Would ATM style EFTPOS fees deliver a more efficient payment system?

The banking industry has recently announced that retailers will  be charged (or charged more than in the past) when their customers choose to use EFTPOS rather than cash or a credit card. Media reports have suggested that this may lead to some retailers sur-charging consumers for using EFTPOS.

The EFTPOS consortium (mainly banks) argue the changes to “interchange fees” between banks and retailers are required to help fund needed investment in the EFTPOS system. EFTPOS certainly does have advantages for consumers in comparison with credit cards and even the more recently introduced “scheme debit cards” offered by Visa and Mastercard through banks. It’s biggest weakness is difficulty using EFTPOS accounts for online transactions. One EFTPOS advantage – a more secure and so cheaper system based on PINs rather than signature – will gradually disappear. But by cutting out the middleman (Visa and Mastercard) it may retain a price advantage.

Stephen King argues on the Core Economics blog below that overall the payment system is inefficient as the true cost of payments is hidden from the consumer. He suggests that rather then allow surcharging as with credit cards, a fixed fee could be specified as with ATMs. He regards the ATM reforms as generally successful.

There are a couple of problems with this argument.  That the ATM reforms have been wholly successful is questionable. In promoting the reforms the Reserve Bank and the banks touted ATM fees of close to cost pricing (ie in the range 80c to $1), at least in the major cities, but fees have been pretty much uniformly $2 since the day they started. There is little evidence of competition between ATM providers at all.

It may also be a problem that it’s the EFTPOS consortium that decides how much investment is required in their network and the interchange fee they need to cover it. Consumers (and retailers) get no or little say in whether this is needed, or  how much is spent; in other sectors – energy for example – there are processes which try to balance the need for investment with the need to contain prices for essential services (how well they have worked is another question).

And finally it all depends on the assumption that consumers make rational decision based on such small price signals which are very much secondary to their choice of retailer and choice of payment method. How often do very small variations in price trump other factors that influence decisions by consumers as to which instrument to use – do I have cash in the bank? do I need cash out? am I influenced by award points or other marketing?

The extent to which surcharges can be priced fairly – ie the extent to which competitive forces can keep them down – is a real question. For many online transactions there is no actual or convenient alternative to paying with a card, and once you have eaten the meal at the restaurant you have little choice but to pay up if you don’t feel like running out to the nearest ATM to get cash. The Australian reports here on other allegations of excessive card surcharges. The ATM style fee proposal is at least free of the problem of merchants gouging.

Meanwhile the EU has introduced laws to limit surcharges on credit and debit cards, the UK Office of Fair Trading has found debit card surcharges to be unfair, and Which UK can’t wait 2 years and has launched a campaign for the UK government to act on the OFT report.

Here’s King’s argument. What do you think?

As Joshua [Gans] notes, Australian banks have ‘reversed’ the interchange fee for debit transactions using the EFTPOS system. This interchange fee, which is charged by the customer’s bank, is passed through to a merchant by its bank (possibly with other fees and charges added). So now merchants are charged (more) when you use EFTPOS. This brings EFTPOS closer to the ‘scheme’ debit cards and to credit cards which have had this type of charging to merchants for a while.

The interchange fees and the way they are ‘hidden’ in transactions creates an economic problem. When a customer chooses a payment instrument then the customer imposes a cost on the merchant. But if the merchant sets the same price for all customers, then the customers do not see the cost that they are imposing and have no incentive to use cheaper means of payment. Further, the single price effectively means that customers who use low cost payment instruments are cross subsidising those using high cost instruments. Finally, banks have few incentives to keep interchange fees down as the customer does not see these fees so that competitive incentives are weak.

Overall, the payments system is less efficient and less competitive. It may only be a few cents per transaction, but added up over billions of dollars worth of transactions it is a very big sum.

One solution is surcharging. I have discussed this before. It is not a perfect solution and is being investigated by the Payment System Board (PSB).

Another potential solution is currently used for ATM transactions. When taking money from an ATM, the owner of the ATM doesn’t charge your bank but must charge you directly. The ATM tells you the amount you will have to pay for the transaction and gives you the option of not continuing if the price is too high. This transparency probably doesn’t make a lot of customer discontinue their transaction once it is started, but it does inform the customer, and they may plan to use a ‘cheaper’ ATM next time. The banks have entered deals to increase their networks of free ATMs and the reforms have generally worked.

So, a potential reform for credit and debit cards is the following:

  1. Abolish interchange fees for credit and debit cards (or require the fee is set at zero;
  2. Allow a consumer’s bank to charge the consumer directly for a debit or credit transaction; and
  3. Require that the fee is made clear to the customer (on the EFTPOS handset) and the consumer has to verify that they are happy to pay the fee to complete the transaction.

My prediction is that this would suddenly create a lot of interbank competition to keep fees down for customers. Most customers would note the fee and continue with their transaction. But a high fee will mean that they pull out a different card next time they transact.

What are the limitations with this policy? The main one is that it cuts the merchant out of the picture. Different payment instruments will still have different costs to merchants, but direct payment would probably mean the end of surcharging – otherwise it would just become too complex and messy. But given the PSB’s concerns about surcharging, this may be a good ‘second best’ solution.

The other feature is that banks would have to set down fees for card use that do not depend on the identity of the merchant. This avoids the banks favouring particular retailers. It also gets rid of the price discrimination by merchants that is causing the PSB concerns.

So – not a perfect solution, but worth some thought given that it has worked well for ATMs.

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