Facts and Analysis. Integrated EU Market for Card, Internet and Mobile Payments

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Lithuanian Free Market Institute (LFMI) provides the analysis regarding European Commission’s (EC) proposal to regulate Interchange Fees (IF) across Europe. This is an executive summary of the analysis.

Interchange Fee (IF) is a fee paid by a merchant when a transaction is carried out between merchant’s bank and consumer’s bank for goods or services purchased by a consumer with the help of a card drawn by a consumer from his/her bank.


–          Briefing paper of the analysis (3 p.): http://files.lrinka.lt/AM/LFMI_IF_summary.pdf

–          The extensive analysis (13 p.): http://files.lrinka.lt/AM/LFMI_IF.pdf

The problem in brief

According to the European Commission:

  1. Current IFs are too high, vary across countries and are not transparent. This situation hampers development of a single market in EU, and thus requires regulation.
  2. This fee (IF) is the main obstacle for e-commerce growth, spread of electronic and new innovative payment methods and development of single market.
  3. Harmonizing IF rates across EU would promote competition, innovation and the growth of e-commerce.
  4. Additional regulations, such as co-badging, “easier market access” for new companies, standardization on various levels, changes in ownership structure of companies by separating card schemes from payment processing companies would also bring benefits.

According to LFMI:

  1. LFMI supports the EC’s aim to develop a single integrated European market, but measures suggested by the EC are not entirely suitable for the objective and instead could harm consumers and businesses and reduce EU’s global competitiveness if it were implemented.
  2. Regulation would be especially harmful to consumers and new merchants or startup businesses that rely on or are developing new innovative solution for the e-commerce market. It is highly likely that consumer would have much less to choose from and the prices for goods and services could be higher, whereas entrepreneurs could have less incentive to innovate, develop and invest.

Brief analysis of proposed regulation

  1. Payment market differences across EU do not mean that market is not functioning. IFs across countries are determined by market conditions (economic, technological, regulatory and etc.) therefore are different between states. High IFs rates are observed in countries that lack the infrastructure necessary for development and spread of card, internet and mobile payments. While countries with low IFs usually enjoy high numbers of cards and card users, higher value transactions per card, a significant number of points of sale (POS) and people are in the habit of using electronic payment options, instead of cash or bank transfers. Suitable examples would be Estonia and Lithuania. Rates in Estonia are much lower than in Lithuania, because the spread of cards, their usage, transaction values and number of POS is greater than in Lithuania.
  1. Obligatory co-branding increases costs. A suggestion to force companies to use co-branding (several brands on a payment card) would create a number of issues and potential problems. Just to name a few: Which brand is liable in the case of fraud or theft? Different brands have different technologies and IT protocols, how to resolve it? How would few brands on a card affect time spent at the cash register and which brand is the main one? Can the consumer choose the default priority brand or make the choice every time when paying? Instead of benefiting the consumer and increasing usage if cards, co-badging may have an opposite effect. High likeliness of more expensive services to the consumers due to increased costs that are related to implementation of these proposals and less consumer choice.
  1. Artificial separation of companies does not increase efficiency, but increases costs and prices. EC claims that separating ownership between card schemes and payment processing companies would make market access for new or cheaper card schemes easier and thus such action would promote competition. However, separating payment card schemes from their payment processing subsidiaries could mean higher operating cost and this would result in higher fees for both consumers and merchants. This could happen because companies would no longer enjoy economy of scale and could not set standard procedures and, this would decrease efficiency. Companies have invested through the years to improve operations, to reduce costs and build reputation. It is highly unlikely that such separation would promote efficiency and innovation in the market and promote entrepreneurs to take risk.
  1. Pricing transparency of payment services does not require regulations. According to EC, consumers are not aware of particular costs of payment methods that they use. LFMI argues that regulating the price is not a solution to a problem of lack of information. There are a number of examples when markets are working perfectly, even if the consumer is not aware of the costs. From “iPhone” to cars or to electricity bills. Consumers care about the final price of goods and services.
  1. Forced standardization could reduce EU competitiveness.  European Commission suggests setting standards for cards and card operations, establishing a standardization body (regulatory agency) and setting standards for e- and m-payments. However, there are market standards and even ISO standards for cards which are in circulation today. E- and m-payment are new payment options and are still being developed, especially m- payments. This market is rapidly developing and the introduction of common standards might prevent or slow down the growth of it. In order for Europe to be in the lead in terms of e-commerce, it is necessary to allow such markets to develop on their own with the minimal level of intervention from regulatory authorities. We will never know how a new payment method would look tomorrow if we prevent entrepreneurs from developing it by setting standards that do no promote innovation.
  1. Excessive payment and data security regulation does not ensure greater security. EC emphasizes the fact that payment and data security is not sufficient and therefore requires improvement and the number of parties which have access to sensitive consumer data, have to be kept to a minimum. LFMI agrees that payment and data security is very important. However, a lot of investment has been done by companies to prevent fraud in traditional payment methods, which gave good results. But due to rapidly increasing use of internet technologies fraudulent activities are moving to the internet and mobile payments (e- and m-payments). However, there should be a careful consideration when creating rules for security and understanding the nature of fraudulent activities. We suggest that EC should restrain from setting up specific standards or rules for companies on how to prevent fraud and data loss. Companies have a self-interest to prevent fraud and data loss and they invest a lot into new technologies, conduct strict due diligence. More so, additional requirements by government require additional resources (investment, time and human), which in the end add up to the costs and increase the final price. More importantly, because a lot of operations are carried out globally, certain security regulations might prevent global interoperability.
  1. Consequences of IF regulation from other countries does not support the need for IF regulation in EU. Results of regulations, mainly of regulating IFs, can be seen in Spain or Australia. In both cases, consumers saw increased card fees, fees for overdrafts, reduced discounts and benefits. Banks were increasing such fees for consumers, because they saw reduced cash flows from IFs paid by merchants. More importantly, merchants in Spain and Australia internalized these savings and did not pass them to consumers in the form of lower prices. This was clearly opposite of what, the governments of both countries had expected. In the end, there was less incentive to invest and innovate and to develop new payment methods and for entrepreneurs to enter the market. Competition was dealt a serious blow and consumers paid the price for reckless intervention into the market.

In 2011 there were 727 million payment cards in circulation, 1.44 per capita and it is a 4.6% increase of non-cash payment instrument usage from the previous year.  There were 90.6 billion transactions carried out with a card, with an average value of such transaction at around 52 EUR with the total value being 1.9 trillion EUR. According to Ecommerce Europe, the e-commerce market grew by 19% in 2012. Europe is the biggest e-commerce market in the world (surpassing USA and Canada) in business to consumer (B2C) segment with a 35.1% share while USA and Canada has a 33.1% share and Asia-Pacific with 25.6% share. It its estimated, that by the end of 2016 the European B2C market should reach a volume of 625 billion EUR or more than double the current volume. Additionally, it has been estimated, that m-payments (mobile payments), the newest payment platform that has the most potential of all payment methods, should reach 1 trillion USD volume by 2014 of which 350 billion USD should come from Europe. To add, around 47% of Europeans have a smartphone. That empowers entrepreneurs to develop m-payments and expand the e-commerce in Europe.