RBA to set Australian credit cards free, but who will bring the disruptive competition?
One of the most fundamental functions of an advanced financial system, to which Australia belongs, is to provide and facilitate efficiency of trade, the ease with which participants engage in trade activities – that is, ability to make and/or receive payments. One way of delivering efficiency in the systems is by reducing the transaction costs involved and thereby attracting and encouraging more trade activities
And at the apex of such a financial system’s eco-system is a central bank. Here we have the Reserve Bank of Australia (RBA), an entity focused on overall (all inclusive) public policy goals and smooth operation of the system itself. Therefore, what the RBA does or intends to do in terms of policy can reasonably be expected to effect a systemic change.
RBA on failure
According to a recent report by the RBA, dated March 2014, on potential changes to the credit card scheme, the daily value of transactions in all credit card systems in Australia averaged $720 million in 2012/13, with net obligations likely to be a fraction of this. This compares with real time gross settlement payment (RTGS) payments of $158 billion and direct entry of $40 billion per day.
In the same report, the RBA has come out and stated that it has formed the view (after listening to both the financial industry players and the public) that there needs to be more competition in the Australian credit card space. In 2004, the RBA went down the same route and introduced a ‘specialist credit card institution’ (SCCI) category. SCCI being qualified entities that would be allowed to participant in the Credit Card Scheme without having to have a full banking license, as was previously the case. A decade later the RBA is proactively looking to make further changes, amend the Credit Card Scheme rules, so as to encourage more participation. This is after having noted the unintended onerous costs and entry requirements associated with the application of the SCCI status.
Big business should borrow a leaf from the RBA on this. Unintended consequences combined with not being able to achieve set goals does not mean failure. Failure is not recognising that good decisions are made on current best scenario (upfront cost) with the objective of attracting future (risk) benefits over a proposed (distant) timeframe. And more specifically that timely recognition of missed set target outcomes (benefits) should be embraced as an opportunity for change. The response should be iteration at the very least. Denial or blame appropriation, the road most travelled, should be avoided.
Credit card competition
From a simplistic viewpoint, the Credit Card Scheme as a system primarily includes financial service providers/banks (card issuers and acquires), platform (Visa and MasterCard), traders and their customers.
As an example, when using a typical credit card, a $100 spend at a local store may translate to the store owner getting $97, while the other $3 goes to the credit card system. The $3 fee (merchant discount rate, or MDR) is split between the customer’s card issuer, the merchant’s agent and the credit card schemes (Visa or MasterCard). This MDR is set by the acquirers, issuers and Visa or MasterCard and is generally explained as the cost of providing and maintaining this particular system.
The engagement benefit in terms of convenience provided by this credit card system to the consumer and equally to the store owner is very clear, including but not limited to, ease of interaction (payment gateway) security of transactions (verification) and real time processing (settlement) benefits.
In a free market, competition is usually the antidote to complacency and a driver for innovation that leads to incremental or sometimes disruptive change. By going back to its 2004 objective of increasing competition in the credit card space and noting that this has not happened at a rate or pace they had possibly hoped for and subsequently making its intentions clear, the RBA settled on three options. Option One: do nothing, let it be. Option Two: attract new entities into the scheme, competition. Option Three: scrap the scheme entirely.
New kids on the block
Not to disadvantage the current participants, banks and SCCI’s, Option Two proposes to automatically include current players. The interesting space will be the ‘new kids on the block’
Going back to 2004, groceries and insurances shopping did not fit into the same basket/trolley, online purchases under $1000 did not attract GST with little or no cause for concern from retailers and there was no global financial crisis. Now, Coles and Woolworths both have their own branded insurance products, online trade activity has shifted the goal posts for Australian retailers resulting in a push by some retailers to the introduction of GST for purchases under $1000 and the GFC is a number one ticket holder in most if not all discussions regarding macro finance.
What effect, if any, will a Coles branded Visa or MasterCard have compared to a NAB, ANZ, Westpac or Commonwealth Bank branded Visa or MasterCard? What about an AustralianSuper or HostPlus super fund branded Visa credit card? As an opinion, the net effect will be in line with other ‘older new kids on the block’, including online payment options like PayPal and more recently Square, incremental competition.
The disruptive competition will happen along the lines of RBA’s Option Three or a bypass of Options One and Two. The ‘New Kid’ who delivers increased convenience and a commercially sustainable merchant discount rate, pegged say at -0.8%, to what is offered by the scheme. This with the full knowledge that the scheme participant, as it currently stands, will find it very difficult to match this offer without considerable disruptions to their businesses models. Reason being that a major component of the MDR is the interchange rate charged by the schemes.
If incremental competition is your focus as a potential new kid on the block this may not be feasible. For the rest, is it another classic case of this being in the too-hard basket or falling under ‘not our core business’ mantra’?
Should a start-up entrepreneur prove it first, disrupt the market and by doing so cause a significant and tangible headache to current participants. The RBA has clearly shown that it sides with change (as a constant) in its policy goals as long there is no negative effect to the smooth operation of the system.
From my view point there are a number of institutions in Australia that are well placed to bring on this disruption. Whether they do so or not is another story, one thing that is for sure is that by 2024 there will have been winners and losers.