Why the Reserve Bank isn’t the right regulator for our payments system

The Reserve Bank regulates interchange fees - the credit card fees paid by merchants - but why? Image sourced from www.shutterstock.com

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

At the moment 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 isn’t 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.

But there is no such thing as a free lunch or a costless transaction. All the technology and organisation that underpins the credit card system has to be paid for. The costs can either be paid by consumers, or merchants, or some combination of the two. 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 being 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’s obvious that the RBA should be involved in regulating them too.

Actually, no.

The main argument for why the regulation of the payments system remains with the RBA can be summarised, in essence, as “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 that can be approximated as follows:

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

  • Interchange fees are connected 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 1 above).

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

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

  • 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 are solid economic arguments, each can be picked apart logically and empirically, 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 shouldn’t. 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 is built 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. It is entirely based in microeconomic theory (not macroeconomics) and is focused on private market behaviour under different degrees of competition (from perfect competition to monopoly).

So 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. So in the first instance we argue the RBA should be stripped 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. So 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.