You are on page 1of 12

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 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.

Gans-King (RNE, 2003):
    

Merchant Service and Interchange Fees
3.00 2.50 2.00 1.50 1.00 0.50 0.00
ar -0 3 Ju n0 Se 3 p0 De 3 c0 M 3 ar -0 4 Ju n0 Se 4 p0 De 4 c0 M 4 ar -0 5 Ju n0 Se 5 p0 De 5 c05

MC/ & Visa Am Ex Diners Interchange Fee

%

M

10000

11000

12000

13000

5000 May-94 May-95 May-96 May-97 May-98 May-99 May-00 May-01 May-02 May-03 May-04 May-05

6000

7000

8000

9000

Number of Credit Card Accounts

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

C r e d it C a r d D e b t ($ m )

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 Feb-05 Apr-05 Jun-05 Aug-05 Oct-05 Dec-05

100%

40% D e b it C re d it

50%

60%

70%

80%

90%

S h a r e s o f C r e d it & D e b it

Au g-0 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 v-0 5

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 85.0 80.0 75.0 70.0 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 A m E x & D in e rs M / C & V is a

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