Malcolm Edey: The current agenda in retail payments regulation
Address by Mr Malcolm Edey, Assistant Governor (Financial System) of the Reserve Bank of
Australia, to the Cards & Payments Australasia 2012 Conference, Sydney, 20 March 2012.
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Once again I thank the organisers of Cards and Payments Australasia for the invitation to
speak here today, my third time at this event. Looking at the conference agenda for these
two days, what stands out to me is the intense focus on innovation. This is an industry where
there is a great deal of work going on in areas like online payments, mobile payments, new
card-payment products, and improvements in security. All of these are signs of a vibrant
industry.
My subject for today is the current agenda in retail payments regulation.
The Reserve Bank has had a direct role in payments regulation since 1998. Following the
report of the Wallis Committee, the Payment Systems (Regulation) Act in that year
established the basic governing structure that we have today. It set up the Payments System
Board within the Reserve Bank with a mandate to promote efficiency and stability. And the
Act gave the Bank significant powers to that end. They include the power to designate a
payment system and to set standards in areas like network pricing and various aspects of a
payment system's internal rules.
One of the first areas of focus for the Board was on credit card schemes. But the remit of the
Payments System Board extends much more broadly than just card payments, or even retail
payments more generally. The Board also has oversight responsibilities in the high-value
system as well as for clearing and settlement facilities in Australia, and it has been
increasingly devoting attention to the second of those areas. I expect that trend will continue,
given the rapid changes that are taking place internationally.
Today, though, I want to focus on our work on retail payments.
Public consultation is an important part of that work. In some matters we have a formal
obligation to consult, but that is not the only reason for doing it. The issues involved in
payments regulation are often complex and we see it as very important to engage with
industry, and other stakeholders, to make sure we have all the relevant facts when we make
our decisions.
Currently there are four areas of retail payments regulation where we are in various stages of
public consultation. I want to take the opportunity to review those briefly today.
The first is the surcharging standard for card payments.
The question here is a simple one: should card schemes be allowed to place limits on
merchant surcharging for card payments, and if so, in what form? That question was first
examined by the Payments System Board during its initial round of credit card reforms, which
were announced in 2002. The Board's decision, as you know, was to require the removal of
rules against surcharging. That was part of a wider reform package that also included a
standard for interchange fees.
A newcomer to this debate might ask the question, why did we take action against
no-surcharge rules when the effect would be to make some cardholders pay more for their
transactions?
It's worth briefly re-capping the answer to that.
One of the distinctive features of card payment systems, historically, has been a lack of
alignment between pricing and decision-making power. In a typical credit card transaction,
the person who makes the choice of payment instrument is usually the cardholder, but the
transaction fee is incurred by the merchant. In simple terms, the cardholder makes the
decision but the merchant pays the fee.
The interchange arrangements that underpin this fee structure have tended to be configured
in a way that rewards issuance and usage of cards while adding to merchant costs. We have
observed in this structure that competition tends to push fees up rather than down because,
the higher the fee, the greater the capacity to reward cardholders for using a given card.
Scheme rules prohibiting surcharging have had the effect of reinforcing that pattern, because
they prevent price signals from flowing to the person who chooses the payment instrument.
This was the basic logic for the decision to prevent schemes from making rules against
surcharging.
A decade later, what can we say about the effects of that decision?
I can best answer that by describing the results of the reform package as a whole, because
the different elements of it were closely inter-related. The clearest impact has been a
reduction in card payment costs. In the case of the four-party credit card schemes, the
average merchant service fee has fallen by about 60 basis points. Although the three-party
schemes are not regulated in this way, they have voluntarily accepted the surcharging
standard and have been subject to some of the same competitive pressures. As a result,
merchant service fees for the three-party schemes have fallen by a similar amount.
Since the adoption of the reforms, the prevalence of surcharging has significantly increased.
According to data from East & Partners, around one-third of Australian merchants now
impose a surcharge on at least one of the credit cards they accept. The figure is higher for
the largest merchants1, where the proportion surcharging is slightly over half. It also seems
likely that surcharging will become more widespread in the future - only 12 per cent of
merchants say they are not at least considering applying a surcharge.
In the early stage of the reform process the Payments System Board considered, but did not
proceed with, an alternative approach that would have allowed schemes to limit surcharging
to an amount linked to the cost of acceptance2. The Board's view, on balance, was that
giving merchants the right to surcharge was important in realigning incentives and in giving
merchants more bargaining power in the determination of fees. The Board also took the view
that market forces could be expected to work as a discipline against excessive surcharging.
The growth of surcharging has, however, brought to light practices that look inconsistent with
the efficiency objective. While comprehensive data are not available, there is significant
anecdotal evidence of some surcharging that is not reasonably related to the cost of
acceptance. One example is the practice of blended surcharging, where a merchant might be
recovering costs on an average basis without distinguishing between high- and low-cost card
payments. Another would be where a surcharge simply exceeds any reasonable estimate of
the cost of acceptance. Although these practices do not appear to be widespread, they are of
concern from a payments efficiency point of view because they can distort consumer choices
about the payment methods that they use. They go against the principle I stated earlier of
allowing the efficient flow of price signals to the economic decision maker. It is for these
reasons that the Bank reopened consideration of the surcharging standard last year
A draft revision to the standard was released in December, and is now in the final stage of
consultation. If adopted, the revised standard will allow schemes to limit surcharging to a
reasonable cost of acceptance, but schemes will not be able to prohibit surcharging
altogether or prevent merchants from recovering their costs. For this purpose, the cost of
acceptance will be defined as including, but not being necessarily limited to, the merchant
service fee.
I want to stress that we should not view this change as a panacea that will do away with
every consumer complaint. It is also important to make clear that the Reserve Bank is not
setting itself up as a regulator of merchant behaviour. What the proposed standard does is to
empower the schemes to take action where surcharging is clearly excessive. It will be in their
own interests to make use of this power. At the same time, the proposal preserves the
original goal of giving merchants the right to recover their costs. In that way I think it strikes a
reasonable balance and it should strengthen the incentive for schemes to compete in
lowering their fees to merchants. The less a scheme costs to merchants, the lower will be the
permissible surcharge.
The second policy area I want to talk about is the Reserve Bank's strategic review of
payments innovation.
This was the subject of my talk here a year ago and so I can be much briefer in my remarks
today.
When we talk about innovation, we need always to keep in mind the distinction between what
is proprietary and what is systemic. The proprietary sphere covers any area where a service
provider can act independently and use an innovation to gain a competitive edge. The
payments industry is very good at innovating in that way, and we see the evidence of it in
many of the things that are being talked about in today's conference. Systemic innovation is
much harder to achieve because it requires co-operation in the collective interest, even when
there may be no strong proprietary benefits at the level of the individual service provider
It's this second area that is the focus of the current review. We are asking the question, are
there any gaps in the system that can only be addressed collectively, and if so, how do we
make that happen?
Submissions to the review have been helpful in identifying a number of gaps of that nature.
Here are the main ones:
Transmission of data with payments. This has been a long-time concern of
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businesses, who often find the 18 character limit under the Direct Entry system too
restrictive. Often this drives businesses to use cheques so that paper-based
information, like an invoice, can accompany the payment. Alternatively they might
separate the payment and the remittance information, and then rely on a separate
process to reconcile them at a later stage. This is likely to be expensive and error
prone.
 Use of international standards. I won't dwell on this one, but in some ways it is
related to the previous point, because the international framework for messaging
standards provides for transmission of a significant amount of additional data. I think
there is widespread acknowledgement within the payments industry that
international standards should be adopted wherever possible.
 Timeliness of Payments. As communications technology advances, there is little
doubt that people are expecting greater immediacy in many areas, and payments
are no exception. It is currently not possible for me to make a payment to someone
who banks with another bank and for them to be able to use those funds within a
short space of time. In some circumstances this lack of capacity can be a significant
problem - for instance when someone is waiting on an emergency government
payment. This seems like an area we could improve on and it is increasingly
becoming a focus overseas. Likewise, the fact that payments cannot occur between
banks out of normal business hours seems out of line with the 'always on' world we
now live in.
 Addressing Payments. Cheques are always a good reminder of the things that are
missing in our electronic payments. I can pay someone with a cheque when all I
know about them is their name. But if I want to make an electronic payment, I
typically need to know a 6-digit BSB number and a 9-digit account number, things
the receiver probably cannot readily provide. People are finding partial workarounds
that make use of mobile phone numbers or email addresses, but we are yet to have
a truly seamless system.
All of these are areas where any progress will have to be made co-operatively, because they
are characteristics of the network, not just of the individual players. But that also means that
a decision to move ahead in any of these areas needs to take into account the costs and
benefits across the system as a whole, both for service providers and end-users.
That raises the broader question of whether there needs to be a change in governance
arrangements in the industry, so as to make them more conducive to innovation in general.
There are a number of reasons why co-operative innovation can be hard to achieve. Industry
participants have differing commercial interests, and even factors like the timing of their
investment cycles can make coordinated actions difficult. A change in messaging standards
or timeliness of payments might benefit the public, yet remain hard to achieve because there
is no proprietary benefit to the individual service providers. The challenge is to find a way of
determining when innovations of that nature are in the public interest and, if so, to ensure
they go ahead. Industry-level decision making may be only part of the answer.
Along with these questions of governance, the critical decisions of the review are likely to
relate to the architecture of the payments system. By that I mean in particular the question of
whether there is a place for additional centralised architecture in the Australian payments
system. A possible argument for that proposition is that centralised systems may be better
able to innovate than bilateral systems. They may also be structurally more efficient when a
network has a large number of participants, and better suited to providing open access to
new players. The possible need for a centralised architecture is also relevant to the question
of faster (or real-time) payments at the retail level.
The consultation process has brought out a range of views on this subject. Some argued that
the existing architecture provided a sufficient level of centralisation, or pointed to the potential
cost of moving existing systems onto a hub. Others focused on the potential for some form of
hub to provide real-time retail transfers and went as far as proposing a governance
framework for such a system. We should be in a position to announce some conclusion on
that in the near future, along with the other matters I've outlined today.
Let me turn briefly to the third and fourth areas of current policy work.
Issue number three is the regulatory framework for the eftpos system.
One of the very significant developments in recent times has been the establishment of ePAL
as a national scheme for eftpos payments. The Reserve Bank has welcomed that
development because we see it as strengthening competition among card payment schemes
in the domestic market.
As a consequence of the establishment of ePAL, the eftpos system now works largely as a
multilateral network. But much of the existing framework - the Access Regime and
interchange fee standards - was designed in reference to the earlier bilaterally-based
system. As a result, the relevance and applicability of the existing framework will need to be
reviewed.
One change that has already been made was the decision in November 2009 to bring
multilateral eftpos fees under the same interchange fee standard as applies to scheme debit
cards. But further changes to all elements of the regulatory framework for the eftpos system
will need to be considered. Some of the reasons for that are purely technical, because the
regulations as they stand do not reflect the system's current structure. But there are also
some more substantive questions as to whether we need to maintain the currently existing
arrangements and, if so, in what form. We expect to complete the consultation on those
questions and reach conclusions later in the year.
The fourth issue on which we are currently consulting is retail payments system
resilience.
Much of the work of the Payments System Board over the years has been in regulation and
oversight of what we might call self-contained systems: things like a credit card network, or a
clearing and settlement facility. But the Board's remit extends more broadly to the efficiency
and stability of the payments system as a whole. On any common sense reading, the
payments system encompasses the capacity of person A to make a payment to person
B when they bank with different banks. The ability of the system as a whole to deliver that
basic service, dependably and efficiently, clearly comes under the Payments System Board's
overall policy mandate.
That is why it is appropriate for the Board to be conducting the innovation review that I've just
outlined. It relates to the efficiency of the system as a whole. It is also why it is appropriate
for the Board to take an interest in the operational resilience of individual payments service
providers.
In recent years there have been a number of high-profile outages affecting the availability of
services to significant numbers of customers. Obviously individual banks have a strong
incentive to minimise the risk of these sorts of incidents. It affects their own reputation when
something goes wrong and it impairs their ability to meet the needs of their customers.
But there is also a system-wide dimension to these problems. All participants in the system,
and all users of payments services, have an interest in high standards being maintained
across the system as a whole, not just their own component of it. When Bank A's systems go
down, customers of all the other banks are affected, because their capacity to exchange
payments with customers of that bank is impaired.
For some time the Reserve Bank has been monitoring significant retail payment outages,
and following up with the relevant banks as to diagnosis and appropriate remedial actions.
So in a sense, a role for the RBA in this area is not new. What we are now proposing is to
formalise that role in two ways. First, we have announced that we will be putting in place a
more systematic reporting regime for retail outages. And second, we have begun a
consultation process with the banks as to whether further measures are needed to improve
operational resilience across the system.
Conclusion
Those then are the four areas in retail payments regulation where the Reserve Bank is
currently conducting consultations with industry, and with other interested parties. What ties
all of these things together is the focus on efficiency and competition. In many ways
competition is working well to deliver benefits to end users. But in an industry of complex
network interactions like this one, there is an important role for regulation in promoting
efficient outcomes.
As I said earlier, in carrying out that role the Payments System Board takes very seriously
the need to consult, both with industry and end-users. Many of you here today will have
participated in that process, and I take the opportunity to thank you for your co-operation.