Dramatic Credit Card

System Reform: What

Happened?
Joshua Gans
Melbourne Business School
(March 2006)
Reforms
 1st January, 2003: surcharging permitted
 31st October, 2003: capped interchange fee
based on issuer costs (approximately 50%
reduction)
 23rd February, 2004: opened up access to
credit card schemes
Theory of Reform
 Gans-King (ER, 2003):
 If permit surcharging, then interchange fee (a) reform unnecessary
(neutrality hypothesis)
 Will see surcharging by monopolists in excess of merchant service
charges
 Gans-King (RNE, 2003):
 If a non-neutral and want to minimise transaction costs (not consumer
welfare), then set a to send price signals to consumers and merchants.
 Try to achieve α bc = (1-α )bm (α : consumer share of benefits)
 Cost imposed by consumers on merchants (cA – bm). So set a = bm – cA to
compensate.
 This gives: a* = α cI – (1-α ) cA
 If α = 1 and cA = 0, then RBA standard of cI is ‘approximately’ optimal.
Previous standards were excessive.
 Merchant Service and Interchange Fees

3.00

2.50

2.00
MC/ & Visa
Am Ex
1.50
%

Diners
Interchange Fee
1.00

0.50

0.00
Se 3

Se 4

Se 5
M 3

M 4

05
De 3

De 4

De 5
3

5
0

0
0

0
-0

0
-0

0
-0
n-

n-

n-
p-

c-

p-

c-

p-

c-
ar

ar

ar
Ju

Ju

Ju
M
 10000
11000
12000
13000

5000
6000
7000
8000
9000
May-94

May-95

May-96

May-97

May-98

May-99

May-00

May-01

May-02
Number of Credit Card Accounts

May-03

May-04

May-05
 V a lu e o f C r e d it C a r d P u r c h a s e s ($ m )

16000
14000
12000
10000
8000
6000
4000
2000
0
May-94

May-95

May-96

May-97

May-98

May-99

May-00

May-01

May-02

May-03

May-04

May-05
 14000
16000
18000
20000
22000
24000
26000
Aug-02
Oct-02
Dec-02
Feb-03
Apr-03
Jun-03
Aug-03
Oct-03
Dec-03
Feb-04
Apr-04
Jun-04
Aug-04
Oct-04
Dec-04
C r e d it C a r d D e b t ($ m )

Feb-05
Apr-05
Jun-05
Aug-05
Oct-05
Dec-05
Au
g-0

40%
50%
60%
70%
80%
90%
100%
No 2
v-0
Fe 2
b-0
Ma 3
y-0
Au 3
g-0
No 3
v-0
Fe 3
b-0
Ma 4
y-0
Au 4
g-0
No 4
v-0
Fe 4
b-0
Ma 5
y-0
Au 5
g-0
No 5
S h a r e s o f C r e d it & D e b it

v-0
5
D e b it
C re d it
 S h a r e s o f C r e d it a n d C h a r g e (V a lu e )

100.0

95.0

90.0
A m E x & D in e rs
85.0
M / C & V is a
80.0

75.0

70.0
Jul-02

Jul-04

Jul-05
Jul-03
Jan-02

Jan-04

Jan-05
Jan-03
Apr-02

Apr-03

Apr-04

Apr-05
Oct-02

Oct-03

Oct-04

Oct-05
Dramatic Changes but …
 No apparent change in credit card usage
(numbers, value)
 Continued credit card debt
 Constant relative use of credit and debit
 Small shift towards charge cards
 Few instances of surcharging
Did someone say ‘neutrality’?
 Gans-King hypothesis: sufficient retail competition
to make interchange fees neutral
 Acquirer margin is unchanged (about .4%): complete
pass through (a condition for neutrality)
 Lerner ((m-a)/m) index has grown (cA = 0)
 Sept 2003: 0.32 = (1.4 – 0.95)/1.4
 Dec 2005: 0.42 = (0.96 – 0.55)/0.96
 Acquiring welfare distortion has increased!
Not competition but consumers
 Credit card reform was not a competition
policy issue. Competition instruments are
ineffective.
 If concerned that consumers are either:
 Choosing expensive forms of payment
 Incurring too much credit card debt
 Issue for consumer protection policy
 Implication: give payment systems policy to
the ACCC