Malcolm Edey: Card payments and the retail sector
Speech by Mr Malcolm Edey, Assistant Governor (Financial System) of the Reserve Bank of
Australia, at the Australian Financial Review Retail Summit, Melbourne, 28 September 2016.
* * *
I thank Darren Flood for his extensive assistance in preparing this speech.
Introductory remarks
This is a conference about the retail industry, not the payments industry. However, a retail
business is not a business if the retailer cannot get paid. And a retailer won't be at their most
competitive if their payment costs are higher than they should be. This is an issue staff at the
Reserve Bank think about every day, and one that I hope retailers are taking a close interest
in as well.
Today I'll talk about how the way we pay is changing, and what it means for retail businesses.
I'll also talk about the Reserve Bank's role as a payments regulator and about some of the
things that are just around the corner in payments.
The changing nature of payments
A good place to start is an observation that will not be lost on anyone here. That is that the
nature of the payments we use is changing, and changing quite rapidly at the moment.
Probably the clearest example to most people has been the take-up of contactless, or
tap-andgo, card payments. These have taken off extraordinarily quickly in Australia, to the point where
Australia is thought of as the leading contactless market in the world. This is a technology that
offers a benefit to both consumers and merchants in terms of the time taken to process a
payment, and as a result it has been embraced - but many merchants might also notice that
their payments costs have risen because of the resulting change in their payments mix. This
is a good example of the complex dynamics of competition in the retail payments system.
But the rise of contactless payments is only one of a range of changes that have been occurring
to the payments system over time - some of which you might have noticed, some of which you
have probably never thought about.
Possibly the most important trend we are seeing is the steady decline in the use of traditionally
paper-based payments. Think of when was the last time you wrote or received a cheque. In
2000 the average Australian wrote around 35 cheques per year. In 2015/16 that was down to
six. What is more, while cheque use has been declining for two decades, the decline if anything
is accelerating; after falling by an average of about 13 per cent per year in the preceding five
years, the number of cheques written fell by 17 per cent in 2015/16 (Graph 1).
We have been observing the decline in cheques for many years, but more recently it has been
a decline in the use of that other traditionally paper instrument - cash - that has been attracting
attention.1 The only real way to adequately measure the use of cash is to survey the users -
something the Reserve Bank does via a consumer diary once every three years. We ran the
first of these surveys in 2007, when a large majority of consumer payments - 69 per cent -
were made with cash. By 2010, that percentage had fallen to 62 per cent and by 2013, 47 per
cent, with the decline occurring across all payment values (Graph 2). We will run the survey
again this year, but it seems a safe bet that there will be a further, probably quite large, decline
in cash use.2
This trend is not all about people falling out of love with cash; a significant factor is the rapid
rise in online commerce, where of course cash is not an option.
So what has filled the gap left by our paper instruments? In the retail space it is largely cards,
which have grown by an average of 11 per cent per year over the past five years (Graph 3).
This reflects cards' large share in online commerce, as well as their having gained ground at
the retail point of sale. Based on the Bank's consumer survey, card payments made up 43 per
cent of all consumer payments in 2013, and 55 per cent of those over 50 dollars. The ubiquity
of card payments is one reason we care a lot about how those systems operate, as I will
discuss more a bit later.
It is also worth noting that in the period measured by our survey, BPAY also gained an
increasing share of the market, while the relative newcomer, PayPal showed strong growth
from a low base. I will speak a little later about some of the other types of payments that might
start to register on the radar in the coming years.
The cost of payments
Of equal interest to these broader trends in payments usage is the cost of payments. The retail
sector clearly has a strong interest in the cost of payments to merchants, and while the Reserve
Bank is also interested in this, its principal focus when evaluating the efficiency of the payments
system is the resource cost of payments - that is, how much it costs the economy in total to
produce a payment - abstracting from the various fees that determine the cost to any single
party or sector. Determining resource costs is a large job, requiring detailed information on
financial institutions' costs and things like the cost of processing time for merchants.
The Reserve Bank last went through this exercise in 2014. The most comforting news from
that study was that the resource cost of consumer to business payments had declined as a
percentage of GDP since the previous cost study in 2006, from 0.80 per cent to 0.54 per cent,
even though the number of transactions had risen. Despite the favourable trend overall, the
mix of payments within the total acted in the direction of increasing costs.
Looking across the main non-cash retail systems, we see that, unsurprisingly, the highest
pertransaction resource costs were generated by the cheque system, with each cheque written
costing the economy about $5.12, if account overheads are ignored (Graph 4). This is not
surprising given the cost of shipping and processing physical cheques, although there have
been some efficiency improvements in the cheque system since the time of the study.
Perhaps of more current interest to the retail sector is the cost of our card systems. Credit
cards are quite costly at around 94 cents for the average sized transaction, while MasterCard
and Visa debit are less costly and eftpos uses the fewest resources of any of the card systems,
at around 45 cents per transaction.
The broad relativities between the resource costs of these systems is similar to those faced by
merchants. Another way to think about that is that it is merchants who, by and large, bear the
cost of payments. This is largely achieved by the way fees are used in these systems. I think
the most telling illustration of that is to compare the actual costs faced by merchants to the
costs faced by consumers once fees and benefits to consumers, like interest-free periods and
reward points, are taken into account. What you will see is that, despite being more expensive
to produce and more costly to merchants, on average a credit card transaction costs a
consumer slightly less than a debit card transaction (Graph 5). These are the incentives that
shape payment choices by consumers.
Payments as a business
The arrangement of incentives I have just shown you is a defining feature of card payment
systems, and one that the Reserve Bank has devoted a great deal of attention to over many
years.
The principal reason that the relative cost of cards to consumers looks so different to the
resource cost of cards is the payment of interchange fees in these systems. An interchange
fee is a fee paid from a merchant's bank to the cardholder's bank every time a card payment
is made. While cardholders and merchants have little visibility of these fees, their effect is
nonetheless substantial. They place a floor under the fee that a merchant is charged by its
bank to accept cards and they help fund the rewards, interest free periods and other benefits
that encourage consumers to use a particular card. In large part, this can occur because many
merchants feel that they cannot refuse to accept some types of card payments. This in turn
means that competition, both between financial institutions and between card schemes, can
be directed towards influencing the card that the consumer takes from their wallet to make a
payment.
The effect of interchange fees has been well understood in Australia for many years, with the
Reserve Bank first requiring interchange fees to be reduced in 2003 following earlier joint work
with the Australian Competition and Consumer Commission. A number of other regulators
internationally have subsequently followed the Reserve Bank's lead.
The role of interchange fees in affecting payment choices is so powerful that, even under the
interchange fee caps applied in Australia, card schemes have seen benefit in setting very high
interchange rates on some categories of cards - to encourage growth in that segment - offset
by much lower rates on transactions at some "preferred" merchants. The unfortunate effect of
this is that those "preferred" merchants pay very low fees on all transactions, while other
merchants pay the much higher rates that support generous rewards programs on
superpremium cards. Such a card might cost a large merchant around 0.2 per cent of transaction
value, whereas a small merchant that did not have a "preferred" rate, might be paying up to
2 per cent. The Reserve Bank estimates that in 2015, non-preferred merchants on average
faced interchange fees more than half a per cent higher than preferred merchants.
This is one of several factors that led the Reserve Bank to conclude in 2015 that a review of
card regulation was warranted.
The RBA as a payments regulator
Before I get onto the details of that review, I would like to revisit how the Reserve Bank has
come to be involved in this area of regulation.
Legislative reforms in 1998 following the Wallis Committee's Final Report enshrined the
longunderstood central bank responsibility for the stability of the payments system in the Reserve
Bank Act. They also gave the Bank for the first time an explicit mandate to promote competition
and efficiency in the payments system and some new powers that would allow it to pursue that
mandate. The Wallis Inquiry had also provided some guidance on areas where this new
mandate could be applied, including card interchange fees.
These developments set the scene for a period of fact finding, analysis and eventually
regulation to cap interchange fees and force the removal of "no-surcharge" rules. Interchange
fees on MasterCard and Visa cards were reduced in 2003 from around one per cent of
transaction value to 0.5 per cent. Fees on MasterCard and Visa debit cards were reduced in
2006 to 12 cents per transaction.
While at the time there were predictions from some quarters that regulating interchange fees
would be catastrophic for card systems, as we have seen, they have thrived. Regulators in a
number of other countries have now followed Australia's lead in this area of regulation and
indeed some - notably the European Union - have gone further.
Nonetheless, while we think our cards regulation has been very successful, we have known
for some time that there were elements of it that could be improved upon - either because the
payments system has evolved since the regulation came into force, or because those affected
by regulation have adjusted their behaviour over time. This led us to initiate a review of cards
regulation in 2015, which was completed in May this year. Some changes to regulation have
already occurred as a result, with the remainder coming into force over the coming year.
There were three key elements of the reform package that the Bank announced in May.
First, the Bank considered whether the current regulated levels of interchange fees remained
appropriate, particularly given that, as I mentioned, there were now examples of lower
interchange fee caps in other parts of the world. The Bank decided to leave credit card
interchange fees unchanged, but to further reduce the level of debit card interchange fees -
from 12 cents to 8 cents. This decision reflected the fact that the average size of MasterCard
and Visa debit card transactions had fallen by 43 per cent since 2008, meaning that
interchange fees had been rising as a percentage of transaction value.
I mentioned earlier that specifying the interchange cap as an average had resulted in some -
typically small and medium-sized merchants - bearing much more of the burden of high-cost
cards than "preferred" merchants. The Bank has now decided to limit this effect by placing an
absolute limit on the level of interchange fees for any card or any transaction in addition to the
cap on the average. A limit of 0.8 per cent will apply to credit cards and 15 cents (or 0.2 per
cent) to debit cards. The current 2 per cent interchange fees applying to some super-premium
cards will no longer be possible from July 2017. This will benefit non-preferred merchants.
Some further technical changes to how the caps are applied will reduce average interchange
fees by reducing upward drift in the average over time.
The second element of the May reform package is to place what we refer to as American
Express companion cards on the same regulatory footing as MasterCard and Visa cards.
Traditional American Express cards have been issued by the company itself, with Amex also
arranging acceptance of those cards for the merchant. However in the mid 2000s, banks began
issuing some American Express cards under license. Under these arrangements, American
Express paid fees and incentives to card issuers, which had a similar effect to interchange fees
- funding rewards points and influencing payment choices by consumers. But because these
payments were unregulated, the rewards tended to be significantly higher than those offered
on MasterCard and Visa Cards. This raised questions about whether the regulatory regime
was fully competitively neutral.
From July 2017 the Bank will now cap interchange fees and other payments to issuers in an
equivalent fashion across American Express companion, MasterCard and Visa cards.
Traditional American Express cards, which have no equivalent to interchange fees, will not be
subject to fee regulation.
Finally, the May package further strengthens the regulation of card surcharging.
Giving merchants the ability to signal to consumers through a surcharge that some payment
methods are more costly to accept than others has been an important element of payments
regulation in Australia. The overwhelming majority of merchants that have taken up the option
of surcharging have done so at a level that recovers or under-recovers their card acceptance
costs. However there has been community concern about a small number of cases where card
surcharges exceed card acceptance costs - at least for some transactions. The lightning rod
for these concerns has been airlines and their fixed dollar surcharges, which clearly
overrecover card acceptance costs for low value airfares. In addition, while the Bank had in place
a regulatory framework that could cap card surcharges to merchants' card acceptance costs,
there were concerns about how these caps could be enforced, given the limits of the Reserve
Bank's powers.
The May package of reforms provides a simpler measure of the allowable surcharge, which is
already in force for large merchants and will take effect for other merchants from September
next year. In order to make it as simple as possible to understand payment costs, banks and
other organisations that provide card acceptance services will be required to give each
merchant a clear statement of their acceptance cost for each card scheme. A merchant will be
able to use this to set its surcharge, or could include some limited other costs if they can be
supported with receipts or statements. One implication of the revised framework is that
merchants will generally no longer be able to apply fixed dollar surcharges.
The other key change from the previous framework is that the government has passed
legislation to ban excessive surcharging. This step will give the Australian Competition and
Consumer Commission the power to enforce the ban.
The ban on excessive surcharging for large merchants has now been in place for a few weeks.
The airlines have responded. Qantas, for instance, has moved from a $7 fixed fee on domestic
flights on credit card payments to 1.3 per cent, with a cap of $11 for higher cost fares. For debit
card payments they now surcharge 0.6 per cent. That means a $200 fare would be surcharged
$2.60 for a credit card payment, compared with $7 previously. We also know that the large
event ticketing agents have removed their card surcharges, which seems appropriate for an
industry where alternatives to paying by card in most cases are limited.
This should already have eased the broader community's concerns about excessive
surcharges to an extent. By this time next year we will have a framework in place for all
merchants which should give consumers confidence that any surcharges they pay are
reasonable, while at the same time providing merchants with a much clearer understanding of
their payment costs.
The future
I began by talking about the decline of some of last century's payment systems. I would now
like to turn briefly to the future, because there are some important developments just around
the corner.
One trend that seems very likely in the near term is the migration of contactless card
transactions to mobile phones. Not everyone will see appeal in this, but the latest generation
of mobile wallets are secure and convenient and can rely on what is now a very widespread
contactless acceptance network in Australia. There is little doubt that the prospect of being
able to leave home with only a mobile phone will have appeal in some circles. Mobile wallets
bring new players and new processes into the payment flows, and the Bank expects to remain
closely engaged with these developments in the period ahead.
It would be unfortunate if there were a perception that the Bank's only contribution to the
efficiency of the payments system was regulation of card systems. We do in fact have higher
ambitions. In my view the most significant contribution to the future of the payments system
that the Bank has made in recent times - certainly in my time as Assistant Governor in this
area - has not been regulation, but playing the role of catalyst for a major industry project to
create a new payments system - the New Payments Platform, or NPP.
The creation of the NPP has flowed from the Strategic Review of Innovation in the Payments
System that was undertaken by the Bank between 2010 and 2012. In finalising the review, the
Bank identified a number of important features that electronic payment systems were not able
to provide in Australia and challenged the payments industry to look for a solution. To the
industry's great credit it took up that challenge and has focused a very large industry effort on
filling those gaps through the delivery of the NPP in the second half of next year.
The NPP will allow individuals and businesses to make account-to-account funds transfers,
with the recipient having access to those funds in most cases in a matter of seconds. That will
be possible at any hour of the day or night, seven days a week, regardless of the financial
institutions that the sender and receiver bank with. The sender will not need to know the BSB
and account number of the recipient; they will be able to use a phone number, email address
or ABN to address the payment. And importantly, it will be possible to send a much larger
amount of information with a payment than the 18 characters permitted through our current
system. That will potentially represent an enormous benefit to business users of the system in
particular. Finally, with an eye to the rapid pace of innovation, the structure of the NPP will
allow new types of third party commercial services to be delivered through the system, once
the initial service, to be offered by BPAY, is up and running.
Conclusion
This will be my last opportunity to speak in an official capacity on payments system issues. I
am proud of the things that the Reserve Bank has been able to achieve in this area, both
through world-leading regulation and through playing the catalyst role that I spoke of. Efficiency
of the payments system is not always a high-profile topic, but it is a tremendously important
one when you consider the 28 million non-cash payments made each and every day in
Australia. It is certainly in the interests of the people in this room to take a deep interest in
payments, and I would encourage you to continue to do so. I think retailers understand that
our reforms have worked to reduce their payment costs, and I thank all those retail
organisations that have participated in our policy consultations and supported the direction of
reform.
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