The Effect of Regulatory Intervention in Two-Sided Markets: An Assessment of Interchange-Fee Capping in Australia

Abstract

The Reserve Bank of Australia reduced interchange fees by almost half thereby eliminating a significant source of revenue to issuers of credit cards. The purpose of this intervention was to align the prices of using various payment instruments with their social costs and thus reduce the use of cards, which the RBA viewed as a socially less efficient payment method than cash, checks, and PIN debit cards. The short-run result of this regulatory intervention has been the following: (1) Bank issuers have increased the fixed prices for cards and thereby recovered between 30 and 40 percent of the loss of interchange fee revenue; this fraction is likely to increase over time as cards renew and new solicitations go out. Bank issuers have not changed the per-transaction fees for cards much. (2) Merchants experienced a very small reduction in their costs. Both theory and limited empirical evidence suggest that the highly concentrated merchant sector in Australia has captured the reduction in interchange fees as profits and has not passed it on in the form of lower consumer prices. (3) The per-transaction price at the point of sale has not changed significantly. Merchants have not generally availed themselves of their right to surcharge card transactions and the per-transaction price faced by consumers from their card issuers has not changed much. Holding the number of cards fixed, the regulatory intervention has not altered prices in a way that could achieve the intent of the intervention. (4) There is relatively little evidence thus far that the intervention has in fact affected the volume of card transactions in Australia as intended by the regulation. (5) In the short-run, the effect of the regulation has been to transfer significant profits to the Australian merchant sector with that transfer being borne partly by bank issuers and partly by cardholders. (6) Since proprietary systems such as American Express were not subject to the pricing regulations and since American Express can enter into deals with banks to issue cards, banks have shifted volume from the regulated association systems to the unregulated proprietary systems.