The Fin Review is portraying it as a cave-in but Peter Mair reckons the offer by the banks to the RBA on interchange fees would be far more a sell-out by the regulator.

The following may be jumping at shadows. However, this press report and evidence recently given by the Reserve Bank to the Parliamentary ‘Banking’ Committee (EFPA), is a foundation for some unease in the general community about policy-making processes bearing on credit card schemes conducted by Australia’s banks.

A reasonable impression from the AFR headline is that the banks have now agreed to accept the thrust of the regulation of credit card schemes foreshadowed by the Reserve Bank in the ‘Consultation Document’ issued last December. A more realistic interpretation of this story is that far from the banks having ‘caved in’, it is the Reserve Bank that has been offered the opportunity to do this — a consequence that would more fairly be described as a ‘sell-out’.

What did the story say?

Looking closely at the story, the substance is that three of the four major banks have apparently agreed to ‘something’ but one — the Commonwealth Bank — has not. The ‘something’ agreed to apparently is the Reserve Bank proposals to allow ‘new entrants’ into the business of issuing credit cards and another, to allow merchants to ‘surcharge’ customers for credit card transactions.

Significantly no one (including the banks) attaches any material practical importance to either of these points of agreement. There is little prospect of retailers surcharging normal credit card transactions and even less prospect of new entrants to the business of issuing credit cards (on the contrary, the consensus is that some existing issuers will stop).

What banks have not agreed to is the Reserve Bank proposal to substantially abolish interchange fees payable for credit card transactions. That is the real point of the AFR story. As the debate about interchange fees has unfolded the common interpretation is that the Reserve Bank has proposed to cut the interchange fee from about 1% of purchase values to about “0.3%”. Also in circulation is the possibility that the cut in interchange fees would be to a level of 0.7%, consistent with the proposal eventually put to European banks by the European Commission about a year ago. The Reserve Bank document is also sensibly open to a tighter ‘reading’ — that the permitted interchange fee would be very close to zero.

No interchange fee at all would best serve the community interest. This would mean the effective withdrawal of the credit card product and the issue, in substitution, of debit cards to which is attached the line of credit normally associated with a credit card. Not surprisingly, the banks prefer the status quo but if there is to be a reduction, to make only the minimal reduction proposed in Europe (to 0.7%) the new standard.

The offer in the paper

As I read the story yesterday, the banks were offering ‘not to appeal’ against the Reserve Bank decision if it were to reduce the interchange fee only marginally to 0.7%. However, if the Reserve Bank pressed ahead with proposals to substantially reduce the fee than the offer of ‘no appeal’ would be withdrawn.

The offer to not appeal was accompanied by submissive remarks by Visa — “the RBA is judge, jury and executioner” — and by the Commonwealth Bank — “It is the court of no appeal once again for business in Australia” and ‘banks would have no recourse to appeals against RBA decisions.

Conversely, if the Reserve Bank holds to its hardline, then other comments in the AFR story have a different relevance. Visa said we “might sue the Reserve Bank if reforms damaged the economic appeal of Visa to member banks or provided a competitive lift to Amex and Diners”… and, if its fundamental interests are being compromised, then litigation is a strong option”, followed by “we see this as having a long way to go”.

For its part, the ‘disagreeable’ Commonwealth Bank was also reported as willing to broadening the scope of the debate to include interchange fees on debit card transactions — a tactic that might see the Reserve Bank back at the drawing board for another 18 months, or more.

In short, the banks are bargaining a plea of ‘no appeal’ in exchange for minimal change (0.7%) — but to litigate and otherwise delay effective reform if the Reserve Bank wants more than marginal change to the interchange fee (0 to 0.3%)

Reserve Bank attitude

As noted last week in a paper “A Governor Uneasy” it would be almost incredible for Reserve Bank to now back down, or water down, its intention to substantially abolish interchange fees for credit card transactions. Still the Parliamentary Committee left hanging on the air remarks by the RBA consistent with some rethinking of the proposals foreshadowed in December. There are shadows in play worth jumping at.

More important is the reliance that the Reserve Bank seems to the placing on “there is no right of appeal” (against ‘the outcome’ that it will announce). One can only wonder from where the Reserve Bank got this idea, and why the Chairman of the Parliamentary Committee put the rhetorical question “there is no right of appeal” to the Reserve Bank. Time will tell but one might fairly wonder which legal adviser gave the Reserve Bank and the Parliament this opinion — and the converse, why the legal advisers to the banks and Visa are giving them a different, conflicting opinion.

The question about appeals or not, is a matter of fact that will presumably be answered shortly. The danger is in the offer, the plea bargain, being made to the Reserve Bank. Consider,

* if the Reserve Bank accepts the banks’ plea bargain on 0.7%, then the Reserve Bank will be made to look good — especially after the banks and Visa and MasterCard, promise to over react to a 0.7% decision in a way that would make Jemimah look like an unbridled optimist; but

* if the Reserve Bank presses ahead for 0.3% or less, and the banks go to court, then not only will Reserve Bank look ‘powerless’ but attention will shift to the review of the trade practices legislation and the potential to put in place effective laws against ‘price setting’ and restore the ACCC as the pre-eminent competition regulator, including for the banking system.

That’s why the community should be uneasy. The Reserve Bank is loitering in a Garden of Eden proclaiming its almighty, no-appeal powers while it is concurrently being tempted with a bite of the 0.7% apple.

The RBA probably won’t take the apple but it is a worrying situation that leaves the community in an uneasy position — if the Reserve Bank is soft on the banks again, an ‘appeal’ on behalf of the community would be very difficult to mount. The Reserve Bank’s record in dealing with the banks is not one that is reassuring to those who are keen to protect the interests of the broader community against the banks. (What about BPay? — for example).

In the Reserve Bank, the ‘payments policy’ and ‘financial stability’ functions are conducted in the same division. When payments policy decisions make banks more competitive and make it harder for banks to earn profits, it simultaneously makes it harder in future for banks to recover from any threat that that might emerge to their stability. The Reserve Bank has a conflict of interest.

Ideally the payments policy responsibilities of the Reserve Bank would be limited to issues — ‘settlement’ and so on — associated with stability of the financial system. Ideally the Reserve Bank would not have responsibility for making choices that may make banks more competitive and unable to set prices collectively, but less profitable. This conflict of interest was recognised in the UK where the Office of Fair Trading was given responsibility for banking competition rather than the Bank of England.

Trade practices law and the ACCC

The situation in which the Reserve Bank now finds itself is unsatisfactory. Australia needs strong provisions in the trade practices law against prices being fixed or collectively set, against the public interest. Australia does not need defacto trade practices law that is compromised by the simultaneous pursuit of otherwise conflicting responsibilities.

Proper, effective trade practices law is the imperative. The scope of such effective trade practices law is broader than the banking industry. The expertise needed to identify and assess ‘price-fixing’ in the public interest would preferably be concentrated in the competition regulator — the ACCC — rather than dispersed to other regulatory agencies, including the Reserve Bank. In the UK the resources available to the Office of Fair Trading were augmented by separately constituting a division to deal with banks and the retail financial services industry more generally.

All things considered, the UK approach would probably be best for Australia as well.

A submission to this effect has been made to the TPA Review Committee.

Credit card schemes may threaten bank stability

The ineffective development of competition policy about credit card schemes has perhaps created the very circumstance that underpins a developing a concern for the viability of financial institutions.

Credit card schemes have burgeoned in the past few years while much ‘circle work’ was being done ineffectively aimed at bringing the operation of these schemes to heel in the public interest. Banks have grown fat on excessive profits from excessive interchange fees on credit card transactions will eventually be vulnerable to competition from foreign banks offering cheaper and more efficient retail payment systems, without interchange fees.

This risk is perhaps not so evident in Australia where foreign banks not dependent on credit cards, are only slowly building the transaction deposit base that would sustain a better, different retail payment system. The risk is more evident in the UK where, as part of a united Europe, there is more effective scope for European banks that do not promote credit cards, to offer UK retailers and UK customers linkages to the better cheaper payment systems operated from outside the UK. In the USA some banks have chosen to concentrate their activities on credit card business and their viability is accordingly more effectively tied to continued access to bloated interchange fee ‘fixes’ in credit card schemes.

The circumstances where the bank stability authorities could be looking to cut retail banks off from an unsustainable flow of interchange fee revenue may be coming into range.

End Piece

Unexpectedly, Australia is now in a position to make a useful contribution to the development of retail payment systems policy globally. The action foreshadowed in December by the Reserve Bank is clearly in the right direction. These decisions should now be formally implemented without further delay and the matter of whether there will be an appeal or whether there won’t be, decided by the banks and the promoters of credit card schemes.

Irrespective of that, the TPA review now getting underway should start with a clean slate about proposing effective trade practices law. This need is especially so for provisions that would preclude agreements taking effect about price-fixing or collective price setting, unless and until the ACCC had assessed the agreements. The test would be not only are they in the public interest but also, are they the ‘best’ agreements that could be reached in the public interest to achieve their objectives.

Peter Fray

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