The Regulation of Interchange Fees: Australian Fine-Tuning Gone Awry

Abstract

Two-sided markets are generally defined as markets in which the value attributed to the goods and services received by parties on one side of an exchange depends not only on the intrinsic properties of those items, but also on the number of parties located on the other side. In the credit card context, which I shall address here, the story plays out as follows: merchants accept credit cards only if customers are willing to use them to make purchases. Customers use credit cards only if merchants will accept them. Today, there also exists extensive literature describing the theoretical features of these markets, which, as this Article will explain, do not operate with the matchless efficiency of ordinary competitive markets. Given this starting point, the question of industrial organization faced in two-sided markets is that of selecting the second best option. Because the ideal solution cannot be achieved, we must locate the closest approximation to that ideal that can be attained under practical circumstances. Stated more generally, this inquiry can be reduced to the question of whether state regulation can improve the operation of two-sided markets. Fortunately, we do not have to examine two-sided markets solely from a theoretical perspective. We have available at least one real world example, namely the interchange fee restrictions that the Reserve Bank of Australia (“RBA”) imposed on the credit card industry in July of 2003. In a report entitled Reform of Credit Card Schemes in Australia, the RBA implemented a series of recommendations that had been announced in its comprehensive 2001 regulatory initiative. The RBA’s key initiatives focused on two essential features of the open credit card systems used by Bankcard, Visa, and MasterCard. The first of these was the regulation of interchange fees. The second was a contract provision that prevents merchants in these systems from offering lower prices to their cash customers. Ultimately, these regulatory interventions are intended to address what the RBA claims are efficiency and distributional concerns, thereby reducing the implicit subsidies that cash, check, and debit card users pay for credit card users. The RBA’s program is explicitly designed to improve the position of merchants (and their broad customer base) and acquiring banks relative to that of issuing banks and their cardholders (which are only a subset of all customers). This Article shall examine whether implementing these reforms has allowed the RBA to make good on its objectives.