Clarity in charges for payment instruments

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As Joshua notes, Australian banks have ‘reversed’ the interchange fee for debit transactions using the EFTPOS system. This interchange fee, which is charged by the customer’s bank, is passed through to a merchant by its bank (possibly with other fees and charges added). So now merchants are charged (more) when you use EFTPOS. This brings EFTPOS closer to the ‘scheme’ debit cards and to credit cards which have had this type of charging to merchants for a while.

The interchange fees and the way they are ‘hidden’ in transactions creates an economic problem. When a customer chooses a payment instrument then the customer imposes a cost on the merchant. But if the merchant sets the same price for all customers, then the customers do not see the cost that they are imposing and have no incentive to use cheaper means of payment. Further, the single price effectively means that customers who use low cost payment instruments are cross subsidising those using high cost instruments. Finally, banks have few incentives to keep interchange fees down as the customer does not see these fees so that competitive incentives are weak.

Overall, the payments system is less efficient and less competitive. It may only be a few cents per transaction, but added up over billions of dollars worth of transactions it is a very big sum.

One solution is surcharging. I have discussed this before. It is not a perfect solution and is being investigated by the Payment System Board (PSB).

Another potential solution is currently used for ATM transactions. When taking money from an ATM, the owner of the ATM doesn’t charge your bank but must charge you directly. The ATM tells you the amount you will have to pay for the transaction and gives you the option of not continuing if the price is too high. This transparency probably doesn’t make a lot of customer discontinue their transaction once it is started, but it does inform the customer, and they may plan to use a ‘cheaper’ ATM next time. The banks have entered deals to increase their networks of free ATMs and the reforms have generally worked.

So, a potential reform for credit and debit cards is the following:

  1. Abolish interchange fees for credit and debit cards (or require the fee is set at zero;
  2. Allow a consumer’s bank to charge the consumer directly for a debit or credit transaction; and
  3. Require that the fee is made clear to the customer (on the EFTPOS handset) and the consumer has to verify that they are happy to pay the fee to complete the transaction.

My prediction is that this would suddenly create a lot of interbank competition to keep fees down for customers. Most customers would note the fee and continue with their transaction. But a high fee will mean that they pull out a different card next time they transact.

What are the limitations with this policy? The main one is that it cuts the merchant out of the picture. Different payment instruments will still have different costs to merchants, but direct payment would probably mean the end of surcharging – otherwise it would just become too complex and messy. But given the PSB’s concerns about surcharging, this may be a good ‘second best’ solution.

The other feature is that banks would have to set down fees for card use that do not depend on the identity of the merchant. This avoids the banks favouring particular retailers. It also gets rid of the price discrimination by merchants that is causing the PSB concerns.

So – not a perfect solution, but worth some thought given that it has worked well for ATMs.

 

One Response to "Clarity in charges for payment instruments"
  1. Reading the series of blog posts on this I have never been able to get my head around exactly who is charging who and why under the various different schemes. Is there an infographic around somewhere that can make it easy to see?

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