PSD2, interchange fee and surcharging: lessons from history

Now that we have the second Payment Services Directive going live in a couple of jurisdictions, the news media are reporting on one of its prominent features: the retailers do not have the right to pass on payment fees to consumers for all cards that are subject to the EU regulation on multilateral interchange fees (MIFs).

As can be seen in the tweet below, the UK chose to extend this to 3 party schemes as well.

From today we're banning hidden charges for paying with your credit or debit card - a move that will help millions of people avoid rip-off fees when spending their hard-earned money. pic.twitter.com/EEk5jxdk7R

— Theresa May (@theresa_may) 13 januari 2018

As I expect quite some further discussions on this topic (and retailers circumventing the rules by introducing other types of charges to their customers) I figured it would be good to provide some background on the reasoning that is occuring in the area of MIF-regulations. A further look at history would even suggest that we need to take one step further back in order to rethink our analysis so far.

Some background on MIF-modelling (and subsequent regulation)
If we try to assess the arguments pro and con interchange fees, some important thinking in this area is done by Nobel prize winner Jean Tirole, who worked together with Rochet on competition in two-sided markets, such as payment-cards markets. At the heart of their studies is the question what the pricing structures are in two-sided markets and under which conditions and to which extend compensation payments between different sides of the market (interchange fees) are justified.

This work has been at the core of many regulatory strategies but it is subject to a lot of discussion. All market players, whether 3 or 4 party card schemes, issuing banks, acquirers, processors, retailers, consumers and regulators, heavily debate pro's and con's of interchange fees. And in doing so they must use the reasoning and models of Rochet and Tirol. In essence the model tries to determine which cost and interchange fee levels are relevant for competing products/platforms such as cards vs cash.

Do note however that already more than 10 years ago, Brookings Institution released a very good paper on interchange fees, concluding that it is impossible to prove one or the other side of the arguments on interchange fees, let alone determine which level of interchange fee is correct. I think their analysis still stands which means that in the end, interchange fee regulation is more about lobbying and power politics than actual econometric calculations.

Europe's reality under PSD2 and MIF regulation
What is happening under the current payments regulation in Europe, is that:
- a maximum cap is defined for the interchange fee of credit-card and debit-card transactions (reducing the cost to the retailer),
- retailers are forbidden to surcharge for payment costs, when the customer uses a card which has a capped interchange fee (reason being that they may not gain from reduced costs on the one hand while keeping surcharging intact on the other hand).

In essence this means that the EU has bought into the argument that multilaterial interchange fees were being set to high and require regulatory intervention (thus emulating the behaviour of other regulators such as the FED and Australian Reserve Bank). In doing so they accept and embrace academic models which mostly focus on the topic of optimal price regulation in a stationary market with alternative platorms/products.

Historic approach: where did the interchange fee come from in practice?
It strikes me that all the economists at play use an empirical description and mathematic approach to start their reflections on interchange fees. One very obvious element is missing in a lot of papers (except Baxter, who goes at length to discuss history): what were the market players thinking when they wanted to introduce these fees? What is the industry trade-off they are facing?

In Dutch payment history, the banks have been very keen not to disclose their cost/benefit considerations and finances. It was only in 2005 that they allowed McKinsey - as a notary - to have a full look at all internal costs and benefits, in order to draw up a report on costs/benefits based on a full insiders view. I have been personally committed to this effort and helped making it become a reality based on the belief that a lot of misconceptions can be eliminated by being open on ones business model.

However, while this report shows the situation in 2005, it doesn't tell us where the interbank fees came from. The archives of banks do however and to me it is stunning that very few academics in the interchange fee domain have tried to uncover these sources to calibrate their reasoning. Because if they would, they might be able to enrich their analytical approach.

Core question: can we avoid double charging for the retail customer ?
Reading through the old reports of collective groups of players in the Dutch payments domain, we can see an interesting game-theoretic approach to the multilateral fee discussion (which I will be disclosing more in detail in an upcoming publication on the history of Dutch retail  payments).

In essence, in the 1980s the emergence of new players, that were going to be piggy backing on an existing infrastructure without interbank compensation, fueled an existing debate on the distortion of the cost/benefits of banks. Banks with a lot of private consumers would usually bear many processing costs, while banks with corporate customers would reap the benefits. And the winner in the game would be new players, for example investment funds, that would hold pooled accounts for customers funds at a large bank, without having to pay anything for the incoming deposits that came from all the Dutch banks.

Setting an interchange fee in this context leads to:
- a more appropriate allocation and compensation of payment costs along the payments value chain: the entity that benefits from a payment will also bear part of the originating cost,
- the elimination of free-riders in the system,
- interbank understanding that consumers would not be levied fees for instruments where an interchange fee arrangement existed.

The explicit reasoning in a well documented cost/benefit study here in the Netherlands (never officially published as banks made sure to not disclose their thinking) was that it was of course also possible to not introduce an interchange fee system. The involved payment experts noted however that this would lead to bank fees on both the consumer and corporate side of the market. Absent coordination and agreement of reasonable interchange fees, the expectation was that those individual fees of banks to their respective customers would be higher than necessary.

In addition, the bankers expected the corporate side of the market to also add on surcharges and administrative charges to the consumer, which meant that effectively the consumer would then pay twice for payments processing costs: one time at the issuing bank and the other time at the retailer/corporation side, where the payments costs were incorporated into the price of services. Thus, for the Dutch society as a whole, this situation with mark ups on payment processing costs starting at the bank individual level, would undoubtedly be more costly, than the situation where the bank layer coordinates its cost/fee level and thereby avoids double charging of the customer.

The EU-choice revisited: higher payment costs as unintended side-effects of the MIF-regulation
It is clear that the EU perspective on interchange fees is:
- we don't trust the diverging interests of banks and competing card schemes in combination with competition to lead to an appropriate level of interchange fees, so we set an interchange level by ourselves,
- we also don't trust merchants and want to avoid them pocketing the benefits of lower interchange fees at the costs of consumers.

In practice we may now see in Europe that:
- issuing banks have shifted their income base and costs to consumers are increasing,
- acquiring banks will use other fee mechanisms to charge the retailer for the relevant payment costs in the card chain (as long as it exists as such, because a move to instant sepa credit transfers looks pretty enticing of course),
- retailers will use other fee mechanisms or labels (service charges) to charge the consumers for payments,
- consumers are paying higher fees to their issuing bank,
- consumers will effectively be paying twice for the relevant payment costs, in spite of the EU goal that they don't.

Where Europe has chose to intervene in interbanc dynamics, in order to achieve the best result for society, I am not sure if this will indeed work out as such. Yet, I must confess I am not an academic scholar in MIF-models and I get dizzy when reading all the equasions. However, I sense that some of the MIF-modelling doesn't match the actual game-theoretic constellation that occurs in practice.

Personally, I would rather place my trust in the diverging conflicts of interests between closely collaborating banks in an industry (leading to an interchange fee level that is scrutinised among quarreling bank experts) to keeping my payment costs appropriately low, than the good intentions of regulators that expand their interventions towards those mechanics themselves (thereby unleashing the possibility of double charging to me).

From DNB Coin to ECB Coin...?

About a year ago, it became clear that the Dutch central bank, much like other central banks, was actively experimenting with blockchain technology to further establish pros and cons of distributed ledger technology. It had developed a so-called DNB-coin - a private fork of the bitcoin blockchain - which further reinforced a whole discussion on central bank issued bitcoin-like currencies (Fedcoin as outlined by the blog of JP Koning).

Fast forward to the EU parliament, where last week, rapporteur Cora van Nieuwenhuizen presented a draft Fintech report, that calls on the European Commission to draw up a Fintech Action Plan. And in this plan, under item number 6, the ECB is recommended to launch experimentations with a 'virtual Euro'. I think we may dub this as the call for an ECB-coin.

One can only guess what exactly would be meant here, but my best guess would be that this means the ECB can now freely choose to experiment with methods for distributing digital euro's using advanced blockchain or distributed ledger technology. So would they design it themselves, or involve themselves into market initiatives such as R3, Hyperledger?

Anonymous ECB-coins or not? 
Time will undoubtedly tell how this experiment with ECB-coins will evolve. We should note however that, there is also a European legislative initiative to limit the use of cash. So it appears logical that the cash-limiting initiative could reinforce the development of central bank issued virtual currencies (i.e. euro's on a blockchain).

Those will not be truly anonymous ECB-coins, if you ask me. Close reading of this last legislative proposal, I noticed that anonymous digital currencies (such as the good old digicash) are not truly desired:

In view of the development of cryptocurrencies and the existence of other means of payments ensuring anonymity, an option could be to extend the restrictions to cash payments to all payments ensuring anonymity (cryptocurrencies, payment in kinds, etc.) 

The end of anonimity and begin of pseudonimity 
In sum we will be watching the end of anonimity, but this may not be its true end. I think it would be fairly easy to device new business and payment models where one slices off the good-reputation of a payer/payee (not blacklisted, no terrorist etc) into a pseudonomous, tokenised system that allows payer, payee and all involved financial institutions not to know each other but still transact securely and within the legal parameters as set by society.

Which most likely brings us back to square one: the blockchain.

ECBs renewed virtual currencies report: implications for the Third Payment Services Directive

This week the European Central Bank (ECB) revisits the subject of virtual currencies (VCS) in a renewed virtual currencies report with a further analysis. I have read the publication with interest to discover that the previous position on the subject essentially remains the same:
- virtual currencies don't come near money or legal tender concepts,
- the uptake of virtual currencies is still very limited
- the wait and see approach of the ECB will be continued.

The typical paragraph that summarises this approach is:
The usage of VCS for payments remains limited for now, which implies that there is not yet a material risk for any central bank tasks, including promoting the smooth operation of payment systems. However, a major incident with VCS and a subsequent loss of trust in VCS could also undermine users’ confidence in electronic payment instruments, in e-money and/or in specific payment solutions. 

Whereas at first sight the report doesn't lead to a lot of new insights, the broader scope of its definition of virtual currencies does beg a number of fundamental questions with respect to the future regulation of payments. These questions lead me straight into a renewed regulatory approach, to be used in the Third Payment Services Directive.

An improved definition
The major improvement of this Eurosystem-report over the previous one lies in its correction of the definition used for virtual currencies. In an earlier blog I commented that the definition was too vague:
“A virtual currency is a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community”.
With this report, the definition of virtual currencies has formally changed into:
"a digital representation of value, not issued by a central bank, credit institution or e-money institution, which, in some circumstances, can be used as an alternative to money."

I am quite pleased with this change as it allows for a better understanding and classification of the subject of virtual currencies. Interestingly, the elimination of the element of decentralized issuance leads to a far broader range of virtual currencies than previously discussed. And this leads to an interesting follow up question.

Virtual currencies are suddenly everywhere... 
The table below lists the major payment options in the Netherlands, with the virtual currencies listed at the far right. When looking at the turnover figures, one can understand why the Eurosystem will be primarily monitoring the virtual currency scene. The most interesting observation is however that all the blue coloured segments of the table are now also considered to be virtual currencies.

We can see that in particular the giftcard and transport payments (which are out of scope of the payment regulations for a number of reasons) do amount to quite a substantial payments volume. Literally these payments are now also considered to be payments with virtual currencies. And from an analytical perspective, this is a logical consequence.

Regular (e-) payments	OV-Chipcard	Mobile telephone	Retailer Giftcards	Bitcoin / alt-coins
16 million per day	5 million per day (includes loads)	Premium services	500.000 - 1.000.000 per day	Less than 1000 trx per day in NL
€ 903	€ 2 - € 20	€ 2- € 5	€ 12	€ .?
Payment Services Directive (PSD)	Exemption under PSD1	Explicit exemption of PSD1	Out of scope when issued as a single retailer	Out of scope of PSD

Effectively we can now better appreciate today's payments world, seen from the eyes of the consumer. Because the consumer is not bothered by the details of Payment Services Directives and obscure exemptions of mobile payments. The consumer will use the mobile or ticketing payment means as a matter of convenience (or: obligation) and will have to undergo the payment experience as a fact of life.

Particularly in the Netherlands this leads to the interesting situation where a sloppy and easily hackable implementation of NFC is being widely used for public transport payments, alongside a safer NFC implementation of banks that is still working on its nationwide roll-out. Users use them both.

Similarly interesting was the occurrence, last month, of a virtual currencies bank run. As retailer V&D threatened to go out of business, one could witness the sale of its pre-paid gift cards on Marketplace (the Dutch ebay) for considerable discounts. At the same time everyone in the Netherlands dug up and spent their old gift cards, before it was too late.

What the third Payment Services Directive will have to look like 
If we take the wider definition of virtual currencies that the ECB uses, it becomes clear that the user experiences with virtual currencies (and losses: for example the sudden vaporisation of retailer gift card value after a period of 18 months) happen alongside the heavily PSD-regulated instruments and mechanisms.

Based on some prudential rules we now burden some forms of payments with a whole lot of rules, while we neglect all schemes that are out of scope (but may still have relevant consumer effects). This difference is - in my view - too big and requires a changed approach to be used for the Third Payment Service Directive (PSD3).

Under the Third Payment Service Directive, we should recognise that payments can and will be made and offered by everyone to everyone. The PSD3 should thus define a light-weight conduct supervisory framework for all payment mechanisms, regardless of the institutional status of the issuer. Alongside this wide conduct framework, we keep the current prudential framework intact, which outlines the prudential rules applicable to the different institutional payment setups (e-money, payment institution, bank).

The new conduct based framework would apply to payment mechanisms and e-money alike and have as a goal that the user is always properly informed on the basic terms and conditions, redeemability etcetera. The control-mechanisms should not be supervision based, but could be reputation-based for example, allowing the market to monitor and redress, rather than costly supervisors. Only in exceptional circumstances would a European conduct supervisor step in.

In sum: more analysis ahead
The broader scope of the Eurosystems definition of virtual currencies begs a number of fundamental questions with respect to the future regulation of payments. In particular the area of non-regulated payment schemes at the fringes of the PSD might deserve more attention than they do receive right now.

Not only could the question be whether or not a separate regulatory conduct-framework should apply, the European Retail Payments Board might also decide to expend its analysis towards these mechanisms, particularly when they reach a volume/scale which is equivalent to that of the regular payments.

Reflection on almost 100 years of retail payments in the Netherlands

These next few days we will be processing the last Chipknip transactions in the Netherlands. This marks the end of a period of almost hundred years of consumer payments in the Netherlands. Here is a brief reflection on this period. My hope is that we retain our innovative mindset and that we abandon old school practices like: competition on technology and inward-thinking-based marketing practices.

The beginnings
It all started out with a certain demand of the public and small retailers, around 1900. It took however more than ten years before the city giro of Amsterdam (1916) and the national giro of the Netherlands (1918) were set up. In the period leading up to this moment, the cashiers were asked whether they wished to improve their services, as this might lead to the parliament to conclude that no national giro was necessary. Their response was too meagre as a result of which they created their biggest rival: the national giro system, operated by government.

This system effectively created a benchmark for the private industry by offering (some time after it's start) payment services for free to the public. Today we would call this the Internet model, but in those days, this lead to repeated discussions on the undue competition element. Bankers and cashiers assumed that the national giro was cross-subsidized by government; while effectively the reverse became true. The national giro acted as a cash cow that covered some of the other costs for the Ministry of Transport (including the costs of post offices etc).

The city giro Amsterdam has stood out mostly for its innovations: the use of modern bookkeeping machines, the introduction of photo-imaging (in the 1930s) to process payments easier as well as the early introduction of a payment card to the public. The national giro, in turn, was early to create a mechanism of inpayments that could be used by government services, that used similar (punch card) standards.

In this respect it should be noted that the national giro, during the previous century, was plagued by several operational distortions, leading to 'giro stops'. One big one occurred in the 1920s and shut the system down for almost a year, other ones happened after the second world war. These stops instilled a big trauma into the organisation with the effect that when in 1965 a change was made to using punch cards and mainframes, this was done with meticulous scientific precision in order not to fail. Ever since, the postal giro (later Postbank) would be very keen and strong in the area of operational logistics and control.

Competition on standards and technology
For the most part of the evolution of Dutch payments, there were differences in technology used. A first attempt to bridge these differences occurred after the second world war when a commission on the integration of giro traffic tried to bridge the bankers vs giro gap. This didn't work out.

In the mid 1960s the bankers were keen to find funding in the retail market and realised they needed a better clearing system to process faster payments. While they were in the process of deliberating this move, the postal giro offered them to join/use the same standards as they were, in order to achieve uniform processing. For strategic reasons, the banks decided not to do this and chose a slightly modified technology and numbering system of their own. Remember: this was of course the age of shielding off markets by technology.

The net effect for the consumers and companies was less positive however. In the end it took some 30 years to create bridging standards/protocols to integrate the different payment standards of bank and giro. And even when the digital, networking time started (in the 1980s) banks and giro found it hard to abandon the classic competition by technology paradigm. For the EFTPOS network they did use a common standard and this also seemed to work for the Chipknip e-money products. Yet, due to misunderstandings and distrust at the board room level, the Postbank decided to jump the Chipknip ship to start the separate Chipper product. Again, the effect was that consumers and retailers were burdened with dual standards in a market that is too small to do so.

Inward based marketing of the big banks
With the deregulation of financial markets and the privatisation of the Postbank, all providers of payments were commercial companies. The Dutch banks grew bigger and with that their bureaucracies. Postbank gradually lost its touch-and-feel as a former public entity and became a bank like all others. The best event that symbolises this is the abolition of the Postbank brand by ING.

The net effect of becoming bigger and more ambitious is that straightforward customer research and marketing gets stampified. This is a word that I coined to denote the fact that in those big banking bureaucracies the responsibilities of employees - with the only exception of the board - becomes limited to the size of a postal stamp. The result is that these companies (marketing) departments require more time for internal debate, offcie politics and consensus-finding which they can't spend at finding out how to best serve the customer.

The consequence of this stampification is that the banks lose touch with their customers and reality. Our last retail payment product, the Chipknip, showed this most clearly. The ridiculous local battle between two competing e-money schemes (although perfect from a competition perspective) created so much nuisance for retailers that this inspired them to get back at the banks. Infuriated by high terminal switching costs, they found the newly set up competition authority at their side to fight the banks cartel behaviour.

As such our retailers were quite successful: the banks were being fined and a part of the fine was channeled towards them (via a Covenant) to improve the EFTPOS situation in the Netherlands. This Covenant was even prolonged to ensure a continued collective rebate for retailers on EFTPOS fees. Effectively we could thus see the retailers as being the clear winners in the last 15 years of retail payments here in the Netherlands. [And as with today's MIF-debate we can wonder whether the benefits they derived from emptying the pockets of banks did really end up in the consumer pockets by lower prices.]

Back to inward-based-marketing: the best (and typical) example is the way the Chipknip product was initially taken off the market. Banks informed the customers that they all had to unload their Chipknips at specific loading/unloading points. This lead to a big confusion and questions on twitter. Eventually some individual banks decided to give the money back on the basis of the internal administration so that customers didn't need to bother going to an obscure loading point. And then, quickly, all banks decided to do this.

I sincerely hope that we will no longer witness these old school thinking marketing methods in the new year. Banks need to find a way to innovate and listen to clients and society or they will be trapped in old behaviour that is only comprehensible from a stampification point of view but not understandable for customers outside the bank.

Outlook
If history is anything to go by, we may well see a repetition of the SEPA-dynamics in the banking domain. What I mean with that is the following: as banks are busy lining up their internal systems in order to conform with a whole range of upcoming new EU regulation (keywords: PSD2, MIF, AML), the non-banks will be able to build all kinds of new products at the fringes of the payments market.

Most of these new products won't be made from a payments perspective but will solve a user problem. Creating a payment button in these products doesn't require much more than a direct customer relation and a European direct debit agreement. So we might well see the banks moving into a back-seat role of providers of the payment rails for non-bank providers of user services.

Fed issues rules to debit card interchange...

After a lot of thinking, the FED issued its rules for debit card interchange. Essentially they've outlined the borders beteen which the outcome in the market is acceptable. And it's a smart solution for a tricky debate, because at some point it looked as if the FED didn't really knew what they were up to.

An interesting element is that 3 party networks are excluded from the regulation (which is legally inevitable). And that a sort of competition appears to be forced upon the issuer. In any case, the markets reaction in terms of increasing share price was quite clear. Although it might also have been the short-squeeze in US treasuries that did the trick.

Interchange fees: do the FED know what they're up to...?

I've just read the FED's speech on interchange fees. Most striking, in my view, was the conclusion that this is a complex issue. Now, the FED are good thinkers, and if they say something is complex, it means that even they can't make something out of it. So if I read the text below with that in mind:
In light of the novelty and unusual complexity of the issues raised in this rulemaking effort, my colleagues and I are very interested in reviewing the full range of comments offered on our proposed rule and are reserving judgment on the terms of the final rule until we have the opportunity to benefit from these comments.

This just looks as if the FED are saying: Sorry, but even we don't know what to do here. So my guess would be that they go for an easy, less controversial solution. Because in the meantime, I noticed in the SEC filings that Visa and Mastercard are already preparing for a large legal battle (and have agreed how to share the burden between them). And from the above, I reckon the FED is not looking forward to more complexit or novelty.

ING first to announce SEPA strategy for cards/terminals - all brands allowed

Yesterdays Telegraaf contained some interesting news. ING has announced that it will sell POS-terminals and contracts to retailers which accept V-Pay, Maestro and PIN, all for the low price of todays PIN-transaction. Only one condition applies: it should be an EMV compliant terminal.

Well, this is exactly what retailers wished: clarity on future prices and terms and conditions. So one would think that would now be happy.... but are they...?

Well, no of course. The instant that a retailer gets the prices and desires he wants, he assumes that he has insufficiently bargained and that there is more left to bargain for. And he will immediately start negotiating for another round of fee cuts or what have you.

Likewise in the Dutch situation. In their reply to the ING announcement the retailers didn't spend any second complimenting ING on their vision, their fee structure or on fulfilling their previous demand. The next complaint in line is now that they find it intolerable that on the issuing side (which is completely not their concern) the PIN technology is based on magstripe and the other brands on EMV. In their view PIN should move to chip-based PIN as well....

To be continued.... I would say... until banks decide to stop participating in this retailer bargaining game.

van Hove's take on the Commission flawed interchange decision

Amidst all the political noise on the interchange decision of the Commission it is good to also see that some academics still see the whole picture and have the courage to challenge politicians where it hurts. See this article by Leo van Hove and more particularly his closing remark:

So if regulating one payment instrument can have unintended repercussions on substitutes, and a prohibition of interchange fees would be a leap in the dark, what are enlightened policy makers to do? They could simply try to ensure that market forces work, and in particular that merchants cannot be locked in by card networks. To that end, retailers should be allowed to "surcharge" and pass on interchange fees to consumers. Promoting competition among card networks as well as among various payment instruments should also be high on regulators' lists. More generally, we need policy makers who have a comprehensive vision of the future of our payment system -- and who have the political courage to make cash more expensive in order to lower its cost to society.

Commission prohibits MasterCard's intra-EEA Multilateral Interchange Fees

See the press release here to read a landmark decision of the Commission. It's main argument:
The Commission concluded that MasterCard's MIF, a charge levied on each payment at a retail outlet when the payment is processed, inflated the cost of card acceptance by retailers without leading to proven efficiencies.

Well, the discussion cannot be solved and Mastercard will not be able to prove it is right. But neither can the Commission. As I pointed out in an earlier post (ultimate paper on interchange fee by Brookings Insitution). So this is a power game, a legal game and a communication game at the same time.

We should note that at present the multi-lateral fall back MIF allows lots of smaller banks and participants to the Mastercard scheme. Those players would otherwise have to negotiate individually with all issuing banks. And that would be so costly that they wouldn't join the system at all. And I fail to see why the Commission isn't able to calculate those costs of negotation (and view the efficiency benefits of having a fallback MIF). Do they now really expect all members of Mastercard to use the next 6 months to agree bilaterally on new fees...?

Paying cash more expensive than using the debit-card

Here's an interesting bit of research done in the Netherlands. All shops, banks and central bank have joined forces to evaluate the cost of payments with cash, when compared to debit-card. The results are that it has taken us in the Netherlands some 15 years to ensure that the full cost of debit-card payments are lower than cash-payments.

The research outlines that:
- full cost of payments in retail are down from 839 million euro in 2001 to 788 million in 2006,
- in 1992 a debit-card payment was triple as costly as a cash payment
- in 1998 the debit-card payment with PIN was roughly twice as costly as a cash payment
- in 2006 the debit-card payment is almost the same price as a cash payment (20-18 cents in retail-environment),
so that now, at the end of 2007 it's safe to state that the full cost of Dutch debit-card payments to merchants are lower than cash payments (on a per transaction basis).

As a consequence, the retailer representative organisations advise all merchants to use the debit-card rather than cash and to stop old habits that date from earlier days: the surcharging for use of the debit-card. Because other research by the central bank shows that still 20 % of the retailers surchagre an amount of approximately 23 cents for payment wit a debit-card.

So one landmark achievement is that over here in the Netherlands we have started to beat cash in terms of real cost.

Comes with it another interesting development. One fifth of the retailers surcharges 23 cents for a debit-card transaction that costs them 20 cents. Leading to a 3 cent per transaction profit. The bank-side of this equasion is that banks sell their debit-card transaction for 5 cents, while it effectively costs them 13 cents (see McKinsey reports in 2005). Meaning that debit-card payments have turned into a profit maker for retailers and a bleeder for banks.

This makes you wonder why it would make sense for banks to still subsidize debit-card payments to merchants with a one cent per transaction 'efficiency-stimulus' as agreed in the 2005 Covenant.

Mastercard to reconsider ad valorem based fee plan in UK...

See the website of the British Retail Consortium to read that Mastercard planned for a new approach to debit card interchange charging but was stopped by retailers...

In the UK retailers currently pay a fixed fee on debit card transactions regardless of the value of the transaction. Rates range from 6 pence to 18 pence, depending on which card it is and where and how the transaction occurs, but the fee on a £20 transaction is the same as for a £100 transaction.

For this new debit card MasterCard wanted to introduce percentage, or so-called ad valorem, fees. It wanted to charge a fixed fee of 3.5 pence plus 0.15 per cent of the purchase price.

It's intruiging: the attempts of debit card schemes to go for the ad valorem fee structures for payments where actual value (in terms of cost) does not influence the cost of the transaction....

Yes, there is an interbank compensation mechanism (interchange fee) for POS in the Netherlands

For some unknown reason, I noticed that quite some websurfers seem to be interested in the question whether or not an interchange fee (for POS) exists in the Dutch retail payment systems. Well, the answer is that there are interchange fees for:
- direct debits
- bill payments (acceptgiro)
- interbank usage of ATM's
- and an interbank compensation mechanism (not a literal fee) for POS.

As for the latter mechanism, the NVB explains in its reply to the competition report of the Commission:
From an outside view it may seem that the Dutch POS scheme PIN indeed operated or operates without an interchange fee mechanism. But this was and is not the case. In fact there has always been an “implicit” interchange fee till March 2004. Card issuers received the net financial result from the acquiring operation of the only acquirer Interpay/BeaNet, to cover costs on the issuer’s side. From the moment on that the sole acquiring by Interpay/BeaNet ended (March 2004) and individual banks became acquirers for POS transactions, an explicit cost based interchange fee from acquirer to issuer was introduced that forms part of the cost base for acquirers. The underlying interbank agreement was notified to the Netherlands Competition Authority (NMa). The NMa however doubted the necessity of a multilateral interchange fee mechanism. Therefore the interchange fee structure will most likely be redesigned and be replaced by a system of bilateral interchange fees. The discussions with the NMa on this topic are ongoing.

Now, why would this be interesting to the readers?

I guess that it boils down to the current hefty ideological debates on whether or not interchange fees would be necessary in payment systems. While the answer is a clear yes (most certainly to get separate initiatives all aligned to become interoperable and standardized) the regulators seem to forget about the evolution of payment systems. And wish to abandon interchange fees to the past. So they keep on continuing the myth that it is possible to do payments without compensation mechanisms and keep referring to the Dutch situation as an example.

Although every regulator might learn from studying and trying to understand the industry, they also do have a fundamental right not to take things for granted and the right to climb the learning curve from scratch by themselves. In that spirit, I would encourage those interested to start studying the situation in payments via the phone in the Netherlands. At present we have a number of initiatives going. Some use the phone and a voice-mail application, others such as Payter use NFC. And Minitix is a combination of both, while a number of trials is pending.

While the newspapers this week all announced that in the future we would pay with our mobile rather than with e-purse, let's imagine what will happens if all these initiatives grow. Suppose we end up with 3 types of schemes. The consumer and retailer lobby organisations will then say it is too messy and unorderly. You can't expect shop owners to accept all those schemes: they need to be interoperable. And consumers would also benefit from one m-payment technology rather than having to choose from three.

What will happen then is that the initiatives will work out some interoperability agreement allowing one application/device to accept all 3 schemes. But then there is the question: which scheme had the relation with the retailer and which with the customer. And how are the schemes going to be compensated for their efforts in building their customer base (which will now be accessible to all involved). Particularly if the market coverage of the schemes is different:
Scheme A: 30 % consumers ; 30 % merchants
Scheme B: 10 % consumers ; 60 % merchants
Scheme C: 60 % consumers ; 10 % merchants

The answer to this economic puzzle is of course an interchange agreement. Yet, if regulators would insist on forbidding it, they force the market into a situation where no single technology will serve the whole market in an interoperable way. Which is beautiful from a competition perspective, because there is lots to choose for all. But perhaps it may be less convenient from a customer and efficiency-perspective.

So if we would call interchange fees a 'hidden tax' the alternative is an 'open and visual tax' consisting of the burden for merchants and consumers to have a higher number of different, not-interoperable payment instruments in their wallets, on their phone's and on their pc, in order to be able to pay for all the purchases they'd like to do (and to be able to accept all the payments from consumers). That is in my view the bottom-line policy choice in the interchange debate.

And if it's the hidden cash we're after, why not start eliminating the hidden tax (or stealth tax that Dave Birch calls it) that is out there for cash?

Interchange complaints are just a call for lower merchant fees..?

Here's an interesting article on the Javelin Strategy and Research site. It ends with the open remark that all the fuss about interchange payments, made by retailers could be merely those groups posturing for lower fees by whining about high charges for merchants and disruptive interbank agreements.

Now, if indeed all this hidden tax for merchants, interbank agreements and huge profit would be so terrible to retailers, why dont't they set up a retailer based card scheme....? Because in the end accepting payment with cards in a shop is a make or buy decision.

If you don't like the brands and fees out there, just do it better yourself. And then, when the argument comes that it would be impossible to reach all consumers with your single retailer card, or that it would become a messy world if each retailer would issue its own card: well, that would make one really understand what it is exactly that you as a retailer are paying for, when you decide to go along with bank issued cards.

Banks have solved a complex cooperation, coordination and reachability problem in the cards-space and do not just use their expertise for themselves (by limiting the interbank card usage to ATM withdrawals) but also allow their consumers/merchants the benefit of using that same card for paying in the shop. But then, when push comes to shove, all the users can do is be unhappy with the pricing (as if anything in the world would need to be provided for free).

So indeed, I would agree with the Javelin remark. It is high time for either a retailer based third card scheme in Europe or a more modest and less agressive approach by retailer lobby organisations.

House Financial Services Committee hearing on credit-card practices

See the website of the House Financial Services Committee to view a webcast on the hearing on credit card practices. The chair of the committee announced that a second hearing will be held (first week in June) with all bunch of regulators. Late May the FED will publish a revision of disclosure rules for credit-cards (I think its reg E).

Continued retailer battle in the US via the competition authorities

See the news-article onn National Retail Federation website. It shows how regulators call upon state legislators to do something about credit-card interest rates. Effectively this may not really be about policy any more.

It appears as if the existence of competition authorities is creating a new battlefield for businesses. Which is to hurt any other business by complaining and having them investigated by the competition authority. Even if the claim fails, one will have won by damaging the image of the other company and by having them allocate resources to lititgations/competition discussions, thus increasing the cost base. We may have seen a similar thing here in Europe in the beer-brewery market. Belgian based Inbev provided information to the EU Commission which then fined the breweries. And The Belgian-based InBev group received no fines as they provided decisive information about the cartel under the Commission’s leniency programme.

So what may become a serious problem in the future is that regulators that do not understand the workings of the market, may be fooled by some in the market into believing that a situation of non-competition occurs, while effectively there is nothing going on. But if you're cunning enough and having a cartel-buster (bound to view cartels everywhere as a part of his job description and goal in life) you can do damage to competitors or other stakeholders in the market.

So while we are already used to an increased number of litigations in society between players themselves (consumers, companies, governments) we may also face an increasing number based on administrative and competition law. I am not sure if that will really be productive, especially not in a situation where the Commission effectively not just wishes to fine the companies themselves but also states that all those damaged must be compensated too.

Belgians reconsider rolling out Maestro for domestic payments

The Belgian newspapers all cover the news that, contrary to earlier reports and choices, the Belgian banks have chosen not to move over to Maestro as of 1.1.2008, for national Point-of-Sale payments. Their argument is that the European policy framework for payments is a bit unclear and also that merchants and domestic stakeholders were not really in favour of the idea. This very much looks as a victory for retailers, who have been sounding the alarm bell all over Europe that moving to SEPA may mean higher costs/fees for merchants.

Well, how should we read this stuff about an unclear policy framework? The Sepa Card framework is indeed a bit vague, but generally the idea to converge to panEuropean card payments is quite clear. So what would be the real issue here?

My guess is that it's not only the merchants voice, but also the uncertainty and threats of local and EU governments as to interchange fees for card payments, that is now making market developments come to a temporary standstill. The main issue is whether all brave and tough speeches by cartel-busters are merely gallery-play fr the public or a reflection of a serious determination to end interchange fees in Europe. And at present there is a formal complaint pending with the Belgian competition authority as to the Belgian move to Maestro. So given this uncertainty it may indeed be wiser for Belgian banks to adopt a wait-and-see approach to the issue, rather than moving ahead towards a scheme which will then be subject to further competition-reviews by regulators.

And more retailers into credit-cards....

While one part of the Dutch retailers seek to continue a battle against the credit-card, their own colleagues are making this a losing battle. Webwereld has an article that outlines that on-line retailer Wehkamp will start accepting ideal for webpayments. Furthermore, Wehkamp is planning the issuance of its own credit-cards. Which neatly fits their consumer lending business model.

New competition in payments to lead to more transparant pricing...

Many many years ago, payments between banks in the Netherlands were sent back and forth between banks without allocating costs to one another. The bacis principle being that it wasn't worth within a group of similar companies and similar interests to device a charging system to ask your competitor for the fact you processed something, while next week he would charge you in return.

Enter the giro-based Robeco on the scene (1975). Without having any offices they allowed customers to use the payment system to send them money for buying stock/securities. Which drained money from the system. But as those credit-transfers were free the banks felt it would be useful to introduce more cost-based pricing and interchange fees. Because in a world of different business model, imbalances between players require explicit cost-allocation and renumeration.

Fast forward to 2004-2006. Enter new players such as Argenta and DSB Bank on the Dutch banking scene. Having a full bank license but not operating with a lot of branches. So the cream off the market by offering customers high interest rates on savings and offering 'free payment accounts'. But there is a catch. It's not free for all. A customer will not be able to visit the bank (there are hardly any branches) but is required to do internet banking. And as forcard-usage, the new players lift along on international brands (without operating any ATM themselves).

This week Rabobank presented the loss-profit of last year. And FEM BUsiness featured an article that outlined that the competition for Rabo is increasing. Both in mortgages (where already 10 % of the Dutch mortgages is sold by a non-Dutch bank) and in payments (where new players offer free payment accounts). Of course Rabobank (having a dense network of branches) feels a bit annoyed by these new players in the payments domain. If such trends continue, they end up competing on price but also having only those customers left that do not do internet banking and need to revert to their physical distribution outlets.

So this week CEO Heemskerk of Rabo outlined to the press that Rabo will charge for all transactions related to the work for those new players. If any of the DSB- or Argenta clients will be using Rabo ATM's, either the customers or their banks will be charged for doing so. Because the days of free lunches are long gone.

Continued retailer action against credit-cards

Remember my post of last december on an clear retailer action to attack credit-cards and interchang fees? It's now been three months since and the branche organisation for hotels/restaurants (Horeca Nederland) now brings in the boss himself. In what is in spirit and text almost a similar letter, Jeu Claes states in the Financieele Dagblad that credit-cards cost too much. Which goes to show that the retailer strategy is to keep on reminding the public, over and over, on stuff that appeals to the public, but essentially leads to only one thing: lower cost to the retailers themselves.

Which is their good right of course, but it is a bit double-hearted when actually one of the main strategies of Horeca Nederland to attract more members is to offer a serious ,5 % discount on average credit-card fees with major acquirers.

And the credit-card enquiries continue...?

US Senator Dodd convened his first hearing as Chair of the Senate Banking Committee in the US and put credit-card practices on the agenda... so it seems enquiries continue and the complex interchange fee discussion once again gets the spotlight.