Capco institute on European Commission decission on InterChange
Capco Institute wrote a comment on European Commission decission aiming to reduce the interchange fee. Full comment is below:
European Commission decides on InterChange and for once the European consumers should feel relieved
Francesco Burelli, Principal Consultant, Capco
The InterChange fee (IC) is a vital part of a four party card scheme, a payment system involving four separate participants – the cardholder, card issuer, merchant acquirer, and the merchant – without which card payments would not function properly. The role of the IC is to act as a mechanism to adjust for the cost imbalances that exist between the issuer (the bank that issues the card to the cardholder and settles the transaction by collecting the transaction amount from the cardholder) and the acquirer (the bank that provides the point of sales terminal and acquires and processes the transaction on behalf of the merchant). The cost imbalances arise owing to the provision of services provided by the issuers without which the overall card payment mechanism could not operate: for example the payment guarantee without which a merchant would not accept a debit or credit card so easily in lieu of a cash payment.
The IC is collected by the merchant acquirer as part of the Merchant Service Charge (MSC), the fee that the merchant acquirer charges the merchant for the provision of the transaction processing services. It is a pure cost to the merchant acquirer. In fact, it is the biggest cost component that is bundled with the MSC and as such has been the main point of contention between the banking industry and the card payment schemes (notably VISA and MasterCard ), on one side, and the retail lobbies and pressure groups of merchants that have been trying to force a reduction in the charge through regulatory intervention, on the other.
The IC rate is not negotiable between the merchant and its acquirer and it is set periodically by the card schemes on the basis of Activity Based Costing principles, which take place at a country and regional level, involving a number of issuers and acquirers as a statistical representative sample of the industry. The collective setting of ICs by the schemes has been opposed firmly by merchant associations. In some cases the merchant lobbies have acted directly against the four party schemes, including a number of lawsuits in the U.S. alleging collusion, conspiracy, and violation of anti-trust laws at the expense of the retailers. The Merchants Payments Coalition, a representative group of about 20 American merchant trade associations, believes that the collective setting of IC fees violates antitrust laws and costs merchants and consumers around U.S.$30 billion a year. In many other countries, the regulators have taken side with the watchdog in New Zealand that initiated legal actio The European Commission (EC) launched its IC investigations much earlier than the New Zealand regulator. VISA and MasterCard have adopted two completely different approaches to defend and guarantee the survival of such a vital part of a four party scheme: VISA has reached a compromise agreement by cutting fees by 20% in July 2002 and MasterCard has engaged with the EC in a lengthy consultative process that started at the end of 2002 and adopted the disclosure of an audited cost-based approach to address the objections of the Commission.
The European Commission (EC) is due to publish a report on the European retail banking markets in the next few weeks. Based on the information leaked to the press, the document will not include recommendations to change the controversial IC fee structure, although it does accuse banks and credit card companies of maintaining unnaturally high fees. European merchants and retail associations will be outraged by this announcement as they maintain that high IC fees are damaging merchants and consumers by forcing up retail prices as a result of the high costs associated with banking services. Banks and the card schemes, on their part, are likely to be relieved. The consumer who is the party who bears the highest impact is likely to not even be aware of the issue. Merchant lobbies and retail associations will continue to voice their frustration and keep accusing the European card industry of price fixing at the same time as the industry is facing challenges from increasing levels of fraud Australia offers a good case study of what are the most likely consequences of an arbitrary IC reduction. On 1st November 2003 the Reserve Bank of Australia ordered a reduction of the IC rate to about half of its original value. Its reasoning was based on the belief that a lower IC fee would have driven MSCs down and that the merchants would have fully passed on those savings to the consumers in the form of lower retail prices. The regulatory enforcement translated to a lower MSC. Issuers saw their IC revenues falling and as a consequence were forced to find ways to cut costs, including cutting or reducing some card related benefits, such as insurance, loyalty programs, etc. Furthermore, annual fees were applied to cards and issuers migrated non-revolving cards to third-party card schemes (a payment system involving three separate participants: the cardholder, the merchant, and a third-party acting as card issuer to the cardholder and acquirer and the merchant at the same time), as t Instead of retail prices coming down, as it had been originally envisaged, the Australian consumers ended up worse off; it cost them more to hold a card in their wallet, most of card related benefits they were accustomed to were lost, and surcharges were levied by merchants for payments with card instead of cash.
European merchants are already resisting card payments as a plastic transaction is perceived to be more costly than cash and, more importantly, cannot be kept from bookkeeping and be hidden from the taxman. I would strongly challenge the position of the Merchants Payments Coalition and believe that the EC has taken a cautious position by its decision. Not only does this eliminate the risk of dampening consumer appetite for cash substitutes that are so beneficial to the economy, but ultimately mitigates against consumers having to pay more for their transactions in Europe, as was the case in Australia.
Below are links to two Fed papers showing that interchnage fee is country specific and complicated issue