Korea s Credit Card System: Issues & Potential Measures

Transcription

1 Finance VIP Series Vision, Insight and Policy Korea s Credit Card System: Issues & Potential Measures Jae-Youn Lee January 2011

2 Author Jae-Youn Lee Senior Research Fellow

3 Ⅰ. Issues Summary 02 Ⅰ. Introduction 05 Ⅱ. Comparison of Credit Card Systems Types of Credit Card Systems 2. US Credit Card System 3. Credit Card Systems of Other Countries Ⅲ. Korea s Credit Card Industry Credit Card Market Structure 2. Characteristics of Korea s Credit Card Industry 3. Problems with the Transaction Scheme for Korean Credit Cards Ⅳ. Potential Measures for Improvement Mandating a Merchant Member Pool System 2. Limits on Merchant Fees 3. Promoting Debit Cards 01

4 Korea s Credit Card System: Issues & Potential Measures Korea s credit card industry contains both 3-party and 4-party schemes, but unlike most countries, the share of 3-party schemes centered on independent card companies is markedly higher. In a 3-party scheme, the card companies performing both member services such as card issuance, and acquiring transaction from merchants, while in a 4-party scheme these are separated. BC Card is the only company to have adopted a type of 4-party scheme in Korea, performing acquiring business for 11 member card companies, but unlike a typical 4-party scheme, it does not determine merchant fees, and only collects an agency fee from member banks. The dominance of the 3-party scheme presents the following challenges. Individual credit card companies recruit card user members and issue cards, while each card company must recruit merchant members separately, which entails high costs for recruitment and management, making it hard for new card companies to enter. Merchants are only able to ask acquiring transactions to the relevant credit card company, so they have low bargaining power in the determining of the merchant fees that can be called the cost of processing credit card transactions. 02

5 Summary Merchants must enter into contracts with all credit card companies to prevent card user members using credit cards from going elsewhere, which produces management-related costs and complications. Since card companies hold the power to determine merchant fees, they compete by using this to offer excessive beneficial services for card user members. It will not be easy to switch to a 4-party scheme, but mandating a merchant member pool system should alleviate the problems under the 3-party scheme. Allowing card companies to use other companies merchants as a pool will alleviate the problems of redundant contracts with merchants. When using a credit card at a non-affiliated merchant member, the joint interchange fee can be calculated appropriately and imposed on merchants. It is necessary to stimulate the use of a merchant member pool system by lowering inconveniences such as time lags when disbursing payment for non-contracted merchant members. With merchants obligated to join and accept credit card payment, limits on fees would be the most effective and direct means of tempering dissatisfaction among smaller merchant members about fee levels. 03

6 Korea s Credit Card System: Issues & Potential Measures If such limits are established, most fees would be determined to match these limits, so establishing an average fee limit instead of a fee cap may be considered. It s been pointed out that, if merchant fees are capped, this sets a precedent of the government interfering with the market pricing mechanism, but given the mandatory merchant participation, some government intervention is needed. In Korea, credit cards are used far more than debit cards, which has brought about overconsumption and credit delinquency, so debit cards need to be promoted. Considering that debit card use is markedly lower than credit cards, the income deductions for both need to be readjusted in addition to other measures to stimulate debit card usage. 04

7 Ⅰ. Introduction Ⅰ. Introduction Korea s credit card market (including debit cards) took off following the 1998 currency crisis, buoyed by government policies designed to spur consumption and make taxable income more transparent. The government introduced income deductions to individuals for credit card use, and required merchants to become credit card merchant members and accept card payments (Regulation on Supervisor of Specialized Credit Financial Business, Article 19, Clause 1). The result was that credit card usage (goods and services purchases) has grown seven-fold between end-1999 (43 trillion won) and end-2009 (290 trillion won). However, while growth and competition in the credit card market led to an expansion in benefits for card user members, the costs of these benefits have been excessively passed on to merchant members, sparking complaints especially from small merchants. Korea s credit card market features eight network companies (brands), more than other countries, which compete by offering discount charges or interest-free financing plans to attract card members. * In most countries, there are four network companies, i.e. Visa, MasterCard, Amex, and Diners. 05

8 Korea s Credit Card System: Issues & Potential Measures In Korea s credit card system, card companies conduct both card issuance and acquiring transactions, for which they directly set both fees for user members and merchant members. With merchants mandated to accept card payments, an excessive cost burden has become passed on to them. This paper shall examine the issues facing the Korean credit card market by comparing different types of credit card systems to explore measures for resolving the persistent dissatisfaction among merchant members, despite merchant fees being lowered multiple times since

9 Ⅱ. Comparison of Credit Card Systems Ⅱ. Comparison of Credit Card Systems 1. Types of Credit Card Systems Credit cards have become widely used around the world as the main payment instrument that allows for purchasing goods and services without cash. In a credit card system, when card user members purchase goods or services from card merchant members, the card company settles payment (after deducting the merchant fee), then collects payment from the card user members on the settlement date. Card companies offer this system to card user members and merchant members, while they impose annual fees on user members and merchant fees based on sales for merchants. Credit card systems consist of a 3- or 4-party scheme depending on whether the same company handles card issuance and acquiring transactions. The 3-party scheme involves card user members, merchant members, and card companies in credit card transactions. Credit card companies recruit card user members and merchant members to build a card network, and conduct card issuance and acquiring transactions from merchants. Card companies not only collect member fees and monthly payment from card users, but also settle payment by deducting industry-specific commissions. 07

10 Korea s Credit Card System: Issues & Potential Measures Card companies selecting a 3-party scheme include Amex (American Express) and Diners Club, and all Korean card companies except for BC Card. * In the US, some large banks have issued Amex cards since 2004, weakening the nature of the 3-party scheme. <Figure 1> Settlement Flow Chart in a 3-Party Scheme Three-party scheme Cardholder Payment Product/service Merchant Invoicing Payment Card scheme/franchisor Setting the rules for the interchange, rules and regulations between the different franchisees License fee Servicefee Settlement of funds Franchisee/ Issuer & Acquirer In contrast, in the 4-party scheme that predominates in most countries, credit card transactions consists of card user members, merchant members, card issuers, acquirers, and card network company. Credit card network companies such as Visa and MasterCard provide a network for issuers, who issue cards to members, and acquirers, who acquire card transaction from merchants. Card issuers take part in the network by offering user member management services, such as recruiting user members and 08

11 Ⅱ. Comparison of Credit Card Systems issuing cards (account opening), billing and collecting payment, and loan services. Acquirers offer merchant member management services such as recruiting merchants and entering into contracts to be able to process card transactions normally, and forwarding payment to merchants for card transactions received from issuers. When card user members purchase goods or services by credit card at merchants, the issuer collects payment from the user member on the settlement day and settles the deducted interchange fee with the acquirer. Then the acquirer dispenses the additional commission-deducted payment to the merchant. <Figure 2> Settlement Flow Chart in a 4-party scheme Four-party scheme Cardholder Card Payment Service/Product Merchant Invoice Payment Card schemes Setting the rules to applied within the Network. Acting as switch and router between the issuer and acquirer Servicefee Settlement of funds Issuer Interchange fee Settlement of funds Acquirer Legend: Electronic information Monetary funds In the 4-party scheme, the interchange fee refers to the share of the merchant fees that belongs to the issuer, and is set by network companies such as Visa and MasterCard. 09

12 Korea s Credit Card System: Issues & Potential Measures The interchange fee is the fee paid by the acquirer (merchant bank), which acquires the transaction from the merchant, to the issuer of the card that was used by the customer, and is the most important element of merchant fees. The higher the interchange fee, the better for the issuer and the lower the costs for the card user member or the more beneficial services are able to be offered. Conversely, the lower the interchange fee, the better for the acquirer and the less burden for the merchant members, allowing it to keep fees low. Visa and MasterCard set the interchange fees to be able to spread the costs between card user members and merchant members in a balanced way. In a two-sided market like the credit card market, the card company (the network company) must set the price by spreading the costs of providing the service appropriately between parties so that transactions between card user members and merchant members can be maximized. If card companies impose high fees exceeding expected gains on the purchaser for card usage, then card user members will leave, and the same is the case for the merchant members, which will reduce revenues from card usage, ending up eroding card companies returns. Therefore, 3-party scheme card companies and 4-party scheme network companies consider both markets and try to maximize returns by setting a balanced price that can consistently produce the highest amount of transactions. 010

13 Ⅱ. Comparison of Credit Card Systems 2. US Credit Card System 1) Credit Card System Credit cards began in the US as two-party cards that would allow creditworthy customers to use at individual companies only. To get rid of the inconvenience at hotels, department stores, gas stations and restaurants, etc. of having to carry around large amounts of cash, store cards began to be used in the US from the early 20th century. Credit cards used at multiple merchants appeared from the 1950s with the creation of the Diners Club card, and Amex. After that, Visa, MasterCard, and Discover cards also became used. The Diners card (1950) and the Amex card (1958) were issued with the main purpose of use at hotels, restaurants, travel companies, and selected stores, and had the 3-party scheme in which the issuer and the acquirer belong to the same entity. Visa and MasterCard began in the late 1950s centered on banks. For small banks, it was hard to invest the massive amounts to build a network between merchants and cardholders, so they agreed to licensing contracts and took the form of a 4-party scheme separating the issuing bank and the merchant bank. Today, the US credit card system comprises four card network companies (brands), around 6,000 issuers, around 8,000 acquirers, and multiple third-party processors. 011

14 Korea s Credit Card System: Issues & Potential Measures Issuers are mostly banks, which issue credit cards to customers, while acquirers consist of both banks and specialized acquirers, and acquire transaction from the merchant members. Since it is hard for the acquirer to manage the tens of thousands of merchant members, they pay a fee and entrust this to processors (similar to the VAN (value-added network) companies in Korea). There are two forms of processors: one serves issuers by conducting user member s credit management, card issuance and user risk management, etc., and the other serves acquirers by approving transactions and making deposits for merchant members. 2) Credit Card Market Structure There are four major US credit card brands, namely Visa, Master Card, Amex, and Discover, with Visa having the highest market share. In 2008 in the US, goods and services purchased using commercial or consumer credit cards and debit cards totaled trillion USD. * Unlike with credit cards, when purchasing goods and services with debit cards, payment is immediately deducted from the customer s account. Among consumer cards, market share was as follows: Visa, 56.60% (1 trillion billion USD); MasterCard, 29.11% ( billion USD); Amex, 10.13% ( billion USD); Discover, 4.16% ( billion USD). 012

15 Ⅱ. Comparison of Credit Card Systems Among commercial cards, market share was as follows: Visa, 39.78% (225.5 billion USD); Amex, 37.34% ( billion USD); MasterCard, 22.51% ( billion USD); Discover, 0.37% (2.12 billion USD). Both 3-party and 4-party schemes exist in the US, though the latter is far more prevalent. Amex and Discover have adopted a 3-party scheme, while Visa and MasterCard adopted a 4-party scheme. Among consumer cards, the share of 3-party scheme cards like Amex and Discover was 14.29%, while those of 4-party scheme cards like Visa and MasterCard was 85.71%; however, for commercial cards, the respective shares were 37.71% and 62.29%. <Figure 3> Market Share by Credit Card Brand consumer card commercial card Discover 4.2% Discover 0.4% Amex 10.1% Master Card 29.1% Visa 56.6% Amex 37.3% Visa 39.8% Master Card 22.5% Source: Nilson Report, Sep

16 Korea s Credit Card System: Issues & Potential Measures On the other hand, for the overall issuance market, combining credit cards, debit cards, and prepaid cards, the concentration ratio (CR4) of the above 4 companies was 49.7% for all payments to merchants (3 trillion billion USD). Payment cards such as Visa, MasterCard etc. issued by JPMorgan Chase spent billion USD at the merchant members and took the highest share of total payment card receipts at 14.5%. Bank of America was next at billion USD. The reason the US credit card market is oligopolistic is that the initial investment in the credit card industry is very high, so economies of scale exist. The greater the number of card user members and merchant members, the larger the economies of scale and network effects there are in the credit card industry. <Figure 4> Market Share of Spending at Merchants by US Payment Cards (2008) Chase 14.5% the rest 35.0% $3.285 Tril. BofA 14.1% Discover 2.8% CapOne 3.0% U.S.Bank 3.1% Wells 6.4% Citi 7.2% Amex 13.9% Source: Nilson Report, July

17 Ⅱ. Comparison of Credit Card Systems 3. Credit Card Systems of Other Countries European countries such as Germany, France, and Switzerland made their own Eurocard credit card system from 1965, but this merged with MasterCard International in Eurocard was created in 1964 by Swedish bankers to stand up to the Amex card, and was developed in 1965 as a federation of European banks, called Eurocard International NV. In 1968, Eurocard International entered into a strategic alliance with MasterCard International to accept each others cards and became used internationally, and acquired the sole license to be able to issue MasterCards in Europe. In 1992, the credit card company Eurocard International merged with the direct payment company Eurocheque International, and Europay International was founded. In 2002, Europay International and MasterCard International merged, founding MasterCard Worldwide, and its name was subsequently changed to MasterCard Europe. In Australia, the 9 large banks jointly issued the country s first mass-market credit card, called Bankcard, in 1974, though this was discontinued in Bankcard was a joint brand credit card issued in Australia between 1974 and 2006, expanding to New Zealand from 1984, and securing as many as 5 million card members. However, in 1984, as Bankcard member banks launched Visa and MasterCard products, Bankcard usage fell, and issuance was discontinued in

18 Korea s Credit Card System: Issues & Potential Measures In Spain, local banks developed a credit card network jointly. Banco de Bilbao introduced its BankAmericard (now Visa card) in 1971, helping make credit cards widely available. Spain s top credit card network, ServiRed, was established as an independent entity by 29 financial institutions in 1979, and is jointly owned as of end 2009 by some 102 financial institutions (banks, savings banks, credit unions), and are used internationally through joint brands with Visa and MasterCard. * Number of cards issued: million(21 million credit cards, 19.3 million debit cards); number of merchant members: 724,000. Sistems 4B was founded in 1974 by Banco Santander and two other Spanish banks, and has 11 banks as shareholders as of 2010, as well as 9 financial institutions including ING Direct as members. * Number of cards issued: 20 million(includes credit and debit cards); number of merchant members: 460,000. Euro 6000 was founded by savings banks as a credit card network, with 35 member savings banks as of end

19 Ⅱ. Comparison of Credit Card Systems <Table 1> Credit Card Usage in Major Countries Asia-Pacific Americas Europe Country Australia Canada US Mexico EU UK Denmark Spain Market Share 1) 2.2% 23% 23% 10% not applicable 15% 1% 14% 4-party cards Bankcard MC, Visa MC, Visa MC, Visa MC, Visa MC Visa MC, Visa MC, Visa MC, Visa 3-party cards Amex Diners JCB Amex Diners Amex Diners Discover JCB Amex Amex Diners JCB Amex Diners Amex Diners JCB Note: Share among non-cash transactions. Source: Weiner, Stuart E. and Julian Wright, Interchange Fees in Various Countries: Developments and Determinants, Review of Network Economics Vol.4 No.4, December

20 Korea s Credit Card System: Issues & Potential Measures Ⅲ. Korea s Credit Card Industry 1. Credit Card Market Structure Credit cards in Korea began to be introduced in 1969 in the form of department store cards, while credit cards able to be used at other merchants were introduced by banks from Store cards were two-party cards only for use at the given business, and after being issued in 1969 by Shinsegae Department Store, were offered in 1974 by Midopa Department Store, and in 1979 by Lotte Department Store. Credit cards able to be used at other merchants were first issued in 1978 by Korea Exchange Bank as Visa cards, then Kookmin Bank issued KB cards in 1980, and 5 commercial banks jointly established BC Card in Corporate groups such as Samsung and LG managed to enter the card industry through acquiring existing companies, in spite of government guidelines against the establishment of new card companies by such groups. Korea s credit card market consists of 8 credit card networks and 21 card companies including card issuing banks, with the share of the top 4 at 56.4% (end March 2009). The 8 networks (brands) are Kookmin, Korea Exchange Bank, Samsung, Shinhan, Hyundai, Lotte, Hana SK, and BC. Credit card issuing companies are divided into independent card companies and card issuing banks. 018

21 Ⅲ. Korea s Credit Card Industry Independent cards are 7 cards including 3 cards, issued by non-banks - Samsung, Hyundai and Lotte- 3 cards issued by the banks Shinhan, Hana SK, BC, and 1 card issued by KDB Capital. There are 14 cards issued by banks, which mostly were independent card companies until the 2003 credit card crisis and merged with parent banks in the process of clearing up defaults. Recently Hana Bank established an independent credit card company with a separate credit card business, and KB and NACCP are considering it too. * Independent card companies merged with parent banks, such as KB Card (September 2003), KEB Card (February 2004) and Woori Card (March 2004). LG Card combined with Shinhan Card (October 2007). <Figure 5> Market Share of Card Company BC 0.1 KDB Capital 0.1 Lotte 6.3 Kookmin 15.8 Hyundai 9.8 Hana 6.8 independent card company (47.1%) Shinhan 20.2 Samsung 10.6 Woori 6.8 NACCP 6.7 IBK 5.6 card issuing bank (52.9%) etc. 6.6 City 3.1 SC First Bank

22 Korea s Credit Card System: Issues & Potential Measures Payment card settlements as a share of private consumption (goods and services purchases) was just 15.5% in 1999, but with policies to stimulate credit card use, this figure rose sharply, and was 51.4% as of end Korea s credit card usage as a share of GDP was 44.5% as of end 2008, sharply higher than other countries such as the US (14.9%) and Canada (18.3%), but the same figure for direct payment and check card usage was just 2.6%, below that of the US (9.3%) and Canada (10.5%). <Table 2> Credit & Debit Card Use/Private Consumption (Unit: 100 billion won, %) Credit Cards (A) 1) , , , , , , ,524.1 Debit Cards (B) Private Consumption (C) , , , , , , , ,616.8 (A+B)/C Note: 1) Excludes cash service and corporate purchasing cards. Source: Bank of Korea. <Table 3> Credit & Debit Card Use/GDP (2008) Korea US UK Canada Germany Switzerland Japan Credit Cards (%) ) Debit Cards (%) Note: 1) 2007 data. Source: BIS, Bank of Korea. 020

23 Ⅲ. Korea s Credit Card Industry 2. Characteristics of Korea s Credit Card Industry In terms of the structural characteristics of Korea s credit card industry, while both 3-party and 4-party schemes exist, unlike most other countries, the former is far more prevalent. Most independent card companies, excepting BC Card, have adopted 3-party schemes, in which the issuing bank and merchant bank are the same entity. Conversely, BC Card is adopting a 4-party scheme by acquiring transactions from merchant members for member card companies, but the merchant fees are set by the issuing company itself and it only collects an agency fee. In Korea, Visa and MasterCard do not offer a credit card network like the 4-party scheme in other countries, and only provide such a network for use outside of Korea. Under the 3-party scheme of Korea, settlement agency services (VAN companies) approve card member transactions and acquire them. VAN companies offer terminals and VAN networks to recruit merchant members and provide credit card inquiry services, and calculate settlement data for card companies, charging a VAN fee. There are 13 VAN companies currently in operation, including KICC, KS Net, NICE, KOCES, KIS, KOVAN, KFTC, Smartro, CCK VAN, TCI, and KMPS. 021

24 Korea s Credit Card System: Issues & Potential Measures BC Card is separate from an independent card company, but generally it manages merchant members and performs acquiring services on behalf of member companies, adopting a 4-party scheme. BC Card s member banks perform member management, recruit merchant members, and manage delinquencies, with each member bank using all recruited merchants without paying fees, and BC Card does merchant management, and payment settlement, and collects an agency fee from member banks. BC Card has adopted a type of 4-party scheme, but individual issuers set merchant fees on their own, so there is a difference from the 4-party scheme of Visa or MasterCard. Currently, it has 11 members: IBK, Kookmin Bank (formerly Housing & Commercial Bank), NACCP, Shinhan Bank (formerly Chohung Bank), Woori Bank (formerly Hanbit Bank), SC Cheil Bank, Daegu Bank, Busan Bank, Kyongnam Bank, Hana Bank (formerly Chungchong Bank and Seoul Bank), Citibank (formerly Koram Bank). <Figure 6> BC Card s Card Settlement System Issuing Member Bank Transact. approval notice, computation of payment Request for approv, Notice of transact. BC Card Settlement Issuance, Payment charged Acquiring transaction, Merchant fee payment Acquiring contract w/merchant, payment upon deduction of merchant fee Cardholder Credit Card Transaction Merchant 022

25 Ⅲ. Korea s Credit Card Industry Korea s credit card industry is dominated by the 3-party scheme centered on independent card companies, and BC Card s 4-party scheme grew its share after the 1997 currency crisis, it has since gone back down. In 2000, before credit card usage was stimulated, 3-party schemes, which independent credit card companies such as Samsung Card adopted, occupied 99% of the market. But as credit card use expanded from 2001, banks sales expanded and the share of BC Card with its 4 party scheme shot up to 32.8%, reflecting expanded card business of banks. * BC Card s share is the combined share of its member companies. However, this share has gone down, excepting the 2003 credit card crisis, when bank credit card companies were merged with parent banks. With banks scheduled to spin off more credit card business, this share is expected to be cut into further. <Table 4> Share of Credit Sales by Credit Card Company (Unit: trillion won, %) Total Samsung Hyundai Lotte Bank Cards BC Note: Bank cards are specialized or joint bank cards that except BC Card member companies. 023

26 Korea s Credit Card System: Issues & Potential Measures 3. Problems with the Transaction Scheme for Korean Credit Cards 1) Problems with the Credit Card Market In Korea, a highly competitive market structure has formed to attract credit card user members. As of end March 2010, the 8 credit card networks and 21 issuers, and 4.5 cards per member of the economically active population mean that the credit card market is saturated. As a result, credit card companies including banks offer customers points, mileage, discount services, no-interest installment services and annual fee exemptions in order to entice them to use their cards. In the market structure that has formed, there is almost no need to compete for merchant members. Since government policy makes it effectively mandatory for merchants to be card members join and accept card payments, credit card companies have little need to compete for merchant members. Smaller merchant members have complained that, in such a market structure, credit card companies pass on most of the expenses for systems maintenance and marketing to the card user offering added members on to them by maintaining high merchant fees. While credit card companies should have to spread the related costs evenly to the card user and merchant members in order to expand their member and merchant network. 024

27 Ⅲ. Korea s Credit Card Industry Credit card companies argue that the various benefits offered to user members for card usage help expand merchant s sales, but with 4.5 cards for every member of the economically active population, it appears to be of more help in expanding use of their cards. Credit card companies have imposed the costs of providing such services to card user members on the merchant members, but this ultimately gets passed along to consumers, particularly non-card members, in the form of higher prices for goods and services. Card members receive points from card companies according to their usage, but the points that could not be used because the expiration date had passed reached 85.5 billion won in 2004, billion won in 2005, billion won in 2006, billion won in 2007, and billion won in Credit card companies hold greater bargaining power over prices with most smaller merchants, but low power with larger ones. In 2006, large supermarkets made up 16.5% of card companies transactions by number, and 13.6% by transaction amount, so are important to card companies for expanding their earnings. Further, new user members can be recruited through kiosks installed at such large marts, and credit card companies can expand credit card usage through offering services such as discounts for using credit cards. Large marts merchant fees are from 0.5%-1.5%, much lower than average fees (2.33% in 2006) because of competition 025

28 Korea s Credit Card System: Issues & Potential Measures among card companies, and lowers the capacity for card companies to bring down smaller merchants fees. In a credit card transaction, approval and acquiring have fixed unit costs, so if the merchant fees are set according to the expenses that arise, larger merchants with larger transactions may have lower fees. However, lower fees for large marts has widened the fee gap among merchants, and this has spurred resistance from smaller merchants. When setting fees to maintain their card networks, credit card companies must consider balance between both members and merchants, as well as smaller and larger merchants, but in a market structure where it s hard for merchants to opt out, this latter balance may be overlooked. Credit card companies must build a diverse merchant network for the convenience of card user members, and to do so, must reduce the fee gap for smaller merchants so that such merchants don t opt out. When merchants are dissatisfied with fee levels, they may cancel their contracts, but this is not a realistic option in Korea. 2) Pros and Cons of Korea s 3-Party Scheme Under the 3-party scheme, individual credit card companies recruit members and issue cards, but having to separately recruit merchants entails high expenses for merchant recruiting and management. 026

29 Ⅲ. Korea s Credit Card Industry Under the 3-party scheme, a single credit card company handles both issuance and acquiring services, so each card issuing financial company must separately recruit merchants and build its network. As of end 2009, each of 8 credit card network has agreed on merchant contracts with around 2.9 million merchants, and while 500,000 merchants close their doors annually, 500,000 new contracts are also agreed to. Conversely, under the 4-party scheme, credit card companies handle issuance and acquiring separately, so issuers can issue joint brand credit cards, and acquirers are able to jointly use recruited merchant members. As a result, it is very hard for new credit card companies to enter under the 3-party scheme, but easier under the 4-party scheme. Merchants are only able to ask for acquiring transactions to the relevant credit card company, so they have low bargaining power in the determining of the merchant fees that can be called the cost of processing credit card transactions. Merchants present the billing statement from card members goods purchases to the relevant credit card company and collect the sales price less the preset merchant fees. It is in reality obligatory for merchants to join and accept credit card payment, and since the relevant card companies can pay for the goods in place of the customer, these companies hold the power to determine the merchant fees. Conversely, under a 4-party scheme, merchants can choose the acquiring bank that acquires transaction, so it s possible to choose an acquirer that offers more advantageous terms. 027

30 Korea s Credit Card System: Issues & Potential Measures In addition, merchants must enter into contracts with all credit card companies to prevent customers using credit cards from going elsewhere, which produces management-related costs and complications. There are currently 21 credit card companies (6 independent card companies, 15 card issuing banks), but some card issuing banks are allied with larger ones for which they issue cards, so merchants must make contracts with 9 credit card companies (networks). Merchants receive payments from card user members into different accounts according to each card company s payment cycle, which makes it hard to manage payment. Conversely, under a 4-party scheme, the acquirer can acquire all transaction using various credit cards, which is much more convenient for the merchant members. <Table 5> Credit Card Companies in Korea Number Company Name Credit Card Company Bank subsidiary 4 BC, Shinhan, KDB Capital, Hana SK non-bank subsidiary 3 Samsung, Hyundai, Lotte KEB Card 1 KEB Card Issuing Bank KB Card and alliance 2 KB, NACCP (formerly KFLC) Shinhan Card and alliance BC Card Members 11 4 Shinhan, Cheju, Suhyup, Chonbuk, Kwangju IBK, KB, NACCP, SC First Bank, Hana, Woori, Daegu, Busan, Kyongnam, Citi Korea, Shinhan 028

31 Ⅲ. Korea s Credit Card Industry Since card companies hold the power to determine merchant fees, they compete by using this to offer excessive services for card user members. Since card companies can impose most of the transaction costs on merchants, they compete by trying to entice customers to use their cards through offering services such as points, mileage, discounts, and no-interest installment plans based on usage amount. Under the 4-party scheme, network companies like Visa and MasterCard set the interchange fees that determine merchant fees, so they can control to some extent the marketing expense of card issuers on behalf of customers. 029

32 Korea s Credit Card System: Issues & Potential Measures Ⅳ. Potential Measures for Improvement 1. Mandating a Merchant Member Pool System 1) Review Switching to a 4-Party Scheme Introducing a 4-party scheme by consolidating the eight card networks into one or two networks and switching existing card companies to issuers would be expected to be able to ease problems for merchant members. Merchant members would be able to seek out and transact with acquirers beneficial to them that apply low merchant fees. Since a small number of networks such as Visa and MasterCard would determine the interchange fees for card issuers, this would rein in the offering of excessive beneficial services to card user members. Further, if card network providers are consolidated, this will allow the costs of maintaining the card networks to be imposed to some extent on larger merchants, which may ease the fee gap between small and large merchants. However, each card company possesses around 2 million merchant members, so it won t be easy to have them give up their merchant members and switch to being issuers. If card companies are turned into issuers, this may save costs for recruiting and managing merchants, but part of the fees will have to be paid to acquirers and the networks, and proprietary marketing will be hard to conduct. 030

33 Ⅳ. Potential Measures for Improvement 2) Mandate a Merchant Member Pool System It will not be easy to switch to a 4-party scheme, but mandating a merchant member pool system should alleviate the problems under the 3-party scheme. Allowing card companies to use other companies merchant members will alleviate the problems of redundant contracts. When using a credit card at non-affiliated merchant members, the joint interchange fee can be calculated appropriately and imposed on merchant members. For the card companies, mandating a merchant member pool system can help improve bargaining power over large merchants. For large merchants, since they would have to accept all credit cards regardless of whether they are merchant member of them and the industry-specific interchange fee would be applied, card companies would be able to decline requests by large merchants for excessive lowering of merchant fees. However, currently, virtually all merchant members fear being put at a disadvantage and sign individual contracts with credit card companies, so there is almost no use of a compulsive merchant member pool system. Under the current merchant member pool system, acquiring transactions from affiliated merchant members would be handled electronically, with payment taking 1-3 days, but acquiring transactions from non-affiliated merchant members would be handled manually and this will have the disadvantage of taking 6 days or more to settle the payment. 031

34 Korea s Credit Card System: Issues & Potential Measures Therefore, it is necessary to stimulate use of the merchant member pool system by lowering inconveniences such as time lags when disbursing payment for non-contracted credit card receipts. The merchant member pool system may allow for the good points of the 4-party scheme under the current 3-party scheme. 2. Limits on Merchant Fees A measure to place upper limits on merchant fees has been discussed since early 2010 in the National Assembly. But card companies have announced they will lower merchant fees voluntarily. So this measure was not introduced. With constant complaints about merchant fees, the National Assembly established a Merchant Fee Investigative Committee, which mulled introducing a bill calling for ceilings upon a cost analysis. In response, card companies announced plans early this year to lower fees for small merchants (with sales under 96 million won) from the current % to %, and for merchant at traditional markets from % to %. However, if there are changes in merchant fees resulting from economic conditions such as rising interest rates or a jump in credit card defaults, complaints over fees could appear again. Even at present, smaller merchant members have complained that the current measure to lower fees has not gone far enough. 032

35 Ⅳ. Potential Measures for Improvement With merchants obligated to join and accept credit card payment, limits on fees would be the most effective and direct means of tempering dissatisfaction among smaller merchant members about fee levels. If such limits are established, most fees would be determined to match these limits, so establishing an average fee limit instead of a fee cap should be considered. * Australia limited average merchant fees in its 2005 credit card system reform. Card companies may differentiate fees by merchant type, and be able to manage it so the average fees don t exceed a set level. It s been pointed out that, if merchant fees are capped, this sets a precedent of the government interfering with the market pricing mechanism, but given the mandatory merchant participation, some government intervention is needed. 3. Promoting Debit Cards In Korea, credit cards are used far more than debit cards, which has brought about overconsumption and resulting credit delinquency, so debit cards need to be promoted. Credit cards offer convenience by allowing the customer to buy goods and services without immediate payment within a preset limit. 033

36 Korea s Credit Card System: Issues & Potential Measures Conversely, debit cards deduct payment upon usage from the purchaser s bank account within 2-3 days, and thus do not offer credit, and only offer convenience. Debit cards offer several benefits for card user members, merchant members and card companies, and have thus become used in many countries as the primary small-sum payment system. For customers, it prevents abuse by limiting usage to within their deposits, and can effect rational consumption habits, and may also be issued to minors or those with poor credit who would not be able to obtain credit cards. For card companies, there are no losses from unpaid card payments and there is no need to raise funds for paying merchants for goods, so there is no interest rate risk. For merchants, card companies impose lower fees on merchants versus credit cards, which may cut the expense of accepting card payments. The Korean government expanded income deductions for such cards from 2010 to support their usage, but more forceful measures are needed. Keeping the income deduction ratio for credit cards at 20% and expanding it to 25% for debit cards would expand usage of the latter. However, considering that debit card use is markedly lower than credit cards, the income deductions for both need to be readjusted in addition to other measures to stimulate debit card usage. 034

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