Payments sector

Payment systems are networks that enable individuals, businesses, banks and other financial system participants to make and receive payments.

Submissions on payment systems covered:

  • Interchange fees, merchant service fees and customer surcharging
  • The competitive neutrality of regulation for different debit payment systems

Overview of payment schemes and participants

Two of the largest payment systems in value terms are the Direct Entry system, which processes direct debits and credits between bank accounts, and the Real Time Gross Settlement System, which processes inter-bank fund transfers. However, submissions do not raise competition issues about these systems.

The primary focus of submissions is on debit and credit card systems. These are now used almost as frequently as cash for consumer transactions and are therefore of considerable importance to customers and retailers (merchants).31 Debit card systems link customer payments to their transaction accounts, while credit card systems enable customers to pay for purchases using credit.32 Both systems generally function for both point-of-sale transactions and online transactions. In addition, new online-only payment schemes have begun to emerge, which often interlink with traditional payment schemes.

eftpos, which is owned by a number of financial institutions and retailers, is the largest debit card payment scheme provider. Its main competitors are MasterCard and Visa, which are increasing their share in that market.33

In comparison, MasterCard and Visa are the main providers of credit card payment schemes, with a combined market share of 80.7 per cent.34 For these schemes, the financial institutions that issue the cards (see issuers below) provide the credit. The main competition for credit card schemes comes from American Express (Amex) and Diners Club, which provide credit for the cardholder in addition to operating the scheme network. Their combined market share has increased from 14.6 per cent of the value of transactions in April 2003 to 19.3 per cent in April 2014.35

To date, PayPal has been the most successful online payment provider, although there is continuing innovation and market entry in this area.

A number of participants compete within debit card and credit card payment schemes. They compete on issuing payment cards and associated services to customers and providing acceptance facilities and associated services to merchants. The major banks are the main issuers of payment cards, with competition from most other ADIs and a number of non-bank issuers. The major banks are also the main providers of acceptance facilities, with competition from other ADIs and Tyro. In addition, some of the largest merchants, including the major supermarkets, have in-house payment acceptance facilities.

Other payment systems include Automatic Teller Machine (ATM) networks, cheques and BPAY. However, submissions do not focus on them from a competition perspective. The Inquiry would welcome views on whether there are competition issues with these systems or any other parts of the payments sector.

Regulation of debit card and credit card schemes

Payment schemes are regulated by two main instruments under the Payment Systems (Regulation) Act: access regimes and standards. The RBA has designated the eftpos, MasterCard and Visa payment schemes under the Act and applied access regimes, primarily to ensure that smaller and non-ADI participants could enter and compete in these markets. Standards cover scheme pricing arrangements, or interchange fees, and the removal of restrictions on merchants, such as in relation to customer surcharging.

Interchange fees

Interchange fees are often a feature of four-party payment card schemes (Figure 2.1), which include the debit and credit schemes operated by eftpos, MasterCard and Visa. Acquirers, the merchants’ providers of payment acceptance facilities, pay interchange fees to issuers, the cardholders’ payment card providers. The fees enable issuers to recover the cost of processing transactions. Payment schemes can also set interchange fees to incentivise financial institutions to issue their payment cards. Issuers can incentivise cardholders to use their cards by passing on a proportion of interchange fees as reward points, interest-free periods or other benefits.

Figure 2.1: Simplified example of a four-party payment scheme

This figure shows the payments involved in four-party payment schemes, which involves the payment for the good or service in the transaction as well as the payments of processing fees.The merchant receives payment for the good or service via their financial institution (the acquirer), which receives the payment from the cardholder’s financial institution (the issuer), which receives the payment from the cardholder. For pre-paid cards, the cardholder pays the issuer in advance, for at-time payments the purchase amount is withdrawn from the cardholder’s transaction account, for credit card payments the cardholder repays the issuer at a later date.  The merchant pays the acquirer a merchant service fee to process the transaction. The merchant also has the option to surcharge a customer to reflect this fee. The acquirer pays a fee to the issuer for processing the transaction. The issuer also often passes of this fee through to the cardholder in the form of reward points and/or other benefits.

Payment schemes designated by the RBA (eftpos, MasterCard and Visa) ensure that the weighted-average value of their interchange fees complies with caps established by the RBA. The caps are 0.5 per cent of the value of transactions for credit card schemes and 12 cents per transaction for debit card schemes. The RBA established these caps following a cost-based benchmarking exercise.

The RBA caps interchange fees for a number of reasons.

  • Price signals are not efficient in four-party payment schemes, which can result in competition and paradoxically lead to higher prices. Merchants generally exhibit low price sensitivity to merchant service fees for widely used payment schemes, such as those operated by eftpos, Visa and MasterCard. If merchants do not accept these cards, they may lose sales to the majority of merchants that do. In comparison, cardholders are often more price sensitive. They have access to a range of payment schemes, and will respond to incentives like reward points when determining which scheme to use. Payment schemes therefore have an incentive to set high interchange fees, which issuers can use to offer reward points for cardholders.
  • Interchange fees act like price floors for merchant service fees. To break even, at a minimum, acquirers set merchant service fees at the cost of interchange fees, plus the cost of processing transactions.
  • Cross-subsidisation will occur if merchants do not recover merchant service fees through customer surcharges. The cost of absorbing merchant service fees would be reflected in higher prices for goods and services. This would result in cross subsidisation from customers using low-cost payment mechanisms, such as eftpos and cash, to those using high-cost payment schemes – an inefficient outcome.

Amex and Diners Club operate three-party payment schemes. In three-party schemes, the scheme takes the role of issuer and acquirer. As no interchange fees are involved, these schemes are not covered by interchange fee regulation. Issues with the regulation of a variation of three-party schemes, known as companion cards, are discussed below.

Customer surcharging

Since 2003, the RBA has required payment schemes to remove ‘no surcharge’ rules so merchants can pass on the reasonable costs of card acceptance, such as merchant service fees, to cardholders. These standards apply to both three-party and four-party schemes, but not to online payment system providers.36 Allowing merchants to surcharge introduces a price signal to customers about the cost of the payment mechanism they use and can help reduce the effects of the interchange fee issues highlighted previously.

Table 2.1: Summary of payment system regulation
System Type Interchange fee regulation Customer surcharging regulation
eftpos debit Four-party Weighted-average cap of 12 cents per transaction No explicit prohibition on ‘no surcharge’ rules, but no such rules applied
MasterCard/Visa debit Four-party Weighted-average cap of 12 cents per transaction Prohibition of ‘no surcharge’ rules
MasterCard/Visa credit Four-party Weighted-average cap of 0.5 per cent of transaction values Prohibition of ‘no surcharge’ rules
Amex/Diners Club credit Three-party No regulation (no interchange fees to regulate) Voluntary undertaking to refrain having from ‘no surcharge’ rules
Amex companion cards In between three-party and four-party No regulation (only service fees, which are not regulated) Voluntary undertaking to refrain from having ‘no surcharge’ rules
Online payment systems Variety of models, often linked to other systems No regulation No regulation

Preliminary assessment


Regulation of credit card and debit card payment schemes is required for competition to lead to more efficient outcomes. However, differences in the structure of payment systems have resulted in systems that perform similar functions being regulated differently, which may not be competitively neutral.

Interchange fees


The RBA submission argues that interchange fee caps have reduced merchant service fees, citing that merchant service fees declined for MasterCard and Visa credit card schemes shortly after interchange fee caps were introduced in the early 2000s (Chart 2.3).

Merchant service fees also fell for the non-designated Amex and Diners Club schemes. This suggests these schemes responded to the lower prices of the designated schemes, potentially because merchants have more bargaining power in relation to three-party payment schemes. Merchants know they are unlikely to lose business if they do not accept three-party scheme cards, because most three-party scheme cardholders also hold four-party scheme cards.

Although eftpos debit card fees have increased, they are still lower than fees for other schemes. Initially, they were negative because issuers paid acquirers to use the system to incentivise take-up.

Chart 2.3: Merchant service fees as a percentage of transaction values

This chart show merchant services for Amex decreasing gradually from 2.5 percentage points to around 1.75 percentage points from 2003 to 2014. Over the same period, Diners Club fees decrease from just under 2.5 percentage points to 2 percentage points. MasterCard and Visa fees decrease from just under 1.5 percentage points to around 0.8 percentage points, with most of the decrease occurring between 2003 and 2004 when interchange fee regulation was introduced. eftpos fees increased from just over 0 percentage points to around 0.15 percentage points.

Source: RBA.

Submissions from MasterCard and Visa argue that interchange fee caps are not efficient, as they benefit merchants rather than cardholders. They contend that, although the caps may have reduced costs for merchants, they have also lowered the value to cardholders, limiting reward points and potentially making credit card fees and interest rates higher than they would have been.

On balance, the Inquiry considers that interchange fee caps have improved the functioning of four-party payment schemes. They have reduced merchant service fees. Although difficult to measure, they have also likely reduced cross-subsidisation across payment mechanisms. It may be possible to build on these efficiencies by lowering interchange fee caps or by applying caps to arrangements of similar economic substance across the payments sector.

Companion cards

Companion cards, which typically operate through the Amex scheme, are issued by ADIs. Companion cards can be thought of as a blend of three-party schemes and four-party schemes. The scheme is the acquirer, but an ADI is the issuer.

Submissions from MasterCard and Visa argue that the service fees companion card schemes pay to issuers are equivalent to interchange fees in four-party payment schemes, as they are both payments made to issuers funded by merchant service fees. They submit that payment scheme regulation lacks competitive neutrality because these service fees are not capped, which allows companion card schemes to provide more generous incentives to issuers and cardholders to incentivise take-up. They point to the increase in the market share of Amex.

Amex argues the service fees it pays to ADIs for its companion cards are more akin to the incentive payments that MasterCard and Visa pay issuers in four-party schemes. It notes that, unlike interchange fees, which are set by payment schemes for all ADIs, companion card service fees are negotiated bilaterally between the scheme and individual ADIs.

The Inquiry considers that payment systems of similar economic substance should be regulated consistently. An argument could be made that four-party interchange fees, companion card service fees and incentive payments under all schemes are equivalent in economic substance. The Inquiry would welcome stakeholder views on this matter.

Merchant routing choice

Payment cards issued by banks and other financial institutions often provide cardholders with access to more than one payment scheme. This enables cardholders to choose which scheme to pay with by selecting ‘savings’ or ‘credit’ at the terminal.37 It also potentially enables merchants to choose which debit scheme to route debit transactions through. The Australian Retailers Association submits that many acquirers do not provide merchants with the opportunity to route transactions through their payment scheme of choice. This reduces both merchants’ ability to choose low-cost acceptance schemes and the incentives for debit schemes to operate as efficiently as possible.

Impacts on small merchants

Interchange fees are not applied evenly to all transactions. Instead, schemes must ensure that weighted-average fees fall below the cap. Large merchants with more market power are often able to secure lower interchange fees than smaller merchants. This difference in purchasing power can reduce small retailers’ ability to compete with large retailers.

Customer surcharging

Allowing merchants to surcharge customers for the reasonable cost of acceptance improves efficiency by providing cardholders with clearer price signals about the costs of different payment mechanisms. Therefore, ‘no surcharge’ rules can reduce efficiency. ‘No surcharge’ rules do not apply to other traditional mechanisms, such as cash and cheques. The RBA considers customer surcharging appropriate for any payment mechanism where merchants incur acceptance costs.38

However, submissions raise some issues with surcharging for debit card and credit card transactions that warrant consideration:

  • If merchants over-surcharge customers, they will skew price signals and make the payments system less efficient. Submissions raise concerns that some merchants, particularly in the airline and ticketing industries, over-surcharge. Scheme operators argue they are not well placed to control this behaviour because they do not have direct relationships with merchants. However, the Inquiry notes that they were generally able to enforce ‘no surcharge’ rules when they were in place.
  • Submissions from MasterCard and Visa argue that some merchants surcharge the same amount for their cards as for the more expensive Amex and Diners Club cards. They argue that this unfairly reduces the volume of payments made using their schemes. However, evidence suggests that, on average, merchants surcharge Amex cardholders more than MasterCard and Visa cardholders.39
  • Submissions also note that online payment system providers are still able to impose ‘no surcharge’ rules, which is not competitively neutral. As noted above, the Inquiry considers payment systems operate most efficiently when merchants have the capacity to recover the reasonable cost of acceptance.

Policy options for consultation

Interchange fees

Stakeholders suggest a number of ways to reform interchange fee regulation:

  • Lower interchange fee caps. Although, in Australia, interchange fees are currently set to approximate the cost of processing transactions, other jurisdictions such as Europe apply a merchant indifference test. This test aims to set interchange fees at a level that makes merchants indifferent to which payment mechanism a customer uses, resulting in lower fee caps than in Australia. An argument could potentially be made for banning interchange fees altogether, which would require issuers to recover the cost of processing transactions directly from consumers. Although lowering fee caps for four-party schemes may make these schemes more efficient, it could exacerbate issues around competitive neutrality with companion cards. In addition, if caps are set too low, it could risk the viability of some participants’ business models.
  • Expand interchange fee caps to capture other payments of similar economic substance. This could include service fees under companion card schemes and incentive payments under all schemes. This would ensure competitive neutrality between different schemes. It would also mean that schemes compete less on incentive payments and award points to drive take-up by customers and more on improving cost efficiencies, innovations and system performance. It could address submission concerns that the current designation process is open to inconsistencies and involves considerable upfront compliance costs.
  • Remove interchange fee caps. The MasterCard and Visa submissions argue for this option, partly on the basis that service fees under companion card schemes are not regulated. Given the benefits interchange fee caps have delivered, it may be more effective to address any competitive neutrality issue by consistently regulating fees of similar economic substance.
  • Cap merchant service fees. The Australian Retailers Association argues that this could ensure retailers pay similar merchant service fees, no matter their strategic importance to scheme providers. Small merchants generally pay higher fees than large merchants. However, regulating merchant service fees would act like a price control on the final product, representing a more interventionist approach. It may also harm innovations that deliver considerable benefits to merchants but cost more than current practice. A less interventionist approach could involve setting limits on how much interchange fees could vary between merchants.
  • Require acquirers to enable merchants to choose which scheme to route transactions through once customers have selected debit or credit. Submissions note this option would improve competition by incentivising schemes to reduce their costs.

Customer surcharging

Stakeholders suggest a number of ways to reform customer surcharge regulation:

  • Allow schemes to reintroduce ‘no surcharge’ rules or ban ‘no surcharge’ rules for all payment systems. Somesubmissions argue for the return of ‘no surcharge’ rules. They contend that some surcharging provides inaccurate price signals and is therefore inefficient. They also argue that it puts regulated payment schemes at a disadvantage to unregulated, online payment systems that can still apply ‘no surcharge’ rules. The Inquiry is predisposed to address instances where surcharging is inaccurate, rather than allow surcharging to be banned.
  • Enforce reasonable cost recovery in customer surcharging. Submissions from payment schemes suggest this option; however, it is not clear that payment schemes need regulator assistance with enforcing reasonable surcharging, given that previously they were able to enforce ‘no surcharge’ rules. If there is a case for regulator enforcement, it may be more efficient to target industries with high rates of over-surcharging, rather than introducing economy-wide regulation.
  • Provide merchants and customers with real-time pricing information regarding interchange fees and merchant service fees. The CSR submission argues that this could enable customer surcharges to reflect costs accurately. Interchange service fees depend on a range of circumstances, including the payment system being used, the type of card being used (such as standard, gold or platinum) and the merchant receiving the payment. Currently, merchants can only estimate the average costs of acceptance. Accurate and transparent prices could allow clearer price signals and improve efficiency.

The Inquiry would value views on the costs, benefits and trade-offs of the following policy options or other alternatives:

  • No change to current arrangements
  • Lower interchange fee caps or ban interchange fees
  • Expand interchange fee caps to include payments of similar economic substance
  • Remove interchange fee caps
  • Cap merchant service fees or cap differences in interchange service fees between small and large merchants
  • Require acquirers to enable merchants to choose which scheme to route transactions through
  • Allow payment schemes to reintroduce ‘no surcharge’ rules or broaden the ban on ‘no surcharge’ rules to all payment systems
  • Enforce reasonable cost recovery in customer surcharging
  • Provide merchants and customers with real-time pricing information regarding interchange fees and merchant service fees

31 Ossolinski, C, Lam, T and Emery, D 2014, The Changing Way We Pay: Trends in Consumer Payments, Research Discussion Paper 2015-05, Reserve Bank of Australia, Sydney.

32 Some debit cards also work on a pre-paid basis and are known as stored value cards. Charge cards are a variation of credit cards and require cardholders to pay their outstanding balance monthly, instead of providing a revolving line of credit.

33 eftpos 2014, First round submission to the Financial System Inquiry.

34 Reserve Bank of Australia (RBA) 2014, Statistical Table: Market Shares of Credit and Charge Card Schemes – C2, RBA, Sydney.

35 Reserve Bank of Australia (RBA) 2014, Statistical Table: Market Shares of Credit and Charge Card Schemes – C2, RBA, Sydney.Note: due to a series break in March 2008, the increase in market share is over-represented by 1.5 percentage points.

36 The standards only apply to four-party payment schemes; however, the three-party payment schemes have provided voluntary undertakings to comply with them.

37 However, for contactless transactions, customers are automatically routed through the scheme that provides the contactless facility.

38 Richards, T 2014, Transcript of Question and Answer Session with Tony Richards, Head of Economic Analysis Department, Reserve Bank of Australia, Sydney, 4 June, viewed 23 June 2014.

39 Reserve Bank of Australia (RBA) 2013, Payment System Board Annual Report: 2013, RBA, Sydney, page 34.