Abstract
Abstract : Credit card reform has been canvassed in Europe, the US and in Australia. The Reserve Bank of Australia (RBA) is in the process of implementing wide-ranging reforms to credit cards aimed at increasing entry, allowing merchants to surcharge for card payments and regulating the interchange fee – the payment made between financial institutions when settling card payments. In this paper, we develop a simple model of payment systems designed to analyse the impact of the RBA reforms. We build on the main assumptions used by the RBA and show that some of their concerns about excessive card use are justified. Allowing merchants to surcharge may eliminate much of the concern over the interchange fee. At the same time, increased competition between card association members need not lead to either improved transactions efficiency or lower interchange fees as claimed by the RBA. The socially optimal interchange fee depends on the nature of customer and merchant card fees, and on both issuer and acquirer costs. The RBA’s regulated interchange fee only considers issuer costs and is only optimal in highly specialized circumstances.
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