Terms of Access to Payment Systems

1 Terms of Access to Payment Systems The Different Positions of Small and Large Banks English summary of Swedish Competition Authority report 2006:1

2 Summary The Swedish banking market is dominated by a handful of major actors who have been turning a good profit for several years. New banks have entered the market, but they still represent only a small part of it, and there is no general tendency towards lower prices for consumers. One problem that newcomers have encountered is that consumers are not as a rule inclined to switch banks as they have difficulty comparing the alternatives and find it complex making the switch in practice. Another problem experienced by small actors is the way the terms of access to the general payment systems in the banking market are designed. These concern both pricing and other requirements, particularly ones of a technical nature, which are said to favour large operators. The Competition Authority has previously stressed the need to ensure that the terms are non discriminatory in the case of newcomers and small banks. In the preliminary work leading up to the new Banking and Financing Business Act from 2004, the Government and the Riksdag heeded this and noted the importance of following up the terms. Consequently, in February 2005 the Government instructed the Competition Authority to examine the conditions under which the general payment systems operate in Sweden and to address the question of whether (lack of) access to the infrastructure in these systems might deter small actors in the market and thereby hamper the development towards increased competition. A payment transaction is usually divided into three steps: authorisation, clearing and settlement. At the authorisation stage, banks establish the customer s identity, the validity of the payment instrument and whether the requested sum is available in the account. Every day, a large number of payments are processed. At the clearing stage, these payments are collated by an organisation

3 that calculates how much the various banks owe one another as a result. To a fairly large extent, the amounts cancel each other out. The net sums i.e. the sums that the banks owe one another after clearing are regulated at the settlement stage. Most of these transactions take place in the Swedish Central bank s system, RIX. In practice, the banks simply deposit money in each other s accounts at RIX to pay off the debts that have arisen as a result of the payment transactions. The most widely used payment instruments are giro transfers, direct transfers between accounts, and cards. In the case of giro transfers, the bank giro service (Bankgirot) plays an important role at the authorisation and clearing stages. In the case of direct transfers between accounts in different banks, these are usually handled by the data clearing system (Dataclearing). Both giro transfers and direct account transfers are settled in RIX. In the case of payment by card, the situation is partly different. When a customer uses a automated teller machine (ATM), the payment is authorised and cleared using one of the four communication systems available before the settlement order is sent to RIX (via Bankgirot). The authorisation of card payments is mainly carried out by CEKAB (a company owned by several major banks) or by Babs (a system owned by Föreningssparbanken). Clearing takes place abroad, via the Visa or Mastercard infrastructures, before the transaction is settled in Sweden. Banks wishing to meet most consumer demands in terms of financial services must be able to link basic payments services such as cards, giro transfers and direct account transfers to the customer s transaction account. This in turn assumes that the bank has access to the infrastructure underlying the payment systems on nondiscriminatory terms. As the transaction account represents a gateway to other banking services, such as savings products, deposits and credits, this issue crucially determines how competition develops in markets in the banking sphere.

4 Price discrimination, i.e. when a retailer prices identical goods differently, is fairly commonplace. One example is the practice of giving discounts to specific consumer groups, such as students or old age pensioners, or to consumers who buy large amounts. Price discrimination may affect welfare both favourably and unfavourably. It usually has an adverse effect when a retailer s pricing is designed to foreclose competitors. In certain network industries, such as electricity and telecom, there are special regulations 1 restricting such practices. If a retailer uses pricing in an attempt to prevent competitors from entering the market, this may infringe competition rules. It is only prohibited, however, if the company seeking to exclude competitors has a dominant position in the market. If several non dominant companies, acting independently of one another, set prices that deter other actors, this does not usually conflict with the competition rules. Thus situations may arise where competitive problems exist but cannot be dealt with under the Competition Act. Price surveys The Competition Authority has requested data on the prices paid by large and small banks respectively for access to the infrastructure in the payment systems described above. Some of the systems Bankgirot, Privatgirot, CEKAB, Dataclearing and RIX apply roughly the same principles when setting fees irrespective of the customer s identity. They offer volume discounts on total invoice amounts, which means that small actors are given discounts below five per cent while the large banks enjoy discounts that are often in the region of 10 30 per cent. This represents a cost disadvantage to small actors, but the explanation offered by the system s advocates is that there are significant scale economies in production. Also, the participation of 1 E.g. the Electronic Communications Act (2003:389).

5 the market s large actors with their substantial transaction volumes is essential to cost efficiency in the system without them, smaller actors would probably have to operate on considerably less favourable terms. In certain cases, these volume discounts have been examined by the Competition Authority as well as the Market Court, and found to be compatible with the competition rules. The smaller actors that the Competition Authority contacted were not altogether against the idea of discounts, but questioned whether these were entirely cost motivated. In the case of cash withdrawals, banks usually agree bilaterally on what fees they should pay for accessing each other s ATMs. Thus the terms under which the various actors operate vary. A general conclusion is that small banks pay higher fees to large banks for access to the latter s ATMs, compared with the amounts that large banks pay one another for accessing each other s ATMs. This represents a cost disadvantage to small banks, particularly as the large banks own almost all of the ATMs in Sweden. The situation concerning card payments is partly different. Only a few actors, in principle only the major banks, provide the service to merchants required for accepting card payments. When a payment is made by card, the merchant s bank (the acquirer) pays a fee to the consumer s bank (the card issuer). The size of these fees is prescribed in bilateral agreements, or via multilateral agreements where the fees are fixed at the level that applies for cross border payments in the EU. The terms may differ between large and small banks, but in the view of the Competition Authority not to such an extent that they place smaller banks at a disadvantage as regards card issuing. In general, however, the smaller banks have refrained from offering retail companies the services required for receiving card payments. This market is dominated by the large banks. To sum up, the smaller banks have a cost disadvantage in terms of the fees charged for giro transfers, direct account transfers and cash

6 withdrawals, but not, as far as the Competition Authority can see, in the case of card issuing. The question of whether this deters small actors to such an extent that it jeopardises increased competition must, however, be viewed in the light of its overall impact. In assessing this, the competition has estimated the costs to small and large banks respectively of an average consumer s use of cash withdrawals, direct account transfers and giro transfers. Our calculations show that the cost disadvantage to the small banks is an estimated SEK 100 250 per year/customer (approx. 11 28 euros). The single largest cost disadvantage concerns the banks access to ATMs. The cost disadvantage to the smaller banks in terms of cash withdrawals, direct account transfers and giro transfers is offset by the fact that they are in a more favourable position than the major banks as regards card issuing. Few ATMs in Sweden By international standards, Sweden has few ATMs. Those that exist, however, are used very widely. A comparison with 13 other EU member states shows that no other country has fewer ATMs per capita than Sweden yet more withdrawals per machine, as the figure shows below. In Sweden, withdrawals from ATMs are usually free of charge to the cardholder. This means that for the banking community as a whole, this area of activity does not cover its own costs, which may partly explain the limited number of ATMs in this country. However, as the cost of providing ATMs is in our assessment lower than the amount that the major banks generally pay one another for the right to access each other s networks, individual banks should find it profitable to install additional ATMs. There would also appear to be a market potential for an actor exclusively interested in supplying ATMs in Sweden. Such a development is contingent, however, on the large banks paying this actor fees that do not differ

7 substantially from the amount paid by the small banks for access to the major banks ATM networks. As far as the Competition Authority can determine, the large banks are unwilling to do so, which hampers this type of market entry and contributes to the relatively low number of ATMs in Sweden. Figure. Number of ATMs and withdrawals among the EU14*, 2003 Thousands of cash withdrawals per ATM 20 40 60 80 100 120 Sweden Netherlands Finland Ireland Greece Germany Belgium France Italy UK Austria Luxembourg Portugal 200 400 600 800 1000 1200 ATMs per miljon inhabitants Spain Sources: European Central Bank, 2005, Blue Book 2005, Payment and Securities Settlement systems in the European Union. *) No data available for Denmark Is the development towards increased competition being impeded? For the banking market as a whole, the terms of access to payment system infrastructure does not appear to have impeded the

8 development towards increased competition, despite the cost disadvantages for small actors. This conclusion is based both on the fact that the small banks are growing and are turning a profit, and also on their own assessments as outlined in interviews with the Competition Authority. In some segments of the payment service, however, the terms of access to payment system infrastructure appear to be constraining competition. In the view of the Competition Authority, the differences in fee levels paid by large and small banks represent a competitive problem as they limit the establishment of further ATMs. In the case of card issuing, the differences in fee levels do no represent any disadvantage to smaller banks, in the Competition Authority s view. Regarding card acquiring, this is an activity that mainly targets businesses and a market segment that smaller banks generally are absent from. This situation may be a result of unfavourable terms. The Competition Authority regards these latter problems as more serious than the cost disadvantages to smaller banks of volume discounts in giro transfer, direct account transfer and settlement systems. Stricter rules for infrastructure sharing The Competition Authority proposes that the commercial management of payment system infrastructure be made a separate operation and thus be freed from potential conflicts of interest. In network industries, rival companies sometimes cooperate in what are termed infrastructure clubs. This is common practice in Swedish

9 payment systems. Perhaps the foremost example is Bankgirot, where board members not only represent the owners but are also the system s biggest customers. While this kind of cooperation sometimes improves efficiency, there are also risks involved. Competitors may, for instance, gain a greater insight into one another s operations than is strictly necessary for the management of their joint activities, which may restrict competition. Alternatively, participants may design the terms of access in such a way that they place new market actors at a disadvantage or cause product development to focus on the needs of the large participants rather than those of the smaller banks. The Competition Authority wishes to emphasise the risks inherent in the current situation. It is therefore desirable that the commercial management of the systems be made a separate operation and thereby be freed from any potential conflicts of interest. More effective access rules The Competition Authority proposes that rules be developed to ensure that the terms of access to payment systems are objective, proportional and non discriminatory. As part of its efforts in the EU, the Government should press for a tightening of the rules in Article 23 of the New Legal Framework, in accordance with this objective. Strong network effects are a distinguishing feature of payment systems, as they are of the banking market in general. The benefit of gaining access to a given system increases as more people access the system. Other network industries, not least electricity and telecommunication, have special rules for how terms of access may be formulated. The rules are set up to prevent the introduction of discriminatory terms that impede market entry and thus harm competition. The rules may apply to prices and/or other requirements imposed on actors wishing to join the systems, and may be viewed as a supplement to the general competition rules

10 operating in Sweden. Under the Electronic Communications Act, for instance, certain obligations may be imposed on infrastructure owners concerning transparency, separate accounting and terms of use. In the electricity market, there are rules for how network charges are to be priced, and the Postal Services Act contains provisions requiring the terms of access to the facilities of licence holders to be reasonable and non discriminatory. Such rules are largely lacking with respect to the pricing of payment system infrastructure. While the Swedish Exchange and Clearing Operations Act (1992:543) requires the terms to be nondiscriminatory stating that equal cases shall be treated equally 2 it does not cover fee agreements between banks for things like cash withdrawals and card payments. The Competition Authority is of the opinion, therefore, that rules are needed here, too, to ensure that the terms are objective, proportional and non discriminatory. The introduction of non discriminatory terms of access should be accompanied by the establishment of an efficient supervisory model based on experience gained in the telecom field. This matter is also dealt with in Article 23 of the New Legal Framework setting out common rules for payment systems in the EU. However, the issue of non discriminatory terms is not explicitly dealt with here, either. In its work in the EU, therefore, the Government should press for a tightening of the rules so that Article 23 stipulates that the terms of access to payment systems must be non discriminatory. In the Competition Authority s view, such a change would put smaller actors in a better position, which would encourage the development towards enhanced competition. 2 Govt. Bill 1991/92:113, p 61.

11 Consumer support for switching bank The Competition Authority proposes that the responsible state authorities be instructed by the Government to strengthen the Consumers Banking & Finance Bureau s support to consumers, with a view to encouraging market mobility. A factor that may be even more crucial to competitive growth than better access to payment systems is consumer mobility in the market. Today, Swedish consumers switch banks fairly infrequently. If competition is to become stronger in the banking market, therefore, greater consumer mobility between banks is essential, as this makes it easier for new actors to test new products in the market. This in turn makes the market more dynamic and promotes development over time. In order to make rational choices, consumers have to be able to assess the various market offerings and at the same time compare them with their actual needs. It should be stressed that this is not primarily about comparing the prices of different payment services. Consumers may save considerable amounts by adopting a comprehensive approach. What services does the household utilise today and how much do they cost? What needs are the services supposed to meet is some form of personal service required, for instance? Based on the answers to these questions, consumers can decide whether the services they are using in the household are competitive and actually meet the household s real needs. Perhaps the household would benefit from switching banks or having more than one bank? We should bear in mind, however, that the cheapest service is by no means always the most beneficial one. Adopting a comprehensive approach to these questions is by no means a simple matter, and most consumers therefore need help and advice. Such support would involve providing consumers with the tools they require to act as their own financial advisers.

12 The Consumers Banking & Finance Bureau is best suited to this task. The Government, therefore, should instruct the responsible state authorities to strengthen the bureau s support to consumers and thereby promote market mobility. Here, the UK is a valuable source of inspiration as regards appropriate support measures. Retaining account numbers when switching banks - portability The Competition Authority finds it unreasonable that switching banks necessitates more administrative work on the part of private individuals than on the part of business customers. Besides the provision of practical support to consumers, mobility can be encouraged by simplifying the actual bank switching procedure. This could involve introducing number portability for bank accounts in the same way as for telephony services. Such a course would mean private individuals being able to retain their old account numbers, and would also mean automatically transferring all services associated with that account such as direct debiting and wage and benefit payments to the account in the new bank. European banks and central banks, however, have raised objections to a proposal along these lines presented by the European Commission. They argued that portability had only limited benefits when set against the costs of introducing it. In the Competition Authority s view, this argument does not necessarily apply in Sweden as the systems technological design varies considerably from country to country. Some of the smaller banks have proposed introducing account number portability to boost competition, and have also recommended that the banks develop a common technological solution in this respect. When a legal person switches banks, the bank giro services that are linked to the old account are automatically transferred to the account

13 in the new bank. Such a solution is not available to private individuals, however, as they are not offered a bank giro number. The Competition Authority finds it unreasonable that switching banks necessitates more administrative work on the part of a private individual than on the part of a business customer. It should be possible, therefore, to develop a solution for private individuals along the same lines as the one used for businesses. Simpler to switch banks The Competition Authority proposes that the Swedish Financial Supervisory Authority (FI) be instructed by the Government to review the possibility of supplementing the general guidelines concerning deposit accounts, with a view to simplifying the administrative work required of consumers who switch banks. Many consumers feel the process of moving direct debit orders from one bank to another is too elaborate. To simplify the procedure, the banking industries in the UK and Ireland have adopted selfregulating codes of practice. Under these codes, the banks agree to inform customers about how to switch banks, and about the maximum time allowed for the various parts of the switch, and also undertake to inform the new bank about the various payment services that are linked to the customer s old account. In the opinion of the Competition Authority, similar rules would have a favourable effect in Sweden. With reference to the arrangements in place in the UK and Ireland, it should be possible for the Swedish Bankers Association to have its members to cooperate in this matter voluntarily. A voluntary commitment that enjoys public confidence, however, requires not only rules but also controls and the possibility of imposing sanctions. Such a structure within a self regulatory framework does not exist in the Swedish banking sector.

14 The FI issues general guidelines to the banks concerning good practice in the market. In the case of deposit accounts, it issued general guidelines concerning both these and related banking services in 2001 (FFFS 2001:8). The Government should therefore instruct the FI to review the need, and appropriate format, for supplementing these guidelines with the objective of simplifying the administrative work required of consumers who switch banks, based on the examples of the UK and Ireland. In the EU, work is under way to create a simplified and harmonised set of rules on the requirements to be imposed on suppliers of payment services. In its comments 3 on the European Commission s proposed directive on payments in the internal market (the New Legal Framework), the Swedish Competition Authority stressed the importance of taking a closer look at how customer mobility might be encouraged, for instance through the introduction of rules simplifying the administrative work of consumers switching banks. As the ability of consumers to switch banks or seek new banking relationships is crucial to the future growth of competition, the Competition Authority will be keeping track of developments in this area in the years ahead. This applies in particular to measures aimed at simplifying the procedure for private individuals wishing to compare and switch banks. In conclusion......the Competition Authority takes the view that the Government should develop a cohesive strategy for improving competition in the banking market. This strategy should incorporate the proposals outlined above, i.e. clearer rules for infrastructure sharing, tougher requirements concerning objective and non discriminatory terms of access to payment systems, and measures to make it easier for 3 Ref 976/2005.

consumers to become active in the market. Taken as a whole, more effective rules lead to tougher competition and encourage banks to meet customer needs more fully, which in turn benefits the economy as a whole and leads to greater welfare. 15