw upon and extend this literature, paying particularattention to the Australian environment and the potential forregulation of interchange fees. As will become apparent below, ourconclusions are stark. Some reasonable economic assumptions lead usto conclude that regulation of the interchange is at best, innocuous and,at worst, could seriously undermine the efficiency of the paymentssystem.The remainder of this paper proceeds as follows. The next twosections define what a credit card association does and considers theroles and choices of the four key participants in open loop credit cardassociations – customers, merchants, issuers and acquirers. In Section 4we consider the various externalities between these participants andhow different rules and restrictions may affect the efficiency of thecredit card as a payment instrument. One of these mechanisms is theuse of an interchange fee to share costs among issuers and acquirers.Section 5 considers the role of the interchange fee in more detail whilesection 6 provides a thorough analysis of its effect on competition. Insection 7, we turn our attention to consider some issues that arise fromthe RBA/ACCC Joint Study into interchange arrangements inAustralia while a final section summarises our conclusions.
4
Reserve Bank of Australia/Australian Competition and Consumer Commission (2000),
Debitand Credit Card Schemes in Australia: A Study of Interchange Fees and Access
, Sydney.
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Role of Interchange Fees in Credit Card Associations
Joshua S. Gans and Stephen P. King, "The Role of Interchange Fees in Credit Card Associations: Competitive Analysis and Regulatory Issues" 29th November, 2000
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