The banks and credit card companies are digging in against much-need credit card reform when it really is time to act.

Well done, at last, now do it

Taken on its own, the Reserve Bank’s Consultation Document (CD) on credit card schemes is commendable mainly for the proposed limits on ‘eligible costs’ that card issuers may recover in transaction interchange fees — and one may fairly wonder what material costs, if any, will be deemed ‘eligible’.

One can also appreciate the Bank’s proposals to both allow new entrants (access) to the schemes and to allow merchants to recover (surcharge) the additional costs of credit card transactions. However, neither of these complementary proposals is likely to be of much practical import. This is especially so if lower interchange fees do reduce both the incentive to be a card issuer and the additional costs to merchants that might be recovered as surcharges. The ‘Commissioned Report’ prepared by Professor Michael Katz, was also welcome — particularly the demolition there of the contrived defences mounted by the promoters of credit card schemes.

Taken together, the Bank made a useful contribution to resolving policy issues of global relevance and should now proceed to put the standards in place.

The following discussion is under the headings of’ ‘the sorry history’, ‘the broader scheme of things’ and ‘legal authority’.

THE SORRY HISTORY

The Reserve Bank understood well that bank credit card schemes were offensive for many years in the 1990s but chose to obscure the situation and do nothing about it. However the open disclosure, in 1999, of this ‘secret bankers business’ for the first time put issues on the table in a way that the Reserve bank could no longer ignore.

Under pressure to properly address credit card schemes, the Reserve Bank has done so slowly and reluctantly, and at considerable unnecessary cost to the community. Nonetheless, the Reserve Bank may now, finally, be ready to run a good race — it seems to be on the right track, in the starting stalls and facing the right way — but the lawyers may hold up the start.

The Reserve Bank has not always been on the right track. The ‘lost decade’ of the 1990s is still to be accounted for by the Reserve Bank. The following gives some clues about where to look.

1991 – 92

The spotlight fell on credit card schemes in 1991 when, among other things, the Prices Surveillance Authority (PSA) conducted a review of credit card schemes ahead of allowing annual fees to be charged for issuing credit cards. In the Reserve Bank, the Australian Payments System Council was addressing related issues (ineffectively) and work was also being done to re-cast the statistical collections about transaction card activity into their present format.

One way or another the PSA was led a merry dance by the banks’ ‘evidence’ that their credit card schemes had been unprofitable for the previous 15 years but were then ‘edging into the black’.

The banks’ evidence to the PSA was coloured by the imaginative ‘transfer pricing’ of services provided within banks to their credit card business units, so as to erode and disguise the otherwise excessive profitability of these schemes. The Reserve Bank did not make a submission to, nor give evidence to, the PSA inquiry but it did liaise with PSA staff. In the event, however, the PSA report in October 1992 was constrained to relatively narrow issues associated with ‘annual fees’. At that time (9 October 1992) the PSA undertook to address the ‘price fixing issues’ in the context of its ongoing surveillance of credit card schemes. It was not done.

The re-casting of the Bank’s ‘transaction card’ statistical collections was designed to show transaction activity on credit cards with that for debit cards. The expectation was that by juxtaposing activity data for these functionally very similar products it would expose the excesses associated with credit card schemes. The draft statistical collections were cleared with the banks CEOs and, among other things, provided for the disclosure of revenues from fees flowing to issuers of credit cards and from issuers of debit cards. However, just prior to the collection commencing, it was decided in the Reserve Bank that the elements relating to revenue collections be deleted.

The publication of the transaction card statistics commencing in the May 1995 ‘Bulletin’ was less effective without this complementary information contrasting the revenue flows. The public disclosure of the relatively very profitable character of credit card schemes was not achieved. The Australian community subsequently paid a high price for the chosen weakness in the design of this statistical collection.

‘1995’

In 1995 it was not ‘politically correct’ to be identifying the obvious excesses of credit card schemes and the ‘clever’ if not outright deceptive, misleading and ‘gouging’ behaviour associated with the marketing of credit card products.

It is what happened in the Bank around this time, in terms of not dealing properly with issues associated with credit card schemes, that most needs to be examined in the light of the more correct attitudes now prevailing in the Bank. It is now approaching mid-2002 — some seven years later — that the issues are, hopefully, about to be dealt with properly. The community paid dearly for the Reserve Bank’s failure of intellectual character in this respect in the mid-1990s.

By the mid-1990s existing problems with credit card schemes were being exacerbated with ‘clever’ marketing approaches. Customers intending to borrow on their credit card accounts were offered a credit card without annual fees or an interest-free period but with the attraction of a (marginally) lower but still high lending interest rate. Beyond that, it is now well understood that giving ‘rewards’ to credit card use was a mechanism promoting the overuse of credit cards as a transaction medium to the benefit of some card issuers. Concurrently the ‘minor’ banks, building societies and credit unions were recruited as issuers of a hybrid product (Visa Debit). This product purported to be a debit card but issuers encouraged it to be used in ‘credit card’ mode so as to reap the high transaction fees — improperly advertising that “this was a way to avoid transaction fees”. More generally card issuers withdrew ‘benefits’ — for example, backdating (high) interest charges to the date-of-purchase if money owing on a “free period” card were not paid in full by the due date. Generally a well-recognised problem — credit card schemes — was getting worse rather than better.

The clear illustration of the Bank’s shortcomings in this context at this time is the Annual Report of the Australian Payments System Council released in late 1996. The initial intention to use this report as the vehicle for exposing the excesses of credit card schemes (and the benefits of debit cards) was abandoned. In its place was substituted a bland description that simply accommodated banks’ practices without insightful analysis or serious question. The report said “no attempt has been made to pass judgment on current practices” and went on to describe the way transaction card services were provided by banks in terms that implicitly put an official imprimatur on what banks were doing. This ‘dynamited’ the hope that the Wallis Committee would be armed by the Reserve Bank to encourage reform of this element of the retail payments system.

Consider the following.

This 1996 report relegated to a non-committal footnote a bland description of the even then known-to-be-bad product, Visa Debit. The 2001 Consultation Document now says ” The Reserve Bank has advised Visa that this .. (product) … has no place in the Australian payments system”. This could have been said without reservation in 1996. It should have been said then. It was not said.

About the ‘principle’ of interchange fees for credit card transactions paid by merchants and recovered in retail prices, the 1996 report was quite culpable. Having identified the funding requirement for ‘free period’ cards and attributed the benefit to merchants, it went on to say “Thus, the merchant is expected to contribute to the cost of the card issuer extending credit to customers. That is, the interchange free represents the merchant’s contribution to the card issuer”. The Reserve bank was given a second chance to properly analyse this issue in its October 2000 report on debit and credit card schemes. The Reserve Bank then ‘conceded’ that customers as well as merchants were beneficiaries of ‘interest-free’ periods but said: “in the absence of any objective criteria, a reasonable benchmark might be to include up to half the cost of the interest-free period in the interchange fee” (paid by merchants). Half right was not right.

Given a third chance, the Reserve Bank has now finally answered the question correctly in the Consultation Document. The telling words were: “In the Reserve Bank’s view, since the provision of the interest-free period is a matter exclusively between individual card issuers and their customers, passing the cost of the interest-free period to merchants through interchange fees would not meet the Reserve Bank’s principles for interchange fee setting”.

Intellectual integrity

As between 1996, 2000 and 2001 relevant principles for analysing the relevance of ‘free credit’ to interchange fees did not change. The ‘analytical errors’ in the 1996 and 2000 reports are more correctly seen as evidence of the lengths to which the Reserve Bank went to protect the banks.

The obvious “Bob-the-Builder’ counter argument, against merchants paying for ‘free credit’ given by banks to their customers — that home builders do not pay banks commissions on loans to homebuyers — though readily accepted now, was not at all acceptable in 1996 and was only half acceptable in October 2000. The Reserve Bank judgment of this issue in 1996 and 2000 is now — six years later — seen to have the character of analytical recalcitrance that beggars belief. It did then, too.

The contemporary significance of this abandonment of intellectual integrity in the Reserve Bank cannot be understated. In 1996 a formal inquiry into the financial system was underway — the Wallis Committee — and looking for submissions about appropriate reforms to the banking industry, including the retail payments system. The 1996 report of the Australian Payments System Council was as close as the Wallis Committee got to a submission from the Reserve Bank on retail payments system matters — and, as we now know, that ‘submission’ was manifestly inadequate. Those in the Reserve Bank that might have made a more forthright private submission to the Wallis Committee were counseled against taking that course. Nonetheless, enough of the underlying truth of these matters got through to enable the Wallis Committee to recommend a review of credit card schemes, particularly interchange fee arrangements.

This brief anecdote about the inappropriate development of payment system policy in the Reserve Bank, circa 1990-2000, does not of course do full justice to the down and dirty detail. To anyone with a reasonable comprehension of what happened — and what did not happen — this episode does not reflect at all well on the character of the Reserve Bank as an important repository of community trust.

If the purpose served by formally reviewing this sorry history was to repair and restore the intellectual integrity of the Bank’s work in this area, it would be time and effort well spent. The lesson is unlikely to be learnt, however, unless and until the failure and its related consequences are acknowledged and redressed. The Reserve Bank might now like to give consideration to doing this.

In summary, the performance over the 1990s of an important part of the Reserve Bank’s responsibility to the Australian community fell far short of what was required and what could reasonably have been expected — and it was deliberate. The long and drawn out process of recognising the way credit card schemes inappropriately re-distributed many $ billion from bank customers to banks was, for the community, a very expensive educational process for the slow and unwilling learners in the Reserve Bank. Among other things, the amount of money involved is well in the ballpark of issues being addressed in the context of the HIH Royal Commission. There is a strong case for a separate public inquiry.

Still the wheels continue to turn slowly. The Wallis Committee reported in April 1997 and it has taken some five more years for the ‘responsible’ regulatory authorities to ponderously come near to properly addressing the credit card issue. Moreover, having become bogged down with the mishandled credit card matter, the Reserve Bank has been unable to perform properly its broader responsibilities for payments system reform.

THE BROADER SCHEME OF THINGS

Nothing much really doing at the RBA

Since the establishment of the Australian Payments System Council in 1984, the Reserve Bank has had primary responsibility for public policy affecting the efficiency and soundness of the Australian payments system. This allocation of responsibility was underscored by the passing of the Payment System (Regulation) Act in 1998, and by the associated establishment of the separate Payments System Board in the Reserve Bank.

Making credit card schemes a focal point of the reform of the retail banking and payment system was always a ‘sideshow’, a means to an end — a simple way to expose the shallow insincerity of the ‘commitment’ to reform the retail payments system. Nonetheless it is an important issue because the bad character of pricing practices associated with credit card schemes was so clear as to make inexplicable the initial ‘denial’ and subsequent lengthy delay in bringing those schemes (almost) within a proper public policy framework.

The Reserve Bank’s failure to address these issues properly over such a long time highlights concerns about the Reserve Bank’s approach to payments policy development and administration — concerns that are reasonably ongoing.

The last ‘annual’ report of the Payments System Board was released eighteen months ago, in October 2000. There has been no real effort made to bring the community up-to-date with the development of the payment system subsequently. Putting aside the generally brief and unstructured discussions of payment system issues with the Parliamentary ‘Banking’ Committee (EFPA), no speeches have been made in the normal course by either the Governor or senior, payment-system policy officers of the Bank. Being unwilling to appear in public is a worry.

In the late 1980s and early 1990s it was customary for the Bank to take opportunities to speak publicly about the development of the payment system and related policy issues — but it is not the custom now. The last public speech about retail payment system issues given by a senior Reserve Bank officer, was at a hastily contrived (and poorly attended) ‘payment system’ conference in June 1999, just prior to the breaking of the ‘cash for comment’ saga involving the Australian Bankers’ Association. The June 1999 speech “The Role of the Payments System Board” given by the Deputy Chair of the Payments System Board is mainly memorable for its closing ‘cricketing’ analogy,

“Those who expected — or feared — that the (Payments System) Board would begin to swing lustily as soon as it reached the crease can be reassured that it is more interested in building a long and carefully constructed innings. Payments system evolution is that sort of match!”

This revelation of the studied determination in the Reserve Bank to do nothing at all quickly about reforming the payments system was unfortunately, apparently, quite sincere. The promise has been kept to the letter and the reference to a concept related to ‘quick’ was redundant. Whatever has been going on in the Reserve Bank on payments policy, it is ‘not cricket’.

The credit card ‘sideshow’ has somehow become the main event and seems likely to remain so. Those subscribing to a deeply held view that ‘justice has not been done until the lawyers have been paid’ would be salivating, unable to believe how useful an ass can be. Simply ‘fixing’ the law is apparently too easy.

Much really does need to be done, however

The contrast of the ‘nothing much doing’ at the Reserve Bank with the pressing need to deal vigorously with a range of retail payment system issues, could hardly be sharper. And we have no up-to-date report of what has been happening — only what should have been happening about credit card schemes a decade ago.

There is a raft of payments-policy issues that should have been dealt with resolutely by the Reserve Bank while everyone seems to have been watching the credit card fire. Among the issues:

* BPay needs to be dealt with. BPay is a scheme modelled on banks’ credit card schemes but more offensive, if only because it was launched in 1997 in defiance of the growing disquiet about ‘interchange fees’. The promoters paraded the scheme to the media as ‘cleared’ with the Reserve Bank and ACCC when it was not and then disregarded the Reserve banks ineffective ‘wish’ to be properly informed about the scheme;

* the probabilities are that the direct debit, the cheapest and most efficient instrument for regular retail bill payments (but least profitable) has continued to languish as ‘relatively unpopular’ because it is not marketed effectively by the banks and the Reserve Bank has been unable to deliver on its plans to promote acceptance among billing companies and the wider community;

* the probabilities are that the cheque continues to be grossly overused by small businesses notwithstanding that it is the most expensive means by far for making retail payments;

* in the past 18 months, banks commenced offering a very cheap payments facility over the internet — pay anyone, anywhere, anytime — but as far as the public record goes the Reserve Bank has yet to bring this innovation and related policy issues (e.g. industry standards) to the attention of the wider community. The community takes reassurance from the Reserve Bank putting its imprimatur on bank payment schemes (and this pay anyone scheme seems to be so deserving — more so than credit card schemes in 1996);

* the use of debit cards has continued to lag because the false and contrived popularity of the banks’ credit card schemes overwhelms them in the public mind. A long overdue resurgence in the growth of debit card usage is the counterpart of the Reserve Bank ‘fixing’ banks’ credit card schemes. Preparatory to that, it would be pleasing to see the Reserve bank deliver on its judgment that transaction interchange fees have no place in the debit card network. Above all it would be enlightening to have an assessment from the Reserve Bank as to why banks do not offer an ‘overdraft’, line-of-credit with customers’ debit card accounts. [As an aside, it is almost perverse for the Reserve Bank to ‘move’ on credit card schemes before fixing the interchange fees situation for debit card transactions. Smaller banks and credit unions may be ‘broken’ by not getting interchange fees for fewer credit card transactions while continuing to pay interchange fees for more debit card transactions];

* the option for customers to access their debit-card accounts over the phone (as a credit card account may be) is not offered nor are the various automatic ‘protections’ against ‘disputed transaction’s and ‘failure to supply’ that come with credit cards — an EFT code-of-practice designed to protect customers is apparently used as a barrier to giving these concessions to the customers; and

* the prospect of a widely useable ‘electronic currency’ as either ‘stored value cards’ or as anonymous ‘internet money’, seems to be as far away as ever notwithstanding the should-be redundant, conventional technology of paper notes and metallic coins.

All of these areas of useful policy development are apparently ‘deferred’ while the seemingly never-ending chase goes on for the elusive credit card bandits.

LEGAL AUTHORITY

Underpinning credit card schemes in Australia is an arrangement between the member banks that fixes a price for credit card transactions — the interchange fee — in ways that return excessive profits to member banks.

This arrangement has been in place for many years notwithstanding a general belief that collusive price fixing against the public interest is prohibited. On the face of it, the community has been let down by ineffective law yet, over many years, there is no record of calls for legislative reform from the responsible authorities, including the Reserve Bank. The situation reasonably calls for both explanation, reassurance and practical demonstration that appropriate legislation is now in place.

The legal footing

The Reserve Bank effectively took over the prosecution of the credit card case in December 2000. Then, in the course of an appearance before the Parliamentary ‘Banking’ Committee, the Bank alluded to weaknesses in the ACCC prosecution of banks under the trade practices law and foreshadowed its intention to step in, using the new law relating to the regulation of payment systems. The Bank did not, however, allude to the likelihood of a legal challenge to any standards it might ‘impose’.

Since then also, there has been no intimation by the Bank of any anticipated weaknesses in the payments system legislation of the sort that were expected to frustrate the ACCC’s ‘price fixing’ prosecution. It would be disturbing if the implementation of the Bank’s proposed standards, were also to be frustrated now by legal maneuvering — and nothing had been done to identify and fix deficiencies in the law.

As the record stands, the community has the implicit assurance of the Reserve Bank that the payments system law is adequate. Much as one might hope that is so, the banks do not seem to share that view.

Catcalling bankers

For the most part the release of the Consultation Document appeared to be well received by the media and the wider community. There was probably a bored sense of deja vu as both had been walked around much the same ‘outrage/promises’ course a few times in the past couple of years without practical consequence. Nonetheless the sense that something potentially useful had been done by the Bank was evident in the shrillcatcalling protests of the bankers and scheme promoters likely to be affected when the draft standards are imposed.

The subsequent public discussion has been one-sided. The rhetoric from the bankers’ side of the street is of uniformly low-grade, protesting ‘loudly’ against the Bank’s proposals but without posting any considered written defence of the banks’ position.

What captured attention was the alacrity with which the bankers went on the front foot to the media making shallow, derisory and contradictory remarks that could be construed as disrespectful of the Reserve Bank (and the Parliament). What did not capture attention was any public response from the regulatory authorities to this public display of disrespect — at the minimum banks might have been asked to put up — a considered, thoughtful response — or shut up.

Public displays of one-upmanship are done for a purpose. The general community will be disappointed if this catcalling behaviour were subsequently seen to have scored when the game is decided and this shallow disrespect subsequently rationalised as a legal challenge to decisions by the Bank.

Taken at face value, the bankers’ public display of disrespect is perhaps indicative of banks having advice that the legal footing on which the Reserve Bank stands is unsound. One hopes not. Perhaps, however, they will play for ‘delay’ anyway — that is a real worry.

Review of trade-practice law

The legislative and regulatory framework needs to be made sound.

In the lead up to the November election, the government promised a review of the trade practices law and its administration to be completed by August 2002. Though the timetable has ‘slipped’, presumably the review will proceed. One might expect that the credit card matter would be a useful case study for anyone reviewing the effectiveness of Australia’s trade practices law and its administration.

No doubt both the ACCC and the Reserve Bank will make submissions in the review process. Imposing standards on credit card schemes will sharpen Reserve Bank thinking on these issues.

One question on the table will be whether to fix the trade practices law so as to avoid a repeat of the situation where the ACCC prosecution of banks for price-fixing credit card services was aborted. Similarly the Bank has probably been considering its legal authority in the context of an expected appeal against a decision to implement standards for credit card schemes.

Taken together there is a question about the most appropriate regulatory authority for trade practices matters in the retail banking industry — the Bank or the ACCC. Hopefully a genuine quest for effectiveness will override any ‘self-interest’ otherwise likely to colour the preferences of these agencies.

One approach to strengthen the trade practices law, and avoid protracted appeals, would put the burden of proof on parties to agreements about fixing prices. Such agreements could simply be proscribed unless the relevant trade practice authority has approved them. The current situation is not tolerable — ie: banks agree to do things against the public interest (and do those things) but, when challenged, appeal their right to do so while continuing to do those things. The law may be an ‘ass’ at times, but there is no need for ‘us’, or our representatives, also to be.

END PIECE

The view that interchange fees in credit card schemes are unfair and underwritten by an ‘illegal’ price fixing agreement between members of credit card schemes, is widely held by informed observers around the world. Remarkably, however, the arrangement continues in place, practically untouched. It is well past the point where the community is entitled to an explanation of why the appointed regulatory authorities — the ACCC and Reserve Bank — have been so ineffective and submissively powerless. Why have they continued to ‘soldier bravely on’ like a David against a Goliath with a ‘sling shot’ but without a sense of urgent determination. Preferably they would have requested proper support from the Parliament to make these undesirable arrangements clearly illegal, rather than ‘probably illegal, but we can’t ever prove it’. Give us a break.

And the story about sensible, policy-led reform of the retail payments system has hardly begun. The Reserve Bank is yet to even strike a blow on the big game — weaning the major banks off their dependence on the tax-avoiding barter inherent in the ‘swapping’ of ‘no-interest’ deposits and over-priced loans for ‘free’ transaction services. With interest rates now at a cyclical low, it would have seemed an ideal time to take up this policy challenge. No chance, apparently — too much work not to be done.

There should be no mistake about the importance of this next step. Unless and until the Reserve Bank summons the courage to deal with this issue, all the pious talk about ‘competition’ and ‘new entrants’ in the business of issuing credit cards and in retail banking more generally, is just so much claptrap. There has already been too much insincere nonsense talked about retail banking for too long.

The best chance of bringing the banks to heel in respect of their credit card schemes and tax-avoiding barter deals, may well be the ‘Al Capone’ route. It would be a simple and correct step to make taxable in the hands of the customer ‘recipients’ all of the income-in-kind delivered by way of ‘free credit’ on credit card accounts and ‘free services’ on transaction accounts. This simple, direct and eminently defensible approach would put the banks on the back foot immediately. It should be done.

[A very feasible complementary policy would protect the poor and disadvantaged against the banks’ retaliatory impost of high fees on basic banking accounts now free-of-charge.]

Peter Fray

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