In a spectacular own-goal against consumers, the Hong Kong Consumer Council has called for support of the "no-surcharge" rule for credit and charge cards, an anti-competitive rule which other countries have outlawed. It maintains higher consumer prices, boosts card issuers' profits, encourages consumer debt and distorts the payment system against cash and debit cards. It should be outlawed.

Consumer Council's own-goal
23 August 2008

Last week, Hong Kong's Consumer Council issued a press release urging credit cardholders to say "no" to merchants imposing a surcharge on purchases. They pointed out that Visa, MasterCard and American Express all prohibit merchants from adding a surcharge on purchases made with their cards (the no-surcharge rule). If a retailer wishes to accept those cards, then it is contractually bound to play by those rules.

The Consumer Council has fallen into a trap and completely missed the core problem - which is that the rule is anti-competitive. They appear to be unaware that in other places the rule has been outlawed. In fact, the Council's call serves to boost credit card-issuers' profits and maintain higher sticker-prices for consumers. It's the first time we can recall the Consumer Council supporting an anti-competitive scheme. The no-surcharge rule also results in a cross-subsidy from those who pay by cash or bank debit cards (such as EPS) to those who pay by credit or charge cards, distorting the payments market in favour of the card systems.

How the card systems work

Each time you pay for something with a credit or charge card, the retailer or service provider (known as a merchant), does not receive the full price on the receipt. The price is "discounted" by the merchant's bank or acquirer, typically by 2-3%, known as the merchant discount. In the case of credit card networks, the acquirer in turn takes a slice and pays the rest as an interchange fee fixed by the card network (e.g. Visa or MasterCard), which in turn pays that fee to the bank which issued your credit card. The network also charges a small processing fee to the acquirer. In the case of American Express, which issues its own cards, it simply keeps the merchant discount. You can see the US Visa interchange fees and US MasterCard interchange fees online. They vary depending on the type of transaction, the type of the merchant and the type of the card. Regardless of card type, merchants are obliged to accept all credit cards on that network. The US interchange fees were not published until about 2006, and the Hong Kong fees are still a network secret.

Consequences of the no-surcharge rule

For the majority of merchants, who comply with it, the no-surcharge rule means that consumers do not normally get a lower price if they are willing to pay cash, or use a lower-cost payment system, such as bank debit cards, which usually have a flat fee rather than a percentage fee. Therefore the rule tilts the market for payment systems in favour of credit and charge cards, and give the card systems a greater share of consumer purchases than would otherwise be the case. The processing cost of a cash payment for the retailer is no more than the cost of taking it securely to the bank, and they get instantly available funds rather than having to wait for the bank or charge-card companies to credit their account a few days later.

Retailers have to make their profit somewhere, so if they make less profit from card purchases, they have to make more profit from cash and debit-card purchases. As a result, sticker prices are higher than they would otherwise be.

The no-surcharge rule also reduces competition for the level of interchange fees, because consumers don't get a lower price if they use a different card network, whereas the card-issuing banks will sign up with the payment network which offers them the highest interchange fee. So payment networks compete to pay the banks the highest fees, driving up the merchant discounts charged to retailers. Only in the extreme will you find that some retailers simply refuse to sign up with payment networks (in particular, American Express) because of the high merchant discount. However, most retailers cannot afford to ignore the two major credit card networks Visa and MasterCard, as there will always be people who want to buy on credit.

Reward schemes

There is of course competition between card-issuing banks to lure customers for their credit cards, in the form of competing points schemes (typically convertible into a range of goods, or into air-miles) or even cash rebates (typically 0.5%), where they pass on some of the interchange fees to the cardholder. However, that doesn't eliminate the fact that they will choose the payment network which gives them the highest interchange fees, which are ultimately passed on to the consumer. Visa and MasterCard both operate premium card schemes which carry higher interchange fees (allowing issuers to give higher rewards), and these higher fees are ultimately paid by merchants and cross-subsidised by those consumers who use cheaper payment systems.

Under the no-surcharge rule, the reward schemes incentivise consumers to use the card systems rather than cash or debit cards, as the price is the same. This also is likely to result in higher levels of consumer credit card debt, as consumers do not see their spending in an immediate reduction of their bank balances, and succumb to the temptation not to pay in full when the bill comes, or sometimes, simply forget to pay, resulting in lucrative charges by the issuing bank and high interest charged from the transaction date onwards.

Australian example

This anti-competitive system is perfectly legal in Hong Kong, because we still don't have a competition law, but in other markets, such as Australia, the EU and the US, the whole system has come under scrutiny and action from competition regulators. In 2000 in Australia, the Competition and Consumer Commission and the Reserve Bank of Australia published a study which identified the same problems with the no-surcharge rule and with interchange fees, which at the time averaged 0.95%, while the merchant discount averaged 1.78%. Consequently, in 2002 the RBA required that interchange fees be reduced to reflect actual processing costs, and removed the "no surcharge" rule. Australian interchange fees have since come down to around 0.5%. American Express, being a proprietary system, was outside of the ruling on interchange fees, but undertook to scrap its no-surcharge rule.

Consumer Council: take action

So instead of supporting the no-surcharge rule, the Consumer Council should be urging the Government to outlaw it, either directly or through the proposed competition law if it is promptly enacted. It is unclear whether the card networks also prohibit a discount for cash (they keep their rule books secret, and the rules prohibit disclosure by member banks), but if there is a "no-discount" rule, then that rule should also be outlawed, as a cash discount is just the flip-side of a card surcharge.

Consumers: take action

If you are shopping, and your retailer (like most major chains) plays by the card network rules and will not make a surcharge for credit cards, then if you are willing to pay cash or by local debit card (such as EPS), you should demand a discount. There is no reason why you should hand a higher profit margin on your transaction to a retailer who is clearly willing to settle for a 2-3% smaller profit if he accepts a credit or charge card. All you are doing is cross-subsidising those who pay with credit cards.

Other countries: take note

This problem is far from unique to Hong Kong. Many other countries have the same issue. Media and populist politicians are often easily misled into thinking that credit card surcharges must be "bad" when in fact they benefit consumers overall by pushing down cash prices as well as pressuring credit card interchange fees through competition. The Hong Kong Consumer Council fell into that trap, and believe it or not, last year Ireland was even planning to ban credit card surcharges! The card networks and banks must have celebrated that one! This year, however, they appear to have put it on ice.

©, 2008

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