Credit card associations, such as MasterCard, Visa and Bankcard, set interchange fees for transactions between members of the association. These same members often compete with each other on various aspects of a credit card transaction. The fact that interchange fees are the outcome of cooperation among firms that otherwise compete with each other, raises suspicion as to their efficiency and potential anti-competitive impact.
In the United States, several anti-trust actions have involved credit card interchange fees. For example, NaBanco, a potential merchant acquirer, brought an action against the Visa association alleging that the interchange fee was set prohibitively high. NaBanco claimed that the fee effectively excluded entrant acquirers and favoured incumbents who operated as both issuers and acquirers. That suit was dismissed but controversy remains with the U.S. Department of Justice, in 2000, initiating proceedings against MasterCard and Visa relating to dual membership by various banks in these associations.
In the United Kingdom, the Cruickshank report expressed concern that interchange fees were set too high. The report argued that high interchange fees reduce the efficiency of the payments system and that the interchange fee and other aspects of card associations should be subject to tighter regulation.
Interchange arrangements in Australia are similar to elsewhere. and concerns have been raised about their efficiency and whether they facilitate competition or collusion. The 1998 Wallis report into the financial system recommended further investigation. The Reserve Bank of Australia (RBA) and the Australian Competition and Consumer Commission (ACCC) began jointly investigating these issues in 1999. They have recently reported fin dings that essentially mirror those of Cruickshank. In addition, the ACCC has alleged that the current centralised determination of interchange fees represents potential price fixing by leading banks.
The aim of this paper is to investigate the role of interchange fees and any potential inefficiencies and anti-competitive detriments that might arise from these fees. The academic literature on this topic is limited. We draw upon and extend this literature, paying particular attention to the Australian environment and the potential for regulation of interchange fees. As will become apparent below, our conclusions are stark. Some reasonable economic assumptions lead us to conclude that regulation of the interchange is at best, innocuous and, at worst, could seriously undermine the efficiency of the payments system.
The remainder of this paper proceeds as follows. The next two sections define what a credit card association does and considers the roles and choices of the four key participants in open loop credit card associations – customers, merchants, issuers and acquirers. In Section 4 we consider the various externalities between these participants and how different rules and restrictions may affect the efficiency of the credit card as a payment instrument. One of these mechanisms is the use of an interchange fee to share costs among issuers and acquirers. Section 5 considers the role of the interchange fee in more detail while section 6 provides a thorough analysis of its effect on competition. In section 7, we turn our attention to consider some issues that arise from the RBA/ACCC Joint Study into interchange arrangements in Australia while a final section summarises our conclusions.
