CREDIT CARD ISSUERS AND ACQUIRERS NEW ENTRANTS WHAT EFFECT HAVE THE NEW AUTHORISATION STANDARDS AND GUIDELINES HAD SO FAR?

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1 CREDIT CARD ISSUERS AND ACQUIRERS NEW ENTRANTS WHAT EFFECT HAVE THE NEW AUTHORISATION STANDARDS AND GUIDELINES HAD SO FAR? GREG BRUNNER General Manager, Policy Development Australian Prudential Regulation Authority Presentation to the 9 th Annual Cards Australia Conference 2004 Thursday, 5 August 2004 Credit card issuers and acquirers Greg Brunner 1

2 Introduction It is not my intention today to go into the details of the Reserve Bank s credit card reform initiatives. APRA has been playing a relatively small but nonetheless important part in this reform process by opening the way for the entry of specialist credit card issuers and acquirers. The Reserve Bank saw the need for an access regime which provides that any authorised deposit-taking institution (ADI) in Australia, including the new class of specialist credit card institutions, is eligible to apply to participate in the designated credit card schemes in Australia. The purpose of the access regime is to ensure that any restrictions imposed on participation in the card scheme do not inhibit competition any more than is necessary to protect the financial safety of the scheme. The access regime requires that there should be no discrimination between specialist credit card institutions (SCCIs) as a class and other authorised deposit taking institutions as a class in relation to any criteria applied in assessing applications for participation or in relation to the rights and obligations of participant in the schemes in Australia. The access regime also requires the removal of certain restrictions and penalties on the credit card acquiring activity of scheme members. In accepting that a new class of ADI could be created to encourage competition, APRA has been keen to ensure that the high standards that are expected of ADIs will be maintained. To this end we have developed a set of authorisation guidelines for SCCIs and a new prudential standard on risk management of credit card activities of ADIs. The new standard came into force on 1 August 2003 and applies to all ADI credit card operations. The main features of the SCCI regime are: To give APRA the power to regulate SCCIs under the Banking Act, a regulation has been made under the definition of "banking business" of the Banking Act to prescribe credit card issuing and acquiring activities in four-party credit card schemes (Bankcard, Visa and MasterCard) as constituting banking business. As a result, any entity wishing to undertake the "banking business" of issuing credit cards and/or acquiring credit card transactions as a participant or member in these schemes, whether in conjunction with other banking business (i.e. as ordinary ADIs) or in the form of a pure credit card operation (i.e. as SCCIs), must obtain an ADI authority from APRA. As ADIs, SCCIs will be subject to the requirements of the Banking Act (and any other Acts applicable to ADIs such as the Financial Sector (Shareholdings) Act 1998 and the Financial Sector (Transfers of Business) Act 1999) and APRA s ongoing supervision. SCCIs will be authorised as a special class of ADIs. Conditions will be imposed on the authority of SCCIs restricting activities of these specialist institutions (and their subsidiaries). SCCIs, which may Credit card issuers and acquirers Greg Brunner 2

3 operate either as locally incorporated entities or as branches of foreign credit card banks, will be generally limited to engaging in credit card operations (issuing and/or acquiring). In particular, SCCIs will be prohibited from taking deposits other than holding incidental credit balances in cardholders accounts (e.g. prepayments or refunds) that arise in the normal course of the credit card operations. The Authorisation Guidelines for SCCIs adapt the existing ADI guidelines. In most cases, the authorisation criteria for SCCIs will be the same as for ADIs. Initial capital requirements for SCCIs will be assessed on a case-by-case basis depending on the nature (issuing or acquiring or both) and volume of the anticipated business. As ADIs, SCCIs are subject to the same prudential requirements in respect of capital adequacy, board composition, fitness and propriety of directors and senior management, liquidity, credit quality, asset securitisation, large exposures, associations with related entities, outsourcing, external and internal audit arrangements and risk management systems as set out in the relevant ADI Prudential Standards. Given their specialised nature that may result in a concentration of certain types of risks, it is proposed that SCCIs be subject to a higher minimum capital ratio of 15 per cent. As ADIs, SCCIs are subject to the Financial Sector (Collection of Data) Act Accordingly, all the existing ADI reporting standards (including their corresponding reporting forms) will apply to SCCIs (ADI reporting standards and the relevant reporting forms are available on the APRA website). Since SCCIs will be authorised to engage only in credit card issuing and/or acquiring business, some of these reporting requirements (which intend to capture the full range of banking activities of ordinary ADIs) would not be relevant to SCCIs. APRA will exempt SCCIs from returns that are considered irrelevant to SCCIs given their limited business activities. In due course, further consideration will be given to collecting additional data on the acquiring or issuing businesses As ADIs under the Banking Act, SCCIs are subject to the Financial Institutions Supervisory Levies Collection Act 1998 and the Authorised Deposit-taking Institutions Supervisory Levy Imposition Act Since SCCIs will be restricted to undertake only credit card issuing and/or acquiring business, the supervisory effort required for these specialist institutions will be less than that for other ADIs that undertake the full range of banking activities. To reflect this, a lower levy amount is imposed on SCCIs on the same basis as foreign bank branches. These levies are determined by the Minister for Revenue and Assistant Treasurer. Since the SCCI regime is intended to facilitate non-financial (commercial) corporations to establish wholly owned SCCI subsidiaries, we will exempt SCCIs from some of the requirements of Credit card issuers and acquirers Greg Brunner 3

4 APRA s conglomerate policy (e.g. NOHC structure and consolidated supervision at parent company level) where they are the only ADI in a non-financial or commercial group, recognising the lower risks in their non-deposit taking function. Impact on the Market The question being posed by many is whether the new authorisation standards have encourage any new entrants. The simple answer is that nobody has been authorised so far. I obviously cannot talk about specific applicants. However, we do have a number of applications in the pipeline. At least one of these will formalise the position of an entity with an existing operation. More importantly there are a number of applications from what might be described as non-traditional players - exactly the type of entrant that the new framework was expected to encourage. Some might suggest that the fact that there are no new entrants a year after the new regime was put in place suggests that it has been a failure! I do not accept this proposition. It seems to us that some potential applicants had been waiting for the finalisation of the access regime which did not occur until late-february this year. I would also observe that a number of potential applicants seem to have some exciting concepts but they have been slow to convert these to more tangible proposals. Some of the potential applicants are not familiar with the processes involved in becoming a prudentially regulated entity. There has also been some uncertainty about the how the new regime would deal with debit card acquiring. Key Issues: This latter point is an important one. Many potential entrants to the acquiring field appear to have come to the conclusion that a business case can only be made if they get involved in both credit and debit card acquiring. The APRA guidelines only refer to credit card issuing and acquiring. This would seem to suggest that entities are not allowed to undertake debit card acquiring business. This is not the case. APRA has no specific authority to authorise debit card acquiring business and does not object to it being undertaken within the SCCI vehicle. However, just as we do with other ADIs, we expect that the debit card acquiring business would form part of the consolidated activities of the SCCI for capital adequacy purposes, and be covered by the risk management policies of the SCCI. Another key issue facing potential SCCI applicants is their ability to gain access to the credit card schemes. This appears to be a chicken and egg dilemma. The various scheme rules appear only to provide access to entities which are prudentially regulated. On the other hand, APRA is unable to complete it assessment of an SCCI application until it is satisfied that it will be able to interface appropriately with the scheme. APRA is particularly concerned with any operational risks which may arise in the relationship between the applicant and the scheme. APRA has had Credit card issuers and acquirers Greg Brunner 4

5 discussions with some scheme operators but these have not yet resulted in agreed authorisation procedures. Our preference is for scheme operators to begin a dialogue with applicants at an early stage. In some circles disquiet has been expressed that some other issues still need to be addressed to encourage desirable reform outcomes. One concerns the fact that our guidelines do not make a distinction between the levels of risk associated with acquiring versus issuing, and the distinction that arises between general acquiring and self acquiring. In developing its policy, APRA did in fact consider these differences. In some ways the balance sheet of a credit card issuer will more resemble that of a typical bank, comprising credit card loans and liquid assets for settling payments to acquirers in relation to their cardholders credit card transactions. The fact that there are substantial risk-weighted assets will generate a capital requirement which is appropriate given the risks involved in the business. On the other hand, an acquirer may not have substantial risk-weighted assets. Its assets will comprise mainly receivables from the card schemes, cash and liquid assets. These will generate a considerably lower capital charge for the pure acquirer. The question we asked ourselves when we were developing the framework was not whether pure acquirers were being treated too harshly, but rather whether they were being treated too leniently. Given that one of an acquirers main risks are exposures to potential merchant charge-backs we examined whether these might be explicitly recognised in the capital calculation. We also looked ways of adding some other form of specific transaction or operational risk charge. At the end of the day, we decided that all of these options were unnecessarily complicated and instead we settled on the minimum capital ratio of 15 per cent for all SCCIs. We do, however, require acquirers to establish policies and systems for managing potential chargeback exposure. We fully expect that these policies will recognise any differences arising from general as opposed to self acquiring, and any transactions involving goods subject to future delivery. End Piece APRA did not have any clear expectations about how reforms impacting the operation of credit card schemes in Australia might affect the market. Our recent experience is that a number of potential new entrants are now seriously considering entering the market. This is a positive sign. However we do not have a crystal ball, and are not in a position to forecast what impact these new entrants may have on the market. Credit card issuers and acquirers Greg Brunner 5

6 Greg Brunner Australian Prudential Regulation Authority 5 August 2004 Credit card issuers and acquirers Greg Brunner 6