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Approaches to Regulating Interchange Fees in Payment Systems

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  • Gans Joshua S
  • King Stephen P.

Abstract

Significant attention worldwide has been paid to the regulation of credit card interchange fees. In part, this attention has followed concerns expressed about the level of these fees in Europe, the U.S. and Australia. The Reserve Bank of Australia recently conducted an extensive inquiry into the interchange fees associated with credit cards and has moved to regulate those fees. At the same time, research economists have considered determinants of the socially optimal interchange fee. In this paper, we use the Australian experience to highlight alternative methods of regulating interchange fees in payments systems. We use a simple model to derive a socially optimal interchange fee when merchants cannot freely set different prices for different payment instruments. We compare the socially optimal interchange fee from this model with those presented in the economics literature and show that most analyses capture a simple externality within the optimal fee. Credit card usage for a specific transaction is determined by the customer. But the customer does not bear the costs or receive the benefits that card usage imposes on the merchant. The optimal interchange fee internalises this externality. We then compare the theoretical optimal interchange fee with the approaches proposed in Australia, and show that the regulatory approach adopted by the Reserve Bank of Australia may be viewed as economically conservative in certain situations. Finally, we consider additional issues that will impinge on the regulation of interchange fees.

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File URL: http://www.degruyter.com/view/j/rne.2003.2.2/rne.2003.2.2.1022/rne.2003.2.2.1022.xml?format=INT
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Bibliographic Info

Article provided by De Gruyter in its journal Review of Network Economics.

Volume (Year): 2 (2003)
Issue (Month): 2 (June)
Pages: 1-21

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Handle: RePEc:bpj:rneart:v:2:y:2003:i:2:n:5

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Web page: http://www.degruyter.com

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Cited by:
  1. Fabio M. Manenti & Ernesto Somma, 2011. "Plastic Clashes: Competition Among Closed And Open Payment Systems," Manchester School, University of Manchester, vol. 79(6), pages 1099-1125, December.
  2. David S. Evans & Richard Schmalensee, 2005. "The economics of interchange fees and their regulation : an overview," Proceedings – Payments System Research Conferences, Federal Reserve Bank of Kansas City, issue May, pages 73-120.
  3. Özlem Bedre-Defolie & Emilio Calvano, 2010. "Pricing Payment Cards," ESMT Research Working Papers ESMT-10-005, ESMT European School of Management and Technology.
  4. Nicholas Economides, 2007. "Nonbanks in the Payments System: Vertical Integration Issues," Working Papers 07-06, NET Institute.
  5. Hunt Robert M., 2003. "An Introduction to the Economics of Payment Card Networks," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-17, June.
  6. Chakravorti, Sujit & To, Ted, 2007. "A theory of credit cards," International Journal of Industrial Organization, Elsevier, vol. 25(3), pages 583-595, June.
  7. Rochet Jean-Charles, 2003. "The Theory of Interchange Fees: A Synthesis of Recent Contributions," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-28, June.

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