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Australian Reserve Bank Gets the Economics Wrong on Interchange Fees

A new report commissioned by the International Alliance for Electronic Payments, of which CEI is a member, finds that the Reserve Bank of Australia misunderstood the economics when it first moved to cap interchange fees on electronic card payment systems. That cap was mimicked in the U.S. via the Durbin Amendment in the Dodd-Frank Act and more recently when the European Union decided to impose its own caps.

The new report, written by Professors Sinclair Davidson and Jason Potts of RMIT University, finds that the Reserve Bank mistook an efficient, interdependent system for a monopoly. They write:

In short, the Reserve Bank of Australia engaged in an extensive regulatory intervention based on poor theory, and no empirical evidence. Theory has not provided an unambiguous indication of market failure, and there is no empirical evidence to support the notion of monopoly pricing – other than a vague notion that interchange fees were “excessive”. What the Reserve Bank identified as being “externality” any fair minded observer would label “gains from trade”.

We argue that interchange fees are the outcome of an efficient bargaining process given that banks and consumers, and banks and merchants form long term relationships with each other. For as long as there is competition in the banking sector and competition in the retail sector, the interchange fee itself is subject to competitive pressure.

They also conclude that Australian consumers are likely to be worse off as a result of the regulation. That conclusion is echoed in the empirical research into the effects of the Durbin Amendment in the U.S., with several studies suggesting significant impacts on consumer welfare.

The report, entitled “Australian Interchange Fee Regulation: A Regulation in Search of Market Failure,” can be downloaded here.

The Reserve Bank is currently considering more stringent caps, as is the Australian Government. In addition, an Australian Senate Inquiry is considering interchange fee caps as part of a general inquiry into credit card interest rates. The IAEP/ Australian Taxpayers’ Alliance submission to the inquiry can be found here.