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Diapositive 1

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Title: Diapositive 1 Author: boe Last modified by: Jean-Charles Rochet Created Date: 9/11/2007 3:40:45 PM Document presentation format: Personnalis – PowerPoint PPT presentation

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Title: Diapositive 1


1
Understanding Interchange Fees
Jean-Charles ROCHET Toulouse School of Economics
Prepared for the conference "The Economics of
Payment Systems" ENST, Paris, October 25-26th,
2007
2
1- INTRODUCTION
  • Interchange Fees (IFs) have lately received a lot
    of attention from
  • Regulators, Competition Authorities, and Courts
    of Justice around
  • the world.
  • Recent examples
  • Australia (2002) regulation of IFs on credit
    cards by RBA.
  • UK (2003-2007) Antitrust action against
    MasterCard by OFT.
  • USA (2000-2007) several class actions.
  • Spain (2006) Competition Authority (TDC)
    convinced" banks
  • to reduce IFs (from 1.80 to 1.40)
  • also Israel, Poland, Colombia, Portugal, Mexico
    and of course EU...

3
Introduction
IFs differ a lot across systems and across
countries, both in their levels and in their
formulas. An illustration
Country Debit IF (average) Credit IF (average)
Denmark France Israel Italy Spain UK 0.4 0.24 0.1064 Fraud Element 1.25 0.119 0.18 0.47 0.64 0.75 --- 1.25 0.75 1.30 1.10
4
Introduction
Economic research on the topic is very recent but
already rich Theory Schmalensee (2002) Rochet
and Tirole (2002, 2006, 2007) Wright (2003,
2004), Gans and King (2003) McAndrews and Zhang
(2006), Wang (2006) Farrell (2006), Guthrie and
Wright (2007) Bolt and
Soramäki (2007),Verdier (2007) Empirical Brits
and Winder (2005), Klee (2006) Garcia-Schwartz,
Hahn and Layne-Farrar (2006) Rysman (2007),
Zinman (2007) Ching and Hayashi (2007), Snyder
and Zinman (2007)
Bounie, François and Kiser (2007)
5
My objective here to try and summarize in a
non-technical fashion the points of views of
practitioners and the implications of academic
work. What we know and what we don't know about
IF 2- DOCTRINES (in italics) 3- FACTS (in
boldface) 4- ECONOMIC ANALYSIS (open questions
in red) 5- POLICY IMPLICATIONS
6
2- DOCTRINES
2.1- Cards Systems / Banking Associations
Viewpoint
  • DOCTRINES ARE PRESENTED IN ITALICS (please do
    not cite me on these statements)
  • Open card systems are joint ventures set up by
    banks (issuers and acquirers)
  • IFs are interbank transfers that allow banks to
    share the costs of these
  • joint ventures in a fair and efficient way.
  • Two considerations
  • "fairness" equalize costs/and or profits
  • "efficiency" maximize "value" of system.

7
Doctrines
2.2- (Most) Competition Authorities Viewpoint
Card issuers incur some costs that benefit the
customers of acquirers (the retailers). IFs are
"fees for service" that compensate these costs.
They should not exceed "admissible" costs of
issuers.
System/ Country Transaction Authorization/Processing Fraud prevention /payment guarantee Account Acquisition Management, Maintenance and fixed costs Interest-free period
Australia UK (MasterCard) VISA International France Mexico Switzerland yes yes yes yes yes yes yes yes yes yes partially yes no no no no yes yes yes no no no no yes
Cost elements included in the IFs
8
Doctrines
2.3- Retailers' View Point
  • Retailers associations lobby for a reduction in
    their fees
  • IFs are just a way to put the burden on us.
  • For commercial reasons, we (retailers) are often
    "forced" to accept cards
  • ("must take argument", Vickers 2005).
  • Banks inflate their profits by "taxing" us and
    subsidizing cardholders
  • (air-miles, reward programs).
  • Each side should pay "its own costs".
  • IFs should be mandated at zero (cf "at par"
    regulation of US checks).

9
Doctrines
2.4- The Distortionary View
  • This view is often put forward by non economists
    who paradoxically use an economic reasoning user
    prices are a signal for guiding consumer
    decisions
  • (but their way of applying this reasoning is
    sometimes flawed)
  • Interchange Fees generate several distortions in
    price signals
  • Retailers are forced to inflate retail prices to
    cover IF costs
  • ? consumer welfare reduced when IFs are
    high.
  • Cash (and check?) consumers subsidize card
    users
  • ? abolish no surcharge rules.
  • Debit transactions subsidize credit
    transactions
  • ? "convenience users are parasites".

10
Doctrines
2.5- The Neutrality View
Theory shows that when retailers perfectly
surcharge card payments, the level of IFs does
not impact card usage (neutrality) Gans and King
(2003) and more recently Gans (2007, submission
to the RBA review of payments system reforms)
conclude Much ado about nothing there is no
case for continued careful regulation of IFs
Provided the NDR is lifted, regulation of IFs has
no benefits but costs (compliance and
enforcement) thus it should be abolished Based
on empirical assessment of the RBA reform
Hayes(2007) finds no significant impact
(partially contradicts Chang, Evans and Garcia
Schwarz 2005). Even if there is indeed no impact
on cards usage(?), the reform induced a massive
redistribution between (issuers/cardholders and
acquirers/merchants) .
11
3- FACTS
Some facts (seem to) have been established
empirically 3.1- IFs have an impact on user
fees
IF reductions (increases?) are typically passed
one for one into Merchant Service Charges (MSCs)
but only partially into Cardholder Fees and
Reward Programs. Australia IFs for credit were
reduced roughly by half (0.80 to 0.44-0.46 for
electronic, 1.20 to 0.60 for standard) while
cardholders rewards were reduced roughly 25 and
issuers income (cardholder fees) increased by
roughly 40 (RBA 2005) Similar results in
Portugal, even though there is a quasi monopoly
for acquiring (UNICRE). In Australia, no sizeable
impact on retail prices. Open question for
empirical research are these findings robust?
12
Facts
3.2- Users react to change in fees
  • Recent empirical work
  • Zinman (2007) "pecuniary cost minimization
    account for
  • at least 38 of cross-sectional debit use
    over the period
  • 1995-2004 (50 for 2004).
  • Bounie, François and Kiser (2007).
  • Ching and Hayashi (2007).
  • But difficult to detect any change at aggregate
    level
  • No sizeable decrease in credit card use in
    Australia (after
  • RBA mandated a decrease in IFs).
  • Very often no unit fee nor reward on debit
    transactions.
  • Debit cards are often bundled with current
    account services.

13
Facts
3.3- Fee Structure Matters
Closed systems like AMEX (that do not have
explicit IFs) pay a lot of attention to their fee
structure empirical question estimate these
"implicit" IFs and compare with those of open
systems. Visa and MasterCard react to each
other's changes in IFs (but competition does not
always push IFs down). After Honor All Cards
rule was lifted (WalMart case 2003 in the USA)
IFs decreased for off line debit and
increased for on line (PIN) debit.
14
Facts
3.4- Evidence on Surcharging
Retailers are reluctant to surcharge
Netherlands, Sweden ITM (2000) Australia (RBA
survey of 2279 merchants, June 2006)
corporate commercial SME Micro Total
Currently surcharge Average surcharge 11.6 1.3 8.0 1.6 4.6 1.4 2.4 1.7 5.4 1.5
But the threat of surcharging may be sufficient
to curb down Ifs empirical question.
15
Facts
3.5- Evidence on Multi-Homing
  • Rysman (2007), exploiting Visa PSPS data set on
    US consumers
  • has shown that
  • more than 50 "multi-home" in membership (they
  • own several cards)
  • however they essentially use only one
    (single-homing
  • in usage).
  • New results on this in this conference Snyder
    and Zinman (2007)

16
4- ECONOMIC ANALYSIS
4.1- Usage Externality (Baxter)
  • When a consumer pays by card instead of cash he
    inflicts
  • three externalities
  • the seller has to pay the MSC but saves
    the cost of
  • Cash
  • the issuer incurs a cost
  • the acquirer incurs a cost but receives
    the MSC
  • ? Externality to merchant
  • Total externality (including banks)

17
Economic Analysis
Social welfare is maximum when the consumer fee
is equal to this total externality Total
user surplus (buyer seller) is maximum when
the externality to the merchant is
nil (Farrell's indifference criterion).
18
Economic Analysis
If acquirers are perfectly competitive, the IF
that maximizes Total User Surplus is
(Baxter)
cost of cash for the seller
cost of card for the acquirer
The IF that maximizes social welfare is higher,
since it includes issuers' margin
issuer margin
19
Economic Analysis
4.2- Social Welfare VS User Surplus
  • Competition Authorities often care only about
    user surplus and
  • not about social welfare
  • This is justified if the profit of firms
    (banks) is completely
  • dissipated (business steeling, useless
    advertisements)
  • This is not justified if profit is reinvested
    to provide quality
  • of service or attracts entry (lower prices,
    increased product
  • variety).
  • Long Term User Surplus is maximized for a value
    of IF that is
  • in between and

20
Economic Analysis
4.3- Inter and Intra-system Competition
Intersystem competition tends to reduce IFs, but
only if sufficiently many cardholders
multi-home. By contrast, if most cardholders
single-home (i.e. hold a single card), merchants
resistance to high MSCs is very weak ? high IFs
intersystem competition is ineffective
competitive bottleneck Empirical measurement of
multi-homing is crucial Snyder-Zinman (2007)
21
Economic Analysis
By contrast, if most cardholders have several
cards, it is less costly for merchants to reject
one of them ? low IFs. (close to Total User
Surplus maximum )
W (Social Welfare)
TUS (Total User Surplus)
Competitive IF is in between
(complete multi-homing) and (monopoly or
competitive bottleneck) open question US
enigma competition for issuers ? increase in
IFs
22
Economic Analysis
Intra-system competition drives down banks
margins and therefore total user price The
impact on IFs is less clear
Banks margin
independent of issuer margin
Quality of Service (increases when issuer margin
decreases)
23
Economic Analysis
4.4- Debit VS Credit
So far, theory has paid too little attention to
the substitutability between credit and
debit. Recent empirical work Zinman (2007),
Ching and Hayashi (2007), Bounie, François and
Kiser (2007) indicate that consumers payment
choice is price elastic (rewards, credit
charges). On going theoretical work (Rochet and
Wright, in preparation) suggest that networks
might be inclined to distort IFs so as
to encourage credit use.
24
5- POLICY IMPLICATIONS
  • Systems may be inclined to set excessively high
    IFs (this is
  • because banks' profits seem to increase with
    level of IF)
  • IS THIS A ROBUST FINDING?
  • However, regulating IFs would be a delicate
    exercise,
  • because substitutability between different
    means of
  • payments and long term reactions of the
    industry are
  • difficult to assess.
  • NEED TO MODEL/MEASURE SUBSTITUTABILITY
  • BETWEEN MEANS OF PAYMENT AND LONG TERM
  • REACTIONS OF SYSTEMS
  • Allowing surcharges might be a way to curve IFs
    down
  • but it will not be a panacea.
  • NEED TO MEASURE IMPACT OF ALLOWING SURCHARGES
    ON
  • (NON REGULATED) IFS

25
5- POLICY IMPLICATIONS
  • The conflicts of interests in payment card
    systems have been largely exaggerated merchants
    indirectly benefit from the additional Quality
    Of Service provided by the option to pay by card
    offered to their customers. Even if retailers
    associations legitimately lobby to reduce their
    fees, it is not their interest to go too far.
  • There is a wide perception that inflating IFs
    allow banks to obtain supra competitive profits.
    This may be due to an asymmetric pass through of
    IFs changes into the two user prices. Competition
    Authorities have to find a way to avoid excessive
    IFs.
  • A pragmatic suggestion organizing "IF
    observatories" with representatives of retailers
    and consumers associations. In these IFOs, card
    systems would
  • disclose their methodologies for setting Ifs,
    communicate (average) data on issuing and
    acquiring costs, and advocate for their IF
    decisions.
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