Post on 13-Apr-2017
Interchange fees, a balancing act
An empirical examination of a possible regulatory benchmark
Michal Kalina1 Duisenberg School of Finance
April, 2015
Thesis, LLM Finance & Law
Supervisor: prof. dr. Maarten Pieter Schinkel
1 Author can be contacted through: michal@savnar.nl
2
Interchange fees, a balancing act
An empirical examination of a possible regulatory benchmark
Michal Kalina1 (20120064)
Duisenberg School of Finance, LLM Finance & Law Programme
Master thesis, 20 April 2015
Abstract
In this paper I show the notional development of the level of the interchange fee for
debit card payments in the Netherlands, based on an alternative method to the tourist-
test. The alternative has a few a priori attractive features, such as a closer resemblance
to a debit card favouring market, whereas most of the literature does not distinguish
between debit and credit cards or focusses on the latter. Countries in Europe with high
card usage per capita and low interchange fee levels, are typically debit card markets.
However, using cost data for 2002 and 2009 I show that the method is likely to exhibit
market disturbing effects by reversing the market structure through a negative and
much larger interchange fee than in reality. In the long run, calibrated to actual
institutional settings, the method would create the wrong incentives, stimulating the
use of the more expensive payment instrument and discouraging the more efficient. The
results indicate that application of this alternative method would be ill-advised for
countries such as the Netherlands, with rising costs for cash and declining costs for
debit card; thus, regulators should be looking for other benchmarks.
1 I would like to express my gratitude to a few people without whose support or doings, this thesis would not have
been accomplished: Joe McCahery for directing a superb programme in Finance & Law; Maarten Pieter Schinkel
for sharing his insights on the subject and support to set the scope; Søren Korsgaard for elaborating on his model,
enabling me to properly calibrate it; Nicole Jonker for showing me the adjustments in cost item classifications in
the 2009 data set compared to the 2002; Frank Leerssen at Rabobank for his support and flexibility to combine
my work and study; and foremost my wife, Caroline Spoor-Kalina, for the best support I could wish for throughout
the course, this thesis and beyond.
The views expressed in this study are my own, as are any remaining errors.
3
Table of Contents
1 INTRODUCTION .............................................................................................................................................. 8
1.1 Background and motivation ............................................................................................................. 8
1.2 Research question ............................................................................................................................. 11
1.3 Academic contribution..................................................................................................................... 12
1.4 Thesis structure .................................................................................................................................. 13
2 PAYMENTS MARKETS, INTERCHANGE FEES AND REGULATION .......................................... 14
2.1 Basics and terminology ................................................................................................................... 14
2.2 Social costs of payments.................................................................................................................. 15
2.3 Challenges in payment markets ................................................................................................... 15
2.4 The concept of interchange fees .................................................................................................. 17
2.5 Justifications for interchange fees ............................................................................................... 18
2.6 Some landmarks in interchange fee litigation ........................................................................ 20
2.7 A note on SEPA and PSD .................................................................................................................. 23
3 REVIEW OF LITERATURE ........................................................................................................................ 26
3.1 Preliminary ........................................................................................................................................... 26
3.2 Models of interchange fees and policy implications ............................................................ 27
4 ANALYTICAL FRAMEWORK ................................................................................................................... 37
4.1 Interchange Fee model .................................................................................................................... 37
4.2 Costs model .......................................................................................................................................... 41
5 DATA ................................................................................................................................................................ 45
5.1 Data collection 2002 ......................................................................................................................... 45
5.2 Data collection 2009 ......................................................................................................................... 46
5.3 Data .......................................................................................................................................................... 47
6 ESTIMATION ................................................................................................................................................. 49
6.1 Payments developments in the Netherlands 2002 - 2009 ................................................ 49
6.2 Calibration ............................................................................................................................................ 53
4
6.3 Obtained results ................................................................................................................................. 56
6.4 Robustness ............................................................................................................................................ 57
7 CONCLUSIONS .............................................................................................................................................. 60
7.1 Discussion of the results ................................................................................................................. 60
7.2 Limitations of the study ................................................................................................................... 61
7.3 Afterword .............................................................................................................................................. 61
8 REFERENCES ................................................................................................................................................ 62
8.1 Bibliography ......................................................................................................................................... 62
8.2 (Pre-) Legislation, Cases and Miscellaneous Links ............................................................... 66
9 APPENDICES ................................................................................................................................................. 69
5
LIST OF ACRONYMS AND ABBREVIATIONS
ABC Activity Based Costing
ACH Automated Clearing House, see CSM.
ACM Autoriteit Consument & Markt. Founded in April 2013, merger of Dutch
Telecom regulator (OPTA), Dutch competition authority (NMa) and Dutch
Consumer Rights supervisor.
AFM Autoriteit Financiële Markten. Dutch supervisor of financial markets
conduct.
AML Anti-Money Laundering
ATM Automated (or automatic) Teller Machine.
BBAN Basic Bank Account Number.
BGC BankGiroCentrale. Former interbank payments processor (CSM) in the
Netherlands.
CSM Clearing and Settlement Mechanism. In the context of this paper, CSM can
be deemed synonym for ACH. More info: e.g. Kokkola (2010).
CUP China Union Pay, a four-party scheme card brand based in Shanghai.
DNB De Nederlandse Bank, Dutch central bank.
EC European Commission.
ECB European Central Bank.
ECJ European Court of Justice.
EEA European Economic Area: all Member States of the EU plus Iceland,
Norway and Liechtenstein.
EIM Economisch Instituut voor het Midden- en Kleinbedrijf (~Economic
Institution for the SME sector). Now part of Panteia.
EP European Parliament.
EPC European Payments Council. More info:
http://www.europeanpaymentscouncil.eu/
FD Financieel Dagblad, Dutch leading daily financial newspaper.
HACR Honour All Cards Rule. A business rule set by a scheme prohibiting the
merchant who accepts a particular card brand to distinguish between
issuers (general implementation of the rule in Europe, differs from the US).
IBAN International Bank Account Number.
6
IF Interchange Fee.
JCB A three-party scheme credit card company based in Tokyo.
MIF Multilateral Interchange Fee.
MinFin Either the Dutch Minister of Finance or the Ministry of Finance.
MOB Maatschappelijk Overleg Betalingsverkeer (~Societal Consultation on
Payments), by order of MinFin in 2002. Chaired by DNB. More info:
http://www.dnb.nl/binaries/Oprichting%20MOB_tcm46-274623.pdf
NBC Nationale BetalingsCircuit. See Box 3.
NFC Near Field Communication or Near Field Communication technology.
NMa Nederlandse Mededingingsautoriteit. Dutch competition authority. Now
part of ACM.
NVB Nederlandse Vereniging van Banken (Dutch Banking Association)
NYSE New York Stock Exchange
OFT Office of Fair Trading. UK’s consumer protection and competition
authority.
OJEC Official Journal of the European Communities.
PIN Personal Identification Number. Also the brand and scheme of the former
Dutch domestic debit card. Became part of Dutch vocabulary: to pin is to
make a debit card payment or ATM cash withdrawal.
POS Point Of Sale.
PSD Payment Service Directive (Directive 2007/64/EC). See References.
PSP Payment Service Provider, term introduced in PSD
RTGS Real Time Gross Settlement (system)
SCT SEPA Credit Transfer (scheme)
SDD SEPA Direct Debit (scheme)
SEPA Single Euro Payments Area. The jurisdictional scope of the SEPA Schemes
currently consists of the 28 EU Member States plus Iceland, Norway,
Liechtenstein, Switzerland, Monaco and San Marino. Note that this is a
larger area than the Euro-countries. More info:
http://www.europeanpaymentscouncil.eu/index.cfm/knowledge-
bank/epc-documents/epc-list-of-sepa-scheme-countries/
SME Small and Medium-sized Enterprise
SO Statement of Objections
7
St.BEB Stichting Bevorderen Efficient Betalen (Foundation to Promote Efficient
Payments). Founded in Nov. 2005 to manage EUR 10 million donated by
the banks as agreed in the Convenant Betalingsverkeer. More info:
http://www.efficientbetalen.nl/
SWIFT Society for Worldwide Interbank Financial Telecommunication. A member-
owned cooperative, predominantly owned by banks.
TFEU Treaty on the Functioning of the European Union (2012).
TPP Third Party PSPs, term introduced in PSD2
8
1 INTRODUCTION
“The most important financial innovation that I have seen the past 20 years is the automatic teller machine,
that really helps people and prevents visits to the bank and it is a real convenience. How many other
innovations can you tell me of that have been as important to the individual as the automatic teller machine,
which is more of a mechanical innovation than a financial one?”
Paul Volcker, former FED Chairman1
1.1 Background and motivation2
The history of the payments industry is the history of banks and money. And it is full of
“mechanical innovations”, some of which successful like the ATM, while many others were
not or only briefly so. For example, after almost 20 years the Dutch banks have
decommissioned the Chipknip, a domestic e-wallet type payment product3, per the beginning
of this year. An empirical cost study in 2002 showed that a payment made by Chipknip had
already then by far the lowest variable social costs compared to cash, debit card or credit
card4. For the longest time most consumers had one in their wallet and the system had
worked without an interchange fee, yet as a payment product it never became a real success5.
One may wonder why. Clearly, the absence of an interchange fee is no guarantee for a
successful payment instrument. Nor is the presence of one. This paper is however not a post-
mortem on the product.
The worldwide success of payment cards is undisputed and it provides a fruitful ground to
academics for study. And for regulators to intervene, so it seems. For long, offering payment
services has been the exclusive domain of banks and their legal monopoly on providing
current accounts or creating money remains until today. Being mostly private institutions
entrusted with the facilitation of a public good6, banks are obligated to comply with a sizeable
and increasing set of rules and regulations. On the one hand, this may ensure the security and
1 Speech at the occasion of addressing ideas for reforming financial services at Wall Street Journal Future of
Finance Initiative in the UK, December 2009. [1], 21 August 2014. 2 Several terms and concepts introduced in this paragraph will be properly explained later on in this paper. 3 e-wallets currently on the market are more advanced and can typically contain several virtual payment ‘cards’.
The Chipknip was designed as an alternative to coins and low-denominated banknotes. 4 3 eurocents, compared to 11, 19 and 80 eurocents for a cash, a debit card and a credit card transaction
respectively. Source: (DNB) Brits & Winder (2005), table 4.3, p.26. 5 The officially first Chipknip transaction was done by Wim Duisenberg, then president of DNB on October 26,
1995. It reached its peak in 2010 with 178 million transactions that year; by comparison, there were 2,154 million
debit card transactions (source: Currence Annual Report 2011, p.8). The decommissioning was announced by the
banks and the brand owner Currence in March 2013, to take effect as of 1 January 2015. 6 See also e.g. Freixas & Rochet (2008) par. 1.1.
9
safety of the entire payment system. For example, banks are expected to take appropriate
measures to fight illegal activities such as fraud, money laundering, terrorism financing or tax
evasion, or prevent payments to entities (e.g. persons, institutions and countries) that have
been sanctioned1. On the other hand the regulatory burden amounts to a significant cost level
and since the efficiency of the payment system is also of fundamental concern to society, it
constitutes another justification for public intervention. A frequently taken route by
governments to increase efficiency, is to create or let market participants create (regulated)
monopolies that can then capture the economies of scale that so typically characterise
payments processing volumes2. Another way to increase efficiency is to increase competition,
or so the contemporary paradigm dictates. In the payments industry however this can lead
to different or even opposite results3. To illustrate this point from theory: Matutes and Padilla
(1994)4 model a case of three competing banks who choose membership to some ATM
network and find that if equilibrium exists, it will not be efficient as there will be either three
incompatible ATM networks (so the cardholder can only withdraw cash at ATMs from his
own bank) or two banks sharing their ATM network and leave the third bank out. To illustrate
the point from practise: it is generally posited that the US banking sector and the US payments
industry is competitive, and more competitive than for example (most countries in) Europe.
Yet the interchange fees for credit cards are significantly higher in the US (around 50%) than
in Europe, the UK or Australia and that was even before regulatory action brought it further
down in the latter three regions5. One explanation offered for this phenomenon is known as
reverse competition and can be summarized as follows: card schemes compete with each
1 Economic and political sanctions on territories and/or specific persons therein; current examples include Russia,
the Crimean part of the Ukraine, Iran, Cuba (although these are now in the process of being (partially) lifted),
Zimbabwe, North Korea, and others. There are multiple sanction lists, most importantly the US OFAC list, the
EU-sanctions list and lists maintained by designated agencies (e.g. Interpol). Many banks have recently found
themselves facing criminal charges and huge penalties for not taking appropriate measures and/or failing to report
suspicious transactions. For example: JP Morgan Chase $1.7 billion penalty regarding Madoff’s Ponzi scheme;
HSBC for facilitating transactions to and from Cuba, Libya, Iran (and others) and for drug cartels in Mexico and
Colombia ($1.9 billion), similarly BNP Paribas ($8.9 billion); UBS ($780 million) and Credit Suisse ($2.6 billion)
for facilitating tax evasion; Commerzbank for “unsafe and unsound practises” violating US sanctions and AML
laws ($1.7 billion). [2], [3], [4], [5], 12 March 2015. 2 Beijnen and Bolt (2009), in Bolt (2013) p.75, estimate economies of scale for card payments about 0.25–0.30,
based on cost data of 8 European processors spanning 15 years. This means that a 100% increase in payment cards
volume leads to just a 25–30% increase in total costs. 3 Opposite to conventional economic wisdom. Economic history seems apt in bringing forward counter-intuitive
results. For example Gresham’s Law (“bad money drives out good money”) or Akerlof’s lemon (“poor quality
second-hand cars drive out good quality second-hand cars”). Some scholars regard government intervention as a
cause of counter-intuitive results, e.g. Fisher Black on systemic risk: “… It means that they [the government] want
you to pay more taxes for more regulations, which are likely to create systemic risk by interfering with private
contracting…” (in Danielsson, 2013, p.35). 4 Taken from Freixas & Rochet (2008) p.87. 5 See Hayashi (2004), p.3, chart 1, also to be found in Weiner & Wright (2005), p.299, chart 2.
10
other by offering ever higher interchange fees to banks that issue their cards. These IFs
constitute revenues to these bank and this results in higher fees for card payments for
merchants who pass these costs on to consumers, either directly or indirectly1. The European
Commission (EC) uses this argument in their assessment of the economic effects of
interchange fees2. A second effect of reverse competition is that the increased interchange fee
(IF) level then may serve as a protection for incumbents from market entry of new card
schemes as these will at least have to match the existing IF level to get a foothold.
Similarly, the increasing regulatory burden can also work as a barrier to market entry as a
large part thereof are sunk costs. In this sense it may perhaps seem ironic that the EC has
recently proposed more regulation to increase competition and foster innovation on the
payments market. I’m referring in particular to the ‘Payments Legislative Package’3,
consisting of an Interchange Fee Regulation (IFR) and a revised Payments Services Directive
(PSD). Years of legal combat and emotional debate have preceded the IFR4, in courts and in
political and academic circles5. The IFR has largely been voted for on 10 March 20156 in the
Plenary of the European Parliament7. Once official, a maximum IF will apply for debit cards
of 0.2% and for credit cards of 0.3% for cross-border consumer transactions as of 2 months
after the IFR enters into force (art. 3) and equally for all consumer transactions as of 2 years
1 By applying a surcharge on the card payment or by slightly increasing overall prices of the goods sold. 2 See for example SDW(2013) 288 final, the EC’s Impact Assessment accompanying the proposals for PSD2 and
IFR (see footnote 3 below). Europe Economics, a London based consultancy firm, in a report commissioned by
MasterCard finds this assessment to be “plainly wrong” (Europe Economics, 2014, p.11). 3 Presented by the EC on 24 July 2013. Core pieces are COM(2013) 547 final, hereafter PSD2 (Payment Services
Directive 2); and COM(2013) 550 final, hereafter IFR (Interchange Fee Regulation). The EC currently expects
adoption in May 2015. 4 Parts of the PSD2 are also still under heavy debate, see §2.7. 5 As another example of possible adverse outcomes: several banks have voiced that the EC’s choice to let the
cardholder choose the payment card brand at the moment of the transaction when more than one brand is accepted
at the POS (IFR art. 8(18)), will lead to higher costs for the users and strengthen the MasterCard/VISA duopoly
in Europe. The argument is that the cardholder will choose the brand that’s on top of mind which is most likely
one of the two international brands and not some cheaper yet less known local brand; thus, this will start an ever
intensifying advertising campaign, a race ultimately to be won by the two deep-pocketed companies. See for
example [12], 9 April 2015. The hypothesis bears similarity to the reverse competition argument, formal economic
literature however points in the opposite direction, see e.g. Rochet & Tirole (2002). For more on consumer
payment behaviour, see e.g. HBD (2002), Jonker (2007), Bolt, Jonker and Renselaar (2008), Jonker, Kosse and
Hernandez (2012), Kosse and Vermeulen (2014) and Bagnall et. al. (2014). 6 Proposed amendments to articles have been taken into account in this paper as far as possible and relevant until
31 January 2015. As the exact final wording of the entire text is not yet officially published, I use the text as
published in 2013 (COM(2013) 547 and 550), unless otherwise indicated. 7 Similar developments take place all over the world. For example Rochet & Wright (2009, p.4-5) report “...more
than 50 lawsuits concerning interchange fees filed by merchants and merchant associations against card networks
in the US, while in about 20 countries public authorities have taken regulatory actions related to interchange fees
and investigations are proceeding in many more”. Hayashi (2013) gives an updated overview and accounts for
over 30 countries where regulatory actions have been taken.
11
after the IFR enters into force (art. 4). These caps have been calculated by MasterCard1 using
a test called the (merchant) avoided-cost test, popularised as the ‘tourist-test’, derived from
Rochet and Tirole (2008). The EC finds it a “reasonable benchmark for assessing a MIF level
that generates benefits to merchants and final consumers”2. To calculate the figures
MasterCard used three empirical cost studies of the central banks of Belgium, Sweden and
the Netherlands (DNB). The latter study was published by Brits and Winder (2005) and
contains data pertaining to the year 20023. MasterCard implemented the caps on their cross-
border MIFs with the EC’s consent as of July 2009 (see also §2.7).
Jonker and Plooij (2013)4 have analysed the tourist-test using the Brits and Winder data and
a second dataset pertaining to 2009 and report in an understatement that their results
indicate the test can have “unintended consequences”: in a country like the Netherlands
where social costs of cash are increasing and the social costs of debit card payments are
decreasing, the IF level may actually more than double from 0.2% to 0.5% of an average debit
card transaction size and still pass the test (in other words: the test would qualify the IF level
as ‘not excessive’). If this rise were to be passed on to merchants completely, they would
experience a surge in their costs by 233%. Moreover, where an IF is intended to cover (part
of) the internal costs of the issuing bank, the calculated tourist-test IF level would be higher
than the issuing and acquiring costs of the banks combined. The researchers therefore
recommend competition authorities to look for a different benchmark.
1.2 Research question
The objective of this study is to examine an alternative model to the tourist-test and analyse
how that model, if applied, would affect the IF level for debit card payments in the
Netherlands over time, using cost data for 2002 and 2009, i.e. the same data sources that the
DNB researchers used for their empirical test of the tourist-test. This alternative model has
some preferable features, in particular a closer resemblance to a debit card favouring country
such as the Netherlands, whereas the Rochet and Tirole’ model does not distinguish between
debit and credit cards. The main question to be answered is:
Does the method present a viable alternative to the tourist-test benchmark?
1 Schwimann (2009). 2 Press release by the EC, Commissioner Kroes, 1 April 2009, memo 09/143. 3 The Belgian and Swedish studies concern the years 2003 and 2002 respectively. 4 Also published by Bolt, Jonker & Plooij (2013).
12
PM: I make a distinction between the formal model and its operational counterpart which I
casually refer to as ‘method’.
1.3 Academic contribution
After Baxter (1983) his contribution, the topic of interchange fees faded from academic view
and policy circles. By the end of the 1990s the topic started to attract academic attention, in
parallel with law suits and regulatory investigations in a number of countries in the world.
Rochet and Tirole (2000) published a seminal paper and since then economic literature on
the topic surged, together with the building of knowledge on the functioning of two-sided
markets. The more formal economic literature in the first decade of this century generally
yields two broad conclusions: 1) IFs are foremost a balancing device, as opposed to a collusive
device, their level depends on much more (if at all) than the costs of producing the payment
alone; 2) there is no apparent need for a regulator to intervene. These findings are of
particular importance considering that regulators and courts usually employ a test based on
issuers’ costs in their assessment of possibly excessive merchant fees. Some more recent
academic contributions however do point to market failures that might need mending by
regulation. Confrontation with empirical data was for long very rare. As far as I am aware,
Brits and Winder (2005) were one of the very first to publish empirical cost data (see also
section 5). Their study concerned the Dutch POS1 payment market in 2002. Similar studies
by other central banks in European countries followed, often adopting their conceptual cost
model. Schmiedel, Kostova and Ruttenberg (2012) present the aggregated results of thirteen
of these empirical studies, most of which with data on 2009. So far, only for the Netherlands,
Sweden and Norway detailed cost studies on two or more years are available2 (year 2009
data on the Netherlands and Sweden were part of the study by Schmiedel c.s.). This offers a
first opportunity to study the development in social costs of card payments. Jonker and Plooij
(2013) use two datasets on the Netherlands in their examination of an application of the
tourist-test. To my knowledge Korsgaard (2014) is the first to construct a formal model that
resembles more that of a debit card favouring market, whereas other papers focus either on
credit cards or on the payment activity, rather than the particular instrument. He also reviews
his model in the light of empirical data for Denmark3 and finds a ground for regulation (as is
1 Point Of Sale. 2 See Jonker (2013) p.9. 3 Most of the data Korsgaard uses is published in Danmark Nationalbank (2011, 2012) which were the basis of
the Danish part of the cost study by Schmiedel c.s.
13
already the case in Denmark). My study is the first to calibrate that model to two different
years and to analyse the predicted notional IF levels over time. By using the same datasets
and data sources as in the empirical test of the tourist-test for the Netherlands, the
predictions of the two models can be compared.
1.4 Thesis structure
The remainder of this paper is structured as follows. Section 2 offers an introduction to the
retail (card) payments industry, introduces basic terms and concepts and touches upon
regulatory developments. Section 3 reviews the literature on interchange fees with a focus
on formal models that allow for a welfare analysis. Section 4 presents the analytical
framework to examine the notional interchange fee levels in the Netherlands, consisting of a
formal model for optimal interchange fees and a cost model that captures the concept of
social costs in payments. Section 5 outline how the data for the two years, 2002 and 2009,
have been collected and presents the most important data. Section 6 then shows how I
calibrate the model with the empirical data, presents the results and extends some
robustness checks. Section 7 discusses the results and offers some recommendations for
future research and policy. Finally, section 8 contains the references.
Reading notes
For illustrative purposes, I sometimes make references to news articles, position papers etc.
that can be found on the internet. I refer to them, mostly in footnotes, with a simple [#], which
is short for: “see References, link [#number]”, for example link ‘[9]’. The references link is
followed by a date indicating when I last accessed it.
Occasionally I place short stories, also meant as illustrative background information, in boxes.
They can be skipped without loss of thread of this study.
14
2 PAYMENTS MARKETS, INTERCHANGE FEES AND REGULATION
This section provides a brief introduction to the retail (card) payments industry and a context
for putting the findings of my research into perspective.
2.1 Basics and terminology
In retail payments there are usually four parties involved: the payer and the payee who
transact with each other, and their respective banks. In their roles of economic agents, the
payer is normally referred to as the “buyer” (of goods) and the payee is the “seller”: the
payee/seller sells goods or services to the payer/buyer and in return the payer offers cash,
writes a cheque, uses his debit or credit card, initiates a credit transfer, mandates the payee
to initiate a direct debit, or uses some other payment instrument1. In the context of (wire)
transfers, the payee is normally referred to as the “beneficiary” (of the funds) and his bank is
the “beneficiary’s bank”. In the context of payment cards, the seller is usually referred to as
the “merchant” and his bank as the “acquirer” or “acquiring bank”; the buyer is then referred
to as the “cardholder” and his bank as the “issuer” or “(card) issuing bank”.
A debit card is issued by the issuing bank to the cardholder and provides him electronic
access to his current account2, either through internet/online banking, to withdraw cash
from an ATM or to initiate a transfer of funds at a POS terminal. A credit card on the other
hand is not directly linked to a current account and in three-party models (see §2.3), the
credit card company is an entirely different firm than the bank where the cardholder holds
his current account.
Retail payments between banks on behalf of their customers, millions per day, are usually
not executed individually but sent to clearing institutions or Clearing and Settlement
Mechanisms (CSMs) who sort, match and net all of the incoming and outgoing payment
instructions and then calculate the net amount to be paid or received per bank participating
in the mechanism. Information on these calculated net amounts is then sent to the settlement
institution, usually the local central bank, who settles the claims. This means that the central
bank, where all domestic banks hold an account, transfers funds between these accounts
corresponding to each bank’s claim, provided there is sufficient liquidity or collateral. The
banks are only liable for these net amounts but the banks receive details of all underlying
1 I use the term “payment instrument” in a general meaning as a way to initiate a transfer of funds. Whether a
paper cheque, a plastic card with a magnet stripe or chip, a chip with NFC inside a mobile phone or an app on a
smartphone, the exact technology or carrier is not of particular relevance in the context of this paper. 2 Synonyms for “current account” are “payment account” and “checking account” (typically US custom).
15
transfers from the CSM, enabling them to credit each customer’s account accordingly. The
settlement is usually a daily process at the end of the business day, but frequently the
participants choose to settle several times a day1.
2.2 Social costs of payments
From the point of view of society, payments are costly: estimations of the costs of retail
payments for the European Union (EU) are roughly 1% of GDP, i.e. € 130 billion. Banks and
interbank infrastructures (e.g. CSMs) incur 50% of these social costs, retailers about 46%,
central banks about 3% and the remaining 1% is incurred by cash-in-transit companies (e.g.
conveyance of banknotes)2. Social costs refer to the costs of the resources employed to
‘produce’ the payment services, that is: the sum of all internal costs by all the agents involved
to execute a payment transaction. Private costs are all the costs a single agent faces and/or
incurs to produce a payment transaction and include by definition internal and external costs.
External costs are the charges (e.g. fees) the agent pays to other agents in the value chain.
Since the external costs to one agent in the chain are revenues to others, these external costs
cancel out in the calculation of total social costs. Equivalently, social costs can be defined as
the sum of all parties their net costs (total costs – revenues)3.
2.3 Challenges in payment markets
Payment markets exhibit interesting dynamics, in part resulting from multiple potential
market failures. I will indicate a few, in no particular order. Banks are in competition with
each other and increasingly with non-banks. Yet a payment transaction cannot take place
without some basic form of cooperation between the bank (or party) acting on behalf of the
payer and the bank (or party) acting on behalf of the payee, at the very least on some standard
of exchange4. The element of cooperation may conflict with the element of competition. An
1 Next to this there are systems to settle individual, typically high-value transactions in real-time, so-called RTGS
systems, for example TARGET2 used by e.g. central banks in Europe. The CSMs in the payment cards business
are usually different from the CSMs used for wire transfers. Indeed, within the payments business these are rather
separate domains. Typically cards settlement is a daily cycle (end to end) whereas wire transfers often take a few
working days. For example an SCT, see §2.7, is regulated to take no more than 2 business days, that is: the
crediting of the beneficiary’s account must happen at the latest at the business day following the business day on
which the bank received and accepted the payer’s payment instruction (as of 1 January 2012 (PSD, art. 69); until
2012 this was max. 4 business days and before the introduction of the PSD, this could be even longer). 2 Schmiedel, Kostova and Ruttenberg (2012), p.6. Numbers refer to the year 2009. This excludes social costs
incurred by households, which would add on average another 0.2% if those were to be included (id. p.7). 3 See e.g. Schmiedel c.s. (2012), Brits & Winder (2005) or Jonker (2013). Section 4 will give more details. 4 This is the case even when the economic transaction is settled in cash (with fiat money): if a merchant sells goods
and accepts some ‘pieces of paper’ in exchange but later finds out other economic agents such as the banks do
not, then he is likely to end up with a real loss. On a larger scale, the economy might then revert to barter trading.
16
industry practise is to separate (as a first step) the set of standards, e.g. the ‘scheme’ and
scheme rules, from the product, i.e. the payment instrument. The latter is the object of
competition, whereas the former defines the space where cooperation is, under certain
conditions, allowed; in the case of payment cards the space has been gradually narrowed
down by courts and regulators where for example certain scheme rules have proven to
hamper competition, see section 3. For a standard to be set effectively requires the
cooperation of a significant part of the market to gain critical mass, which may pose
coordination problems. Similarly, for a card scheme to be successful requires attracting a
sufficient number of merchants as well as consumers (cardholders). Three-party schemes,
for example American Express, Diners Club, JCB and Discover, who issue their cards directly
to cardholders and directly acquire merchants, can set a price structure and price level that
appeals to both sides of the market. Four-party schemes on the other hand, such as
MasterCard, VISA and CUP, do not deal with both sides of the market simultaneously and are
therefore unable to directly balance the costs and benefits to both. This may be a role for
interchange fees. But without the right price structure there may be no payment card product
in the first place. Typical of payment card markets and two-sided markets in general, is the
asymmetrical distribution of costs and benefits, resulting in a (heavily) skewed price
structure: one side of the market bears a significantly larger part of the total costs than the
other. More on these points follows in the next paragraphs and section.
Strong economies of scale may lead to monopolistic platforms with the most efficient cost of
production possible but equally to a risk of abuse of the dominant position and/or a price
setting below socially optimal, thus leading to an underprovisioning of payment cards and
furthermore a lack of incentives to continue to improve efficiency through innovation. The
presence of switching costs to bank customers may reduce banks’ incentives to make their
(ATM) networks interoperable. The same mechanism applies to banks themselves: the
presence of switching costs may reduce interbank networks (e.g. CSMs) to become
With cash, the payment instrument and the standard of exchange coincide. With electronic money there is a
difference: some technological standard for data exchange and the acceptance of these data as a change in debt
obligation (through entry in the bank’s books), that is: liability or ‘money’. This is indeed somewhat ambiguous
because ‘money’ has no clear and unambiguous real-world definition, despite being such a fundamental economic
concept. Recall the definitions of monetary aggregates M0, M1, M2 etc., see e.g. Danielsson (2013) p.36. See
also §2.5.
17
interoperable1, which could ultimately make a transfer of funds between two banks
connected to two different networks, impossible2.
As a last example, I revisit the role of banks as guardians of a safe and secure payment system.
For this they need to share payments information and sometimes information on the
transacting parties, the beneficiary and payer. This sharing of information can conflict with
consumer data protection and privacy rights. These conflicts can occur on national level but
are exacerbated on international level as countries, e.g. the US and the EU, or Member States
within the EU, not always agree or align their positions3.
2.4 The concept of interchange fees
The concept, the mechanics so to say, of interchange fees is straightforward. Following the
setting of payment cards in a stylized setup, picture a consumer (the cardholder) using his
payment card to pay for some goods at a merchant’ store. The cardholder received this card
from his issuer; in case of a debit card this is usually his own bank, in case of a credit card this
can be his own bank, a company affiliated with his or some other bank or a totally unrelated
firm (e.g. American Express and other three-party schemes). This relationship is mirrored at
the other side of the trade: the merchant can accept this payment card as a legitimate way of
receiving payments ever since he has a contract with his acquirer4. When the cardholder
swipes, or nowadays ‘dips’ his card at the POS terminal5, he initiates an authorisation request.
In case of a debit card this request is sent to his bank and if there is enough money on the
account, the transaction will be authorised. In case of a credit card, the request is sent to the
acquirer who authorises the transaction6. The authorisation is observed by the merchant who
1 See also Box 3. 2 Matutes and Padilla (1994) in Freixas and Rochet (2008); for more on the economic effects of switching costs
in general see for example Klemperer (1987). 3 Recall for example the conflict between the EU and the US in the summer of 2006 on the latter’ Terrorist Finance
Tracking Program where they, based on their International Emergency Economic Powers Act of 1978, gathered
information on financial transactions from SWIFT, the world’s largest financial communications network,
following the events of September 11, 2001. The EU forced SWIFT to process intra-EU financial messages within
the EU, removing their backup systems from US territory. 4 The merchant also need a contract with at least a telecommunications network provider for data exchange
between the terminal and a switching centre. 5 For the example it is irrelevant whether it is a POS transaction in the physical world or an online transaction, the
IF works exactly the same way. 6 In practise, there is obviously more to this. For example, the card has to be validated first, checked for not
reported stolen, missing or other fraudulent options and the authorisation request is first sent to a switching centre,
perhaps rerouted to another before it arrives at the issuer. The request can also be handled offline by the terminal.
See e.g. Kokkola (2010) for more on these mechanisms. Notice the difference in risk and liability between a debit
and credit card transaction. Credit card companies will sometimes contractually shift the risk of e.g. eventual non-
payment to the merchant.
18
then can rest assured he will receive a transfer of funds to his bank account in an amount
equal to the selling price of the goods. An IF is simply an amount of money, a fraction of the
value of this funds transfer, that usually goes the opposite direction: from the acquirer to the
issuer1. It is calculated per card-transaction, either some percentage of the value of the
transaction or a fixed fee per transaction.
The IF can be determined either bilaterally between the issuer and acquirer in an arm’s-
length agreement or multilaterally by the scheme. The multilateral interchange fee (MIF)
then applies as a default fee, a fallback in the absence of a bilateral agreement. From a
practical point of view, the MIF accomplishes that the transaction between the merchant and
cardholder can proceed, without the issuer and acquirer ever having made agreements with
each other. The efficiency gain is obvious: with more than 8,000 credit institutions (banks) in
Europe alone, one would need over 32 million bilateral agreements to accommodate all
possible card payment transactions. Disturbing to regulators is that a MIF, in case of VISA and
MasterCard before they were listed (and even thereafter) used to be set by an association of
banks. Parallels with a cartel are apparent. In case of a (pure) three-party model there is no
(explicit) IF as the scheme typically combines and includes the issuing and acquiring
functions.
2.5 Justifications for interchange fees
Whereas the concept of IFs is straightforward, it is the interpretation and justification that
meets scepticism and critique. For a part this is understandable as payment markets are an
instance of two-sided markets and the body of economic knowledge on their functioning is
still evolving. In the earlier literature, economic scholars have gone sometimes to a
considerable extent to emphasise that two-sided markets are nothing exotic but an often
observed and old phenomenon, for example Evans (2003), Rochet and Tirole (2000, 2002,
2005) and Wright (2004a). This has lead others to the remark that therefore no new antitrust
policy should be necessary, at least when dealing with predatory pricing, see e.g. Motta, 2004,
p.452. The main message from these early contributions is that in a two-sided market, it is
perfectly normal and just that one side of the market pays (substantially) more than the other
(instead of each their own ‘fair share’). Consequently, there is no economically justified
reason for a regulator to intervene.
1 The only country I know of where the opposite used to be the case is Australia for eftpos-transactions, a PIN
based debit card scheme (Weiner & Wright, 2005, p. 293 fn.5). However, in 2012 the IF direction was reversed.
19
It should be noted that IFs are not a feature exclusive to payment cards: other retail payment
instruments like cheques, direct debits and typical local instruments like the Dutch
Acceptgiro also carry IFs1. An ATM cash withdrawal by a customer of a different bank than
the one owning the ATM is sometimes mentioned in the literature as another example of an
IF, as it involves a fee from the customer’s bank to the ATM-owning bank. This is however not
a good example as there are only three agents involved: the two banks and a customer of one
of them, but a merchant is missing. In a ‘true’ two-sided market, an issuer (or: bank of the
payer) supplies a service to an acquirer (or: bank of the payee) who supplies a service to the
merchant (payee), but the issuer also supplies a service to the cardholder (payer) to enable
his payment transaction with the merchant. The more merchants accept the payment
instrument (cheques, debit card, credit card, direct debit,…) the higher the benefits of using
it to the payer/cardholder and vice versa. One could therefore reframe the question on the
justification of the IF as: does the issuer get compensation from the acquirer for part of his
internal cost? Or do the issuer and acquirer essentially cooperate to redistribute some of the
benefit the payment instrument usage has to the merchant from the merchant to the
cardholder, in order to induce the latter to use it through a lower fee? This interdependency
and ‘general’ feature adds merit to the argument that IFs are primarily a device to balance a
two-sided market when there is not a single platform to do that implicitly, as for example
with a three-party scheme2.
What complicates matters is that once a line of thought has been chosen, e.g. by a regulator
or the market participants themselves, the line tends to persist. Domestic direct debit
schemes in France, Italy and the Netherlands for example carry an IF but these are strictly
cost based and, as for the Netherlands, set collectively by the Dutch banks based on the per
transaction processing costs of the most efficient debtor bank (issuer). This practise was
1 During the ‘free banking periode’ in the 19th century, commercial banks could issue their own banknotes and
central banks were typically established to organise their orderly issuance. A central bank issues its own liabilities
for use as ‘central bank money’. Commercial banks too began increasingly to issue liabilities, i.e. ‘commercial
bank money’. A layered structure then emerged, whereby private individuals held their deposits in commercial
banks, and these in turn held theirs in accounts at the central bank. Individuals’ confidence in commercial bank
money lay in the ability of commercial banks to convert their liabilities into liabilities of other banks or central
bank money when requested by their customers. The central banks were in particular responsible for ensuring that
central bank money and commercial bank money could coexist and be ‘interchangeable at par’ (Kokkola, 2010,
p.152). 2 See e.g. Rochet and Tirole, 2003, p.73-76, where they argue that for four-party models, the IF is the only
balancing device available.
20
authorised by the NMa1. For SEPA Direct Debits (SDDs), (M)IFs are prohibited as per
November 2012 for cross-border SDDs and as per February 2017 for domestic SDDs2.
This leads to the question if/when an IF is competitively neutral or socially optimal and
consequently, if there is reason for a regulator to intervene. These questions are addressed
in the review of literature section.
2.6 Some landmarks in interchange fee litigation
Evans and Schmalensee (2005) report the case of National Bancard Corporation (NaBanco)
vs. VISA3, filed in 1979 and decided in 1986. NaBanco claimed the MIF that VISA’s member
banks set, was a per se violation of the Sherman Act. This claim was rejected by the court with
reference to the potential efficiency benefits for a two-sided market. In 1983, William F.
Baxter, then professor of Law at Stanford who had worked on the case, published a paper that
was the first to explain the rationale for interchange fees. After the court’s ruling however “...
interchange fees faded from view in academic and policy circles and was a topic of interest
mainly to industry insiders” (Evans and Schmalensee, 2005, p.75). That changed with the
proliferation of payment cards in the Western world (see charts 1 and 2a below for an
illustration) accompanied with lawsuits and complaints to regulators by retailers who were
confronted with an increase in their costs of receiving payments as a result of the usage
increase.
[charts 1 and 2a about here.]
The high profile case in the US of Wal-Mart, Sears Roebuck, Safeway and a long list of other
merchants versus VISA and MasterCard marks the increase in litigation. The case started in
October 1996 and took seven years of legal combat before it was settled in 20034. In Europe
a similar case was filed in 1997 by EuroCommerce, an association of large European retailers
1 Exemption granted in 2002 for 5 years and since then prolonged. Exemption is based on art. 17 Dutch
Competition law (Mededingingswet) “…promoting technical or economic progress…”, compare art. 101(3)
TFEU. 2 Per Regulation EU 260/2012, with the exception of so-called R-transactions, i.e. returned or rejected DDs. These
IFs too must be “strictly cost based” (art. 8). 3 As do Rochet and Tirole (2000, p.2 fn.9). 4 The case turned into a class-action lawsuit and was finally settled on June 4, 2003 for “the largest antitrust
settlement in history” ($2 billion for VISA and $1 billion for MasterCard). Later that month, the district court
approved the notice of settlement. Eighteen merchants, of around five million in the class, objected to the
settlement; the district court however approved it in January 2004 after a fairness hearing. E.g. [7], 7 Sept. 2014.
21
and national commerce federations, however not before court but with the EC. The difference
in approach between these two quests for relief is noteworthy. An important explanatory
factor is the difference in the implementation of VISA’s and MasterCard’s Honour All Cards
rule (HACR). In the US the two schemes required merchants who accept their credit card to
also accept their (signature-based) debit card, whereas in the EU the merchant is not allowed
to distinguish between issuers of a card brand, that is: the merchant has to accept e.g. all debit
cards but is allowed to refuse the scheme’s credit card. Wal-Mart c.s. argued that the tie-in of
both types of cards, together with other scheme rules was an attempt to monopolize the debit
card market in violation of section 1 of the Sherman Act (anti-cartel rule) and as a
consequence the plaintiffs had been charged excessive interchange fees during October 1992
and June 2003. The courts affirmed this notion. This tie-in of both types of cards has never
been present in the EU1. After the EC’s investigation into VISA’s MIFs and VISA’s offer in 2002
to cap them at the level of relevant costs, VISA’s intra-EEA cross border MIFs were exempted
based on Art. 81(3) of the EC Treaty until the end of 20072. EuroCommerce and First Data, a
cards transactions processor and acquirer, appealed against the exemption. Both eventually
dropped the case but First Data did not do so until VISA had withdrawn another one of their
scheme rules: No Acquiring Without Issuing3. Meanwhile, MasterCard had received a
Statement of Objections (SO) from the EC in October 2003 for the way it sets its MIFs,
basically suggesting MasterCard is acting as a cartel. MasterCard was listed on the NYSE in
May 2006, which led to speculations that this change in its legal structure may have been to
avoid the antitrust allegations, or at least in part; see Schinkel (2010) for an entertaining
account. It nevertheless received a supplementary SO from the EC in June 20064, followed by
its infringement decision in December 20075. MasterCard sought annulment of this decision
but the General Court upheld it in May 2012, including the surprising assessment that
1 See also Weiner & Wright (2005) p.300. 2 OJEC L318, 22.11.2002. VISA will apply flat-rate intra-EEA MIFs before the end of 2002 whose weighted
average will not exceed EUR 0.28 (par. 18) and similarly for credit cards an ad valorem fee of 0.7% before the
end of 2007 (par. 19); exemption granted until 31 December 2007 (par. 109). In short, Art. 81(3) states that certain
restrictions on intra -EU competition may be allowed if the agreement / decision / practice “…contributes to
improving the production or distribution of goods or to promoting technical or economic progress...” provided
certain criteria have been met. Art. 81 of the EC Treaty of 1957 has been renumbered as Art. 101 in TFEU. 3 See e.g. Bos (2007, p.114-115) for more on this case. 4 MEMO/06/260, 30 June 2006. [9], 3 April 2015. 5 Case COMP/34.579, December 19, 2007: the EC views MasterCard’s multilateral intra-EEA IF for cross-border
payment card transactions made with MasterCard (credit card) and Maestro (MasterCard’ debit card brand) a
violation of Art. 81 and the MIFs should therefore be withdrawn within 6 months.
22
MasterCard “… had continued to be an institutionalised form of coordination of the conduct of
the banks…”1. MasterCard’s appeal to the ECJ was rejected in September 20142.
After the expiration of VISA’s exemption and just before the IPO on the NYSE in March 2008
as of when VISA Inc. separated with VISA Europe with the latter continuing to be a
membership organisation, VISA Europe was informed of the EC’s opening of antitrust
proceedings, for which it received an SO in April 2009. Another year later both parties had
come to an agreement: following MasterCard who had introduced caps on its weighted
average cross-border MIFs for debit (0.2%) and credit (0.3%) card transaction in July 2009,
VISA Europe would likewise cap its intra-EEA cross border MIFs for debit cards at a weighted
average of 0.2%; moreover the same cap was agreed to apply to domestic VISA debit card
transactions in nine Member States3. The agreement was made legally binding in December
that year. In May 2013, VISA agreed to adopt the same cap of 0.3% MIF for both its cross-
border intra-EEA and domestic credit card transactions.
As already noted in §1.1, the IFR will take this another step further and apply caps to all four-
party payment card transactions, both cross-border intra-EEA transactions and domestic
transactions, both debit card (0.2%) and credit card (0.3%) transactions, regardless how the
IF is set (multilaterally, bilaterally or otherwise). An exemption is made for pure three-party
schemes, schemes that directly contract both the cardholder and merchant. This may raise
speculations as to whether the four-party schemes will add another chapter to market
oversight games (Schinkel, 2010) and perhaps turn into three-party schemes. As evidenced
from a working document, the EC seems aware of this risk of regulatory circumvention4.
Impact IFR
Had the scope been only cross-border intra-EEA transactions, or only MIFs (as a fallback fee),
then the impact of the IFR on issuing bank’s revenues would not have been that large. Merely
to illustrate this point: most economies are still locally oriented; to take an ‘extreme’: the
1 Case T-111/08, 24 May 2012, par. 259. 2 Case 382/12P, Sept.11, 2014. Note that the decisions relate to MIFs, not bilaterally agreed IFs or IFs set
collectively at national level. 3 See [8], 11 April 2015, for an overview of the EC’s work on MIFs, including links to relevant documents. 4 Commission Services, Working Party on Financial Services, Proposal for a Regulation on interchanges fees for
card based payment transactions, Inclusion of three party card schemes under the scope of Chapter II,
WORKING DOCUMENT #27, MIF, 17 October 2014. This document was shared with payment industry insiders
(such as the author) and may not be available outside the stakeholder group.
23
economy of the Netherlands has a relatively large international orientation, ranking for
example no. #1 in 2014 in the Global Connectedness Index of logistics company DHL1. Still,
only 2.7% of all debit card transactions are cross-border2. The number can reasonably be
taken as an upper limit indication when generalizing to other European economies. However,
with the domestic transactions in scope, the impact of IFR will be much larger. How large
exactly will depend on the actual IF levels in each country, see for an estimation the EC’s
Impact Assessment3. As for the Netherlands, the actual market IF levels are substantially
below the proposed caps, in 2009 between 1 and 2 eurocents per debit card transaction, i.e.
0.04% of an average debit card transaction4. The Dutch government therefore would like the
EC to choose an even lower cap on debit card IFs5.
2.7 A note on SEPA and PSD
The EU and the Member States started a huge endeavour with the integration of the internal
market, including money to transact. First cash (banknotes and coins), then the instruments
to transfer money electronically. However, throughout the years each country had developed
and grown accustomed to their own payment instruments so this proved to be quite a
challenge. The European banking industry created the European Payments Council (EPC) in
2002 to help realise SEPA, a Single Euro Payments Area6. Through its efforts and under its
coordination, the two most commonly used instruments in the EU for electronic payments,
the credit transfer and the direct debit, were redefined in standardising schemes7. Soon
thereafter a scheme for payment cards, the most common alternative to cash, followed. To
dismantle legal barriers between the countries and create a ‘level playing field’, the Payment
Services Directive (PSD) was introduced, taking effect on November 1st, 20098. As already
1 Measured in cross-border traffic of goods, capital, information and people. The Netherlands also ranked #1 in
the previous edition of the Index in 2012. Source: FD (Financieel Dagblad), 5 November 2014. 2 Around 70 million cross-border transactions versus 2.6 billion POS debit transactions in total. Cross-border
includes Dutch cardholders paying abroad and foreigners paying in the Netherlands. Taking credit card
transactions into account, the number is 5.5% (152.6 million cross-border POS transactions versus 2.8 billion in
total). Looking at other retail payments instruments, credit transfers and direct debits, then the numbers are 2.1%
and 0.0% (too low to measure). Source: DNB retail payments statistics 2014. 3 SDW(2013) 288 final, figure 6, p. 21. 4 Average transaction amount with a debit card in 2009 was EUR 39.07. Calculated with an IF of 1.5 eurocents. 5 Fiche 1: Verordening interbancaire vergoedingen, Kamerstuk 22 112, nr. 1705, 4 October 2013 6 The jurisdictional scope of the SEPA Schemes currently consists of the 28 EU Member States plus Iceland,
Norway, Liechtenstein, Switzerland, Monaco and San Marino. Note that this is more than the countries carrying
the Euro as their currency. 7 The SCT (SEPA Credit Transfer) and the SDD (SEPA Direct Debit) were implemented as of 2008 and 2009
respectively. 8 The PSD however does not apply to Switzerland and Monaco. Previously, the jurisdictional ‘misalignment’
between the PSD and SEPA was much larger.
24
noted, the PSD is currently being revised. The proposed changes have caused an intense and
still ongoing debate and lobbying over certain topics. Two are at the heart of the controversy:
1) the introduction into its scope of two new payment services, so-called payment initiation
services and account information services, and the legal provisions regarding the parties
offering these services; and 2) the prohibition of surcharging together with caps on IFs (the
IFR).
Just to briefly illustrate one of the several issues regarding the first controversial topic before
continuing with the second, which is the focalpoint of this paper. The parties offering the
newly introduced services1 will be allowed to gain access to account information of the
consumer and initiate a payment on his behalf using his personal credentials, the same as the
consumer himself uses to log in to his internet/online banking environment. The banks
consider this a major security risk as it may be impossible for them to unambiguously
distinguish the consumer, i.e. their own customer, from a potentially fraudulent party
disguised as the consumer. A contract or agreement between the TPP and the bank will
however not be required2. The concern has even created ‘unnatural allies’ where banks find
regulators3 and consumer’ interest organisations at their side and this has struck a chord
with the EP and several Member States4 but so far not visibly with the EC.
Given the significant reduction in the general IF level across Europe and the expected
consequential reduction in merchant fees, the EC finds surcharging no longer justified for the
regulated payment cards and will therefore prohibit surcharging (PSD2, art. 55(4)). The PSD
left its regulation at the discretion of Member States and this resulted in half the countries
(thirteen) prohibiting it while the other half allowed it5.
1 Called TPPs, Third Party Providers or Third Party PSPs. PSPs are Payment Service Providers, a term introduced
in the PSD for banks and non-banks (“payment institutions”) authorised to provide payment services. 2 ING filed suit against AFAS, a provider of bookkeeping tools for small businesses and individuals, claiming
AFAS seduces ING’ customers to share their personal credentials in breach of ING general terms and conditions.
AFAS used inter alia the upcoming PSD2 in their defence. The court agrees with ING (30 July 2014). [6], 18
August 2014. 3 E.g. BaFin, the German Federal Financial Supervisory Authority; [13], 18 April 2015. 4 For example, France, Denmark and the Netherlands have officially notified the EC of their strong objections
against the provisions requiring the sharing of personal credentials. Austria has even filed a waiver, stating that it
will under no circumstances transpose these provisions into national law. 5 Situation at the time of the PSD2 proposal, July 2013. A few countries have changed their policies since.
Countries that currently allow surcharging include the Netherlands, Denmark and the UK, where regulation
abolished the no-surcharge rule in 1991 (Vickers, 2005, p.233 fn.10). In Denmark, only for international debit and
credit cards surcharging is allowed, but not the domestic Dankort (so-called ‘split model’, see Danmark
Nationalbank, 2012, p.121). For the Netherlands see section 6.
25
Next to these provisions (and a few others), the IFR sets forth in art. 10 the HACR, basically
reconfirming the European interpretation of the HACR (§2.6). It will also enforce a legal and
organisational separation between the scheme and the processing infrastructure.
26
3 REVIEW OF LITERATURE
The cost-based approach, derived from conventional economic wisdom on monopolistic and
oligopolistic ‘one-sided’ market behaviour and benchmark perfect (Cournot and Bertrand)
competition, does not fit a two-sided market. Market authorities and courts using
benchmarks based on issuer’ cost to assess possible excessiveness of merchant charges and
interchange fees, have therefore been strongly and unanimously advised by economists to
readjust their logic. I have borrowed from Wright to summarise in Box 1 some incorrect
applications of ‘one-sided logic’ to two-sided markets. See Wright (2004a) for a discussion of
each fallacy and an entertaining illustration using quotes from investigations into credit card
schemes by three different market authorities.
3.1 Preliminary
At that time however, the economic knowledge on two-sided markets was still rapidly
developing. As Evans and Schmalensee put it in their survey of the economic literature on
interchange fees and their possible regulation in 2005: “Economists have only scratched the
surface of the theoretical and empirical work that will be needed to understand pricing in two-
sided markets in general and the determination of interchange fees in particular” (id. p.104).
The most important conclusions from the survey can be summarised as follows. Next to the
factors that determine socially optimal prices for customer groups in multisided industries,
inter alia a) price elasticities of demand, b) indirect network effects between the customer
groups, and c) marginal costs for providing goods to each group, socially optimal prices in the
payment card industry also depend on other characteristics, including d) the use of fixed and
variable fees, e) competitive conditions among merchants, issuers, and acquirers, and finally
f) the nature of competition from cash, cheques, and three party payment schemes. Thus, the
socially optimal interchange fee is not, in general, equal to any interchange fee based on cost
BOX 1. Eight fallacies - lessons to forget in two-sided markets.
1. An efficient price structure should be set to reflect relative costs (user-pays).
2. A high price-cost margin indicates market power.
3. A price below marginal cost indicates predation.
4. An increase in competition necessarily results in a more efficient structure of prices.
5. An increase in competition necessarily results in a more balanced price structure.
6. In mature markets (or networks), price structures that do not reflect costs are no longer justified.
7. Where one side of a two-sided market receives services below marginal cost, it must be receiving a
cross-subsidy from users on the other side.
8. Regulating prices set by a platform in a two-sided market is competitively neutral.
27
considerations alone and such a solely cost based interchange fee is unlikely to improve social
welfare (id. p.102).
In my selection I have mainly focussed on contributions with formal models that allow for a
welfare analysis, either total surplus or user surplus1. I describe these models in non-
technical terms.
3.2 Models of interchange fees and policy implications
In Baxter’s (1983) model, cardholders use and merchants accept a card payment if the per-
transaction price charged to each of them is less than the per-transaction benefit they derive
from it. Each of their marginal valuation of the payment transaction depends on the other
party accepting, respectively using the card (otherwise the valuation is zero). Cardholders
are assumed to be more price sensitive than merchants and so their costs, that is the price
they pay for the transaction to the issuer, need to be lowered to reach equilibrium. For this, a
transfer – the IF – needs to be made from the acquirers to the issuers who both are assumed
to behave (perfectly) competitively. Therefore the IF does not affect the overall price level (it
could be at any level), only the price structure. In absence of bargaining power, the price the
issuers charge the cardholders is not based on their marginal costs, nor is the price the
acquirers charge the merchants based on their marginal costs (which is what ‘one-sided logic’
would suggest); instead, in equilibrium aggregate joint demand for card payment services of
merchants and cardholders equals the total combined issuers and acquirers costs of
providing them. In this perfectly competitive world, an assumption Baxter acknowledges may
not hold in reality, without e.g. fixed costs or membership fees, the equilibrium is efficient
(the model is not equipped for a welfare analysis). Baxter concludes his article stating that
the characteristics of the payments market, i.e. joint costs and interdependent demand, are
not well understood and the controversy that troubled the US banking industry for more than
five decades around ‘clearance at par’ of cheques2 is likely to repeat in the context of debit
and credit cards (id. p.586). Those words proved prophetic. In light of this anticipated
controversy, Baxter warns that governmental intervention should be resisted. See Box 2 for
a sidestep to Baxter’s account of payment instruments and substitutes.
1 Total welfare, or total surplus, is the sum of consumer surplus and producer surplus. In the context of payment
markets, the producer is (are) the banks and other providers in the chain and the consumer is (are) both the
payer/cardholder and the payee/merchant, both are “users” of the card. Consumer surplus, or consumer welfare,
thus involves simultaneously both users. 2 Baxter uses the US spelling: checks.
28
Schmalensee (2001) allows for imperfect competition among issuers and among acquirers.
He focuses on credit cards and on a four-party, cooperative (not-for-profit) scheme that sets
a MIF. Assuming the scheme is facing a multiplicative demand function and conducting a
welfare analysis, first with a monopolistic issuer and a monopolistic acquirer which he next
generalizes to oligopolistic competition, Schmalensee arrives at similar conclusions as
Baxter: privately optimal IF is also socially optimal and the IF depends on demand conditions,
costs, competition among issuers and acquirers and on externalities between merchants and
cardholders. He sees no cause for a regulator to step in.
BOX 2. On payment means and substitutes.
Baxter’s historical account of US four-party payment systems covering roughly 200 years narrates the
growing popularity of cheques (initially: drafts) and currency (initially: bank notes) as markets developed
from very local to increasingly larger geographies, while inferior country bank notes were driving sounder
city bank notes out of circulation and transporting bank notes was increasingly costly and risky. This
explains the heavy usage of cheques for which later the credit card became the prime substitute. By
contrast, cheques have never gained comparable popularity in other countries such as Sweden, Spain,
Denmark, and the Netherlands (revisit chart 1). Baxter speculates that the ‘clearance at par’ of cheques,
before Federal regulation put an end to this heterogeneous practise by imposing an ‘IF’ of zero, was a result
of a shift in relative demands of purchasers (~cardholders) and merchants for cheque services and a shift
in relative costs in providing them. It is also interesting to note that Baxter treats cheques and credit cards
as main substitutes (thus cheques’ costs are the most appropriate benchmark for credit cards’ costs,
including IFs) whereas in Europe, economists and the EC focus more on cash versus debit cards. Though
these may perhaps be better comparable substitutes , the comparison is not without difficulties as cash
usage is very difficult to measure reliably, comes with “interchange fees at par” and nowadays involves a
monopolist supplier (i.e. the central bank, see §2.5).
Note 1: Although Baxter occasionally mentions debit cards simultaneously with credit cards, the focus of
his article is largely on the latter. Indeed, the debit card is a “poor man’s card” as “…any cardholder entitled
to use a credit card, will always use it rather than a debit card” (p.585), because of the float benefits
attached to the credit card. For this reason, and because of a lower risk of default, Baxter predicts that debit
card transactions will be substantially cheaper than credit card transactions and with different IFs. This
prediction is confirmed in Weiner & Wright (2005) who report credit card IFs typically between 1% to 2%
of transaction value and debit card IFs typically between 0% and 1% for a number of regions and countries
(id. tables 1 – 3).
Note 2: Payments practitioners frequently use a rule of thumb categorisation of payment instruments from
a payer’s point of view: Pay Before, Pay Now and Pay Later. Cheques and credit cards are examples of Pay
Later instruments, while cash and debit cards are Pay Now instruments. Prepaid cards like a gift card or
special purpose card, are often considered Pay Before instruments as it involves a transfer of funds (from
the cardholder’s account to the card or to the administrator of the card) while the goods or service will be
delivered somewhere in the future. Because the card usually cannot be used everywhere and for all
purposes, like cash, consumers tend to view their funds have ‘changed currency’. Examples are the Dutch
Public Transport card (OV-chipkaart) and, according to most of its (former) users, the Chipknip.
29
Rochet and Tirole (2000, published in 2002) introduce in this seminal paper a formal
framework upon which most of the later scholarly contributions build. Like Baxter, they take
into account the (direct) benefits of using and accepting a card payment. However, they also
model merchants and cardholders as strategic players: merchants use the acceptance of
cards to generate higher sales revenue by winning consumers (cardholders) from
competitors and consumers may decide to visit stores based on stores’ card acceptance
policy. Thus merchant resistance to increases in IF is likely to be lower than in Baxter’s model.
Their framework also allows for consumers to hold cards of more than one scheme1, making
merchants’ opportunity costs of card acceptance endogenous. Acknowledging that the
schemes compete for cardholders, merchant resistance to increases in IF may in this respect
be higher than in Baxter’s model. Furthermore, acquirers are assumed to behave
competitively while issuers may enjoy some market power2. Cardholders are assumed to
have a fixed volume of transactions3, which (technically) implies that there is no difference
between an annual fixed fee or a variable per-transaction fee, at least not from the issuer-
cardholder relationship perspective4. Cardholders are modelled to have structural
preferences for using cash or cards. The model makes no specific distinction between debit
and credit cards as it focusses on the payment activity rather than the instrument. Merchants
face no fixed costs for accepting payments. Given this model setup where by assumption all
profits fall at the issuing side of the market, Rochet and Tirole show by applying a total
welfare analysis that the socially optimal IF, which is the one where the total cost of the
marginal transaction equals its total benefit, coincides with the privately set IF (as set by the
scheme, i.e. the issuers) if that IF exceeds the level at which merchants accept the card. This
requires a low cardholder fee. Or the privately set IF exceeds the socially optimal IF, in which
case consumer fees are set too low leading to an overconsumption (overusage) of cards5. No
cost-based regulatory intervention can prevent this. Both equilibria apply under the no-
surcharge rule, a scheme rule that prohibits the merchant to price-discriminate between
payment means (e.g. demand an extra fee from the customer for a card payment). Lifting this
rule creates however ambiguous welfare effects6.
1 This is sometimes also referred to as multi-homing (vs. single-homing). 2 As Rochet and Tirole note on p.5 fn.13, this is closer to reality. As an indication thereof, they refer to the voting
rights of the banks in the US in VISA and MasterCard (before their respective IPOs) which are more sensitive to
issuing than to acquiring volume, suggesting some bargaining power is on that side. 3 In their model this is normalized to one transaction for each customer. 4 For their main model, cardholders are assumed to be charged a fixed annual fee. 5 This situation can be found in countries where regulation prevents banks from charging customers for the use of
cheques, thus leading to an overprovisioning of cheques (Rochet & Tirole, 2000, p.17 fn.23). 6 Rochet & Tirole, 2000, p. 18-20.
30
The main result, including its corollary that there is no equilibrium where a privately set IF
is lower than the socially optimal IF, critically depends on an assumed merchants
homogeneity. Relaxing this assumption can lead to an underprovisioning of cards, depending
on how well informed the cardholder ex ante is of a merchant’s card acceptance.
Interestingly, the way cardholders are charged for card usage does matter as it influences
merchant resistance: if the cardholder would be charged a perfect fixed and variable fee, with
marginal cost pricing for the variable fee, then this would reduce merchant resistance if (and
only if) the IF exceeds the issuer cost. Indeed, the main mechanism at work in this model is
merchant resistance to accept cards. A higher resistance is likely to bring an equilibrium
where private and socially optimal IF coincide; a lower resistance is likely to create an
overconsumption of cards with a higher than socially optimal IF. The question whether the
IF is ‘too high’ is left an empirical one.
Gans and King (2001b, published in 2003) show in a general way that if merchants can
costlessly surcharge, then interchange fees will have no real effects irrespective of the level
of competition at either the banks or the merchants.
Following closely Rochet and Tirole’s main model, Wright (2004b) relaxes the assumption
of identical merchants and introduces heterogeneity on both sides of the market, applying a
standard Hotelling model of competition (of ‘linear cities’). This accounts for the fact that in
some sectors accepting card payments may be more beneficial to merchants than in others.
Cardholders are assumed to pay a per-transaction fee as do merchants and neither pays a
fixed fee or faces fixed costs. Cardholders are supposed to be fully informed about merchant’s
card acceptance policy before they frequent the store, which maximises the merchant’s
incentive to accept cards. Cardholders discover their preference for a cash or card payment
at the moment of purchase of the good1. The results show that the privately set IF may or may
not be equal to the socially optimal IF and either one can be higher than the other. Thus there
may be too many or too few card transactions from a socially optimal point of view. No cost-
based regulation would be able to restore balance in case of a troublesome diversion as it
depends on differences in price elasticities on both sides of the market, competition (among
issuers, among acquirers, among merchants and among schemes) as well as costs. Again, this
leaves the question of a possible excessive IF an empirical one.
1 This makes merchants’ card acceptance decisions independent rather than strategic complements as in Rochet
& Tirole (2000)
31
By this time the literature had rapidly build into several directions focussing on specific
topics such as platform competition1, multiple card membership (multi-homing) and usage,
market two-sidedness and the influence of merchants and cardholders entering into a
Coasean negotiation as to set their own fee directly. Rochet and Tirole (2005) integrate in
particular the findings on multiple membership and multiple usage (in the broader context
of two-sided markets, not only card payments industry) and reinterpret some of the
previously obtained results. In summary: 1) pricing in two-sided market obeys standard
Lerner principles2 with a reinterpretation of marginal costs as ‘opportunity costs’3; 2) a
market is two-sided if the price structure matters (and much less so the price level),
measured by the ability to affect the volume of transactions; however, in the absence of
membership externalities, the market can turn one-sided in the presence of asymmetric
information between the card-users (merchants and cardholders) if the transaction between
them involves a bilaterally negotiated price or monopoly price. A market turns two-sided
when there are transaction costs to the bilateral price negotiation or constraints on this kind
of price-setting (like an imposed no-surcharge rule) or when there are membership fixed fees
(fixed costs).
This latter finding is one found in McAndrews and Wang (2008) who develop a formal
model different from the ones described above in that they 1) ignore benefits consumers
derive from using a payment instrument (the instrument imposes a frictional cost to the
purchase of a good), 2) assume a contestable market for merchants, which simplifies the
welfare analysis, and 3) take merchants and consumers as non-strategic players (as Baxter).
They do take both fixed and variable costs into account. Starting with cash as a benchmark,
they analyse the choices of merchants and consumers when offered a payment instrument
such as a card that comes at a higher fixed cost but offers lower variable costs. Consistent
with empirical studies (id.), they find that large merchants adopt payment cards faster than
smaller merchants and will set a price that is lower than cash customers would experience at
only-cash accepting merchants; smaller merchants on the other hand may accept card
payments or not and those who do, set a price higher than the competing only-cash accepting
1 See in particular Rochet & Tirole (2002) and Guthrie & Wright (2007). 2 The price charged to a side of the market is inversely related to that side’s elasticity of demand. 3 Marginal cost c is in the context of a two-sided market with a platform replaced by (c-vj), i.e. platform cost c per
transaction minus vj, the ‘other’ side j’s willingness to pay to interact with ‘this’ side. See for an accessible account
Tirole’s lecture in accepting the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2014;
[10], 18 January 2015.
32
merchants; finally, the small merchants will not accept cards. The paper adds the insight that
if a merchant serves both cash-preferring and card-preferring consumers, the first group is
facing a lower selling price than they would if the store only accepted cash. This insight
contradicts the findings and intuitions that price coherence1, or the inability to surcharge,
leads to higher selling prices.
In another milestone contribution, Rochet and Tirole (2008) respond to Vickers’ (2005)
“must take card” argument. The then head of UK’s Office of Fair Trading2, Vickers posed that
in the UK retail business it had become a market practise to accept at least the two major
credit card brands (VISA and MasterCard) and non-compliance with this market standard
could jeopardise the retailer’s business as he would risk losing customers to competing
retailers who do. It should be noted that the use of credit cards (and cheques) is very high in
the UK compared to other countries in Europe. See also chart 1 and as a further exhibit:
“Indeed, the United Kingdom has accounted for more than 75 percent of credit card spending in
western Europe in recent years. By contrast, France and Germany each account for less than 1.5
percent” (Vickers, 2005, p.232). Rochet and Tirole operationalise and validate the argument
under different models of merchant competition building on earlier frameworks, in
particular the ones described above. The possibility that a merchant might accept a card
payment even though this would increase his net operating cost3, was already identified in
their earlier paper (2000). The reason for the merchant’s decision lies however not in
competition, i.e. to win over a customer over a competitor: the property holds even when the
merchant is a local monopolist. It lies in the merchant’s improved quality of service by
offering the customer extra payment means, which translate into slightly higher retail prices4.
The paper presents an alternative to the benchmark for excessive IF-setting used by
regulators, which is based on issuer’ costs5. Their alternative is based on the merchant’s
1 A term coined by Frankel (1998) and later adopted by others, which he defines as: “the phenomenon in which
the price paid by a consumer for a product does not vary with modest differences in the costs imposed on the
merchant by the customer’s choice of brands or payment methods” (p.314). 2 The OFT was at that time involved in a several-year-long investigation into MasterCard’s MIFs. 3 The property that has become known as merchant internalization states that merchants accept cards if, and only
if, the merchant fee 𝑝𝑀 is equal to or less than the sum of the merchant benefit of accepting a card payment 𝑏𝑀
plus the average net cardholder benefit per card payment 𝑣𝐶(𝑝𝐶): 𝑝𝑀 ≤ 𝑏𝑀 + 𝑣𝐶(𝑝𝐶) This can lead to merchants
accepting card payments even when it increases their net operating costs: 𝑝𝑀 ≥ 𝑏𝑀 Rochet & Tirole show that
this property holds under three important models of competition: perfect competition, Hotelling-Lerner-Salop
differentiated products competition and monopolistic competition. 4 This result is also derived in Bedre-Defolie and Calvano (2009). 5 See e.g. the EC COMP/34.579 in 2007 (as mentioned in par. 1.1), the Reserve Bank of Australia in 2003 (Wright
2004a) and the US Federal Reserve by the Durbin Amendment (section 1075, adding section 920 to the Electronic
Funds Transfer Act) to the Dodd-Frank Act as of July 2011.
33
avoided-cost: would he have an incentive to refuse a card payment if an incidental customer,
like a tourist, wants to pay and is also able to pay in cash? (hence the nickname the “tourist-
test”). Since accepting this card transaction would trigger a fee to his acquirer1 - a significant
portion thereof constitutes the IF - the test looks for the merchant’s point of indifference
between the two means of payment. The merchant fee passes the avoided-cost test if, and
only if, the card payment does not increase his net operating cost compared to accepting a
payment in cash. If it does not pass the test, then this should be interpreted as an indication
of an excessive IF. Rochet and Tirole show that the test yields unbiased results if the objective
is short-term total user surplus2, provided that issuers’ margin is constant. However, the IF
that would be optimal from a social point of view lies higher in that case and the same holds
in the case of variable issuers’ margin. The test yields false positives if the objective is total
welfare. Zenger (2011) shows the avoided-cost test and the model of Rochet and Tirole
(2000) under perfect surcharging yield the same outcomes.
Discussion of the avoided-cost test
Before moving on to the last piece of review of literature in this section, I briefly discuss the
test and its implications in some more depth. The avoided-cost test seems reasonable at first
sight but on second thought appears problematic. The test makes no distinction between a
debit and credit card transaction, while the proposed benchmark is cash. As noted before,
from a payer’s point of view, cash and debit cards are more or less substitutable payment
instruments, but credit cards and cash are much less of substitutes3. More importantly, as the
test looks for the merchant’s point of indifference between the means of payment, it thus
removes incentives to choose the most efficient one from a social point of view4. If the aim of
1 The fee paid by the merchant to the acquirer is usually called the Merchant Service Charge in the credit card
business (MasterCard and others). Rochet & Tirole have consistently used the term “merchant discount”,
indicating that the merchant does not receive the full amount, i.e. the sales price for the goods sold, from the
cardholder (through the issuer and acquirer) but that the acquirer subtracts (“discounts”) a fee from this amount.
From the merchant’ point of view however, he does not get a “discount” in the meaning of common language. To
avoid confusion, I use the more neutral term “merchant fee” throughout this paper. The practise to actually subtract
a fee from the full amount was abolished by the PSD, as of then the merchant can still be charged such a fee but
it has to be invoiced and paid separately. 2 As indicated before, in a two-sided payment market, the ‘one-sided’ consumer surplus includes both the
cardholder’s and merchants’ surplus. I will use the term “total user surplus” from this point onwards, as do Rochet
and Tirole. The term “consumer surplus” is then reserved for the card and cash using consumers (their surplus),
i.e. ex. merchant surplus. In their (2008) model, all consumers hold cards, so there is no distinction between a
consumer paying in cash and a consumer paying with a card in the context of welfare analysis. The “short term”
reflects a situation without market entry. 3 A similar remark is made by Rochet & Wright (2009) who define the avoided-cost test with respect to “store
credit” (credit supplied directly by the merchant to the consumer) instead of cash. 4 A point Rochet and Tirole are aware of (id. p.8).
34
a regulator is to correct a market that is failing in producing economic efficient outcomes,
then adopting this test will at best result in maintaining the status quo if the benchmark, cash,
is the correct one. But empirical studies show that cash payments are relatively expensive to
‘produce’ compared to electronic payments, debit card payments in particular, and the price
to use cash does often not reflect the full (social) costs; see Schmiedel c.s. (2012), Brits and
Winder (2005), Leinonen (2011) and Humphrey, Willesson, Lindblom and Bergendahl
(2003). Indeed, putting the avoided-cost test to an empirical test, Bolt, Jonker and Plooij
(2013) show that it creates the wrong incentives when a country’ social costs of cash
payments are rising and those of debit card payments are declining; as is the case for e.g. the
Netherlands1. These findings are particularly relevant since the EC accepted the tourist-test
as a “reasonable benchmark for assessing a MIF level that generates benefits to merchants and
final consumers”2 and the caps proposed in the IFR are the result of MasterCard’s calculations
using the test and three empirical cost studies3 which MasterCard implemented with the EC’s
consent as of July 2009.
A final remark in this sidestep concerns the welfare objective. Most economists, and I agree,
argue that competition authorities should adopt a total welfare standard instead of a
consumer welfare standard. See e.g. Motta (2004, par. 1.3) and Rochet & Tirole (2003, p.77).
Whether courts and regulators favour one over the other is difficult to say, wording such as
in art. 101(3) TFEU4 merely seem to induce its explicit inclusion in court’s rulings, not
prioritising consumer welfare over total welfare. However, as evidenced by the adoption of
the avoided-cost test and the quoted memo, in the case of the IFR the EC seems to adopt a
strict consumer welfare standard5. Such a standard is unlikely to solve a market failure, more
likely the opposite (see also Rochet and Wright, 2009). In particular, capping the IFs may
initially lead to lower prices but in the longer run are likely to deprive the ‘producers’ of
1 Bolt cs. calculate that the tourist-test may allow the IF level to increase from 0.2% to 0.5% of the transaction
amount of an average debit card payment. In case of a full pass-through this would increase the notional merchant
fee by 233%. For other debit card favouring countries similar results should be expected, see also Leinonen (2011)
and Danmark Nationalbank (2011). 2 Press release by the EC, Commissioner Kroes, 1 April 2009, memo 09/143. 3 These concern the cost studies of the central banks of Belgium, Sweden and the Netherlands. The latter is the
study published by Brits and Winder (2005), with data from 2002. The Belgian and Swedish study contain data
from 2003 and 2002 respectively. See also Bolt c.s. (2013). 4 Certain restrictions on intra-EU competition may be allowed if the agreement / decision / practice “… contributes
to improving the production or distribution of goods or to promoting technical or economic progress, while
allowing consumers a fair share of the resulting benefit...” [underline font added]. 5 Another indication can be found in the EC’s Impact Assessment: “Rochet and Tirole (2002) find that the
privately set interchange fee either is socially optimal (but only total welfare has been analysed)…” (p.102)
[underline font added]. Also Rochet and Wright (2009) have noticed and seem to disapprove: “Thus, if regulators
only care about (short-run) consumer surplus, our theory can provide a rationalization for placing a cap on
interchange fees.” (id. p.6).
35
incentives to innovate. Note that the issuer and acquirer function can be fulfilled by others
than banks and the incentives concern both incumbents and potential new entrants, so this
may negatively affect banks, other PSPs, merchants as well as consumers. Thus, at the very
least the consumer welfare objective should be framed in dynamic terms. Evans (2011)
analyses the relationship of IF levels and innovation and argues that drastic reductions of IFs
may invert the skewness of the price structure on the two sides of the market, resulting in a
reduction in the overall level of innovation in the industry and a discouragement of new
entrants1. Circumstantial evidence of this point can be found in Australia for eftpos-
transactions, a PIN based debit card scheme and as far as I am aware, the only country where
IFs used to go from the issuer to the acquirer. In 2012 however, the IF direction reversed “…to
encourage investment in innovation and enhanced functionality for eftpos, so that it can
continue to compete effectively in a fast changing payments landscape”2.
Whereas Rochet and Tirole confirm some validity of Vickers’ “must take card” argument but
conclude that this need not be harmful to social welfare as there is no systematic bias in the
price structure, Wright (2012) now arrives at the opposite conclusion. Using basically the
same model as Rochet and Tirole (2000, 2008) and Wright (2004b), he finds that a profit
maximizing card scheme sets a MIF or price structure that will lead to an overprovisioning
(overconsumption) of cards with merchants paying too high a fee. This possibility is present
in the earlier work and arises from the fact that a monopolist scheme only focuses on
marginal users and not on average users, thus ignoring the effect of IFs on the surplus of the
average merchant or consumer. As long as this happens on both sides of the market, there is
no particular bias either way. But with the property of merchants internalizing the consumer
benefits (meaning they offer their customers an improved quality of service with extra
payment means) for which the extra costs are uniformly included in the prices of the goods
sold (and in the absence of surcharging, i.e. price coherence), this introduces a systematic
bias in favour of cardholders. Therefore, Wright advises a regulatory intervention, not based
on any antitrust considerations since the bias is not the result of any shortcomings in
competitive market behaviour, including the argument that an IF puts a floor in what
competing acquirers can charge merchants. Such an intervention is to be dealt with
cautiously, he warns: the main mechanism at work in the model is merchant internalization
1 As Evans (2011) summarises it: “getting innovation right is likely to be far more important than getting
prices right” (p.2). 2 [11], 5 September 2014.
36
but to which extent this holds in a particular case, is an unanswered empirical question. As
to the proper level of IF, he stresses that economists have reached near unanimity against a
fee based on issuer’ costs and instead proposes a direct cap on merchant fees (which should
include three-party schemes) or to apply the merchant’ avoided-cost test. This I already
discussed.
As far as I know, Korsgaard (2014) is the first to discuss interchange fees in a setting that
resembles more that of a debit card payments market. As I use this model, more details are
given in the next section. Using basically the same model as Rochet and Tirole (2000, 2008)
and Wright (2004b, 2012), he shows that the level of the IF only influences merchant
acceptance of cards (the higher the former, the lower the latter) and banks will set an IF that
exceeds or equals the socially optimal IF. Two critical assumptions underlie this result: 1) all
consumers already possess a payment card and do not incur fees per transaction (cash nor
card), 2) merchants nor banks face fixed costs. In essence, the two-sided market then turns
one-sided; this echoes a finding earlier stated, see Rochet and Tirole (2005). As the only
condition under which the banks set an IF equal to the socially optimal IF, is when merchants
are assumed to be homogeneous (else the banks set an IF that is higher), Korsgaard advocates
a cost-based regulation. His model features consumers, merchants and banks; the latter in
their capacity of producers of payment services1. Issuing and acquiring banks are not
distinguished individually, which is motivated by the assumption that acquiring banks are
assumed to behave perfectly competitively and so the merchant fee consists only of the IF
plus the acquiring bank’s marginal cost of producing the card payment2. Banks are assumed
to maximise their joint profit, which depends on the fraction of consumers, respectively
merchants using and accepting cards. Both consumers and merchants are heterogeneous and
they may face fixed costs for accepting payments.
A striking result of this model is that the socially optimal IF can turn out to depend solely on
costs. More precise, if merchant fixed costs are assumed to be zero, consumers face no
adoption costs and in the absence of surcharging, then the socially optimal IF equals the
difference in bank’s marginal costs of producing card payments and cash payments. Under
surcharging however, the welfare outcomes are ambiguous and the optimal IF no longer
depends on costs alone (same is true when fixed costs are introduced).
1 From a modelling perspective this is akin to a proprietary platform, i.e. a three-party scheme. 2 The merchant fee and the IF are therefore assumed to have an one-to-one relationship.
37
4 ANALYTICAL FRAMEWORK
This section describes the analytical framework I use to answer the research question. It
consists of two models, the first is the formal model for socially optimal interchange fee
estimation as developed by Korsgaard (2014). I intend to keep the outline, based on the
original paper, as short as possible for a good understanding and leave out the propositions
and extensions not relevant for my purposes, including the analysis on surcharging. For this
I offer three reasons: 1) as indicated before, in this model surcharging complicates the
analytics and may yield multiple (discontinued) equilibria or no equilibria at all. 2) In an
application of his model, calibrated to Danish cost data, Korsgaard finds welfare to be higher
when surcharging is not applied1. 3) Surcharging is allowed in the Netherlands for at least
since the year 2000, yet it has never grown into a general market practise, rather a
disappearing one2.
The second model I use is the concept of social and private costs and the operational content
as added by Brits and Winder (2005); again the outline, based on their study and Jonker
(2013), will be kept concise. Their framework was also used for the cost data in 2009 and
followed in the other twelve central bank studies (Schmiedel c.s., 2012), as well as in the
empirical examination of the avoided-cost test for the Netherlands (Bolt, Jonker and Plooij,
2013; Jonker and Plooij, 2013).
4.1 Interchange Fee model
The model features three types of agents: consumers (buyers “B”), merchants (sellers “S”)
and banks. Merchants compete according to a standard ‘linear cities’ Hotelling model of
competition3 with a unit length continuum of pairs of merchants. Each merchant of a pair,
located at the opposite ends of a line segment of unit length, enjoys the same benefits 𝑏𝑆 from
accepting cards and competes for consumers who are uniformly distributed across the line
segment. Merchants produce a good at cost γ and set a price so as to maximize profits,
assuming price coherence (no surcharging). If a merchant chooses to accept cards, he may
face fixed costs K (adoption costs) and if a consumer pays by card, he additionally incurs a
merchant fee m (usage costs). All merchants accept cash. Merchant pairs differ in their
1 This finding is consistent with an empirical study on surcharging in the Netherlands where Bolt, Jonker and
Renselaar (2008) find that if the merchants who do surcharge would discontinue this practise, social cost savings
of more than EUR 100 million could be realised. See also §6.1. 2 Supra. The decrease was bolstered by an long-running public campaign that started in 2007 to stimulate the use
of debit cards. The campaign proved effective (Jonker, Plooij and Verburg, 2015). 3 As in e.g. Wright, 2004b, 2012, Rochet & Tirole 2000, 2008.
38
benefits derived from card payments (net savings from a card instead of a cash payment),
which are drawn on an interval [𝑏𝑆,𝑚𝑖𝑛, 𝑏𝑆,𝑚𝑎𝑥] from a cumulative distribution function G(𝑏𝑆).
Similarly, consumers differ in their benefits 𝑏𝐵 from card payments (preference for a card
instead of a cash payment), which are drawn on an interval [𝑏𝐵,𝑚𝑖𝑛, 𝑏𝐵,𝑚𝑎𝑥] from a cumulative
distribution function H(𝑏𝐵). I assume the benefits to be uniformly distributed within each
function1. All consumers possess a payment card at no adoption costs nor usage costs2.
Consumers incur a distance cost t per unit of distance from a merchant store, although this
may also be interpreted in the traditional sense to reflect product differentiation. Banks
produce payment services, card and cash payments, and set the merchant fee collectively so
as to maximize joint profits. Since issuing and acquiring banks are not modelled separately,
the merchant fee is assumed to consist of an IF for the issuing bank plus the acquiring bank’s
marginal cost of producing the card payment. Banks have variable costs of producing
payment services of 𝑐𝐶 and of 𝑐𝐷, which are proportional to the fraction of card payments,
respectively cash payments in the economy; additionally banks may face fixed cost F. Banks
revenue is the merchant fee m times the fraction of card payments in the economy 𝜇(𝑚). In
the model the social costs of payments are for simplicity assumed to equal banks’ private
costs. The banking sector profit function for maximization is then:
Π = 𝜇(𝑚)(𝑚 − 𝑐𝐶) − (1 − 𝜇(𝑚))𝑐𝐷 (1)
where 𝜇(𝑚) ≡ (1 − 𝐻(𝑏𝐵∗ ))(1 − 𝐺(𝑏𝑆
∗)) (2)
with 𝑏𝐵∗ denoting the threshold above which consumers use cards, and similarly 𝑏𝑆
∗ denotes
the threshold above which merchants accept cards. Banks are assumed to be obligated to
provide cash. Their rationality constraint, for the moment ignoring fixed costs F , is then that
they must be no worse off by providing cards:
𝜇(𝑚)(𝑚 − 𝑐𝐶) − 𝑐𝐷(1 − 𝜇(𝑚)) ≥ −𝑐𝐷 (3)
1 The original paper assumes, as in the reference literature, each cumulative distribution function to have a certain
density, a monotone hazard rate and to be twice continuously differentiable. The assumption of uniform
distributions is used in the calibration. The monotone (increasing) hazard rate assumption guarantees concavity
of the objective functions, see Prékopa (1973) in Rochet & Tirole (2008). 2 Korsgaard treats consumer adoption costs as an extension to the basic model.
39
The cost component F will be dealt with later on. The reason to proceed in this manner is
mainly to closely follow the setup of the original model for comparison purposes and to be
able to show the (theoretical) existence of a purely cost-based socially optimal IF, which is
when the market turns one-sided; it is this fixed cost component that makes the market in
this model two-sided, just as when merchants or consumers are assumed to face fixed costs
(i.e. adoption costs1). A social planner would aim to maximize the total benefits from card
payments minus the cost of producing the payments. Thus, his objective function is:
𝑊 = (1 − 𝐺(𝑏𝑆∗)) ∫
𝑏𝐵,𝑚𝑎𝑥
𝑏𝐵∗
𝑏𝐵 𝑑𝐻(𝑏𝐵 ) + (1 − 𝐻(𝑏𝑆∗)) ∫
𝑏𝑆,𝑚𝑎𝑥
𝑏𝑆∗
𝑏𝑆 𝑑𝐺(𝑏𝑆 )
−𝜇(𝑚)𝑐𝐶 − (1 − 𝜇(𝑚))𝑐𝐷 − (1 − 𝐺(𝑚))𝐾 (4)
In what follows are basically the outcomes of the assumptions and construction described
above. First the merchant threshold: a pair of merchants accepts cards if the condition below
is satisfied:
𝑏𝑆 ≥ 𝑏𝑆∗ = 𝑚 − 𝐸[𝑏𝐵 𝑏𝐵 ≥ 𝑏𝐵
∗ ] + 3𝑡(1−√1−
2𝐾
𝑡)
1−𝐻(𝑏𝐵∗ )
(5)
If merchant face no adoption costs (i.e. fixed costs) K = 0, this condition simplifies into:
𝑏𝑆 ≥ 𝑚 − 𝐸[𝑏𝐵 𝑏𝐵 ≥ 𝑏𝐵∗ ] (6)
This is the same merchant card acceptance condition Rochet and Tirole (2008) arrive at and
which they show holds under three distinct models of competition: perfect competition,
Hotelling-Lerner-Salop product differentiated competition (as here) and local monopoly.
Wright (2012) refers to this condition as “full merchant internalization”, meaning consumers
are fully informed about merchant’ card acceptance policy and take that into account when
deciding what store to visit. If this was not the case, or only partially so, a merchant would
not (or only partially) be able to attract extra customers from card acceptance.
The next three propositions can be shown to hold2:
1 In derivations, when computing for interior solutions, a unique equilibrium can then no longer be guaranteed. 2 For proof of propositions and lemmas see the appendix of Korsgaard (2014).
40
1) When, as assumed, consumers do not face adoption costs, card usage is decreasing in
merchant fees.
2) When merchant fixed cost K = 0, the socially optimal merchant fee equals the difference
in banks’ marginal cost of producing card and cash payments, that is:
𝑚 = 𝑐𝐶 − 𝑐𝐷 (7)
3) Banks set merchant fees equal to or higher than the fees set by the social planner. The
two equal when merchants are relatively homogeneous across pairs (all enjoy the same
𝑏𝑆), in which case there is an interval of socially optimal merchant fees.
The outcome in proposition 2 is remarkable, it shows the optimal merchant fee can be purely
cost-based, though still not based on issuer’ costs. Intuitively, the social planner sets a
merchant fee to reflect the difference in marginal costs between the two payment
instruments and induce merchants to use the cheapest from a social cost perspective. It can
easily be verified that the banks rationality constraint, equation (3), holds under proposition
2.
When merchants do face fixed costs, K ≠ 0, the socially optimal merchant fee is no longer
purely cost-based and turns into:
𝑚 = 𝑐𝐶 − 𝑐𝐷 + ( 𝐾−3𝑡 (1−√1−
2𝐾
𝑡)
1−𝐻(0)) (8)
As can be shown, the term between round brackets is always negative.
Reintroducing the assumption that the banks may face fixed costs, F ≠ 0, this modifies their
rationality constraint:
𝜇(𝑚)(𝑚 − 𝑐𝐶) − 𝑐𝐷(1 − 𝑚𝜇(𝑚)) − 𝐹 ≥ −𝑐𝐷 (9)
This constraint is no longer satisfied at the socially optimal merchant fee as bank’ profits
would fall below profits in a cash-only economy, which is −𝑐𝐷, and now decreases with an
amount equal to F. Hence, a social planner would need to correct for that by imposing a
(constrained) optimal merchant fee equalling the difference in marginal costs of card and
41
cash payment (that part remains unchanged) plus the average fixed cost of card payments
given that optimal fee. This way, banks may recover their average fixed costs.
𝑚 = 𝑐𝐶 − 𝑐𝐷 +𝐹
𝜇(𝑚) (10)
In section 6, I will calibrate this model according to data from the Netherlands for the years
2002 and 2009, largely the same data as was used to test the avoided-cost test for the
Netherlands1.
4.2 Costs model
Social costs of payment services, in this study debit cards and cash, refer to the costs for
society as a whole of the resources sacrificed to produce the payment services. What matters
however to merchants, consumers and banks (including the central bank) are their private
costs and revenues. Following the conventions in the empirical cost studies, I adopt the next
definitions (all summed over the parties involved):
External costs are transfers (fees, commissions, etc.) to other agents in the payments
value chain2.
Internal costs are then all other costs, roughly the costs of value added payment services.
In the cost calculations, transfers to parties other than the three mentioned are
considered internal cost components, proxied by the actual price paid for that
component3. For example, merchants pay for their use of telephone land lines or secure
(mobile) internet connections and these transfers to telecom network providers are
considered internal costs to merchants; or fees merchants pay to cash-in-transit
companies who deliver the surplus of cash (banknotes and coins) safely to cash centres;
bank pay fees to CSMs to process card and wire payments, etc.
Total costs are the sum of internal costs and external costs.
Revenues are the transfers received from other parties in the payments value chain.
Revenues for banks come in different forms, from merchants, consumers and other
banks. Clear examples are periodical fees (e.g. payment/banking packages) and per-
transaction fees (either fixed per e.g. debit card transaction or related to the transaction
1 “Largely” as obviously the model parameters differ but the data sources are the same. 2 Seigniorage is an implicit transfer of the public to the central bank as holding cash means incurring opportunity
interest costs. These are included in the costs calculations, see Brits & Winder (2005) for details. 3 This introduces a slight bias in the estimate of the social cost of the particular component.
42
amount as with e.g. a credit card transaction or per deposited sealbag or ATM
withdrawal). There are also less clearly visible sources of revenue, for example taking
float, value-dating1, paying no interest on payment accounts2 and all sorts of margins (e.g.
in currency conversions). If merchants surcharge, these would count as revenues.
Total net costs equal total costs minus revenues.
Social costs (SC)3 are then the sum of internal costs of all parties in the payments value
chain.
Consumers are assumed not to incur any internal costs associated with making a payment
but do face external costs (typically bank fees).
Fixed and variable costs
Next to social and private costs, external and internal costs, costs can also be divided into
fixed and variable costs. Obviously, agents make decisions based on such divisions (and more
refined categorisations), but in the context of this study it is also relevant as it enables an
assessment of the cost efficiency of payment instruments. Variable costs have a relation with
the execution of the payment transaction, whereas fixed costs do not (within a certain time
span)4. A further division of variable costs is whether they are linked to the transaction value
(“sales-linked”) or to the transaction occurring regardless of the value (“transaction-linked”).
This may also depend of course on existing market practises and the pricing models of the
providers and need not per se reflect the product’s underlying cost structure or associated
risks. For example, for a merchant the charges he faces for a credit card transaction usually
depend on the transaction value, whereas for debit card transactions the market practises
differ: in some countries a fixed fee per transaction is custom5, while in others it is some
percentage of the amount (i.e. sales-linked). Costs for cash on the other hand show to have a
high correlation with the transaction value. The main reason is that larger cash payments
entail increased time consumption for cash handling by retailers (e.g. staff costs to sort and
count banknotes, fees to cash-in-transit companies, etc.) and banks. Intuitively, one can
1 Value-dating and taking float have been abolished or made virtually impossible as per PSD, November 2009.
They are therefore accounted for in the cost estimations for 2002 and 2009. 2 This is often the most important source for banks to recover their costs on retail payment services. See for
example McKinsey&Company (2006). Since these costs/revenues are independent of any specific payment
instrument, they are considered out of scope in this study (as in the reference studies). 3 Only variables that will be used later on get denoted. For the full set and interrelations, see Brits & Winder
(2005). I adopted the notational form from Jonker (2013) in this paragraph. 4 See next section. 5 For example the Netherlands, Sweden and Belgium, the three countries whose cost studies formed the input for
MasterCard to calculate the IF levels that also have been adopted as caps in the IFR (Jonker and Plooij, 2013,
p.57).
43
expect cash to be the most efficient payment instrument for lower transaction values, while
a card is so for higher values (see below).
The (total) social costs SC of a payment instrument j can thus be defined as the sum of its fixed
Fj, variable transaction-linked Vj,tr and variable sales-linked Vj,s costs.
SCj = Fj + Vj,tr + Vj,s (11)
Each of these components is a sum of the corresponding internal costs of merchants, banks
and consumers respectively. The total variable transaction-linked costs of a payment
instrument Vj,tr can also be defined as 𝛼𝑗, the average transaction-linked variable costs per
transaction made with that payment instrument times 𝑁𝑗 , the total number of transactions
done with that instrument: 𝑉𝑗,𝑡𝑟 = 𝛼𝑗𝑁𝑗.
Similarly, the total variable sales-linked costs of a payment instrument Vj,s can be defined as
𝛽𝑗, the average sales-linked variable costs per Euro sales amount paid for with that payment
instrument times 𝑆𝑗, the total sales amount paid for with the instrument: 𝑉𝑗,𝑠 = 𝛽𝑗𝑆𝑗 .
Cost comparison criteria
In order to compare the social costs of each payment instrument, one would need to account
for the differences in the number of transactions and the amounts involved (value). The
charts below indicate how these have evolved during the years 1996 – 2004 in the
Netherlands in relative terms.
[charts 2b and 2c about here.]
Chart 2a (§2.6) shows that the Dutch clearly prefer the debit card over other non-cash
instruments, but chart 2b puts this into perspective and reveals the predominance of cash.
The progression of the debit card replacing cash is however unmistakable, in particular for
transaction amounts (chart 2c).
Thus, three criteria to compare social costs of payment instruments qualify:
Criterion 1: social cost per transaction: SCj
𝑁𝑗=
Fj
𝑁𝑗+ 𝛼𝑗 +
𝛽𝑗Sj
𝑁𝑗
with Sj/Nj representing the average value of a transaction with payment instrument j (scaling
according to number of transactions);
44
Criterion 2: social cost per euro sales amount: SCj
𝑆𝑗=
Fj
𝑆𝑗+
𝛼𝑗Nj
𝑆𝑗+ 𝛽𝑗
with SCj/Sj and Fj/Sj representing the total costs, resp. fixed costs of each euro in sales, and
Nj/Sj the number of transactions needed to generate EUR 1 in sales (scaling according to value
of transactions);
Criterion 3: the cost of one additional transaction of predetermined size s: 𝛼𝑗 + 𝛽𝑗𝑠
Criterion 3 focuses on the variable costs of a transaction, consisting of two components, one
that depends on the occurrence of a payment transaction being executed and a component
that depends on the transaction value. This criterion is most appropriate for discussions on
the efficiency of the individual payment instruments and enables a calculation of a break-
even transaction amount, i.e. a transaction value at which the costs of the two payment
instruments are equal. Using this criterion, Brits & Winder (2005, p.27) compute the break-
even point for cash and debit card for the Netherlands in 2002 at EUR 11.63, meaning for
lower transaction amounts cash is the most cost efficient way to pay from a social cost
perspective while for higher amounts, the debit card is cheaper. Bolt, Jonker and Renselaar
(2008, p.9) report the break-even point to have dropped below EUR 5 in 2006 and by 2009
it had further decreased to EUR 3.06 (Jonker, 2013, p.30).
45
5 DATA
For this study I gleaned data from several sources. Starting point is the Brits & Winder (2005)
study with estimates on social costs of cash and debit card payments in 2002. Their
methodology was followed in the study on social costs of cash and debit card payments in
2009, published by Jonker (2013). In both cases DNB conducted the studies, using a survey
by EIM to collect cost data on the retail sector. The studies used additional data from other
sources, as mentioned below. Unless otherwise indicated, I have revisited all of the original
sources of these data.
5.1 Data collection 20021
The paper published by Brits and Winder, both at that time employees of DNB, was based on
a cost survey conducted by an ad-hoc working group made up of representatives of the
banking community (including DNB and ACH Interpay, see box 3), and merchants’ and
consumers’ interest organisations, chaired by DNB. The banking community supplied their
data on costs, fees and metrics2 directly to DNB, while information about the costs for the
retail trade, hotel and catering, gas stations, street trade and vending machines was reported
to DNB through a survey by research institute EIM. The costs for the remaining retail
subsectors, a largely heterogeneous group including the entertainment sector, museums,
public transport and small service providers was approximated by DNB using the survey
outcome. The core of EIM’s survey is a telephone questionnaire among a large representative
sample of retailing SMEs and a written questionnaire among the (very) large retail
companies. Finally, a time registration was carried out on location to estimate the front-office
time (payment time) per transaction per payment instrument.
DNB supplied the figures on cash usage and Currence3 the figures on debit card usage.
Additional information about the private costs for retailers for 2002 was based on
information on acquiring fees for debit card payments by HBD (2002) and NMa (2006). In
2002 the debit card system worked without IFs. The average merchant fee for a debit card
transaction was 4 - 6 eurocents (NMa, 2006, p.144).
1 This paragraph borrows from Brits & Winder (2005) and Jonker & Plooij (2013). More detailed information on
the data collection 2002 can be found in the annex of Brits and Winder. 2 Parties for whom offering payment services is part of their core business, usually use an ABC cost allocation
method. 3 The scheme owner of the Dutch domestic debit card and brand PIN.
46
5.2 Data collection 20091
The data collection for 2009 was slightly different in setup but followed the same
methodology to ensure comparability of the results throughout the years. The costs, revenues
and profitability of the Dutch retail payments market (covering all retail payment
instruments and payment accounts) was estimated by McKinsey&Company (2006) in a study
commissioned by DNB and NVB, the Dutch association of banks, in consultation with the
banking community and merchants’ and consumers’ interest organisations and in
participation with the five largest Dutch banks. Jonker (2013), also an employee of DNB,
published a study on the social costs of POS payments in the Netherlands 2002 – 2012, using
the Brits & Winder study for 2002 as described in the previous paragraph. For 2009, for the
costs data of debit card payments, she used the McKinsey study and a second, confidential
one on costs of cash services of banks from 2007 and extrapolated the results to 2009, taking
into account changes in the cost drivers for cash, changes in the payment habits of consumers,
changes in the organisational structure of banks, changes in short-term interest rate,
increases in labour costs as well as inflation. The retail sector’ costs were again collected by
EIM in a largely similar setup and with the same scope as for the 2002 data, and extrapolated
by Jonker to cover the whole retail sector. Information about the total number and the value
of POS payments in 2009 was estimated by DNB as part of the ECB cost study. As a result of a
change in institutional setting in the Netherlands during 2004, whereby Currence2 was
founded and the former single acquirer and ACH Interpay transferred all acquiring contracts
with the merchants to the respective banks, the banks introduced interchange fees.
Information on the average IF level and about banks’ acquiring fees was taken from NMa
(2010). The IFs were based on bilateral agreements and averaged between 1 and 2 eurocents
(NMA, 2010, p.21) per debit card transaction3. The average acquiring fee had decreased to 4
eurocents per debit card transaction in 2009 (NMA, 2010, p.20).
Between 2002 and 2009 the classification of cost items was adjusted at some points in
accordance with practises in the retail sector4. For debit card payments these changes
1 This paragraph borrows from Jonker (2013) and Jonker & Plooij (2013). More detailed information on the data
collection 2009 can be found in the annex of Jonker (2013). 2 Started operations as of 1 January 2005 3 This is lower than the cap proposed by the EC: 0.04% of an average debit card transaction, versus 0.2% cap. 4 In short: the time horizon to distinguish fixed from variable costs had changed from 3 to 5 years in 2002 to 7
years in 2009. With respect to cash payments, the classification of “own money transport” was changed from
variable sales-related costs to fixed costs. The back-office costs for cash payments were changed from fixed costs
into a mix of fixed, variable transaction-linked and variable sales-related costs. In 2009, the cost of payments
47
resulted in a shift of EUR 25 million from variable transaction-linked costs to fixed costs. For
cash payments there was a net shift of EUR 125 million from fixed costs to EUR 40 million
transaction-linked and EUR 85 million transaction-sales-linked costs. In section 6 where I
test the results of my calibrated model in a sensitivity analysis, I will examine the impact of
these changes on the estimated notional level of optimal IF. However, such changes keep
occurring in practise and, though interesting from an academic perspective perhaps, a
theoretical optimal IF should reflect the actual social costs in cost allocations as used by the
market participants and not an allocation the market deemed appropriate in the past1.
5.3 Data
The paper of Jonker (2013) contains most of the data I need to calculate the estimations of
the parameters. There are some significant advantages of using the data as reported in that
paper. One is that the methodology for both years was the same, as well as the institute to
collect the data on the retail sector with largely unchanged surveys. Second is that the study
reports the social costs for cash and debit cards for both years per agent, including the
classification into variable and fixed costs using the cost model as described, which saves the
trouble of calculating the social costs per instrument per central bank, banks and retailers
from private costs and revenues (which are much harder to come by). Third is that the
reported social costs for the retailers are a consistent aggregation of the data as collected by
EIM, which have been used by (Bolt), Jonker and Plooij to estimate the interchange fees for
both years according to the tourist-test. But whereas the tourist-test focusses on the private
costs of retailers, the model of Korsgaard focusses on the total net costs of banks.
The total social costs for cash and debit card payments in the Netherlands declined from EUR
2,642 million in 2002 to EUR 2,405 million in 2009; the social costs for cash fell by EUR 334
million to EUR 1,788 million in 2009 while the social costs for debit cards increased with EUR
97 million to EUR 617 million (during which timeframe the total number of debit card
transactions almost doubled; an economy of scale of roughly 0.20). Table I, reused for ease of
reference from Jonker (2013), shows the social costs borne by the central bank, the banks
and retailers for cash and debit card payments for the years 2002 and 2009; this table
contains a large part of the numbers needed to estimate the model parameters. Table II,
related equipment was completely (cash) or largely (debit card) classified as fixed costs, whereas in 2002 the
division fixed to variable was 50:50. 1 In the study of Jonker & Plooij (2013) the estimated tourist-test IF increased from 0.2% in 2002 to 0.5% in 2009.
Using the 2002 cost classifications, the authors calculate it would have increased even further to 0.7%.
48
reused from Jonker & Plooij (2013) shows the breakdown of the costs for retailers
(merchants) into several cost items and classifications (fixed, variable transaction-linked and
variable sales-linked) for the year 2009. A similar table for 2002 can be found in the annex of
Brits and Winder, table A.2 (not reproduced here).
[Tables I and II about here.]
For the sake of completeness: average merchant fees are 7 eurocents per transaction in 2001
(DNB, 2002, p. IX), 4 – 6 eurocents in 2005, 2006 (NMa, 2006, p.144) and below 4 eurocents
in 2009 (NMA, 2010, p.20).
49
6 ESTIMATION
Using the cost data from table I in the previous section, and several other sources which I will
specify, this section shows how I estimate the parameters of the model and calculate the
socially optimal IF for the years 2002 and 2009 according to the model. I will also analyse the
robustness of the outcomes by performing some sensitivity analyses. But first I briefly outline
some stylized facts on POS payments and a few changes in the institutional setting in the
Netherlands during the relevant timeframe, as far as relevant for this study. The outline
suggests that the results found in this paper will not easily generalize to other countries.
6.1 Payments developments in the Netherlands 2002 - 2009
The Dutch sometimes take pride in the efficiency and security of their payment system, see
e.g. DNB (2002) and McKinsey&Company (2006). The next examples are meant to add some
substance to the efficiency claim and illustrate market practises that have bearing on POS
payments.
Efficiency
As a first exhibit the average price for a payment account. In most countries, the Netherlands
included, a payment account comes as a package deal to consumers, comprising an account,
a debit card, access to internet/online banking and a number (or limitless amount) of debit
card transactions, ATM cash withdrawals, credit transfers, standing orders and direct debits.
Chart 3 displays the average annual prices of a payment account for consumers in the EU in
20091. The average prices in the Netherlands were the lowest with EUR 41.17, the highest
amounted to EUR 243.64.
[Chart 3 about here]
This has not been always the case. For long, consumers had been raised with the idea that
payments are and should be free2. This was substantiated by the vision and business model
of the government-owned Postbank that promoted home-banking and had the image of
1 Source: factsheet accompanying another piece of EU payments regulation, the Payment Account Directive
(Directive 2014/92/EU), published OJEC 28 August 2014. Member States must transpose the provisions into
national law and regulations by 18 September 2016. 2 See for example the stated opinion of the consumer’ interest group as represented in the ad-hoc working group
(§5.1): “De Consumentenbond is van mening dat het basispakket van het betalingsverkeer gratis zou moeten zijn
en toegankelijk voor iedereen” [basic payments package should be free for all], DNB (2002, “bijlage III”).
50
providing free payment services1, even after it was privatized (see also box 3). And so,
consumers were not charged for their current account or payment instrument usage; at least,
not visibly because value-dating, taking float and low or no interest on payment accounts
(opportunity costs) were common2. That started to change somewhere around the turn of
the millennium and banks introduced fixed, often annual, fees for consumers. Note that this
is the main and crucial assumption underlying the formal model for optimal interchange fees:
consumers do not pay per-transaction fees. Initially, the fees were labelled “card fees”,
suggesting that debit cards are more expensive than cash (Jonker, 2007), a view supported
by the fact that merchants were allowed to surcharge and some indeed did (Jonker, 2013)3.
The fees have been relabelled to something akin to “payment package fees” and have been
slowly increased over the years, while banks stopped paying interest on payment accounts4.
Credit cards are usually not included and available at extra (fixed and variable) charges.
As a second exhibit supporting the efficiency claim: Schmiedel c.s. (2012), see §2.2, estimate
the social costs of retail payments around 1% of GDP for the EU, based on thirteen empirical
cost studies by as many European central banks5. The authors included in their study the
most frequently used retail payment instruments, that is: cash, cheques, debit cards, credit
cards, direct debits and credit transfers. The social costs of cash and debit cards in the
Netherlands is 0.42% of GDP6, extrapolating this to all retail payments combined yields an
indicative 0.61% of GDP7, which is the lowest of the sample of thirteen8 and likely to be one
of the lowest in the EU9. In 2002 the social costs of cash and debit cards were 0.57% of GDP
(revisit table I). They declined from EUR 2,642 million in 2002 to EUR 2,405 million in 2009.
These net cost savings of EUR 237 million were the result of cost savings in the retail sector
1 E.g. DNB (2002), p.II 2 Those did not cover bank’s cost though. The market perception that it did (and more than that) was a direct
reason for the banks to commission the McKinsey (2006) study. That showed banks were losing EUR 779 million
on cash services and additionally EUR 101 million on debit card transactions. All payment instruments, including
accounts, proved loss making, totalling EUR 2.664 million in losses. Revenue came from account balances, EUR
2.641 million, resulting in an economic profit of EUR -128 million. One exception: the only profitable payment
instrument was the credit card (EUR 69 million profit). 3 I have not been able to pinpoint the exact year when surcharging was abolished. Indirect evidence I found was
a study by ITM Research in 2000 commissioned by the EC to investigate the effects of the abolishment. 4 This practise remains until today for the three largest banks who dominate the market and provides ground for
competition to challengers. 5 These are the central banks of Denmark, Estonia, Finland, Greece, Hungary, Ireland, Italy, Latvia, Netherlands,
Portugal, Romania, Spain and Sweden. 6 Jonker, 2013, table 4, p.26, reproduced as Table I in section 5. 7 Cash and debit card account for 68.4% in market share, see Schmiedel c.s., 2012, table 4, p. 23. Since no domestic
payments instruments have been excluded, a simple extrapolation to 100% yields the 0.61%. 8 Second lowest reported 0.68%; Schmiedel c.s., 2012, table 7, note 2), p.27 and table 11, p.35. 9 Schmiedel c.s., 2012, table 13, p.40.
51
of EUR 264 that offset the small cost increases at banks and the central bank (Jonker, 2013).
For merchants, the operating costs of a cash payment in 2002 were lower than that of a debit
card payment but 2009 the situation had reversed, with lower overall costs for POS payments
for merchants1. Contrary to consumers, merchants never experienced ‘free’ payments and
paid fixed and variable fees for basically all payment instruments to receive funds and make
funds transfers. The fees merchants pay for debit card payments are fixed per-transaction
fees, which is both unusual by international standards (Börestam and Schmiedel, 2011,
Annex I, p.39) and low compared to other countries (EC Sector inquiry2); furthermore, they
have been decreasing over the years: on average 7 eurocents per transaction in 2001 (DNB,
2002, p. IX), 4 – 6 eurocents in 2005, 2006 (NMa, 2006, p.144) and below 4 eurocents in 2009
(NMA, 2010, p.20). Following this decline, the number of retailers that accept the debit card
increased and the number of retailers that surcharged their customers for using a debit card
decreased, with a corresponding decline in revenues from surcharging from EUR 8 million in
2002 to EUR 3 million in 2009 (Jonker and Plooij, 2013, p.63). This stimulated card usage.
Surcharging
In 2007, surcharging was a heterogeneous practise among merchants, with significant
differences among retail sectors (Bolt, Jonker and Renselaar, 2008). On average, 20% of debit
card accepting retailers do surcharge. Many retailers who do, surcharge only debit card
payments below a certain threshold, mostly EUR 10 – 15, in line with the break-even amount
of EUR 11.63 below which cash is cheaper from a social cost perspective, as Brits and Winder
calculated. About 90% of the merchants charged between 10 and 25 eurocents. The charge
initially served as an effective steering device towards the more efficient payment
instrument. But a mentioned in §4.2, the break-even point dropped to EUR 3.06 in 2009,
mainly due to technological progress and increasing payment volumes; cost savings that
were foremost benefitting the merchants themselves. The practise of surcharging however
hardly changed and this lead the researchers to conclude that the practise now hampered the
use of the more efficient debit card and therefore social cost saving of EUR 100 million could
be realised in the long run if the surcharging practise on debit cards would be discontinued.
In 2011 only 2% of the merchants still surcharged debit cards (Jonker, 2013, p.28).
1 Jonker & Plooij (2013), table 2, p.63, reproduced as Table II in section 5. 2 SEC(2007)_106, p.104: MSC debit cards weighed averages 1.0% - 1.5% in 2001 in the EU. Average debit card
transaction value was EUR 47.25 in 2002; i.e. 7 versus 47 eurocents (if taking MSC of 1.0%).
52
Institutional changes
See box 3 for a very brief overview of the Dutch interbank infrastructure developments. In
the context of this study, the changes that occurred in 2004 and 2005 are relevant. Before
2004, Interpay was the only acquirer of debit cards in the Netherlands and also the single
CSM. Following an advice of the ‘commissie Wellink’1, Interpay transferred all acquiring
contracts with the merchants to the respective banks by the end of 2005 and the banks
introduced interchange fees on debit cards, based on bilateral agreements. The merchants
loudly voiced their concern this would lead to higher merchant fees. In a good Dutch tradition
(poldermodel), the issue was resolved with a Convenant Betalingsverkeer where the banks
agreed with merchant’ interest groups not to raise merchant fees for 5 years, offer a 1
eurocent discount on each debit card transaction and donate EUR 10 million to a foundation2
that would promote efficient payments (among others end the practise of surcharging and
induce consumer payment behaviour changes). The transfer of contracts was finalised by the
end of 2005. In the same year, ownership of the domestic debit card brand PIN was
transferred to Currence3 that as of then acted as the scheme owner. PIN debit cards have
usually been co-branded with MasterCard’s Maestro4 to enable debit card transactions
1 NMa, 2006, p.131 2 Stichting Bevorderen Efficient Betalen. The campaign was effective (Jonker, Plooij and Verburg, 2015). 3 Started operations as of 1 January 2005. 4 At the moment one bank, a challenger of the ‘big three’, issues debit cards with both Maestro and VISA’s VPAY.
BOX 3. Dutch market infrastructures.
During last century there were two, largely separate, payment systems: the Postgiro and the
BankGiroCentrale (BGC). The first one can be traced back to the national savings bank, Rijkspostspaarbank
(founded in 1881) and the Postcheque- & Girodienst (founded in 1918), both government-owned until
privatized as Postbank in 1986. The Postbank merged into ING Group in 2009. The BGC was founded in
1967 by a number of merchant- and general banks, including (predecessors of) Rabobank and ABN AMRO
Bank. While the Postgiro was basically one system, the BGC worked as a CSM for the founding banks. In the
mid-seventies, DNB took an active role in stimulating the parties to increase inter-operability and efficiency,
a process that was intensified during the eighties under the then DNB president, Wim Duisenberg, until its
completion more than 20 years later in 1997 (1). In that timeframe several efficient payment products were
introduced: among others the national debit card PIN and the Dutch direct debit. The BGC merged in 1994,
together with BeaNet and Eurocard into Interpay which merged into Equens in 2006. The remaining Dutch
banks are still shareholders of Equens, together with the former shareholders of Interpay’ merging partner,
the German Transaktionsinstitut für Zahlungsverkehrsdienstleistungen AG. With the replacement of all
BBANs with IBANs as per August 1st, 2014 (2), the last noticeable difference between the two payment
systems finally disappeared: giro account numbers were typically 7 digits long whereas bank payment
account numbers were 9 digits. The NL IBAN is fixed to 18 characters.
Note (1): knows as the NBC, “Nationale BetalingsCircuit”; this was not one central system but an
arrangement of agreements, standards and procedures.
Note (2): As a consequence of Regulations (EU) 260/2012 (‘SEPA Regulation’), and (EU) 248/2014.
53
abroad, so until 2011 when PIN (the brand and the domestic infrastructure) was
decommissioned, not every debit transaction carried IFs.
6.2 Calibration1
The key parameters to estimate the (unconstrained) socially optimal IF are 𝑐𝐶 and 𝑐𝐷. Other
parameters are merchant’s cost price of the good γ, merchant’ fixed cost of card acceptance
K, consumer distance cost t, consumer net benefits of cards 𝑏𝐵 and merchant net benefits of
cards 𝑏𝑆. Additionally, for the constrained socially optimal IF we need banks fixed cost for
card payment services F. Below, I show step by step how I estimate the model parameters,
utilising the numbers in table I (unless otherwise indicated). To keep this paragraph brief, I
only exhibit the estimations on the 2009 parameters, the 2002 can be found in the same
fashion. All estimations are summarised in table III.
If one thinks of the model as describing a single transaction, then the transaction value may
be thought of as consisting of two parts2: the cost price of the good γ and a profit margin,
approxied by t. In other words, we will be normalizing for transaction value. The total sales
value of cash and debit card transactions was 58.1+76.1=134.2 billion. The total number of
cash and debit card transactions was 4,579+1,946=6,525 million. So the average transaction
size in 2009 is EUR 20.57. Choosing a markup of around 10.5% yields γ = EUR 18.41 and t =
EUR 2.16. The choice of the markup is arbitrary and I will test the model for sensitivity to this
choice later; the main reason for this exact markup is to be able to compare the outcome with
the outcome of Korsgaard, so I use the same markup. Besides that, a profit margin of 10%
does not seem too wild. In the model, K corresponds to the total fixed cost, but the model
describes a situation in which there is a unit mass of transactions. The logical counterpart
would then be to scale the merchant fixed costs to the total value of cash and card payments.
Merchant’s fixed cost of card payments is EUR 99 million and aggregate sales amount is EUR
134.2 billion which yields for an average transaction size of EUR 20.57: (99/134,200)*20.57
= K = 0.0152.
The parameters 𝑐𝐶 and 𝑐𝐷 reflect the banks’ marginal costs of card and cash payments. The
banks’ economic production function is not observable, so the correct proxy would be the
average variable costs for if we may assume constant marginal costs. Brits and Winder (2005)
assume linearity of the merchant‘s private variable cost function, which implies that unit
1 Unless otherwise indicated, the numbers used can be found in tables I and II. 2 See also Wright (2004b) p.19.
54
variable costs are equal to marginal costs. Apparently, MasterCard also used this assumption
when calculating the caps (Bolt, Jonker and Plooij, 2013, p.13). I extend this assumption to
banks’ variable cost function1. Accordingly, the banks variable average costs for debit cards
can be calculated as their total variable cost of debit cards divided by the total value of debit
card transactions and then multiplied by the average transaction value. Similarly, the banks
variable average internal costs for cash can be calculated as their total variable cost of cash
divided by the total value of cash transaction and then multiplied by the average transaction
value. Since the banks in the model represent the ‘producer’ of payments, the variable costs
of the central bank need to be included (only for cash as the central bank has no part in the
production of debit card transactions).
This yields an average variable social cost of cash 𝑐𝐷 of: 20.57*(445+41)/58,100 = 0.172 and
an average variable social cost of debit cards 𝑐𝐶 of: 20.57*83/76,100 = 0.022.
A little bit more involved are the estimations concerning the distributions of benefits.
Merchant benefits 𝑏𝑆 can be interpreted as the marginal savings from a card payment as
compared to a cash payment. This is where criterion 3 proves convenient: 𝛼𝑗 + 𝛽𝑗𝑠. Jonker
(2013), table 5, reproduced as table IV in the appendix, shows these functions for both years
and both cash and debit cards. For 2009, the function for cash is [0.1376 + 0.0089s] and for
debit card [0.1643 + 0.00013s]. Inserting the average transaction value into both and taking
the difference, yields 0.1537. This is then taken as the midpoint 𝑏𝑆,𝑚𝑖𝑑 of a uniform
distribution2: let 𝑏𝑆,𝑚𝑖𝑛 = 0.1537 − 𝑥 and 𝑏𝑆,𝑚𝑎𝑥 = 0.1537 + 𝑥.
Similarly, the distribution for 𝑏𝐵 can be estimated. This presents however a small challenge
as the consumer costs of payments were not included in any of the studies on the
Netherlands. I worked around this by looking at the Danish cost study, where estimates of
household costs of payments at POS were included and assuming the Danish households are
representative for the Dutch in this respect. The total net cost of cash for households in 2009
is DKK 1,523.5 million3, this is 0.081% of Danish GDP in 2009. Jonker (2013) uses a Dutch
GDP 2009 of approximately EUR 572.62 billion, a number I ‘reengineered’ from table I.
Applying the same percentage, the total net cost of cash for Dutch households in 2009 would
1 To support the assumption from an empirical view, Schmiedel c.s. (2012, p.29), shows diagrams in chart 2 that
depict the relationship between average unit social costs and the number of payments per capita for each retail
payment instrument; the lines are downwards sloping at a decreasing rate, which is consistent with constant
marginal costs. 2 As already mentioned, the assumption of uniformly distributed benefits is convenient for calculations but should
be empirically tested whether it is reasonable. A priori, the assumption seems no more nor less reasonable than
others. Unfortunately, I have no data to execute such a test. 3 Danmark Nationalbank (2011), table 6.
55
then amount to EUR 463.8 million. Dividing this number by the total value of cash sales, EUR
58.1 billion, yields a consumer net cost of cash per Euro sales of 0.0080. Similarly, the total
net cost of debit card for households in 2009 is DKK 718.2 million, this is 0.045% of Danish
GDP in 2009 which translates to EUR 257.7 million for the Dutch households. Dividing this
number by the total value of debit card sales, EUR 76.1 billion, yields a consumer net cost of
debit card per Euro sales of 0.0034. Subtracting the two numbers and multiplying by the
average transaction value indicates consumer enjoy benefits of 0.09 by paying by debit card
for an average transaction size. Setting this as the midpoint 𝑏𝐵,𝑚𝑖𝑑 gives 𝑏𝐵,𝑚𝑖𝑛 = 0.09 − 𝑦 and
𝑏𝐵,𝑚𝑎𝑥 = 0.09 + 𝑦. The estimation of the midpoint for 2002 can be found using the same steps
but as the Danish study only concerns the year 2009, I estimated the corresponding numbers
for 2002 using Dutch GDP of 2002 and I used a small correction to account for fees paid by
the Dutch households to banks; that is, the portion of the total cost of cash for Danish
households, great DKK 1,523.5 million that were fees to banks in 2009 (DKK 153.1 million),
I subtracted to account for Dutch households not paying any such fees in 2002.
The values of 𝑦 and 𝑥 have now to be set so that the fraction of merchants accepting debit
cards and the fraction of consumers preferring to pay by debit card match the empirical data.
According to Korsgaard, almost all of the merchants in Denmark accept the domestic debit
card Dankort: 95% in 2009. For the Netherlands, EIM (2007, p.24) reports 93% of retailers
accepting the debit card in 2006 and 63% in 1998. Since the scope of EIM is a subset of all
retailers, which might be slightly biased towards the more debit card favouring retailers, see
section 5 on the data collection. The number we are looking for here is the percentage of all
merchant stores, locations and venues where debit cards are accepted, regardless how many
debit card transactions actually take place there. Jonker and Lammertsma (2010) use this
metric and report an average percentage of businesses accepting debit cards of 70% in 2007.
I therefore choose more conservative estimates of 75% for 2009 and 60% for 2002, taking
into consideration the successful long-running public campaign that started in 2007 and
other initiatives by St.BEB. In 2009, the total portion of card payments by value is: 76.1/134.2
= 56.7%, so the fraction of consumers preferring to pay by debit card is assumed to be
0.567/0.75 = 75.6%. Now 𝑦 can be found first by solving the following equation for 𝑦:
1 − 𝐻(0) =𝑏𝐵,𝑚𝑎𝑥
𝑏𝐵,𝑚𝑎𝑥−𝑏𝐵,𝑚𝑖𝑛 =
𝑏𝐵,𝑚𝑖𝑑 +𝑦
𝑏𝐵,𝑚𝑎𝑥−𝑏𝐵,𝑚𝑖𝑛 = 0.756 (12)
The merchant threshold is:
56
𝑏𝑆 ≥ 𝑏𝑆∗ = 𝑚 − 𝐸[𝑏𝐵 𝑏𝐵 ≥ 0] +
3𝑡 (1−√1−2𝐾
𝑡)
1−𝐻(0) (13)
where for 2002, 𝑚 = 0 and for 2009 can be set at 𝑚 = 0.04.
This can be calculated using the found parameters estimates and 𝑥 is set so as to solve
1 − 𝐻(𝑏𝑆∗) =
𝑏𝑆,𝑚𝑎𝑥 −𝑏𝑆∗
𝑏𝐵,𝑚𝑎𝑥−𝑏𝐵,𝑚𝑖𝑛 =
𝑏𝑆,𝑚𝑖𝑑 +𝑥− 𝑏𝑆∗
2𝑥= 0.75 (14)
which for 2009 yield 𝑦 = 0.185 and 𝑥 = 0.386 and for 2002 𝑦 = 0.043 and 𝑥 = 0.042.
6.3 Obtained results
The estimated parameters of interest are summarised below in table III.
[table III about here]
The merchant card acceptance threshold 𝑏𝑆∗, equation (13), evaluates to −0.039 which
implies that a merchant would accept debit card payments even if it increased costs relative
to receiving payment in cash by 0.039 for an average transaction amount, i.e. 0.19%,
indicating merchant internalization. For 2002 the merchant threshold is positive but close to
zero (0.007), indicating an on average slightly higher merchant resistance to accepting debit
cards in that year compared to 2009.
The value of y in 2009 is less than x, indicating less heterogeneity in consumer benefits than
in merchant benefits (in the estimation for Denmark, the opposite appears to be case). No
corner solutions have been obtained in the numerical estimates: 𝑏𝑆,𝑚𝑖𝑛 is less than the
merchant threshold.
Recall the formula for the unconstrained optimal merchant fee 𝑚 = 𝑐𝐶 − 𝑐𝐷 it evaluates
for 2009 to −0.150 or −0.73% and
for 2002 to −0.106 or −0.76%.
By comparison, the optimal merchant fee as derived by Korsgaard for Denmark is −0.47%
(which results in an estimated optimal interchange fee of −0.50% as acquiring costs need to
be included and these are 0.03% for Denmark; we could try to approximate the acquiring cost
for the Dutch banking sector for both years, using the average acquiring fees for the two years
as mentioned in §5.3 (times number of debit card transactions) to come to comparable
estimates of the optimal IF but this would be a mix up as these are external costs to merchants
57
and revenues to banks, which are not good proxies for average variable internal costs for the
acquiring banks. Thereofore I leave this small exercise aside).
What would be the optimal interchange fee as set by the banks? The model provides an
approximation that can only be obtained if one assumes uniformly distributed benefits for
both merchants and consumer, still ignoring merchant fixed costs. The equation reads:
𝑚 =1
2 (𝑐𝐶 − 𝑐𝐷 + 𝑏𝑆,𝑚𝑎𝑥 +
1
2𝑏𝐵,𝑚𝑎𝑥 ) (15)
and evaluates to 1.21% for Danmark. It is easy to calculate now the corresponding estimates
for the Netherlands. Similarly expressed in relative terms (relative to the average transaction
value of the respective years), for 2009 that would yield 1.29% and for 2002, −0.07%.
The formula assumes fixed cost for merchants and banks to zero. As said before, the merchant
fixed cost will drive the optimal interchange a fraction further down. I relax both assumptions
consequentially and take fixed costs for both merchants and banks into account. First
employing equation (8) and then equation (10), we obtain the constrained socially optimal
merchant fees
for 2009 of −0.072 or −0.35% and
for 2002 of 0.063 or 0.45%.
6.4 Robustness
I take the two indicators of socially optimal merchant fees according to the model, the
unconstrained optimal fee and the constrained optimal fee, for both the two years to see how
they hold in a few sensitivity analyses.
The first is an analysis of changes to the markup. As table V shows, the model outcomes hardly
respond to the changes. This indicates the model is robust for changes in the arbitrarily
chosen markup of 10.5%. Only the constrained optimal merchant fee is shown in the table as
the unconstrained optimal merchant fee is independent of the markup.
[Table V about here]
58
The next is an analysis of changes in the average value of a transaction. Table VI shows the
constrained and unconstrained socially optimal merchant fees for 2009 and 2002 in absolute
values (EUR) and in percentages for different transaction size.
[Table VI about here]
The unconstrained socially optimal merchant fee is negative for both years for all transaction
sizes. Consequently, the absolute values are also negative. It means that according to this
model, translated back to a four-party model, the issuers pay the merchants a fee per
transaction, instead of receiving one. The reason a social planner would choose to do so is
because cash is relative expensive and banks are effectively subsidising cash. As cash became
even more expensive in 2009, one would expect a higher (i.e more negative) merchant fee,
but this is counterbalanced by the change in fraction of card payments relative to cash
payments measured in value. The socially optimal merchant fee remains fairly unchanged
compared to 2002. And herein lies the weakness of the and model: the costs are assumed to
vary with the fraction of card, respectively cash payments in the economy which seems like
an oversimplification of reality. Furthermore, the estimation method normalizes over the
value of the transactions, thereby neglecting the proper scaling criteria as presented earlier.
As table IV shows, the banks had an average social cost per transaction of EUR 0.17 for debit
cards and of EUR 0.19 for cash. To demand issuing banks to pay EUR 0.15 for each debit card
transaction seems quite out of place, the notion that issuing banks need compensation for
(part of) their internal costs is denied in this setup.
Even more interesting is taking into account banks’ fixed cost. The socially optimal merchant
fee is then adjusted so the banks get compensated to cover for their average fixed cost,
expressed in terms of the fraction of card payments in the economy. In the numerical
example, this is again averaged over the value of card payments. The result is that the optimal
fee, the constrained optimal fee, is negative in 2009 but positive in 2002, as banks had a
relatively larger fixed part of card costs. The result would be that the interchange fee would
actually stimulate the more expensive payment instrument, cash, while discouraging cards.
Note that all the calculated optimal merchant fees (which by modelling assumption include
interchange fees) are much lower in reality than estimated here. With “lower” I mean closer
to zero. A two-sided market is virtually never symmetric so a price level below zero may be
59
expected to lead to different price structure, with the risk of creating a market failure instead
of solving one.
A final exercise in this paragraph is to examine what impact the reclassification of certain cost
items had on the optimal fees. This remains a short exercise as the impact turns out to be
none. The reason is simple, all the changes in classifications concerned the retail sector and
none of those costs have impact on the optimal merchant fee, constrained nor unconstrained.
This is because the model presumes the banks to be the producer of card payments and
merchants are ‘users’. Their costs are no input to the banks’ production function.
60
7 CONCLUSIONS
7.1 Discussion of the results
Whereas most of the literature focusses either on the payment activity rather than the
instrument, or on credit cards, it seemed refreshing to have a model closer to a debit card
favouring market. In particular as those experience lower interchange fees. Secondly, none
of the models in the literature accounted for the fact that consumers do not experience per-
transaction costs as is so often assumed; or a fixed fee for consumers is assumed but then the
total volume of transactions is assumed fixed which renders the difference immaterial. But
the model employed in this study turns out to create the wrong incentives in the long run,
working with the constrained optimal merchant fee. Because in derivations the developer
tried to avoid dealing with corner solutions, at the point of addressing fixed costs of banks
the model showed to contain a superior solution from a welfare perspective compared to the
one used. I will present it here: the social planner would still impose the unconstrained
optimal fee and banks would then be reimbursed their fixed costs as that would not result in
a loss of welfare from lower than optimal card usage. As it happens, the Danish debit card
model actually works in a fashion very similar to this (the system actually does work with an
IF, only implicitly1). Such a model would run against the current institutional setting in the
Netherlands and would reverse large parts of the changes that occurred about a decade ago2.
While the unconstrained optimal merchant fee is a striking result from an economic and
intellectual perspective, the choice to ignore merchant fixed costs or banks fixed costs that
create the simple yet elegant and striking result, seems arbitrary and unsupported from an
empirical perspective.
From an estimation point of view, the model showed to be too coarse to cater for relatively
very small interchange fees like in the Netherlands. Korsgaard views IFs of -0.47% or 0.23%
“still a very low figure compared to actual interchange fees” (p.21), but from a Dutch
perspective these are big numbers. Recall that the Convenant Betalingsverkeer includes a
(real) merchant discount of EUR 0.01 and that agreement has been prolonged twice,
1 See Börestam & Schmiedel (2011), p.11 or Danmark Nationalbank (2011). 2 Whether the Danish model is ‘future proof’ remains to be seen, as the PSDII will demand a separation of
processing and scheme ownership, where Denmark operates a monopoly acquirer, as was the case in the
Netherlands before 2005. Perhaps the Danish will find a way to avoid a negative impact on what otherwise appears
to be a very efficient debit card infrastructure. The point I’m making is more that those enforced changes, have
already passed the Netherlands so also from that perspective a reversal seems unlikely and undesirable.
61
currently until 2018. The assumption of a profit-maximizing banking sector that is the (sole)
producer of payment services, appeared reasonable at first glance. But as it turns out, the
model neglects several costs that are important from a social perspective, in particular the
costs of retailers. In defence of the model, it has to be stated that all benefits have been
modelled and estimated as cost savings. This ignores other benefits merchants and
cardholders attach to card usage.
As in Rochet and Tirole (2000, 2008) and Wright (2004b, 2012), the model produces the
merchant internalization property. But to what extend this is actually present did not show
from the empirical data as I conveniently assumed uniformly distributed benefits. As Jonker
(2011) demonstrates, merchants are sensitive to the cost of accepting card payments,
especially fixed costs. But the competition the merchant faces also influences merchants’ card
acceptance and surcharging decisions. As competition increases, card acceptance is likely to
increase. It would be interesting if this fact would be combined in a model where consumer
do not pay per-transaction fees and study the outcomes.
7.2 Limitations of the study
Next to the limitations I have already indicated above, one I would like to point out in
particular. The concept of social costs is valuable from a cost-to-society perspective. If the
costs would be reduced social welfare would increase as the production resources become
available to other ends. But this view ignores the payment system itself generates social
benefits as well. See my brief accounts on ‘money’. Efficient payment systems are vital to real
markets and financial markets. New products like e-wallets, mobile payments, iDEAL, can
actually create new demand. The difficulty is that the benefits are difficult to measure. But
what is easy is not necessarily what is right.
7.3 Afterword
“All solutions have costs and there is no reason to suppose that government regulation is called for simply
because the problem is not well handled by the market or the firm.”
Ronald Coase, The problem of social costs, p.18
62
8 REFERENCES
8.1 Bibliography
Bagnall, J., Bounie, D., Huynh, K.,P., Kosse, A., Schmidt, T., Schuh, S. and Stix, H., 2014,
Consumer cash usage, a cross-country comparison with payment diary survey data, ECB
Working Paper Series No. 1685
Baxter, W.,F., 1983, Bank Interchange of Transactional Paper: Legal and Economic
Perspectives, Journal of Law and Economics, Vol.26 No.3, p. 541-588
Bedre-Defolie, Ö. And Calvano, E., 2009, Pricing payment cards, ECB Working Paper Series
No. 1139
Bolt, W., 2013, Pricing, competition and innovation in retail payment systems: a brief
overview, Journal of Financial Market Infrastructures, Vol.1 No.3, p. 73–90.
Bolt, W. and Humphrey, D., 2007, Payment Network Scale Economies, SEPA, and Cash
Replacement, (Federal Reserve Bank of Philadelphia Working Paper no. 07-32). Available
at: http://ssrn.com/abstract=1077197
Bolt, W., Jonker, N. and Plooij, M., 2013, Tourist-test or tourist trap? Unintended consequences
of debit card interchange fee regulation, DNB Working Paper, No. 405
Bolt, W., Jonker, N. and Renselaar, van, C., 2008, Incentives at the counter: An empirical
analysis of surcharging card payments and payment behaviour in the Netherlands, DNB
Working Paper, No. 196
Bolt, W. and Tieman, A., 2003, Pricing payment services: an IO approach, Working Paper no.
202, International Monetary Fund.
Bolt, W. and Tieman, A., 2004, A note on social welfare and cost recovery in two-sided
markets, DNB Working Paper No.24, December 2004; published in 2006 in: Review of
Network Economics, Vol.5, Issue 1, p.103–117
Börestam, A., and Schmiedel, H., 2011, Interchange fees in card payments, ECB Occasional
Paper Series, No.131
Bos, P.,V.,F., 2007, Betaalkaarten en mededingingsautoriteiten in Europa: een
mededingingsrechtelijke processie van Echternach, Markt & Mededinging, 2007/nr.4
Brits, J., H. and Winder, C., C., A., 2005, Payments are no free lunch, DNB Occasional Studies,
Vol.3, No. 2
Coase, R., H., 1960, The Problem of Social Cost, Journal of Law and Economics, Vol.3, pp.1-44
Currence, 2011, Jaarverslag 2011. Available at:
http://www.currence.nl/Downloads/Cu_CurrenceJVNL2011.pdf
63
Danielsson, J., 2013. Economics of Risk (Duisenberg School of Finance, Amsterdam, course
syllabus)
Danmark Nationalbank, 2011, Costs of Payments in Denmark. Available at:
http://www.nationalbanken.dk/en/publications/Pages/2012/04/Costs-of-payments-
in-Denmark.aspx
Danmark Nationalbank, 2012, (authors J., G., K., Jacobsen and A., M., Pedersen), Cost of card
and cash payments in Denmark, Danmarks Nationalbank Monetary Review, 2nd Quarter
2012, Part 1, pp. 109-121
DNB, 2002, Werkgroep Tariefstructuren en Infrastructuur in het Betalingsverkeer,
Eindrapport Tariefstructuren en Infrastructuur in het Nederlandse Massale
Betalingsverkeer (DNB). Available at: http://www.dnb.nl/en/publications/dnb-
publications/other-documents/auto38927.jsp
Edelman, B., G. and Wright, J., 2014, Price Coherence and Adverse Intermediation, Working
Paper 14-052, March 2014. Available at:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2373671
EIM, 2007, Het toonbankbetalingsverkeer in Nederland. Kosten en opbrengsten van
toonbankinstellingen in kaart gebracht (EIM).
Evans, D., S., 2003, The Antitrust Economics of Multi-sided Platform Markets, Yale Journal on
Regulation, Vol.20, pp. 325-381
Evans, D., S., 2011, Payments innovation and interchange fees regulation: how inverting the
merchant-pays business model would affect the extent and direction of innovation,
Working Paper June 27, 2011. Available at: http://ssrn.com/abstract=1878825
Evans, D., S. and Schmalensee, R., 2005, The Economics of Interchange Fees and Their
Regulation: An Overview (Federal Reserve Bank of Kansas City). Available at:
http://www.kansascityfed.org/publicat/pscp/2005/Evans-Schmalensee.pdf
Europe Economics, 2014, The Economic Impact of Interchange Fee Regulation. Available at:
http://www.europe-economics.com/publications/economic_impact_of_if_regulation_-
_france.pdf
Frankel, A., S., 1998, Monopoly and competition in the supply and exchange of money,
Antitrust Law Journal, Vol. 66, No. 2, pp. 313-361
Freixas, X, and Rochet, J.-C., 2008. Microeconomics of banking (The MIT Press, Cambridge,
2nd ed.)
64
Gans, J., S. and King, S., P., 2001a, Regulating Interchange Fees in Payment Systems
(Melbourne Business School Working Paper No. 2001-17, October 9, 2001). Available at:
http://ssrn.com/abstract=286535
Gans, J., S. and King, S., P., 2001b, The Neutrality of Interchange Fees in Payment Systems,
Working Paper July 9, 2001; published in 2003 in: Topics in Economic Analysis and Policy,
Vol. 3, Issue 1.
Guthrie, G., and Wright, J., 2007, Competing Payment Schemes, Journal of Industrial
Economics, Vol.55, No.1, pp. 37-67
Hayashi, F., 2004, A Puzzle of Card Payment Pricing: Why Are Merchants Still Accepting Card
Payments?, (Federal Reserve Bank of Kansas City). Available at:
http://www.kc.frb.org/publicat/psr/rwp/WP04MerchCardAcceptance12-28-04.pdf
Hayashi, F., 2013, Public Authority Involvement in Payment Card Markets: Various Countries
(Federal Reserve Bank of Kansas City). Available at:
http://www.kansascityfed.org/publicat/psr/dataset/pub-
auth_payments_var_countries_August2013.pdf
HBD, 2002, Afrekenen in winkels 2002, Meningen, feiten en mogelijkheden tot verandering,
Hoofdbedrijfschap Detailhandel, The Hague
Humphrey, D., Willesson, M., Lindblom, T. and Bergendahl, G., 2003, What does it cost to
make a payment?, Review of Network Economics, Vol.2 Issue 2, pp. 159–174
ITM Research, 2000, The abolition of the No-discrimination Rule, ITM Research for
Competition DG, Amsterdam
Jonker, N., 2007, Payment instruments as perceived by consumers: Results from a
household survey, De Economist, 155 No.3, pp. 271-303
Jonker, N., 2011, Card acceptance and surcharging: the role of costs and competition, DNB
Working Paper, No. 300
Jonker, N. , Kosse, A., and Hernandez, L., 2012, Cash Usage in the Netherlands: Where, When
and Whenever One Wants?, DNB Occasional Studies, Vol.10, No.2
Jonker, N. and Lammertsma, A., 2010, From cash to electronic payments: a survey of the
developments, in: Statistics Netherlands (ed.), The Digital Economy 2009, The
Hague/Heerlen, pp. 203-210
Jonker, N. and Plooij, M., 2013, Tourist-test interchange fees for card payments: down or
out?, Journal of Financial Market Infrastructures, Vol. 1, No.4, pp. 51–72
Jonker, N., Plooij, M., Verburg, J., 2015, Does a public campaign influence debit card usage?
Evidence from the Netherlands, DNB Working Paper, No. 0
65
Klemperer, P., 1987, Entry deterrence in markets with consumer switching costs, The
Economic Journal, No. 97, pp.99-117
Kokkola, T. (ed.), 2010. The Payment System. Payments, securities and derivatives, and the
role of the eurosystem (ECB)
Korsgaard, S., 2014, Paying for Payments, Free Payments and Optimal Interchange Fees, ECB
Working Paper Series No. 1682
Kosse, A., and Vermeulen, R., 2014, Migrants’ choice of remittance channel, do general
payment habits play a role?, ECB Working Paper Series No. 1683
Leinonen, H., 2011, Debit card interchange fees generally lead to cash-promoting cross-
subsidisation, Bank of Finland Research Discussion papers, no. 3(2011)
McKinsey&Company, 2006, Eindrapport Betalingsverkeer in Nederland: een onderzoek naar
de opbrengsten en kosten voor het bankwezen (DNB). Available at:
http://www.dnb.nl/binaries/Betalingsverkeer%20in%20Nederland_tcm46-145628.pdf
Motta, M., 2004. Competition Policy: Theory and Practice (Cambridge University Press, New
York)
NMa, 2006, Monitor Financiële Sector 2006, NMa
NMa, 2010, Visiedocument Betalingsverkeer 2010, Kansen en bedreigingen voor meer
concurrentie in het betalingsverkeer in Nederland. Available at:
https://www.acm.nl/nl/publicaties/publicatie/6830/Visiedocument-Betalingsverkeer-
2010/
Robbins, L., 1945. An essay on the nature & significance of economic science (Macmillan,
London, second edition)
Rochet, J-C. and Tirole, J., 2000, Cooperation Among Competitors: Some Economics of Credit
Card Associations, Working Paper May 16, 2000; published in 2002 in: Rand Journal of
Economics, Vol.33 No.4, pp. 549–570
Rochet, J-C. and Tirole, J., 2002, Platform Competition in Two-sided Markets, Working Paper
December 13, 2002; published in 2003 in: Journal of the European Economic Association,
Vol.1 No.4, pp. 990–1029
Rochet, J-C. and Tirole, J., 2003, An Economic Analysis of the Determination of Interchange
Fees in Payment Card Systems, Review of Network Economics, Vol.2, Issue 2
Rochet, J-C. and Tirole, J., 2005, Two-sided Markets: A Progress Report, Working Paper
November 29, 2005; published in 2006 in: Rand Journal of Economics, Vol.37 No.3, pp.
645–667
66
Rochet, J-C. and Tirole, J., 2008, Must-take cards: merchant discounts and avoided costs,
Working Paper November 7, 2008; published in 2011 in: Journal of the European
Economic Association, Vol.9, Issue 3, pp. 462–495
Rochet, J.-C. and Wright, J., 2009, Credit card interchange fees (ECB Working Paper Series,
no. 1138 / December 2009)
Schinkel, M., P., 2010, Market Oversight Games (Amsterdam Center for Law & Economics
Working Paper No. 2010-11). Available at: http://ssrn.com/abstract=1692733
Schmalensee, R., 2001, Payment systems and interchange fees (NBER Working Paper
No.8256, April 2001); published in 2002 in: Journal of Industrial Economics, vol. 50, no. 2
(June), pp. 103-122.
Schmiedel, H., Kostova, G. and Ruttenberg, W., 2012, The social and private costs of payment
instruments – a European perspective (ECB Occasional Paper Series, no. 137)
Sedláček, T., 2012. De economie van goed en kwaad (Scriptum, Schiedam)
Schwimann, I., 2009, European Union competition policy and payment systems: A review of
recent developments, Journal of Payments Strategy & Systems, vol. 3, no. 3 (April), pp.
243-252
Vickers, J., 2005, Public Policy and the Invisible Price: Competition Law, Regulation, and the
Interchange Fee, Proceedings of a conference on “Interchange Fees in Credit and Debit
Card Industries” (Federal Reserve Bank of Kansas-City, May 4-6, 2005) pp. 231–247.
Available at: http://www.kansascityfed.com/publicat/pscp/2005/Vickers.pdf
Weiner, S., E. and Wright, J., 2005, Interchange Fees in Various Countries: Developments and
Determinants, Review of Network Economics, Vol.4, Issue 4
Wright, J., 2004a, One-sided Logic in Two-sided Markets, Review of Network Economics,
Vol.3, Issue 1, pp. 44-64
Wright, J., 2004b, The Determinants of Optimal Interchange Fees in Payment Systems,
Journal of Industrial Economics, Vol. 52, No.1, pp. 1-26.
Wright, J., 2012, Why payment card fees are biased against retailers, Working Paper version
June 2012, published in 2012 in: RAND Journal of Economics, Vol. 43, Issue 4, pp. 761-780
Zenger, H., 2011, Perfect surcharging and the tourist test interchange fee, Journal of Banking
and Finance, Vol.35, No.10, pp. 2544–2546
8.2 (Pre-) Legislation, Cases and Miscellaneous Links
COM(2013) 547 final, 2013/0264 (COD): Proposal for a DIRECTIVE OF THE EUROPEAN
PARLIAMENT AND OF THE COUNCIL on payment services in the internal market and
67
amending Directives 2002/65/EC, 2013/36/EU and 2009/110/EC and repealing
Directive 2007/64/EC, 24-7-2013. Available at:
http://ec.europa.eu/internal_market/payments/framework/index_en.htm
COM(2013) 550 final, 2013/0265 (COD): Proposal for a REGULATION OF THE EUROPEAN
PARLIAMENT AND OF THE COUNCIL on interchange fees for card-based payment
transactions, 24-7-2013
COMMISSION DECISION of 24 July, 2002 relating to a proceeding under Article 81 of the EC
Treaty and Article 53 of the EEA Agreement (Case No COMP/29.373 - Visa International -
Multilateral Interchange Fee) OJEC L318 22.11.2002
Decision d-g NMa July 24, 2002, case 82/50, GIP-Overeenkomst: Dutch only.
DIRECTIVE 2007/64/EC OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 13
November 2007, on payment services in the internal market amending Directives
97/7/EC, 2002/65/EC, 2005/60/EC and 2006/48/EC and repealing Directive 97/5/EC
DIRECTIVE 2014/92/EU OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 23
July 2014 on the comparability of fees related to payment accounts, payment account
switching and access to payment accounts with basic features
MEMO/09/143 of April 1st, 2009, Antitrust: Commissioner Kroes notes MasterCard's
decision to cut cross-border Multilateral Interchange Fees (MIFs) and to repeal recent
scheme fee increases – frequently asked questions
Regulation (EU) No 260/2012 of the European Parliament and of the Council of 14 March
2012 , establishing technical and business requirements for credit transfers and direct
debits in Euro and amending Regulation (EC) No 924/2009
SEC(2007) 106 COMMISSION STAFF WORKING DOCUMENT, Report on the retail banking
sector inquiry, Communication from the Commission – Sector Inquiry under Art 17 of
Regulation 1/2003 on retail banking (Final Report) [COM(2007) 33 final], 31-1-2007
SDW(2013) 288 final: COMMISSION STAFF WORKING DOCUMENT, IMPACT ASSESSMENT,
Accompanying the document [{COM(2013) 547 final}, {COM(2013) 550 final},
{SDW(2013) 289 final}], Volumes 1 and 2 (of 2), 24-7-2013
Links
[1] Paul Volcker: http://nypost.com/2009/12/13/the-only-thing-useful-banks-have-
invented-in-20-years-is-the-atm/
[2] Penalty JP Morgan Chase:
http://www.justice.gov/usao/nys/pressreleases/January14/JPMCDPAPR.php
68
[3] Penalty HSBC: http://www.justice.gov/opa/pr/hsbc-holdings-plc-and-hsbc-bank-usa-
na-admit-anti-money-laundering-and-sanctions-violations
[4] Penalty Commerzbank:
http://www.federalreserve.gov/newsevents/press/enforcement/20150312b.htm
[5] Penalty BNP Paribas: http://www.dfs.ny.gov/about/press2014/pr1406301.htm
[6] ING vs. AFAS:
http://uitspraken.rechtspraak.nl/inziendocument?id=ECLI:NL:RBMNE:2014:3250
[7] Wal-Mart c.s. vs. MasterCard and VISA: http://caselaw.findlaw.com/us-2nd-
circuit/1181291.html
[8] Short overview of the EC’s work on MIFs with more links: https://www.gov.uk/cma-
cases/investigation-into-interchange-fees-mastercard-visa-mifs
[9] EC sent supplementary SO to MasterCard, MEMO/06/260:
http://europa.eu/rapid/press-release_MEMO-06-260_en.htm?locale=fr
[10] Jean Tirole’s lecture in accepting the Sveriges Riksbank Prize in Economic Sciences in
Memory of Alfred Nobel 2014: https://www.youtube.com/watch?v=YQdF23RfX5w
[11] Reversal of IF direction in Australia: http://www.eftposaustralia.com.au/for-
merchants/faq
[12] Position paper of Groupement des Cartes Bancaires CB in response to IFR and PSD2
proposals: http://www.cartes-
bancaires.com/IMG/pdf/CB_Position_paper_on_MIF_Regulation_and_PSD_2_-
_December_2013.pdf
[13] BaFin expert article on PSD II:
http://www.bafin.de/SharedDocs/Veroeffentlichungen/EN/Fachartikel/2014/fa_bj_
1406_zahlungsdiensterichtlinie_II_en.html
[14] Factsheet accompanying DIRECTIVE 2014/92/EU:
http://ec.europa.eu/consumers/financial_services/bank_accounts/index_en.htm
[15]
69
9 APPENDICES
Chart 1: Non-cash payment shares in selected countries
The chart shows the share of the most frequently used non-cash payment instruments, measured in number of
transactions, in selected countries at three points in time: in the mid-nineties, at the end of the nineties and around
2003 (except Australia and Mexico where data of only two points in time are available).
Source: Weiner & Wright (2005, p.295)
Notes:
- Mexico debit card figures include ATM transactions.
- Weiner & Wright do not further indicate what payment instruments could fall in the category ‘Other’ (it is
not cash).
70
Chart 2a: Non-cash POS payment shares in the Netherlands
The chart shows the share of the most frequently used non-cash POS payment instruments, measured in number
of transactions, in the Netherlands during the years 1996-2004.
In absolute numbers, the debit card use increased with approx. 20% annually, from 371 million in 1996 to 1,247
million in 2004. In share however it lost some to the e-purse (brand: Chipknip). The usage of cheques peaked in
1991 (not disclosed in the chart) but gradually declined in the years after. In 1999 the Dutch banks decided to
stop issuing them during 2001 and on 1 January 2002 cheques were taken off the market. The decommissioning
of cheques and the introduction of the e-purse were part of the trend to stimulate the use of more efficient payment
instruments.
Source: Brits & Winder (2005), table 2.1.
Note: source reports absolute numbers, converted to shares by author.
71
Chart 2b: POS payment shares in the Netherlands
The chart shows the share of the most frequently used POS payment instruments, measured in number of
transactions, in the Netherlands during the years 1996-2004. In other words, this chart depicts the same as chart
2a with the estimated annual number of cash transactions.
Source: Brits & Winder (2005), tables 2.1 and 2.2
Note 1: source reports absolute numbers, converted to shares by author.
Note 2: The number of cash transactions in an economy is difficult to measure reliably. DNB has estimated the
number for the year 2002 on 7,000 million transactions and a value of EUR 120 billion (id. p.11, 12). Using the
yearly number of cash withdrawals by consumers (id. table 2.2), assuming the average value of a cash withdrawal
had not changed significantly in the time period, I have estimated the number of cash transactions for the other
years.
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1996 1997 1998 1999 2000 2001 2002 2003 2004
debit card credit card e-purse cheques cash
72
Chart 2c: POS payment value shares in the Netherlands
The chart shows the share of the most frequently used POS payment instruments, measured in value of the
transactions in Euros in the Netherlands during the years 1996-2004. In other words, this chart depicts the same
as chart 2b now in terms of (sales) value of the transactions.
Source: Brits & Winder (2005), tables 2.1 and 2.2
Note 1: source reports absolute numbers, converted to shares by author.
Note 2: Bolt, Jonker and Renselaar (2008) offer a very similar chart depicting the value shares of the same POS
payment instruments (p.8, figure 1). They use a different method to estimate the yearly value shares, which gives
more accurate estimates. For consistency and comparability of the charts, I choose to use the Brits & Winder
data. The general message in this chart and their figure 1 is the same but more conspicuous in figure 1: in terms
of value share the debit card is gradually taking over from cash in this chart but in figure 1, the debit card has
already surpassed cash as of 2004.
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1996 1997 1998 1999 2000 2001 2002 2003 2004
debit card credit card e-purse cheques cash
73
Table I: Social costs of cash and debit card payments, 2002 - 2009
The table shows the social costs borne by the central bank, the banking sector and the retailers for cash and debit
card payments for the years 2002 and 2009. All numbers are reported in EUR millions, unless otherwise indicated.
Source: Jonker (2013), table 4.
(a) The increase of the average value of cash payments can be explained by the fact that consumers tend to buy
more purchases at one point-of-sale instead of visiting multiple points-of-sale. Consequently, they make less
payments with an on average higher transaction value. In addition, inflation exercised upward pressure on the
average value of a cash transaction.
(b) Variable costs to retailers are split into costs that vary with the number of payments made, the so called
variable transaction-linked costs and costs that vary with the sales generated with the payment instrument, the
so called variable sales-linked costs. No such a breakdown could be made for banks’costs.
.
74
Table II: Merchants’ costs for cash and debit card payments, 2009
The table shows retailers’ main cost components and the allocation to fixed, variable transaction-linked and
variable sales-linked costs for cash and debit card payments for the year 2009. All numbers are percentages.
Source: Jonker and Plooij (2013), table 1.
75
Chart 3: Average price of a payment account per EU country, 2009, in EUR
A study carried out for the EC compared the prices for payment accounts for consumers in the 27 Member States
and found significant variations in prices, measured in absolute terms (PPP adjusted) across Member States.
Source: Factsheet 1, Directive on payment accounts [14], last accessed on 17 April 2015
76
Table III: Model parameter estimates, 2002 and 2009
The table show the parameter estimates to the model, as described in §4.1 and as computed in §6.2 (for
Netherlands 2009 only; the 2002 estimates for the Netherlands have been calculated following the same procedure
as described in §6.2; the estimates for Denmark have been calculated by Korsgaard and added here for
comparison. Units for Denmark are in DKK, for Netherlands in EUR.
parameter
Estimate
Denmark 2009
Estimate
Netherlands 2009
Estimate
Netherlands 2002
γ 230 18.41 12.49
t 27 2.16 1.47
K 0.326 0.0152 0.0085
𝑐𝐶 0.321 0.022 0.017
𝑐𝐷 1.527 0.172 0.123
𝑏𝑆,𝑚𝑖n -2.533 0.2320 -0.0262
𝑏𝑆,𝑚ax 3.698 0.5393 0.0576
𝑏𝐵,𝑚𝑖n -3.823 0.0901 -0.0261
𝑏𝐵,𝑚ax 7.421 0.2791 0.0590
Source: Author
77
Table IV: Cost measures for cash and debit card payments, 2002 - 2009
The table shows the breakup of social costs per transaction and per EUR sales for the banks, merchants (retailers)
and the central bank. Additionally, the table shows variable costs per average transaction. These are exactly the
three cost comparison criteria.
Source: Jonker (2013), table 5.
78
Table V: Sensitivity analysis to changes in distance cost t, 2002 - 2009
The table shows how the constrained socially optimal merchant fee changes with different values for distance cost
t, i.e. the markup, which is in the method the profit margin (in percentages). Only the constrained is shown as the
unconstrained does not depend on the variable t. As is shown, the outcome is largely insensitive to the changes,
although the markup cannot be 0%.
Parameter t
Optimal m
2009
Optimal m
2002
Base (10.5%) -0.35% 0.45%
0.5% -0.37% 0.43%
5% -0.35% 0.45%
10% -0.35% 0.45%
20% -0.35% 0.45%
Source: Author
Table VI: Sensitivity analysis, changes in average transaction value, 2002 - 2009
The table shows how the unconstrained and the constrained socially optimal merchant fee respond to changes in
average transaction values for each year in question (2002 and 2009). The unconstrained does not change in
relative terms, but yields different absolute values (merchant fees in EUR). The BASE line mentions the average
transaction values as from empirical data for that year, for 2009: EUR 20.57 and for 2002: EUR 13.95 and the
corresponding (un)constrained optimal merchant fees.
2009 2002
Unconstrained
Optimal fee
Constrained
Optimal fee
Unconstrained
optimal fee
Constrained
optimal fee
% EUR % EUR % EUR % EUR
BASE -0.73% -0.15 -0.35% -0.07 -0.76% -0.11 0.45% 0.06
1.00 -0.73% -0.01 11.33% 0.11 -0.76% -0.01 18.77% 0.19
3.00 -0.73% -0.02 3.15% 0.09 -0.76% -0.02 5.62% 0.17
5.00 -0.73% -0.04 1.51% 0.08 -0.76% -0.04 2.98% 0.15
10.00 -0.73% -0.07 0.28% 0.03 -0.76% -0.08 1.01% 0.10
15.00 -0.73% -0.11 -0.13% -0.02 -0.76% -0.11 0.35% 0.05
20.00 -0.73% -0.15 -0.33% -0.07 -0.76% -0.15 0.02% 0.00
25.00 -0.73% -0.18 -0.46% -0.12 -0.76% -0.19 -0.17% -0.04
30.00 -0.73% -0.22 -0.54% -0.16 -0.76% -0.23 -0.31% -0.09
50.00 -0.73% -0.37 -0.70% -0.35 -0.76% -0.38 -0.57% -0.29
Source: Author