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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.

Suggested Citation

  • Gans Joshua S & King Stephen P., 2003. "Approaches to Regulating Interchange Fees in Payment Systems," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-21, June.
  • Handle: RePEc:bpj:rneart:v:2:y:2003:i:2:n:5
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    References listed on IDEAS

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    1. Jean-Charles Rochet & Jean Tirole, 2014. "Platform Competition in Two-Sided Markets," CPI Journal, Competition Policy International.
    2. Graeme Guthrie & Julian Wright, 2003. "Competing Payment Schemes," Departmental Working Papers wp0311, National University of Singapore, Department of Economics.
    3. Schmalensee, Richard, 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, Wiley Blackwell, vol. 50(2), pages 103-122, June.
    4. McAndrews, James J. & Rob, Rafael, 1996. "Shared ownership and pricing in a network switch," International Journal of Industrial Organization, Elsevier, pages 727-745.
    5. Sujit Chakravorti & William R. Emmons, 2001. "Who pays for credit cards?," Occasional Paper; Emerging Payments EPS-2001-1, Federal Reserve Bank of Chicago.
    6. Gans Joshua S & King Stephen P., 2003. "Approaches to Regulating Interchange Fees in Payment Systems," Review of Network Economics, De Gruyter, pages 1-21.
    7. Julian Wright, 2004. "The Determinants of Optimal Interchange Fees in Payment Systems," Journal of Industrial Economics, Wiley Blackwell, vol. 52(1), pages 1-26, March.
    8. Baxter, William F, 1983. "Bank Interchange of Transactional Paper: Legal and Economic Perspectives," Journal of Law and Economics, University of Chicago Press, vol. 26(3), pages 541-588, October.
    9. Joshua S. Gans & Stephen P. King, 2003. "A Theoretical Analysis of Credit Card Reform in Australia," The Economic Record, The Economic Society of Australia, vol. 79(247), pages 462-472, December.
    10. Katz, Michael L & Shapiro, Carl, 1986. "Technology Adoption in the Presence of Network Externalities," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 822-841, August.
    11. Gans Joshua S & King Stephen P, 2003. "The Neutrality of Interchange Fees in Payment Systems," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 3(1), pages 1-18, January.
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    Citations

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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, pages 1099-1125.
    2. Evans, David & Schmalensee, Richard, 2005. "The Economics of Interchange Fees and Their Regulation: An Overview," Working papers 18181, Massachusetts Institute of Technology (MIT), Sloan School of Management.
    3. ?zlem Bedre-Defolie & Emilio Calvano, 2013. "Pricing Payment Cards," American Economic Journal: Microeconomics, American Economic Association, vol. 5(3), pages 206-231, August.
    4. Snellman, Heli, 2006. "Automated teller machine network market structure and cash usage," Scientific Monographs, Bank of Finland, number 2006_038, November.
    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. 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.
    8. Nicholas Economides & William N. Hebert, 2007. "Patents and Antitrust: Application to Adjacent Markets," Working Papers 07-07, NET Institute, revised Aug 2007.
    9. 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.
    10. Nicholas Economides, 2007. "Nonbanks in the payments system: vertical integration issues," Proceedings – Payments System Research Conferences, Federal Reserve Bank of Kansas City.

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