The RBA Regulates Interchange Fees Because It Always Has

Sometimes boring debates are important. Mind numbing detail gets in the way of good policy. Therefore, it is with an obscure feature of credit cards known as “interchange fees.”

Currently, these fees are both highly regulated, and inappropriately regulated by the Reserve Bank of Australia (RBA) and not the Australian Consumer and Competition Commission (ACCC).

Sometimes boring debates are important. Mind numbing detail gets in the way of good policy. Therefore, it is with an obscure feature of credit cards known as “interchange fees.”

Currently, these fees are both highly regulated, and inappropriately regulated by the Reserve Bank of Australia (RBA) and not the Australian Consumer and Competition Commission (ACCC).

People tend to overlook the complexity of the market economy. It seems all so easy. People trade goods and services all the time. The Payments System is how we actually pay for things. It is not simply a matter of handing over cash – the Payments System is a complex technological infrastructure, a web of interconnections and protocols between consumers, merchants, and banks. Cash makes up a part of that system but most of it runs on payments technologies that include debit cards, eftpos, and credit cards.

Here is where things get wonky – how many people actually understand how their credit card works? Most people simply swipe their cards and all the “backroom stuff” that actually facilitates the transaction happens. Card payments are very convenient for everyone.

There is no such thing as a free lunch or a costless transaction. One must pay for all the technology and organisation that underpins the credit card system. Consumers, or merchants, or some combination of the two can pay the costs. That is where the so-called interchange fee comes in – historically merchants have paid the costs of operating the credit card system.

All that started changing in 2003, however, when the RBA began regulating interchange fees. The rationale is that interchange fees were somehow monopolistic and the costs of operating the Payments System too high. We have argued that this policy was a mistake.

Here we want to address a more general question: Why is the RBA regulating interchange fees at all?

At first glance, this seems a bit trivial. After all the RBA is responsible for the conduct of monetary policy and it sets the overnight interest rate. Credit cards are about money too, so it is obvious that the RBA should be involved in regulating them too.

Actually, no.

Summarizing the main argument for why the regulation of the payments system remains with the RBA is, in essence, “because it has been with the RBA since 1959.” There is no strong or explicit case for positioning the oversight and regulation of the payments system within the RBA. There are a number of implicit arguments approximated as follows:

1. That the payments system has some connection with the monetary system – payments are in money, and because the RBA controls money, it should control payments.

2. Interchange fees connect to credit cards and credit cards involve interest rates – monetary policy involves interest rates, ergo the RBA should regulate interchange fees. (This is a variant of one above).

3. The payments system is a utility, (albeit run by the banks) or public good. Therefore, the central bank should regulate this.

4. The RBA has acquired historical experience in oversight and regulation of the payments system, and so it should continue in this role.

5. The RBA should regulate the payments system because it can regulate the payments system.

It does not require a great deal of logical skill to disassemble these arguments: (1) and (2) are fallacies of composition; (3) is an empirical claim; (4) is the induction problem, and (5) is the naturalist fallacy. The point is that none of these is solid economic arguments, picking each one apart logically and empirically is easy, and all carry a large amount of expediency.

The Payments System is not a public good and not a utility. Rather it is a suite of technologies and organisations, that is, an industry. It is useful to think of the payments system as a network infrastructure that has cumulatively emerged from entrepreneurial actions, as the economy has grown and developed, in order to facilitate the transaction needs of a market economy.

By contrast, monetary policy is a utility, and monetary stability is a perfect example of a public good. It is both non-rivalrous and non-excludable.

While there is no good economic argument for the RBA to regulate interchange fees, there are good arguments why it should not. In short – it is likely to be a distraction from the RBA’s main function.

Monetary policy is a specialisation based on the theory of both monetary economics and macroeconomics. It builds around the analysis of interest rates and various indices (inflation, asset prices, aggregate demand, GDP, unemployment, industrial production) and involves an understanding of emergent aggregates, transmission mechanisms, and macro-econometric models of economic systems.

Regulatory economics is, in essence, the study of the social control of business and is a very different branch of economic theory and practice to monetary economics. The basis is entirely in microeconomic theory (not macroeconomics) and it focuses on private market behaviour under different degrees of competition (from perfect competition to monopoly).

The RBA has no comparative advantage or good reason to regulate the Payments System. Australia already has a specialist agency to regulate industry – the ACCC. Therefore, in the first instance we argue for stripping the RBA of its regulatory powers and focus its entire attention on monetary policy.

Of course, once we recognise that the Payments System is an industry rather than a utility, the question arises why government would fix prices in that industry. Whether the ACCC should fix prices is an open question of competition policy. Our argument here is that the RBA has no business in regulating industry.

Why the Reserve Bank is not the right regulator for our payments system is republished with permission from The Conversation