EU to MasterCard: Bah Humbug
As expected the European Commission found that MasterCard’s interchange fees violated the EU’s competition laws yesterday. Neelie Kroes, the czarina of competition policy in the EC, says this is a Christmas present for European consumers who will see lower prices at the stores. That statement is just about the best proof one could ask for that after subjecting the payment card industry to nearly non-stop investigations since the late 1990s the Commission doesn’t have a clue how this business actually works and hasn’t apparently looked.
Bank card issuers make money from interchange fees that merchants pay, and card fees that cardholders pay. When interchange fees go up, card fees go down, and when interchange fees go down, card fees go up. It’s basic arithmetic. Kroes should have taken a look at Australia to see what happens in practice in this business as opposed to the blackboards they must use at the Commission to run the world. The Australian regulators also forced interchange fees down. Guess what? Merchants didn’t pass anything along to consumers (now granted, the Australian retail sector is pretty concentrated) as far as anyone can detect. Banks ended up charging higher fees to consumers and cutting reward programs. Some Christmas present.
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Payments, Regulation, consumers
This move by the European Commission can be termed as irresponsible which would lead to the decline of the Credit Card industry and market competiton in Europe.
The European Commission should learn the lesson from the mistakes committed by the RBA in Australia and avoid doing the same mistake.
Of course one can’t detect any price benefit to consumers. Incidence analysis of this sort is ridiculously difficult and we’re talking about a benefit to merchants of less than 100 basis points. The inability to detect a price benefit to consumers doesn’t mean that it isn’t there. If you’re willing to rely on economic theory without empirical evidence in other instances, why not here?
Actually, economic theory and empricial work on the pass through of price changes predicts that there wouldn’t be much benefit in Australia. A large portion of the retail market in Australia is highly concentrated with some sectors such as supermarkets having just a couple of major firms. In these cases theory predicts and empirical evidence confirms that businesses will pass on only a portion of a cost decrease. So my guess is that a good portion of the interchange fee decrease has thus far gone into the pockets of the retailers and hasn’t been passed on to consumers. The card market in Australia is more competitive and therefore likely to pass on more of a cost increase: in any case we do know what banks did in response to the lower interchange fee revenues–cardholders paid higher fees and took a hit on rewards. Of course, Australia has peculiarties and its experiences won’t necessary say what will happen in other countries.
In any event, I think people who advocate the regulation of interchange fees should bear the burden of showing that the payment system in Australia HAS IMPROVED as a result of this massive government intervention. We have now done the experiment on a massive scale in Australia. We would never approve a drug for sale based on such a massive clinical trial without some demonstration that the drug actually worked. Why should the EC be able to administer the “lower your interchange fee” drug without having to prove, based on hard evidence collected from Australia and Spain which has also lowered its interchange fee, that the drug works?
I’m not quite sure interchange fees regulation will change the revenues that the payment industry rips off as a whole. Interchange fees are rather a way to balance those revenues between the two sides of the market (card issuing and merchant acquiring).
As already said in this post, those financial institutions which will loose interchange fees revenues will likely come back to their cardholders to get what they have lost on the other side. So it’s very likely that putting caps on interchange fees won’t have any significant impacts on costs for merchants and cardholders.
But let’s step back for a while, with regard to the actual purpose of the European Community in its trial to cap interchange fees. The EC has a strong will to lower prices and to ease payments as a whole across EU countries in order to facilitate cross border business.
The EC has taken big steps to achieve its goals, which are likely to be much more effective than regulating interchange fees: facilitating the emergence of new entrants (Payment Service Providers), laying down common standards for the straight through processing of Credit Transfers and Direct Debits … The EC has also designed a common framework for card based payments (the SEPA Card Framework), but unlike what has been done for the CT and DD, The EC has not designed any common standard to support its card framework. I’m afraid that basic technology management theory predicts that without a common and unified standard, the market won’t be able to reach the level of competition and economies of scale required to impact massively bank’s costs structures and, as a consequence, costs merchants and cardholders will bear.
As a conclusion, if a was the EC, I would design a common standard for card processing in Europe instead of putting some caps on interchange fees.