Hendrik J. Brouwer

English

Research Papers in Economics

1
A number of issues will be covered during this conference: the definition of
interchange fee, the market parties involved, and the role of public authorities. 
DEFINITION OF INTERCHANGE FEES
Interchange fees have been the focus of much debate recently. To 
stimulate and enhance the discussion on the subject, I will start with high-
lighting the basic concept of interchange fees. Conceptual clarification is
needed because for countries and market parties involved, definitions and
perceptions may be different. Roughly speaking, the interchange fee is
between issuer and acquirer, in either direction, for compensation of cost
incurred while providing payment services to the client of the other. 
The interesting point about interchange fees is they are not directly paid
by the end user of the payment service, but between competitors. This
leads to a number of questions. 
A crucial question is whether the interchange fee influences behavior of
the end user. In general, the two-sided market theory provides a framework
to analyze this. In the literature, a two-sided market is defined as a market
in which one intermediary deals directly with two involved customer
groups. In this case, those two customer groups are cardholders and mer-
chants. The intermediary can be, for example, a credit card company. The
choice of which payment instrument to use in a certain transaction
depends on both merchant and cardholder. In theory, both parties calcu-
late costs and benefits of different alternatives to pay and choose that 
payment instrument where the benefit outweighs the cost. Cardholders
pay fixed fees and/or transaction fees, while their benefits are, roughly
speaking, of a qualitative nature. Their benefits include safety, availability,
and ease of use. For merchants the costs are fixed investments, fixed 
periodic fees, and transaction fees. The benefits for merchants also include
Conference Overview: 
Issues to be Raised
Hendrik J. Brouwer
 whether a payment is guaranteed or not and a strategic motive that accept-
ing cards may lead to additional sales and customers.
When for one side of the transaction the benefits do not outweigh the
costs, it is possible to influence this situation by lowering the fee or improv-
ing the service level. An interchange fee can be used for this purpose. So,
in theory, in a two-sided market, the total cost can be distributed over two
sides. This means that the volume of transactions not only depends on the
level of total cost but also on the distribution of cost over the two sides. A
message of the theory of two-sided markets is that the socially optimal
transaction volume may not be realized without an interchange fee. 
In practice, it is hard for consumers to make this cost-benefit calculation.
In this respect, it is interesting to note that a consumer survey 
conducted by a Dutch retailer association revealed that consumers seem to
be relatively insensitive to the surcharging of debit card payments done by
some retailers in the Netherlands. On the other hand, Dutch consumers
do not seem to be aware of the payments costs, because they only pay a
fixed annual fee for their debit card. As a consequence, consumers are not
interested in costs and benefits at the level of an individual transaction.
Would knowledge of the costs for merchants and other parties involved
change cardholders’ payment behavior? Or are other factors, for instance
national payment culture and institutional traditions, more important? 
MARKET PARTIES INVOLVED
Another topic where practice is even more complex than theory about
interchange fees is the involvement of other market parties. In addition to
the payer, merchant, issuer, and acquirer bank, there are other parties (for
example, network operators) on regional, national, and international lev-
els, and other parties such as independent ATM deployers and suppliers of
equipment used, for instance providers of terminals. All these market par-
ties have an interest in realizing a smooth and safe payment process besides
profit maximization or cost saving. That another distribution of costs can
change a loss into a profit is shown in the example of the U.K.’s Halifax
Bank of Scotland. For almost a decade, the majority of banks in western
Europe have been struggling to squeeze any profit from their ATM activi-
ties, and many are running them at cost at best. Recently, the Halifax Bank
of Scotland sold its “non-core” ATMs to Cardpoint, a U.K.-based inde-
pendent ATM deployer. Cardpoint said it will introduce direct charges to
the cardholder to make this service profitable. 
2 Conference Overview: Issues to be Raised
 In order to decide whether interchange fees can be used as an instrument
by banks and nonbanks, their incentives must be structured correctly. In
this light, the question can be raised whether and how nonbanks’ partici-
pation in the payments system can contribute to overall efficiency. Also,
attention could be paid to the possible effects of the technological develop-
ments in the payments sector on interchange fees, for example, the intro-
duction of the Windows-based control software for ATMs or a future 
coupling of ATMs to public networks such as the Internet. To answer these
questions, more empirical data on the specific market structure and parties
is needed. 
ROLE FOR PUBLIC AUTHORITIES
I now come to my third issue. What is or should be the role for public
authorities with regard to interchange fees? This is a topical but difficult
and sensitive question. In each country, there are several public policy
objectives. One public policy objective is promoting competition. Another
is safe and smooth operating payments system. Ideally, the right balance of
these objectives would be struck. 
In this perspective, the Dutch case is interesting. On April 28, 2004, the
Dutch competition authority fined Interpay and its shareholders, eight
Dutch banks, for violation of the Dutch Competition Law. Interpay is the
Dutch automated clearinghouse for retail payments that also operates the
network for switching debit card transactions. Interpay was fined  30 
million for excessive charging of network services for online debit card
transactions. The shareholder banks were fined  17 million for coopera-
tion in acquiring through Interpay and thereby eliminating competition in
acquiring. Interpay and the banks have appealed against this ruling
because, in their minds, the interchange fee is only one of the components
of the total costs of a payment.
The Dutch central bank, DNB, is convinced that cooperation between
banks in providing payment services remains necessary to some extent. The
Netherlands disposes a relatively cost-efficient payments system, which can,
at least in part, be attributed to successful cooperation between banks. In a
two-sided market, cooperation up to some level can be beneficial and may
lead to an increased efficiency and optimal social cost. It does not seem
desirable, for instance, that all banks develop their own payment infrastruc-
tures and instruments that are not interoperable. That may well be detri-
mental to both the consumer and the merchant because network externali-
ties and economies of scale may then be lost. In the end, the objective is to
HENDRIK J. BROUWER 34 Conference Overview: Issues to be Raised
reduce social cost and improve efficiency of the payments system. An incor-
poration of this objective in the approach of the competition authorities
also may contribute. In the Netherlands, efficiency is included in the man-
date of the competition authority. The issue is what kind of criteria should
be used to assess efficiency. At the moment, the competition authority and
the central bank are engaged in a constructive and open dialogue in order
to reach an agreement on how to work toward this common objective. 
CONCLUSION
The issues of interchange fees are complex, and there are a lot of parties
involved—all with their own interests. On top of that, defining and pro-
moting the public interest is not easy. This conference will address the
objectives of the public authorities and may lead to answers on questions of
which situations they can or should interfere in and how this can be done
best. In organizing this conference, the Federal Reserve Bank of Kansas City
has brought the various parties involved together in an environment where
views can be exchanged. I look forward to a fruitful discussion.
 

Conference overview : issues to be raised

http://www.kansascityfed.org/publicat/pscp/2005/Brouwer.pdf

Conference overview : issues to be raised

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