Credit Card Payment Services: Regulations for Annual Fees, Merchant Discounts and Interchange Fees

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1 Credit Card Payment Services: Regulations for Annual Fees, Merchant Discounts and Interchange Fees G. Gülsün Akın, Ahmet Faruk Aysan, Gültekin Göllü, Levent Yıldıran

2 Turkish Credit Card Market 2 nd biggest in Europe after the UK: Cards: 15m in 2002, 47m in 2010 Transaction volume: 24b TL in 2002, 234b in 2010 Till 2006, no annual fees, but very high interest rates 130% APR, while inflation was 10% 25 issuers, six controlled 80% of the market, 15-25% of profits High incidence of delinquency, default, foreclosures Very strong anti-credit-card public sentiment Market failures: Ausubel (1991), Calem et al.(2006), Akın et al. (2011) Credit Cards Law in March 2006: Interest rates, minimum amount payable, interest fee calculation method, limits, contracts, solicitations, etc.

incidence of delinquency, default, foreclosures Very strong anti-credit-card public sentiment Market failures: Ausubel (1991), Calem et al.

3 Banks started to collect annual fees from cardholders in 2006 A strong reaction by consumers and consumer unions Claim: After fall in their interest income, banks reprised their services and exercised excessive market power in payment services market. Hence, annual fees should be banned. Lawsuits, counter lawsuits, Supreme Court of Appeal BDDK, Ministry of Industry and Commerce, Consumer Protection Law Objective: Do annual fees and merchant discounts collected by banks suggest excessive market power? Are further price regulations needed? Data: CBRT, BDDK, BAT, all nonparticipation banks (20), , 383 observations Panzar-Rosse (1987) method

Lawsuits, counter lawsuits, Supreme Court of Appeal BDDK, Ministry of Industry and Commerce, Consumer Protection Law Objective: Do annual fees and merchant

4 Revenues from credit cards Total revenue Interest revenue Noninterest revenue Average prices of credit and payment services 0,1 0,08 0,06 0,04 0,02 0 Mean of normalized IR Mean of normalized NIR

5 Background Credit Instrument: Anytime, no application, uncollateralized, within limits Contractual rate if payment >= minimum amount Overdue rate if payment < minimum amount Payment Instrument: Convenience, safety, record keeping facility Merchants: Boosted sales Cardholders: Interest-free grace period, benefits(bonus points, travel miles/insurance, rewards, discounts), reservations, internet shopping, installments, etc. 70% of cardholders only use payment services Cardholder Good or service Merchant Price + Annual fee Merchant discount Issuer Interchange fee Price Price Acquirer

grace period, benefits(bonus points, travel miles/insurance, rewards, discounts), reservations, internet shopping, installments, etc.

6 The cost of providing payment services to be borne by cardholders and merchants Investments in technological infrastructure Funding cost during grace period Personnel expenses Other operating expenses Two-sided markets: Platform services for both cardholders and merchants To remain on board Benefits for merchants>= merchant discounts Benefits for cardholders>= annual fees Other complaints about payment service fees Interchange Fees: anticompetitive, collusively determined, must be regulated IF regulation in 2005 by TCA Merchant Discounts: Much higher than annual fees, asymmetric prices, they must be regulated as well. Optimal merchant discounts, annual fees? Very difficult, beyond the scope. Do annual fees and merchant discounts collected by banks suggest excessive power? Should annual fees and merchant discounts be regulated as well? Bolt et al. (2011) Annual fees depend on benefits from both credit and payment services Two-part pricing on the cardholders side: annual fees, interest rates Costs must be born by cardholders and merchants If interest rates are restricted, banks shift the burden to merchant discounts and/or annual fees

about payment service fees Interchange Fees: anticompetitive, collusively determined, must be regulated IF regulation in 2005 by TCA Merchant Discounts: Much higher than annual fees, asymmetric

7 Panzar-Rosse method From profit maximizing equilibrium conditions Ln (R it ) = α 0 + Σ f α f Ln (P f, it ) +Σ k β k X k, it +ε it From profit maximizing equilibrium conditions R it : revenue of firm i at time t P f : price of factor input f X k : control variable k ε it : error term The PR H-statistic: H = Σ f α f sum of the factor price elasticities of revenue H = 1 competitive market H 0 monopoly/collusive oligopoly 0 < H < 1 monopolistic/oligopolistic competition??? Long-run competitive equilibrium test (Shaffer 1982) Ln (ROA it ) = α 0 + Σ f α f Ln (P f, it ) +Σ k β k X k, it +ε it H ROA = Σ f α f H ROA = 0 long-run competitive equilibrium

sum of the factor price elasticities of revenue H = 1 competitive market H 0 monopoly/collusive oligopoly 0 < H < 1 monopolistic/oligopolistic competition?

8 Criticisms for PR Bikker et al. (2012) Scaling leads to misspecification Average cost curves Long-run equilibrium Shaffer and Spierdijk (2015) For oligopolistic markets H<0 and H>0 are possible Results for competitive case H=1 are robust

9 Variables Dependent variable: NIR (Noninterest revenue) CF (cost of funds): ratio of interest expenses on funding resources to all funding resources (resources: deposits, borrowings and money market takings) PK (price of physical capital): depreciation of fixed assets / fixed assets W (average wage): total personnel expenses / number of employees Other explanatory variables: Age, Advertisement expense, Tr (Trend) and TrS (Trend squared)

(price of physical capital): depreciation of fixed assets / fixed assets W (average wage): total personnel

10 Summary Statistics

11 Model NIR i,t = c i + α 1 CF i,t +α 2 W i,t +α 3 PK i,t + β 1 Tr t + β 2 TrS t +γ 1 IF reg +γ 2 (IF reg*cf) i,t +γ 3 (IF reg*w) i,t +γ 4 (IF reg *PK) i,t +δ 1 IR reg +δ 2 (IR reg*cf) i,t +δ 3 (IR reg*w) i,t +δ 4 (IR reg*pk) i,t + ξ i,t H = α 1 +α 2 +α 3 H IF = α 1 + α 2 +α 3 +γ 2 + γ 3 + γ 4 H IR = α 1 + α 2 +α 3 +γ 2 + γ 3 + γ 4 + δ 2 + δ 3 + δ 4

reg*cf) i,t +δ 3 (IR reg*w) i,t +δ 4 (IR reg*pk) i,t + ξ i,t H = α 1 +α 2 +α 3 H IF = α

12 Regression results (1)

13 Regression results (2)

14 Regression results (3)

16 Results Banks prices and revenues rose after the IR regulation But no evidence for excessive market power Revenues increased and H approached 1 after the IR regulation factor input prices must have risen in this period

Revenues increased and H approached 1 after the IR

17 April-June 2006-financial turmoil Interest rates in developed countries Capital outflows from emerging countries Polarization prior to 2007 elections Governor and MP committee appointed in April Reduction in policy rate 25bp Inflation exceeded the target rate by 3% 15% depreciation Increase in policy rate by 400bp and lending rate by 600bp These rates could not be lowered till the end of 2007

April Reduction in policy rate 25bp Inflation exceeded the target rate by 3% 15% depreciation

18 Conclusion Regulation should always be based on sound economic analysis After IR regulation banks prices and revenues rose, but no evidence for excessive market power We attribute the rise in banks prices to a rise in costs coinciding with IR regulation IR regulation restrained prices in credit services banks had to pass along increase in costs to prices in payment services Our results do not justify further price regulations in the payment services market Banning annual fees across the board Transfer from noncardholders or light users to heavy users A menu of services and fees consumers self-select

services banks had to pass along increase in costs to prices in payment services Our results do not justify further price regulations in the payment

The Role of Simultaneous Regulations of Credit Services and Payment Services on Competition

The Role of Simultaneous Regulations of Credit Services and Payment Services on Competition Abstract. In credit card markets, banks earn revenue from both credit services and payment services of credit