Competition issues arising from interchange fees

In a POS system, agreements on interchange fees lead to a transfer of revenues from acquirers to issuers and thereby distort price competition between acquiring banks. The Commission has in the past considered that multilaterally set interchange fees in the Visa system restrict competition between banks for providing services to cardholders and to merchants, as they largely determine the fees charged to both consumer groups. Visa interchange fees were allowed only after Visa committed itself to (i) set interchange fees on the basis of objective costs incurred by issuers for providing concrete services to merchants; and (ii) allow member banks to disclose these fees to merchants.209 _In subsequent years, authorities such as the UK Office of Fair Trading, the Spanish Tribunal

207 _{16 networks replied to the question as to the purpose of POS interchange fees and three indicated a specific}

purpose for ATM interchange fees. Where networks specifically commented on the purpose of ATM interchange fees, the reasons diverged from the reasons given for POS interchange fees.

208 _{This assumption is challenged empirically in the following Chapter on industry profitability.} 209 _{Commission Decision of 24 July 2002, OJ L 318/17 of 22 November 2002.}

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for the Defence of Competition and the Italian Central Bank have concluded that interchange fee agreements infringe competition law; but that they could be allowed if the fees were set on the basis of costs incurred by issuing banks for providing card-related services.

There are indications that the setting of interchange fees in the international systems may have the object and/or effect of creating market entry barriers to competition between local and foreign member banks. Both MasterCard and Visa allow the parallel existence of multilaterally set (fallback) and bilaterally set (on us) interchange fees. While multilateral fees apply to all national payments in a given country (irrespective of the bank’s identity), bilaterally agreed fees only apply between the parties to the bilateral agreement.

In countries where local banks wish to set low interchange fees specifically for certain merchant segments (e.g. food retailing or petrol stations), they have a basic choice. They can either set these rates by multilateral decision in a local board or go set the same rates in several bilateral agreements between each issuer and each acquirer in a given country. The latter option is clearly more burdensome. Under the network rules of MasterCard and Visa, only in EU Member States where local banks set merchant-specific rates multilaterally in a local board are foreign banks able to benefit from such preferential rates. If, on the contrary, the same rates are set in a bundle of identical bilateral interchange fee agreements, the foreign bank pays higher fallback rates.

A comparison of the absolute levels of MasterCard and Visa national interchange fees suggests that the relatively high level of some merchant-specific rates may result from the exercise of market power by acquirers.

Turning to the analysis of cross-border interchange fees, the evolution of MasterCard and Visa fees between 2001 and 2004 raises the question why the weighted average of MasterCard cross-border interchange fees for credit cards increased from 2002 even though Visa’s weighted average interchange fees for cross-border payments decreased from that year onwards. In other words, does inter-system competition between MasterCard and Visa act as a disciplining market force on bodies setting interchange fees in these networks? The development of MasterCard cross-border interchange fees would rather suggest that inter-system competition did not restrain MasterCard from maintaining higher cross-border interchange fees than those of Visa over more than three years (2002 to 2004). Market forces may therefore be insufficient to 'penalise' card systems with relatively high interchange fees, at least as far as fees for cross-border payments are concerned Finally, the co-existence of bilaterally210 _{and multilaterally agreed interchange fees is} relevant for competition within the MasterCard and Visa systems. In countries where an inter-bank association acquires transactions from an international card network, local banks that are co-shareholders of this inter-bank association may be able to offer lower fees to the association. Thus parties to these agreements can offer lower merchant fees and thereby prevent new competitors form entering a market.

B.5.6. Conclusions

The sector inquiry provides evidence that interchange fees are not intrinsic to the operation of card payment systems. Several national systems operate without an interchange fee mechanism, resulting in generally lower merchant fees.

In the international networks, Visa and MasterCard, the inquiry revealed significant variations in the weighted average of national credit card interchange fees across the Member States. In 2004 the level of the highest fees (over 1.5% of transaction value) was two-and-a-half times greater than the lowest weighted average fees. For Visa and

210 _{These are often referred to in the industry as “on-us” fees, although strictly speaking “on- us fees” arise where}

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MasterCard debit cards, the highest fees were observed in some of the new Member States. For Maestro cards weighted average interchange fees were more than three times higher in some Member States than others, and more than four times higher in some Member States than others for Visa debit cards.

The use of interchange fees may serve several purposes. Card payment networks argue that, given the typical set-up of card payment mechanisms, the card issuers typically bear the main costs of the payment system, while most of the revenues are collected on the acquiring side as merchant fees. Therefore, they claim that there is a need to redress cost imbalances by an interchange fee mechanism; i.e. a fee paid by the acquirers to the issuers. Other systems argued that interchange fees are a co-ordinating mechanism necessary to optimise the operation of four-party payment card systems.

Two competing assessments can be distilled from the economic literature on interchange fees in payment card systems: either that their effect is neutral and provides efficient incentives for card issuers to expand output; or that high interchange fees offer a means of transferring rent (which cannot be competed away) from acquiring to issuing banks. From a competition viewpoint, it is important to assess whether interchange fees are used to extract rents from merchants. Some of the inquiry's findings – in particular concerning large divergences in interchange fees between countries and between merchant segments – may provide indications that the setting of interchange fees could be subject to the exercise of market power in some Member States.

By concluding and acting on a basis of preferential interchange agreements, incumbent players, involved in both issuing and acquiring activities, may indirectly obstruct new entry to the acquiring by not extending the same favourable conditions to newcomers.

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