More silliness on interchange fees II

Following on my discovery last week of intense silliness at the Productivity Commission:

Regulation of bank interchange fees and surcharging has proved complex and there is little genuine commercial justification for interchange fees. The Payments System Board of the RBA should ban, by mid-2019, all card interchange fees as a way to lower overall costs to users.

My RMIT colleagues Chris Berg, Jason Potts and I have a new paper up at SSRN.

Ronald Coase famously argued that “if an economist finds something – a business practice of one sort or other – that he does not understand, he looks for a monopoly explanation”. So it is with credit card interchange fees. Intellectual confusion has led to the phenomenon of interchange fees being misdiagnosed as being a monopoly problem leading to inappropriate policy intervention. Following George Stigler’s path breaking analysis of the US Security and Exchange Commission he claimed that financial regulation was “founded upon prejudice and … reforms are directed by wishfulness”. In our opinion, Australian regulatory attitudes towards interchange fees should be placed into the same category: reforms initiated by ignorance and anti-bank prejudice.

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13 Responses to More silliness on interchange fees II

  1. I would love to know the reason for such fees.

    Money moves around electronically and there is no human interaction whatsoever as there is with cash or cheques.

    Banks prefer you to use cards so that there is no manual handling, which saves on costs, so what are the interchange fees about?

  2. Sinclair Davidson

    I would love to know the reason for such fees.

    Read the paper.

  3. Entropy

    Banks prefer you to use cards so that there is no manual handling, which saves on costs, so what are the interchange fees about?

    All that infrastructure and security costs, and gets outdated real quick. Plus government interference and oversight has its own, shall we say piquant costs.

  4. Interchange fees are not a problem of monopoly exploitation, but rather their genuine commercial justification arises as an efficient solution to an unavoidable bilateral monopoly that arises because banks need to form long term relations with customers and merchants – what are in effect irreversible investments that pay off only if the relationship continues – and which are therefore vulnerable to opportunism.

    Blah, blah, blah.

    It sounds like if I went to the Commonwealth bank and withdrew $50 and then went to an ANZ bank and wanted to exchange it for two $20 and one $10 note, there’d be a fee because I didn’t get the original $50 from the ANZ bank.

  5. Sinclair Davidson

    It sounds like if I went to the Commonwealth bank and withdrew $50 and then went to an ANZ bank and wanted to exchange it for two $20 and one $10 note, there’d be a fee because I didn’t get the original $50 from the ANZ bank.

    Exchanging $50 for 2 $20 and a $10 is a spot market transaction that would usually be a zero fee transaction (some banks in some parts of the world would ask if you are a bank customer). Of course that would be a gift from the bank’s shareholders to you.

  6. MPH

    Bemused, in your example you carried out the transport part and the assurance that there was in fact $50, then took advantage of a sunk cost resource at ANZ along with sunk cost of compliance. Not sure it really adds up.

  7. Tom

    Intellectual confusion has led to the phenomenon of interchange fees being misdiagnosed as being a monopoly problem leading to inappropriate policy intervention.

    Actually, it does seem to me to be a quasi-monopoly problem, but not in the woolly-headed way the RBA has characterised it. The monopoly is in the legal status privileges granted to the Big Four Australian banks at the expense of smaller banks, which restrict them from competing with the Big Four on financial services and therefore allow the Big Four to effectively act as a cartel on interchange fees.

    However, the RBA’s “solution” – regulation of interchange fees – is the worst possible result, as an IPA graph, published last week, shows. Regulation will distort the market and result in all sorts of unintended consequences, much like the ACCC’s decision to ban supermarket fuel discounts of more than 4 cents a litre has made fuel more expensive and encouraged the ramping up of retail and wholesale margins at the expense of consumers.

  8. But all of this is simply economists explaining things to economists. It makes no sense to the layman and thus will never convince a layman that interchange fees are nothing more than a rort by banks.

  9. Bruce of Newcastle

    The Payments System Board of the RBA should ban, by mid-2019, all card interchange fees as a way to lower overall costs to users.

    The RBA should ban taxes, as a way to lower overall costs to users of government.

  10. Up The Workers!

    I can understand a fee being imposed for the use of credit cards, but why are (identical?) fees charged when it is a Debit Card and not a Credit card which is used?

    Surely the bank is aware from the card number, which transactions are on credit via Visa or Mastercard, so why are fees charged to the merchant when the customer is using his/her own funds?

  11. Up The Workers!

    Some years ago, we had a customer who lived in (I think) Sweden, to whom we sent an invoice for $100.00 Australian dollars concerning a property she owned in Australia. She paid by bank draft directly to our bank, with an attached covering letter in which she said she was paying the account in full in the amount of $100.00, but our bank only received the sum of $90.00 from her.

    We sent her a receipt for $90.00, together with an invoice for the remaining $10.00, to which we received a reply a week or two later stating that she had actually sent $100.00 in her first payment and thought that somebody at our end of the transaction had pocketed the missing $10.00, but in order to avoid arguments, she was sending another $10.00 to our bank once again in conjunction with the covering letter, for the outstanding amount. There was no $10.00 amount enclosed with her note.

    I went to see our bank manager to get him to investigate the two alleged missing amounts of $10.00 as a matter of urgency, and it turned out that because of the particular mode of payment she chose, her Swiss payment to us, was routed by the banking system through some intermediary bank in either Hong Kong or Singapore, and their “Handling fee” (even though their intervention was entirely unknown to both payer and payee) was a flat $10.00, which they duly helped themselves to, each time – even when the second transaction was only for the value of $10.00, they charged a $10.00 handling fee, leaving nothing left to pay off the customers’ debt.

    What a wunch of bankers!

  12. I can understand a fee being imposed for the use of credit cards, but why are (identical?) fees charged when it is a Debit Card and not a Credit card which is used?

    Yes, credit cards could be considered a form of loan. But the interest payments commence once the monthly statement is produced and if the full amount isn’t paid. That’s what banks hope happens. Miss the full payment by 5c and you accrue interest based on the full amount of the monthly statement.

    So I still don’t understand the interchange fees. Where do the costs arise for the banks that isn’t accounted for in their normal business operating costs? And most credit cards incur an annual fee, which you would think should cover the individual’s use of credit cards.

  13. The BigBlueCat

    If it wasn’t for the rampant, fraudulent use of credit cards, and if cards were only used in the domestic market, interchange might be a lot lower. Plus it’s the main way the card schemes can make money. Do away with interchange and watch the card companies pull out of the market … there would be no incentive for them to remain. There are 2 main players (Visa and MasterCard) – Amex isn’t a huge player, nor are JCB or Diners. So it’s basically a duopoly.

    The issue is mostly about the cost to the merchant and whether they absorb or defray the cost. My view is that the credit user ought to pay for the privilege of accessing the credit, especially if they pay down their credit card balance each month and pay no interest. The credit is short-term, but there is also the case that interchange might be lower, not eliminated. But regulated???? More competition might be the answer. Or offer discounts for cash.

    Debit cards are different – it’s your own money.

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