DISCUSSION PAPER

THE AUSTRALIAN RETAIL PAYMENTS SYSTEM

                                                         --- SOME UNRESOLVED ISSUES

PETER MAIR 
                                 
 APRIL  1999

Peter Mair (pmair@ezy.net.au), previously a career officer in the Reserve Bank of Australia, is an informed and experienced commentator on public policy issues associated with the Australian banking industry, including the payments system. 

CONTENTS

INTRODUCTION…… 5

PART ONE: WHAT'S WRONG?

THE MARKET HAS FAILED ……  6
CURRENCY……7
CHEQUE MATE…… 7
CARD GAMES…… 9
Bpay…… 14

SERVICES WITHHELD
--EFTPOS: DEBIT CARDS ……16
--DIRECT ENTRY TRANSACTIONS…… 17
--ELECTRONIC MONEY …...18

PART TWO: PUBLIC POLICY

OVERVIEW……  20
FINANCIAL SYSTEM INQUIRIES……  23
SEIGNIORAGE ……25
WHO IS (NOT) RESPONSIBLE?
--THE AUSTRALIAN TAXATION OFFICE…… 29
--THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION…… 30
--THE RESERVE BANK OF AUSTRALIA…… 34

THE CONSUMER LOBBY ……38
THE MAJOR BANKS…… 39

PART THREE: END PIECE: A WAY FORWARD?

APPENDIX: RETAIL PAYMENTS ACTIVITY - USAGE, COSTS AND PRICES …52

INTRODUCTION

Retail banking in Australia is operating neither efficiently or fairly.

Formal inquiries into the Australian financial system over the past twenty years presaged considerable change. Responses to these inquiries led to some worthwhile results. However some key issues about the retail payments system are yet to be openly discussed and resolved in any meaningful sense.

The situation is much the same in many other countries- including the UK; USA; Canada and New Zealand.
PARLIAMENTARY STATUTORY OBLIGATION TO PROTECT AUSTRALIAN CONSUMERS ARE MORE ONEROUS UPON THE RBA THAN THE BANK OF ENGLAND AND THE U.S. FEDERAL RESERVE.

This paper raises relevant issues to stimulate discussion, debate and appropriate policy reform.

If what follows has the general ring of truth, the implications for both public policy reform and further reform and redirection of the public policy machinery will be reasonably evident. 

What follows is in three parts:

•	Part one, "what's wrong" offers a commentary on the failure of the retail payments system to work properly in the public interest; 
•	Part two, "public policy" offers a commentary on apparent shortcomings of current public policy machinery that seems unable to effectively address long-standing issues that underpin the inefficiency of the Australian retail payment system; and
•	Part three "end piece - a way forward?" 

The appendix -- "Retail Payment Activity: usage, costs and prices" briefly summarises current patterns of retail payment activity in Australia, together with some "ball-park" assessments of industry costs in providing the services at as well as the prices paid, or not paid, by customers using those services.

 

PART ONE: WHAT'S WRONG?

This commentary on "what's wrong" with the Australian retail payment system covers familiar ground. It perhaps puts a sharper than usual edge on the identification of some apparent shortcomings.

The appendix briefly describes the range of available retail payment instruments, the current pattern of usage and some aspects of provider costs and customer charges.

While what follows is inevitably critical of current arrangements, it is not intended to infer that the current retail payment system does not work reliably and effectively: rather that it does not work properly and efficiently in the interests of the community.

The commentary on "what's wrong?" is arranged as:

•	The market has failed
•	Currency 
•	Cheque-mate
•	Card Games
•	Services Withheld 

THE MARKET HAS FAILED 

The most expensive non-cash, retail payment instrument - the cheque - is the most used: the cheapest retail payment instrument -the direct debit- is the least used. And there are other paradoxes.

The market for retail payment services has failed.  It is unable to deliver efficiently the retail payment services the community needs.

Markets work.  Markets work well when the underlying structure of the market is good, and badly when the underlying market structure is bad.  The current underlying structure of the market for retail payment services is very bad. The resulting "market outcome" is an indictment of private and public policy settings underpinning the failure of this market to work properly and fairly.

The failure of this market costs Australia billions of dollars annually in resources wasted on providing inefficient retail payment services at high cost to the community.  The technology is in place to allow the retail payment system to work efficiently and cost effectively. However, with the fundamental failure of the underlying market the proper development of the retail payment system is stifled.

CURRENCY 

There's no doubting the importance of currency as the dominant medium of most day-to-day personal transactions.

While the number of currency transactions in Australia annually may not be known with any precision, it can reasonably be assessed to be a large number, of the order of 20 billion transactions each year.  The assessment process is not precise. Assuming that 12 million of 18 million Australians make, on average, some 30 cash transactions each week, then such guesses put the national total at about 20 billion annually -- give or take a couple of billion.  It's a large number. Small cost savings on individual "cash" transactions would translate to very large total savings.

This discussion paper is not the appropriate place to confront the sensibilities of the community with a detailed examination of the emerging technological inefficiencies of conventional currency notes and coin and associated cash transactions.  The continued use of conventional currency for cash transactions is not under threat in the foreseeable future.  And that, per se, is reasonably remarkable -- given the development of the technology for smart card, electronic money akin to the Telstra 'phone card.

It may nonetheless be generally interesting to observe that only a relatively small part (about a third) of the $20 billion total currency on issue in Australia is held with any genuine intention of the holders using it to make cash transactions in anything like foreseeable, near future.  Most currency on issue in Australia is hoarded.

CHEQUE MATE

1 billion cheques are written in Australia each year at a cost to banks of some $3 each, additional costs to customers of some $3 billion and, some $6 billion in total. 

The $6 billion cost is basically an unnecessary waste of resources and, accordingly, deadweight cost on the community.  

In many countries, including Japan and parts of Europe, little use if any, is made of cheques for retail payments.

It is nonetheless unavoidable for customers of Australian banks to write cheques. In Australia, there is usually no convenient alternative way for making one-off payments when the parties cannot be face-to-face.  The failure of the banking industry to substitute alternative, electronic payment instruments for cheques is clear evidence of market failure, especially when cheaper, better facilities could be provided.

Surprisingly, the thought still lingers in the Reserve Bank that cheques have a prominent long-term role in retail payments -- and they will of course if the retail payment system is not reformed.

The debate about the cheque system has been diverted into concerns about the "too long" five-day cheque clearing cycle.  Although some relief has been promised, to a three-day cycle, the slow pace of reform in this area is symptomatic of a general inability of the community to obtain proper cooperation, in the public interest, between the major providers of cheque payment services. It has apparently not been in the commercial interest of the banks to cooperate on reform– the longer the cheque clearing cycle, the longer they have use of customers' money on which virtually no interest is paid.

The unwillingness of the payments industry to purposefully confront reform to the retail payment system is compounded by widespread community attachment to the cheque system.  Writing cheques is a traditional means of payment and, from the perspective of the community, apparently cheap, if not completely free of explicit bank charges.

Little could be further from the truth.

The customers of banks do pay for the $6 billion cost of running the cheque system -- but the way the community pays is not properly and openly explained. Especially not the arrangements where some $1.5 billion per annum is diverted from potential income tax revenues to subsidise the operation of the payment system, particularly the very costly and very inefficient, cheque payment system.

The mechanics of this tax-avoidance and cross-subsidisation arrangement are simple. Customers hold interest-free deposit balances and, in return, are provided with "free" transactions. If a proper rate of interest were paid on their deposits and the services charged for, customers would pay income tax on the interest received but would not be entitled to claim the charges against their personal taxable income. 

Historically, there has been no clear disclosure, or explanation, of the details and consequences of this "smoke and mirrors" conversion of a high-cost cheque payment service into an apparently, "free" service in the hands of the customers.  Keeping such an objectionable industry arrangement effectively obscured from public view has no doubt taken considerable purposeful effort. And one can hardly blame the banks for keeping mum.  

The game does not, however, stop there.  Any curtailment of the flow of soft income to the banking industry to cross-subsidise the retail payment system, prompts the intrinsically sensible, response that additional account keeping fees and transaction charges will need to be imposed. Attention is diverted to, among other things, the burden of bank charges that would be imposed on the poor and disadvantaged when using an essential service.  

Such scare tactics should be nipped in the bud by clear, official statements reassuring the poor and needy that they will be given appropriate, access to the payment system on concessional terms – with those concessions funded directly by government, as subsidies to payment service providers.

The government is, on the face of it, already prepared to contribute some $1.5 billion or more each year (as personal tax revenue foregone) to subsidise the conduct of the present, inefficient retail payment system.  Government could hardly object to spending a much smaller sum to assist the poor to have access to an essential service, preferably one operated efficiently.

Australia would benefit greatly from a purposeful determination to reduce its reliance on the cheque as a prominent payment instrument in favour of alternative electronic instruments -- and nothing would assist that process more than a withdrawal of the unwarranted subsidy from the public purse, and the consequence, full-cost fees for cheques

CARD GAMES

Notwithstanding the ubiquitous character of plastic cards, especially Visa and MasterCard, very little is on the public record about the internal contractual arrangements under which these credit card services are provided to member banks, the merchants they sponsor and the customers operating credit card accounts.  The following assessment may not be correct in all details but is offered as a fair assessment of the apparent situation.

It was reported in the Australian Financial Review in October 1998 that "the United States Justice Department has declared war on global payments giants Visa and MasterCard, alleging that they have colluded in illegal behaviour that has thwarted competition and stifled consumer choice."  It was further reported that Visa international issued a statement saying it did not think the government needed to file the lawsuit, "once the people and the courts know the facts, they will agree that the market is working just fine without government intervention."  MasterCard international was reported to have described the lawsuit as "entirely misplaced" and a mystifying effort to disrupt a highly competitive market structure.

Visa and MasterCard may be right.

From my perspective, however, the design, marketing and management of credit card schemes have confusing, and practically deceptive, "smoke and mirrors" characteristics.  The overall product management structure is unreasonably self-serving to the collective (and individual) commercial interests of banks participating as card-issuing members in the schemes of credit card associations.  

For some schemes, the underlying agreements on terms, conditions and pricing-policy frameworks under which the members of these associations operate are apparently not registered with the relevant trade-practices authority, in Australia, the ACCC.

Moreover, the banking industry has decided that credit card schemes are to be excluded from the policy-making processes of APCA, the industry policy body established to oversee payments clearing arrangements in the Australian payment system.  That means that the relevant industry body has proscribed discussion of the major credit card schemes -- Visa, MasterCard and Bankcard -- in its payments policy-making forums.  
This is surprising, and sometimes explained by crediting Visa and MasterCard as operating under "international agreements", and thus, somehow, a law unto themselves across international boundaries. Visa and MasterCard are not beyond the reach of the Australian Parliament or other national governments, individually and collectively.

Credit cards have some outstandingly good attributes and excellent service is usually provided to cardholders and merchants. Nonetheless, there are aspects of the industry agreements covering credit card payment systems that would seem to be objectionable on a reasonable test of the public interest.  

The questionable features include:

•	Credit cards are marketed as a payment instrument which, when used to make purchases on credit, are "free" of any issuer-imposed, transaction fees and charges to card holders.  While true in a limited sense, it seems not to be widely understood that the merchant service fee arrangements provide for a high percentage - typically over 2% - of the value of credit card purchases to be paid by merchants to the banking industry as merchant service fees. Of that total merchant service fee, 0.8 to 1.2%, of the customer purchase price is kicked back to the card issuer.  This, so-called, issuer-interchange fee is in turn a cost recovered by retailers, from their customers in the retail prices charged for goods and services.  Credit card purchase transactions are not "free" to customers in any meaningful sense, in the same "smoke and mirrors" way that cheques are not "free" either. Customers pay a high price for credit card services while being led to believe that they are free.

•	One unfortunate consequence of the credit card issuer, kickback, revenue arrangements is that promotional effort is withheld for the use of debit cards (a comparable product without card-issuer, kickbacks). In some instances, the supply of payment facilities using debit cards (e.g.: for over-the-phone payments) is apparently withheld to ensure the customers use the credit card facility, which is more profitable to the card issuers.  All this notwithstanding that for many customers their "separate" credit cards and debit cards are embodied in the one piece of plastic.  The whole arrangement, reduced to its basics, is that the one card allows access to the account of the customer with the card issuer. Card issuers could open one account for a customer and at their discretion, grant a line of credit (overdraft facility) which would dispense with the inherent contrivance of the separate  "deposit" and "credit" account arrangements. A properly competitive environment would embrace such alternative arrangements. 

•	An especially objectionable practice has emerged where credit cards are issued to customers but described as debit cards.  Customers holding these credit cards undertake to conduct the underlying account with a positive deposit balance always.  One consequence is that such no-credit, credit card purchases attract merchant service fees (including card-issuer kickbacks) as if they were genuine, credit card transactions.  Insult is added to this injury when the promotional material for credit cards masquerading as debit cards, advises customers about avoiding bank transaction fees. It says transaction charges can be avoided if, when making purchases, at EFTPOS terminals, customers select the credit-card button rather than the debit-card button. The net effect of this "smoke and mirrors" marketing is that the card issuer, instead of paying a small, fixed fee to the sponsor of the merchant where the purchase was made, actually receives a kickback equivalent to some 1% of the value of the purchases made.  This arrangement has not been exposed or explained, to the holders of those deceptive, credit card/debit cards, nor to the community generally where the kickback to the "no credit" card issuer raises costs and retail prices for everyone without reasonable cause.

•	More than 10% of all credit card transactions are made using credit cards that do not have an interest-free period.  There is no "free" credit for holders of "no-free-period cards", they pay interest from the date purchases are recorded.  Notwithstanding this merchants are given no concession on the kickbacks charged for these transactions, even though they are said to cover the "free credit" which is (not) provided.

•	The much-touted "free credit" element of credit card product is, when properly analysed, little more than an illusion for all but a very few customers.

  Among other things:

•	The free credit is only "available" to those customers who pay their credit card account in full by the due date -- generally using funds held in a deposit account on which little, if any, interest is paid.  The customers who borrow "free" under the credit card arrangement also lend "free" to the same group of credit card issuing institutions. On balance these customers get nothing for free. To the extent that their available deposit balance consistently exceeds their credit card debt, the customers are, overall, probably net losers from the arrangement.

•	Free-period credit cards attract annual fees of some $25 per annum, whereas cards issued without the benefit of a free credit period do not. $25 annually, paid only by the "free-period" cardholders, is equivalent to the cost of constant credit card debt of $500 over the full-year (monthly purchases of $1000), when calculated at an interest cost of 5% per annum. The "free credit" is not free.

•	Holders of free-period credit cards are, moreover, charged a higher interest rate than holders of other credit cards, if they fail to pay the balance of the account in full by the due date.  For these customers, borrowing "free" and not paying by the due date attracts a penalty.  A customer's failure to make the required part-repayment of credit card debt for two consecutive months now attracts an additional penalty: this, even if the total debt is within the agreed credit limit. The law-of-large-numbers means that, inevitably, some customers who intended to pay by the due date do not -- for customers taking the risk of obtaining "free" credit the end result can be costly.

•	As well, those free-period card users, who do not pay their credit card account in full by the due date, and do actually borrow, are charged for the privilege at an interest rate of some 15% per annum. The interest charge is moreover, backdated to accrue from the date purchases are recorded.  "Free" credit can be costly.  

•	When responding to criticism that credit card interest rates are "high", banks are inclined to say:

-- many customers pay their credit card bills within the interest-free period so the bank cannot charge interest to cover its transaction costs: every transaction made costs the banks money: and 

-- there is a component of the interest rate to cover the cost of transactions.  

Such explanations conveniently ignore that merchants have already paid unnecessarily high fees to cover the transaction costs. Banks add insult to injury by blithely assuming it is somehow fair that those unable to pay their credit card bills on time, in full should cover the transaction costs of those who can.

•	A justification for the card-issuer kickback of some 1% of credit card purchase values is that it compensates banks for the "free credit" provided by banks to their customers that draw on their line of bank credit when shopping.  

•	Practically this set of arrangements entails that any actual provision of credit is being paid for twice, if not three times. First, by the retailer, embodied in the merchant service fee kickback; second, by the borrower paying interest on any credit actually taken, at a rate acknowledged to be high; and third, embodied in the card-holder's annual, card issue fee.  On the face of it, this would seem to be an arrangement, which, overall, warrants review by the authorities. 

•	It is historical and systemic inertia that retailers, not usually expert in customer credit assessment nor well-placed to raise cheap loanable funds, agree to be charged for providing credit to the borrower customers of banks. Banks are expert at both raising loan funds (deposits -- often at very low-cost) and making credit assessments based on broad banker-customer relationships. Why do retailers pay fees to cover the cost of credit that banks provide to their own customers?  There is no good reason.  Retailers, these days, can hardly decline to offer credit card purchase facilities that are universally available at all retailers. No effectively organised objection from the retailers seems to have been raised against the "rules" of the credit card associations.  An apparently remarkable situation, save for an observation that all retailers (their customers, really) are, more or less, "taxed" equally by the requirement to subscribe to a uniform agreement in respect of overall service fees, including a uniform kickback paid to credit card issuers -- for what? 

•	The rules of the credit card associations also preclude retailers offering to discount prices for purchases paid for with cash or by debit card. Retailers that advertise to breach this rule are threatened with removal of the credit card purchase facility from their store. Because no action has been taken against them, these rules could be incorrectly inferred to be in the public interest. Even if the rules of association are not "registered" trade practices, this should not preclude a "public interest" review of their consequences.

•	The credit card business is dominated by two major card schemes. Both schemes are organised as cooperative associations (which themselves make no material profit). The same, card-issuing, member banks own both schemes. Both schemes have a more or less identical set of terms and conditions, including conditions about card-issuer kickbacks, which are binding on card issuing members -- oh joy to be so bound!

•	In any event, to the extent that some, few, customers may meaningfully be said to obtain free credit, this is a benefit subsidised by the tax system, unnecessarily. In this case a tax deductible business expense, the cost of funds lent free by the banks, becomes non-taxable, income-in-kind in the hands of the customers taking the free credit. Why should the government, the community, subsidise this benefit to the relatively well off able to pay their credit card accounts on time?  

•	The offering of "loyalty" cards and associated "reward"/rebates related to customer purchase transaction volumes has recently enhanced the attraction of credit cards to customers. The option of offering a "loyalty" card scheme to customers is, realistically, only open to the largest card issuing institutions.  Such arrangements are likely to further concentrate market power in the retail banking industry and unlikely to enhance diversity and competition in the provision of credit card services.  The net effect of loyalty schemes is likely to disadvantage the smaller card-issuing institutions. As usual, the promise of an apparently attractive reward by credit card issuers is another likely instance of "smoke and mirrors" marketing to the eventual detriment of all customers.  

-- regulatory inertia

In mid-1997 the ACCC refused to authorise the proposed rules and procedures for the conduct of the Consumer Electronic Clearing System  (CECS) which were submitted to the ACCC by APCA.

This rejection was a watershed event.  Unfortunately little useful has flowed through the shed subsequently.

The ACCC required APCA -- effectively the major national banks -- to make changes to the proposed agreement on rules and procedures.  The required changes concerned matters affecting competitive access to the system, by smaller financial institutions, and a requirement that industry pricing agreements and arrangements covering transactions at ATM and EFTPOS terminals be reviewed to ensure they complied with "efficient pricing principles".

Apparently scant progress, to comply with the ACCC requirements, has been made by APCA in the year or more since.  The system continues to operate as if no challenge had been raised to the  "unauthorised" CECS rules.

In any event the proposed CECS rules and procedures apply only to ATM and EFTPOS facilities.  They do not apply to credit cards.

The major banks have elected not to bring credit card payment arrangements within the purview of the national payments industry body, APCA.  Instead, credit cards remain under the administrative control of the major credit card associations, particularly Visa and MasterCard, and at the direction of their owner members, especially major banks.

The Visa and MasterCard agreements with member card issuers, and between the merchant-sponsor banks and merchants, remain off the public record.

This separation of industry control of the debit card and credit card schemes -- two very similar (same piece of plastic) and very comparable payments facilities (same card issuers, same terminals), is remarkable.  The agreed industry rules for the conduct of credit card businesses should no doubt be the subject of the same (promised) public-interest scrutiny as those for the ATM/EFTPOS system (which failed to pass the public interest test, when reviewed by the ACCC).  

For the reasons outlined above, credit card agreements, to which the major banks are party, are unlikely to meet a "public interest" test.

Bpay
-- on a good thing, stick to it

The major banks, and some others, established a new bill payments facility in 1997 -- it is known as BPay.  

Customers using BPay quote a BPay reference number and transfer funds directly to the participating payee from their transaction account or credit card account. The utilities offering BPay facilities to their customers pay banks a collection fee that is no doubt significantly higher than the fee those same banks would charge for processing direct debits.

The development of BPay occurred, concurrently with the difficulties being experienced, at APCA, in dealing with proposals to revamp the direct debit system.  The direct debit system in Australia had failed to develop, in large part because of the way the service was marketed -- bank customers felt they lost control of their right to challenge unexpectedly high, utility bills.  The shortcomings in the marketing of the direct debit system were of major concern to public utilities, now willing to resist the high costs, fees and charges associated with credit card, cheque and cash payment transactions.  A better, customer-friendly, direct debit system would enable the utilities to collect bill payments at a small fraction of the cost incurred when customers pay by cheque, credit card or cash or, now, BPay. It could reasonably be asked why banks do not offer the cheaper, better direct-entry facility on proper, user friendly, terms.

The BPay system is a generally sound concept -- similar to an electronic ""giro" payment system.  It leaves control of bill payments with bank customers and there are no risks of "dishonors" because BPay payments are debited immediately against available deposit balances or unused credit card limits.

The problems with the BPay arrangement include:

•	BPay transactions are substantially more expensive to customers than direct debit transactions would be; and

•	The higher cost is not paid directly by the customers using the BPay facility, rather the higher cost is paid indirectly by the billing utility (and, no doubt, recovered by passing on the cost to the customers of the utility).

The BPay system appears to have been set up along the same lines as the major credit card associations.  Under these arrangements there is centralisation of BPay account administration, presumably, including pricing and, presumably, elements of uniform pricing -- if only because the customers of any participating bank may use the system to transfer funds to a public utility banking with a different bank.

Uniform pricing, if it prevails, is not necessarily inappropriate, but there are warning signs, including:

•	The BPay agreement is not registered with the ACCC, the relevant trade practices authority; the provisions of the agreement (access, pricing etc.) have not been tested against the "public interest"; and

•	The agreement was made outside the auspices of APCA, the relevant payments industry body, that previously coordinated such developments and had a standing policy of referring new payments clearing agreements to the ACCC for authorisation.

Details of the underlying participation and pricing agreements have not been made public. However there are enough warning signs to suggest that the BPay agreement should be registered with the ACCC and reviewed to ensure that it is likely to operate in the "public interest".

Notwithstanding the suspicion that the BPay arrangement is likely to be very profitable to participating banks, the National Australia Bank has seen fit to impose what a spokesman described "as a small fee of 30 cents" on its customers using the BPay facility.  This decision would seem to be quite inappropriate. The full costs of this service can be (and probably are) recovered from the business payees which can claim the cost as a deduction against taxable income -- a benefit which individual customers are denied. If an additional charge is required, it would seem preferable to charge the business payee, who would need to pass on only about half of the cost to customers as a loading on customers' accounts. The BPay decision of the National Bank offends commonsense and points up a capacity for banks to effectively charge customers twice for the provision of the same service.

 SERVICES WITHHELD

It is not usually in the commercial interests of the major payment services providers to resolutely market payment services using new technologies.  This, not because the new instruments would not be successful, but because successful new instruments could risk unsettling the market and erode the profitability of customers continuing to use conventional instruments, especially cheques, credit cards and currency.

The major banks in Australia collectively own three retail payment systems that are not marketed effectively and remain underdeveloped.  These three systems, are:

•	The bulk electronic clearing system (BECS) a European-style, "giro", payments process more commonly known in Australia as the direct entry system.  This system is underutilised in Australia because banks have not developed it properly. The direct entry system processes direct credits (wages; social security payments, dividends etc.) and direct debits -- especially for the automatic collection from customer bank accounts, of bill payments due to public utilities,

•	Electronic funds transfers at point of sale (EFTPOS) using debit cards. This system could be simply extended (not Bpay) to allow customers access to their accounts to pay bills over-the-phone, as is the case with credit cards, and to allow the deposit of cash to customer accounts at EFTPOS terminals.

•	Electronic money systems, known as stored value cards (SVC). Banks, unable in the current, failed, market to find a "business case" for these systems have shelved them. SVC could be used instead of notes and coin for, mainly, small-value cash purchases not only for face-to-face transactions, but also for purchases on the Internet and, prospectively, for over the-phone payments, card-to-card.

-- EFTPOS: DEBIT CARDS

The infrastructure for a national EFTPOS system was in place, in Australia, in the late 1980s.  Use of EFTPOS by customers was slow to begin with and it was a further decade before growth in the number of debit card purchases accelerated.

This development was not all to the banks' liking – because debit card activity was costly to some of them, and clearly less profitable to them than credit card transactions. 

Although EFTPOS purchases were more likely to have substituted for cash transactions, the rapid growth of EFTPOS activity opened the more profitable possibility of substituting credit cards for debit cards. The introduction of credit card reward schemes, among other things, has worked to boost credit card transactions and slow the growth rate of debit card transaction numbers.  The EFTPOS system remains substantially underutilised

Most of the explanation for the underdevelopment and underuse of the EFTPOS system has to do with the relative pricing, and profitability, of EFTPOS services compared to credit cards.  Whereas the issuer of a credit card (see above) receives kickbacks of some 1% of the value of credit card purchases, the issuer of a debit (EFTPOS) card actually pays the merchant sponsor bank a free for each EFTPOS transaction made on its cards.  

It is little wonder card-issuing banks are not keen to develop the use and range of EFTPOS transactions.  The attraction of debit cards to card-issuers has had more to do with giving their customers access to cash at ATMs, which saves the banks money, than developing EFTPOS purchases. Customers can now have a single card, which incorporates both credit, and debit card functions, and point of sale terminals typically process both EFTPOS and credit card transactions. The customer's choice depends first on merchants offering both facilities, and second on the customer's attachment to "rewards" and /or avoiding explicit transaction fees. The marketing strategy favours the use of higher priced and more profitable credit card transactions. 

It is remarkable that an almost identical transaction service, using the same card, is priced so dramatically differently, depending on whether the customer pushes the "credit" button or the "debit" button on the EFTPOS terminals.  It is more remarkable that nothing has been done to remedy the situation.  This is another clear example of the failure of the market and the public policy environment for retail payment services

In the same general context, EFTPOS terminals could be used to allow cash deposits to be made to debit card accounts, but banks prohibit this. EFTPOS-deposit facilities are generally withheld from the Australian community -- although the service is available at TAB agencies in Queensland, and from retailers choosing to (mis)use the "EFTPOS refund button" to pay, for example, the wages of casual staff.  

In short, there is already available a national network of banking terminals conveniently accessible in most retail outlets, especially in rural and regional Australia, which the banks, lamentably, will not allow to be used to take cash deposits to a customers account at any bank, building society or credit union. Rural bank branches have been closed, but no merchant sponsor has made a simple substitute - basic banking - service available. This shortcoming is another consequence of the more general failure of retail banking markets.

This issue -- EFTPOS deposits -- was recently addressed in the report of the Parliamentary Banking Committee reviewing banking facilities in rural areas.  Notwithstanding the inherent practical simplicity of deposits being accepted at EFTPOS terminals, the Committee reported "disappointment" with the ineffective response of the industry concerning the establishment of such facilities.

-- DIRECT ENTRY TRANSACTIONS

Payments made using the direct entry system cost both banks and their customers, about ten cents each to process.  This cost is a small fraction -- some three or four per cent -- of the cost of providing a cheque payment service.

It is a fair question to ask why the direct entry system has not been developed to accommodate:

•	Payments to be made from anyone to anyone, with proper identification of the transaction in the bank statements of both payers and payees.  The payer needs only to know the bank and account number of the payee to enable funds transfers to be made immediately, including at any ATM of EFTPOS terminal.

•	Direct debit facilities offered on customer-friendly terms and conditions that would give customers the confidence to allow public utilities to collect bill payments directly from their bank accounts.  The cost of direct debits is relatively very small compared with the personal and business resources used up in writing, posting and processing cheques; in paying-by-phone using credit cards or debit cards (Bpay) and in obtaining and using cash to pay utility bills at the Post Office.

There is no clearer evidence of the failure of the retail payments services market than the fact that direct entry services are not the most commonly used payment facility for making payments where the parties are not face-to-face.

Direct entry payments are cheaper than cheque or card payments, and cleared funds are made available overnight in the account of the payee. This is a significant difference compared to the delay of a week or more between the posting of a cheque and the payee having access to "cleared" funds.

There is no acceptable explanation why direct entry services are not more readily available.  The unacceptable, explanation is firstly that the industry has not seen fit to provide them, because it would run contrary to their commercial interests.  Second, there has been a reluctance on the part of government to come terms with market failure in the payments industry and to intervene to ensure that the market is restructured to operate in a way which fosters the provision of cheaper, more efficient, better services.

Again some insight to the reluctance of the authorities to address this, and like, issues was provided in the Reserve Bank Bulletin for December 1998. Surveying "some features of the Australian payments system" and making comparisons with "features" in other countries, the Reserve Bank observed differences -- "most obviously in the limited use of direct debit, particularly by individuals". The best one can hope for arising from such controlled understatement is that the Reserve Bank will move to correct the situation. Given, however, that this "feature" has been widely acknowledged for many years, and under high-priority review at APCA for the past three years or more when Reserve Bank officers were board members (one Chairman), the major utilities seeking such reform could be forgiven for dismissing such a hope as forlorn.  The banks' countered by establishing the more profitable, higher priced BPay facility.  

-- ELECTRONIC MONEY (SVC)

Understanding in the community about electronic money/SVC schemes is so underdeveloped in any practical sense (save for the Telstra Phonecard) that the prospect of widespread use of SVC technology for retail payments is still wishful thinking rather than a practical, near-term prospect.  

What is, however, important in this context of payments market failure, is that the development of SVC schemes is in the hands of the major payment service providers.

As things stand, SVC developments are most likely to occur under the brand names (or a cooperatively joint brand name) of Visa and Mondex/MasterCard.  The major card issuing banks in Australia, directly or indirectly, own the decisions about when SVC services will be provided to the community.

SVC schemes, properly marketed, would gradually make inroads into the use of currency for small cash purchases. There would very likely be significant community benefit in that.  The difficulty for the card issuing banks, however, is that the efficiency of SVC (no signature, no PIN required) would likely make substantial inroads into established non-cash payment facilities, especially debit cards and credit cards. The cards are stacked against electronic money schemes.

The regulatory tide will eventually turn against credit cards, for reasons explained above, and that would seem to be a necessary precondition for the proper development of SVC schemes.  The consequences of market failure in retail banking are extensive.

The failure of the commercial banking market to develop SVC is unlikely to be overcome in the foreseeable future. There may be a case for some of the soft earnings on the Australian currency issue being used to develop a viable national SVC system: this would, among other things, be a better use for the potential earnings presently forgone in holding barren gold in the nations official reserve assets.

PART TWO: PUBLIC POLICY 

This commentary on the public policy framework (old and new) points up both past shortcomings and less than buoyant expectations of any short run reversal of established poor form.

The commentary and assessment is arranged as:

•	An overview, including public inquiry processes; 

•	A digression into the concept of "seigniorage" 

•	An assessment of " who is (not) responsible?, with reference to:

The Australian Tax Office (ATO)

The Australian Competition and Consumer Commission (ACCC) 

The Reserve Bank of Australia (RBA) 

The Consumer Lobby

The Major Banks

OVERVIEW

The general community has no alternative but to place its trust in government, and government agencies, to establish and maintain policy environments that are conducive to the banking industry, among others, working effectively in the general public interest -- which general public interest includes efficient, safe and profitable banks.

The community trust in government is not blind but it is sometimes unduly faithful. Not properly understanding what is going on, the community is inclined to lose confidence in the sense of their misgivings about the banking industry and suppress their feelings. The community can, however, be misled and provoked to dissipate their critical energy on second-order issues such as "higher (explicit) fees and charges", "branch closures" etc. 

All must be OK, because nothing effective is being done at an official level.  An official commitment to purposeful public policy reform of the retail payment system would first entail explaining the current realities to the community and allaying concerns about whether change would be beneficial.

The community has strong but ill-defined feelings that the banking industry is dealing with them inappropriately in the supply and pricing of payment transaction facilities. One should be careful of underestimating the commonsense of broadly held community views.  The community is well entitled to feel that the banks are "having a lend of them" even if they do not understand the mechanics of the process.

It is the purpose of this paper to more clearly establish a basis for those community misgivings and to give the underlying issues a sharper definition.  In the banking industry there is a certain slickness pervading industry attitudes and a range of banking industry practices -- not just what is done, but often equally important, what is not done. 

In respect of the retail payment system community trust in government has been misplaced.  

Public policy issues associated with the development of the retail payment system in Australia emerged in 1979, in the context of the Campbell Committee inquiry into the Australian financial system: then, the debate on payments system issues was initiated and sustained by the credit union industry.  The Campbell committee looked for a retail payment system that, among other things, would be flexible and responsive and operate in an effectively competitive market. The Campbell Committee did not, however, foresee the extent to which the market power of the major banks would be misused to inhibit the proper development of the payments system.  

The proposals of the Campbell Committee were generally endorsed by a 1983 report to the new government.  This report prepared by a group under the chairmanship of Victor Martin extended the proposals of the Campbell Committee, proposing the establishment of an Australian Payments System Council (APSC).

The then Treasurer, Keating, established the APSC in 1984, to oversee the evolution of Australia's payments system.  The members of the Council were drawn from the banking industry, consumer groups and government. The chairman and the secretariat were provided by the Reserve bank.  There was an "open-line" responsibility on the APSC to report to the Treasurer on progress towards needed reform - such reports often fell well short of meeting key elements of that responsibility.  

The Council was required to have regard for public interest objectives, including competition between financial institutions and stability of the financial system -- all in the general context of a charter designed to promote the reform of the Australian payment system. Subsequently, in 1993, the role of the APSC was extended, placing greater emphasis on the protection of consumers of banking services (e.g.: codes of banking conduct).  This change reflected the work of the newly established parliamentary banking committee, which, over 1991, reviewed the state of the banking industry in the wake of its poor performance in the late 1980s.

The amended charter for the APSC included objectives about promoting community awareness of payments issues and ensuring overall payment system stability, efficiency and competitive equity.

The APSC was disbanded in 1998 when primary responsibility for the reform of the retail payment system was given to a newly established Payments System Board, within the Reserve Bank.

By the late 1980s payment system policy was firmly on the agenda for banking industry reform, under pressure from institutions, other than the major banks, especially small banks, building societies and credit unions.

The outcome of this debate was the establishment in 1992 of the Australian Payments Clearing Association (APCA), a self-regulatory industry body owned by banks, building societies and credit unions -- and the Reserve Bank.

The, stated, mission of APCA 

•	 -- to achieve and maintain international best practice in the operation of the Australian payments clearing system 

was supplemented by a range of, similarly high-sounding, objectives for APCA including,

•	 -- to improve the effectiveness and efficiency of the system; to ensure principles of equity and competitive neutrality are applied in determining participation in the system; and to assist the community's understanding of the system and ensure that public debate is well-informed. 

To say that these two public policy bodies -- the APSC and APCA -- largely failed to meet their stated objectives, in the 1990s, is a polite understatement.  In some ways their contribution was actually perverse.  Progress on the reform of the payment system has been painfully slow, an outcome most beneficial to the major banks.  This outcome, lamentable as it is, is especially so in the light of both policy-reform bodies being chaired by very senior officers of the Reserve Bank.

Among the shortcomings of this process:

•	The major national banks collectively control the payment system reform process. This control reflecting both their collective, dominant role in the operation of the system and the, corollary, their collective ability to determine industry policy, especially acting under the auspices of both the Australian Payments Clearing Association (APCA) and the Australian Payments System Council (APSC). A decision by one major national bank to withhold agreement to cooperate with needed systemic reforms effectively becomes a veto on the reform process.  In the event not many reform proposals have the unanimous support of the major national banks.  Consequently, in both the these forums, the reform of the Australian payment system has been a slow, and largely ineffective process.

•	The barriers to the entry of new payment service providers are almost insurmountable. Even with a regulatory framework that is apparently conducive to new entry, the practical realities weigh heavily on potential new entrants.  They cannot get in.  All the portents are, on the contrary, for greater concentrations of market power in the major national banks rather than viable new players. The recent "toe in the water" proposals developed by APRA for banks to be operated in conjunction with non--bank commercial businesses, would seem to be unduly conservative and further cause for concern on the score of an effective competition policy.

•	As things stand, potential new players in the payments industry are effectively confined an "agency" role in facilitating transactions.  In effect, banks are outsourcing their traditional over-the-counter business to organisations such as Australia Post and others with retail distribution networks. The terms of the outsourcing are likely to be suitable to both banks and their agents but, practically, less likely to be of net benefit to the customers footing the bill. 

•	Agreed industry pricing arrangements prevailing in the payments service business are not transparent.  Apparently "free" services provided to individuals are, in practice, quite likely to disguise a raft of "smoke and mirrors" arrangements that, on closer examination, mean that the prices paid indirectly by customers are relatively high.  Business operators laboring under the inefficiency of the cheque payment system and the high cost of credit card transactions look for relief.  They are, sensibly, induced to subscribe to alternative payment arrangements, building into their general cost structure the substantial fees and charges levied by banks: this in exchange for the privilege of using cheaper,more efficient payments arrangements. The businesses inevitably, recover the additional costs from their own customers as a net, non-transparent, addition to the amount payable.  The process of banks shifting costs to "agents" and then recouping substantially higher revenues for the "outsourced" transaction services on their customers' accounts, is doubly beneficial to bank shareholders (and options-acquiring bank management).

Both the APSC and APCA could have been more effective in identifying and developing needed reforms but, being dependent on the major banks for acceptance and cooperation, apparently faced an impossible task in exerting appropriate leadership.

FINANCIAL SYSTEM INQUIRIES

Commencing with the Campbell Committee (1979 -- 1981) there has been a succession of official, public inquiries into the Australian financial system.

Appropriately, these inquiries reviewed the payment system generally and retail payment systems in particular.

All of these inquiries produced some meaningful improvements to the public policy environment affecting retail payment systems.  It is nonetheless equally true that in none of these inquiries were payment system policy matters addressed comprehensively and effectively.  The recent, "Wallis Report" (1997) went close, though stopping short of a detailed program for appropriate payment system reforms -- possibly because the relevant arguments were not submitted to them.

For the most part the shortcoming was not the fault of those responsible for conducting the inquiry.  Rather, the shortfalls reflected the generally poor, and restrained, quality of submissions put before these inquiries.

This assessment applies especially to contributions, in the way of submissions, made by public sector authorities. Given many opportunities to open discussion, and lead the debate, no substantial, material contribution emerged. The submissions of the authorities most likely to be well aware of the failure of the payments industry to operate competitively and cost effectively held back from saying so.  Again lamentable, but, again, not surprising.

The public inquiry process is flawed in a number of respects.  Public sector bodies with ongoing, day-to-day responsibilities for systemic performance are threatened by public inquiries.  Not having said anything of consequence in the prelude to the need for an inquiry being widely recognised, the responsible public authorities seem to feel estopped from proposing necessary reforms, and a strong need to defend their reputation. These authorities usually offer nothing of consequence in their public submissions, in the hope that particular issues will either not arise or, if they do, might be dealt with discreetly.

The defensive position of public authorities reflects their vulnerability -- if things had needed to change, they would already have been changed, wouldn't they?  Not having responded usefully to issues then in public debate, public authorities seem unable to say, openly, that something needs (needed) to be done.

The public sector is not much help in the public inquiry process -- except as the political decision to hold the inquiry is clearly directed at achieving particular outcomes.

The one chance for an effective contribution from public authorities, to public inquiries, lies in this potential for some territorial, functional imperialism.  The recent Wallis inquiry into the Australian financial system is a benchmark illustration.

The big players in the private sector are, similarly, not inclined to say anything provocative either.  On the one hand they risk offending their public sector regulators that are likely to wear the brunt of effective criticisms.  More important perhaps the big players stand to lose most from industry and institutional reforms promoted in the "public interest".  Those who doubt this could peruse the submissions made recently by UK banks to a, current, UK inquiry into banking services. 

Asked to identify shortcomings and issues needing to be addressed, the responses of the UK banks are a universal "not much" -- the current retail banking system (akin to Australia"s) is said, by them, to be working just fine. They would say that, wouldn't they?

In short, among those most likely be able to make a useful contribution -- in the public interest -- to the public inquiry process, there is a commitment to silence which is carefully disguised in otherwise lengthy submissions of no material consequence.  Again, the recent Wallis inquiry process was a benchmark illustration.  

Among other things, there is an unwarranted presumption that the captains of industry, and government authorities, are innately altruistic and will disregard their private interests (including reputation) and speak openly and objectively in the public interest.

Nothing could be further from the truth, in practice.  The limited range of objectives that underpinned the political decision to initiate the inquiry usually predetermines the progress that public inquiries do, often, make "in the public interest".

If the main, headline, players in public inquiry games are effectively off-the-field, a game will only be played out if smaller institutions and associated pressure groups, such as the consumer lobby, open the game up.

Smaller institutions, also driven by their private commercial interests, can be effective.  Over time, however, they have become less effective contributors to the financial system reform process as they have gained concessions from earlier inquiries: concessions which tend to tie then to the main defence team dedicated to preserving the status quo.

With many of the other players off the field, the consumer lobby is singularly effective, especially having regard to their limited resources.  Even so, their effectiveness often lies in their ownership of the evidentiary details of common, customer complaints, which are demonstrably well founded and clearly underpin a need for systemic redress.  Public interest groups, such as the consumer lobby, are, however, less effective in the broad sweep of the big-picture policy debates. Consumer groups, covering a broad field of consumer concerns and without resources to finance the required research and policy development work, tend to be overwhelmed by the resources available to industry insiders where the battle concerns marketing ideas rather than clear facts.

SEIGNIORAGE

It is worthwhile coming to terms with the concept of seigniorage.  It is a key concept in understanding the failure of public policy to properly underwrite the effectiveness of the retail banking market.

The failure of public policy to properly deal with seigniorage revenues accruing to the commercial banks is at the heart of the failure of the retail payment system to operate efficiently.

Seigniorage, a unique concept, is usually simply jargon for the profit which central banks naturally make from the business of issuing banknotes.

Banknotes on issue are akin to non-interest bearing deposit assets held by the community. The counterpart liability is an interest-free borrowing by the Reserve Bank (the note issuer).  The Reserve Bank holds those funds in a range of assets, especially interest-earning domestic and foreign government bonds, but also barren gold.

The business of issuing banknotes is naturally very profitable to the note issuer.  It is especially profitable when interest rates are high.  On the face it, holding banknotes is, correspondingly, naturally unprofitable for the community, especially when interest rates are high. 

The interest earnings "lost" by the community holding banknotes is, overall, substantial: some 1 billion dollars, when the note issue is $20 billion, and interest rates are 5% per annum; $3 billion dollars, at an interest rate of 15% per annum.  

The community interest is protected by arrangements that ensure the seigniorage (profit) earned on the note issue flows, through the Reserve Bank, to the public purse held by the Commonwealth Government.  In this broader context seigniorage revenues are akin to a natural tax which belongs to government (and the community generally).

Seigniorage is a word little used over the past century after national governments took over, from the private banks, the right to issue banknotes.  Even before Federation, state governments levied special taxes (akin to seigniorage taxes) on the value of banknotes issued by private banks.  This arrangement, similarly, ensured that the seigniorage, or natural profit, accruing on the private-bank note issue flowed through to the general public purse.

Recently the concept of seigniorage has been back in contemporary debate, in the context of proposals for the issue of stored value cards (SVC) by private financial institutions. Such electronic money would substitute for currency, as do cheques and transaction cards. The prospect of SVC being substituted for currency captured the attention of central banks, not least because it appeared to threaten their access to seigniorage profits from a, prospectively, contracting note issue. 

For the purpose at hand, the importance of seigniorage lies in extending the range of the concept to embrace some prevalent arrangements in the retail banking industry that are, practically, akin to the business of issuing banknotes. 

Until recently, regulation prohibited banks from paying interest on cheque account deposit balances.  However, even with that regulatory prohibition now rescinded, banks typically pay little or no interest on transaction account deposit balances -- not only in cheque accounts, but also in transaction savings accounts.

Private banks make a profit (akin to seigniorage) as a consequence of them taking low-interest deposits which they invest or on-lend at commercial interest rates.  Where this profit goes is a moot point.  Banks say that seigniorage revenues cover the cost of providing free (or underpriced) transaction services to their customers.

The past decade has seen market interest rates in a range between five and 20% per annum.  In the high interest rate years a very substantial part of the seigniorage taken by private banks was effectively income that was not accounted for: it more than matched the, otherwise unrecovered, costs of providing transaction services.  When interest rates fell to relatively low levels, the seigniorage taken by banks was probably not sufficient to cover the costs they incurred providing free transaction account services. At this time, bank revenues were supplemented by overcharging borrowers for loan funds, especially housing loan and small business borrowers. Effective competition for housing loan business (Aussie Home Loans) subsequently denied banks access to soft revenues, from over-charged housing loans.  

Banks needed to confront the issue of cost-related charges for transaction services. They did.  And they are. Not, however, in an open, transparent, competitive way. Some services are undoubtedly over charged for while some others, especially high-cost cheque facilities, are still available free of charge to most customers able to meet modest, minimum account balance requirements.

That matter aside, there is still the question of whether these government-sanctioned arrangements properly serve the community.  Practically they result in a diversion of potential tax revenues to subsidise the operation of the retail payment system, especially the high-cost, inefficient cheque payment system.  A fair assessment is that the community is not well served.

In short, established public policy approaches ensure that profits earned on the currency issue flow through to general public revenues, and central banks worldwide were quick to see the parallels in the proposed private issue of electronic money in the form of stored value cards.  It should be a short step from that sensible thinking to a reconsideration of long-standing arrangements that have permitted bank earnings, akin to seigniorage, to be retained for their private account rather than sequestered for the public purse.  Similar things are best treated similarly.

All this may seem to be a bit esoteric but the issues raised go to the heart of some key policy issues which affect the capacity of the market for retail banking services to work properly and effectively, and promote efficiency in the operation of retail payment systems.

-- boxed-currency

Some two-thirds or more of currency notes and coin on issue in Australia does not circulate in any meaningful sense. The currency that does not circulate is "boxed" and hoarded, figuratively "under-the-bed", as stocks of banknotes, especially $100 and $50 banknotes.

Holdings of currency notes per-head in Australia exceed $1 000.  This contrasts sharply with the situation in New Zealand, where holdings of currency notes per head average around $400.  This is a marked difference in day-to-day behaviour between two otherwise comparable cultures and economies.

The most obvious explanation for such a marked difference is that access to social security benefits in Australia is subject to a means test, in New Zealand it is not.  The inference is that some Social Security recipients in Australia manage their means-tested eligibility for benefits by holding  assets, anonymously, as currency notes.

In an article "Some Features of the Australian Payments System" the Reserve Bank commented on these, currency, matters in its December 1998 Bulletin. The most it could bring itself to say was that " a proportion of notes on issue is hoarded as a store of value" -- hoarding, running to two thirds of the notes on issue is a very large "proportion".

The relative importance of currency as a transaction medium has clearly declined with the advent, first of cheques, and more recently a range of plastic transaction cards that substitute for cash in the day-to-day retail payments.  The revenue that the national note issuing authority, the Reserve Bank, makes from the issue of currency for transaction purposes has been eroded by the substitution of similarly low-cost liabilities on the books of the banks, for the central bank currency issue. 

Conversely, the continually growing seigniorage-style revenues of the banks that should have been sequestered for the public purse have been allowed to flow without any accountability as to how that "free" money is spent. As has been pointed out, this free money in the banks' hands has been largely wasted on providing expensive and inefficient payment services (to say nothing of the non-repayable loans given to failed entrepreneurs in the high-seigniorage, late 1980s when the foreign banks were being repelled). 

In the early stages of the Commonwealth Government regulating banking, a system of bank's "special account" statutory reserve deposits with the Reserve Bank was introduced to ensure at least part of the seigniorage revenues of banks flowed to the public purse. These arrangements have been abandoned.

In the event it is somewhat ironic that a major part of Reserve Bank operating revenues flow from what is essentially tax-evasion activity arising in the means-testing of social security benefits.  This, while the commercial banking sector is appropriating to itself revenues of some $3 billion per annum, akin to seigniorage, made as a consequence of displacing currency notes for day-to-day transaction purposes. Whether or not this soft revenue flow to the Reserve Bank has been properly disbursed is a moot point: perhaps more could have been spent on reforming the payments system and less financing holdings of barren gold long past its use-by date.

Among the issues raised in this digression, the more important point would seem to lie in the unreasonably large, unaccounted revenues flowing directly to the private banking sector rather than to the people where they more properly belong.  It would best be a separate decision whether the community would choose to appropriate those revenues to subsidise the current retail banking system or not.

WHO IS (NOT) RESPONSIBLE?

Who is (not) responsible for the failure of the banking industry to operate efficiently in respect of its retail payments system operations?

The banks themselves can hardly be held responsible for the current situation.  It is the fault of the banks, only if it is valid to believe that banks should voluntarily act altruistically in the public interest out of some sense of social obligation, and in disregard of their private commercial interests.

Such expectations are fanciful, at odds with the way the world works.  

The customers are not to blame either. Customers of banks act in their own self-interest when choosing between the range of alternative institutions and services.  A more assertive customer base could perhaps force the pace of change.  However, the customers are not organised, nor well informed, and those speaking on their behalf, are generally not properly funded to finance the necessary research and policy development work and promote the reform agenda.

The responsibility for the failure of the retail banking industry to operate efficiently would seem to lie squarely with the regulatory authorities -- including the Australian Tax Office (ATO); the Australian Competition and Consumer Commission (ACCC) and the Reserve Bank of Australia (RBA).

-- THE AUSTRALIAN TAXATION OFFICE (ATO)

The ATO does not recognise the tax avoiding bartering arrangements deeply embedded in he retail banking industry.  Conversely it was quick to outlaw the tax-avoiding behaviour inherent in embryonic schemes promoting the "no money-no tax" swapping of professional services among participating members.

Retail banking customers forgo a proper rate of interest on their transaction deposits in return for access to free, or underpriced, transaction services.

That matters because the process involves the conversion of taxable personal income into a tax deductible business expense. Instead of receiving, say, $100 in taxable, deposit interest, individual customers are given the value of free transaction services costing, say, $100, as income-in-kind.  Tax is avoided, currently to the extent of some $1.5 billion dollars per annum, and much more when interest rates were higher.

While the banks may balance their costs of providing transaction services against the interest earned by investing their customers, transaction-deposit funds, the net effect understates the taxable income of bank depositors.  The tax-free, trade-off of taxable income for tax-free, income-in-kind is endemic in retail banking.  Only the relatively poor typically pay, explicitly, for bank transaction services; the relatively well off meet the, offsetting, minimum balance requirements for access to free transactions, and the "charges" are implicit.

Consider a retail-banking environment where depositors are deemed to earn a market rate of taxable interest income on all bank deposits with no offsets for bank fees and charges (as are social security recipients).

The ability of banks to provide "free" transaction services would be somewhat curtailed in such circumstances.  Driven by market forces to recover the costs in explicit, cost-related prices for transaction services, banks and their customers would quickly reconsider the current situation, especially in respect of costly cheque account facilities, now commonly provided free of explicit charges.

The demand for cheque writing facilities would change quickly if the customers were asked to pay some $3 per cheque -- the likely full cost of banks providing that service. Markedly fewer cheques in retail banking would lead to the substitution of other, electromic, payment instruments and marked cost-efficiency gains, as the banks provided, and the customers used, cheaper, electronic transaction facilities.

-- THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION (ACCC)
  
The ACCC has not, in its normal course, devoted much of its resources to scrutinising the soft, cooperative/collusive, arrangements endemic in the retail banking industry.

These arrangements are administered by industry managed, quasi-regulatory institutions such as Visa/MasterCard and APCA (the successor to the Australian Clearing House).  Such arrangements in the retail banking industry affect the supply and pricing of particular transaction services: on the face of it some of the agreements would not pass any reasonable test of being "in the public interest".

TRADE PRACTICES POLICY

A range of trade practices in the payments industry and related, express and implied, agreements have been let run, untested against the public interest.  The obvious exception as regards official interest is in respect of bank merger proposals, where the ACCC may have decisive authority in calm-market circumstances. 

By way of a slight digression a comment about the ongoing bank mergers debate is appropriate.  Not allowing the debate on big-bank mergers to proceed, effectively ensures that informed discussion about the structure and conduct of the retail banking industry does not take place.  The associated failure to address issues, which would inevitably come to the fore in a proper debate about the merits of big-bank mergers, is lamentable. While some bank executives may be annoyed that the ban on mergers remains, they would be pleased that the focus on the merger issue diverts attention from other issues on which they would be vulnerable, especially in the negotiation of the required preconditions for mergers to be approved.

It would be far preferable if a properly informed debate about the retail banking industry were conducted separate to the current cat-and-mouse game on big-bank mergers.  Under the rules of cat-and-mouse, the mice simply have to wait for suitable market circumstances to achieve their objective, without having to subscribe in advance to an appropriate code of public interest behaviour.  Ideally, on the contrary, some "takeover" redistribution of banking business could be achieved if the major banks were placed in the situation where they had to compete with each other to build and defend their position in the market.

The threat of using official consideration of merger proposals to negotiate needed reforms to industry trade practices should perhaps be put to one side and the negotiation of needed reforms commence forthwith.

A range of matters, identified in the context of "what's wrong?" would seem to warrant the close attention of the trade practices authorities.

Casual observation of what is happening, and is not happening, in the way retail payment services are provided - and not provided - to the Australian community, points up a need for more careful scrutiny of banking industry practices.

It would seem appropriate for parties to trade practice agreements -- express or implied -- to clearly and transparently explain why the agreements are in the public interest.  As things stand, the banking industry seems to disregard the trade practices authorities and to be generally disrespectful of broad community concerns to be assured that common industry practices operate in the public interest.  Many agreements within the banking industry (including common, "bilateral" agreements) are not even registered with the ACCC and thus not on the public record to be transparently assessed against "public interest" benchmarks.

Many banking industry agreements are necessary and clearly in the public interest.  These agreements fall within the range of necessary cooperation: the national payment system would not work unless all classes of payment instruments were automatically interchangeable with all participating providers of those payment services.  The format of all classes of payments (whether they be cheques, cards or direct entry) must meet common industry standards.  Such necessary cooperation is clearly in the public interest.  

A danger arises when agreements founded in "necessary cooperation" include additional, discretionary provisions and informal "side agreements".  It can be a short step in the process of drawing up industry agreements for "discretionary cooperation" to become collusive practices, masquerading as reasonable cooperation, and clearly against the public interest.

In the normal course it might be expected that policy-making for the retail payment system would be guided by developments in other countries -- especially those in the normal reference group, the United States, UK and Canada.  Unfortunately these issues do not seem to have been dealt with properly in those countries either.

-- Does it matter?

Banking industry agreements affecting the nature, range and pricing of services across the industry can be judged against the public interest in different ways.  Some agreements are clearly OK, some agreements clearly not and most have a mix of good and bad features.  The assessment process balances matters of high principle against the pragmatic need to accommodate agreed practices, which enable the industry to operate effectively.

In the normal course it may not matter all that much if a particular banking industry agreement were to deliver relatively generous benefits to the parties to the agreement, albeit at the expense of the wider community.  Objectionable in principle but accepted as a pragmatic reality.  Excess profits, if any, find their way back into the community -- especially to those with direct, or indirect, holdings of shares in banks.

Well-justified concerns arise, however, when the provision of inferior, high-cost banking services persists, while better, lower-cost alternative services are withheld or not marketed effectively.  In those circumstances the community is doubly disadvantaged.  Not only does the community pay (directly or indirectly) for inferior, high-cost services but also they are denied the better, low-cost alternatives.  There can be a substantial, dead-weight cost imposed on the community by industry practices that would, if scrutinised, be judged improper.

Casual observation suggests that some agreements have been let run because the first-glance, redistribution of income in favour of the industry, does not seem to be beyond the pale.  The acceptance of such agreements takes on a colour of very different hue when the consequences underpin a continuing substitution of more profitable, but worse, services for less profitable, but better, services.

--A ray of hope 

In a landmark decision in September 1997, the ACCC rejected the proposed industry agreement on rules, put forward by APCA, for clearing retail payments transactions made using automated teller machines (ATM) and facilities for electronic funds transfers at point aside (EFTPOS).

This decision was remarkable because the industry proposals put by APCA to the ACCC carried the specific endorsement of the Reserve Bank.  Moreover, two officers of the Reserve Bank held positions, separately, as Chairman of the Board of APCA and as a member of the Board that approved the application.

A paraphrase of points made in the ACCC press announcement on 5 September 1997, includes:

•	it is likely that the current ATM and EFTPOS access and payment arrangements would raise trade practices concerns;
 
•	the proposed rules were substantially incomplete and require further development and amendment; and

•	There would be considerable efficiency and competition advantages in:

•	the development and monitoring, by APCA, of mandatory interchange standards for participation by card issuers and transaction acquirers, in the ATM and EFTPOS networks.

•	ensuring that transaction interchange fees paid between banks were based on efficient pricing principles so as to ensure that access to the ATM and EFTPOS networks is available to card issuers and card transaction acquirers on fair and reasonable terms; and

•	removing the "banks only" rules on direct participation in the associated payments clearing system because it was unnecessarily restrictive and not justified in the public interest.

This announcement by the ACCC included two other relevant comments: 

•	First, "The credit card arrangements of Visa, MasterCard and Bankcard, which include participation criteria and clearing and settlement rules, do not form part of the APCA applications for authorisation, and have not been considered by the Commission in the draft determination."; and

•	Second, " Current credit and debit card payment arrangements are not protected under the Trade Practices Act, so persons taking part in any such arrangements that may breach the Act would be open to court action by an aggrieved party or the ACCC."

These comments echoed recommendations in the 1995 report of an inquiry by the Prices Surveillance Authority into fees and charges imposed on retail accounts by banks and other financial institutions and by retailers of EFTPOS transactions.  The PSA specifically addressed suggestions at the time, that the Visa and MasterCard associations may assume control of Australian EFTPOS debit card operations, and establish a pricing regime similar to that existing for credit card transactions, including kickbacks to card issuers. The PSA recommended "that any proposal to introduce international debit cards into Australia be monitored, with a view to ensuring that the pricing principles adopted reflect the costs and risks of providing the service."

It is regrettable that such a useful insight by the PSA in respect of debit cards was not logically extended to a recommendation that similarly objectionable and long-standing practices in respect of credit cards be critically reviewed.  

While these decisions, comments and remarks are encouraging in the context of proper scrutiny of trade practices agreements in the retail banking industry, there are the further questions of when appropriate action will be taken, and at whose initiative.

--THE RESERVE BANK OF AUSTRALIA (RBA)

The RBA has long had a difficult balance to strike in dealing with issues that might compromise its primary responsibility for the safety bank of depositors. Until recently the RBA took only a vague responsibility, if any, for efficiency in retail banking.  The shift of responsibility for the supervision of individual banks, from the RBA to APRA, is a necessary precondition to a better balance in policy development, within the Reserve Bank, to foster payment system efficiency. 

Freed of its responsibility for individual banks, the RBA will be less inclined to accept the trade-off of system efficiency for arrangements that both featherbed bank profitability and are inimical to efficiency in the retail payment system.

 APRA, on the other hand, may not appreciate the withdrawal from the banking industry of soft, unaccountable income flows, originating in unwarranted subsidies effectively drawn from the public purse of the Commonwealth, or excessively profitable services provided to the community.

RESERVE BANK: PAYMENTS SYSTEM BOARD

The newly established payments system board (PSB), yet to strike a blow in public, is concurrently a focal point of both hopes and fears for needed reform of the retail payment system.

As usual, the hopes reflect the legislative charter given to the PSB -- especially the emphasis on competition and efficiency, as well as more traditional, stability and safety objectives.

The fears reflect the risk that, once again, a public policy body reliant on the Reserve Bank for its practical sense of purpose and direction will be found wanting.  The form line on the Reserve Bank in this context, taken through the Australian Payment System Council (APSC) and the Australian Payments Clearing Association (APCA) is, as noted, not good.  

On disclosed form there is no reason to expect the PSB to be a major force for reform of the efficiency of the retail payment system in Australia.  Rather the rational expectation is that the PSB will busy itself with ensuring that administrative arrangements in the retail payment system underpin a safe and sound payment system, but be unable to do much to redress ongoing inefficiencies in the system which will go unchallenged.

Support for this view was provided in the transcript of the discussion between the Governor of the Reserve Bank and the Parliamentary banking committee on 15 December 1998.

Asked to address issues of competition in credit card business, especially the high interest rates charged, the Governor said that he "did not know", "never really understood" why credit card interest rates were so high and referred the committee to APRA and the ACCC. Asked if that meant the Reserve Bank did not propose to do any work on that, the Governor said "No. We do not have any responsibility for the banking sector per se."

This was a surprising and disturbing response, given that the Governor is also the Chairman of the new Payments System Board, a body many hoped would at last take some accountable responsibility for the proper conduct, reform and development of the Australian payments system. 

Safe-and-sound is an important, non-negotiable base point for the structural arrangements underpinning the national payment system.  Safe and sound does not, however, preclude that the retail payment system could be efficient as well as safe.  As things stand the retail payment system is not efficient and, on past form, it is unlikely that the PSB will take purposeful initiatives to turn things around.

Among the handicaps which the Reserve bank carries are:

•	A long history of considered inaction in addressing impediments to efficiency in the retail payments system: 

•	A practical day-to-day dependence on the major national banks to actually implement preferred changes.  The major national banks are renowned for their reluctance to disturb the status quo unless it is clearly in their commercial interest to do so, and it rarely is; and

•	Ongoing confusion of responsibility between the ACCC and PSB for trade practices matters in the banking industry: matters that are in need of prompt attention.  The legislative reluctance to clearly define the location of accountable responsibility for retail payment system efficiency (and prevailing trade practices) is regrettable.  The recently published memorandum-of-understanding between the Reserve bank and ACCC hardly presages a surge in regulatory accountability.

ANOTHER GOVERNOR SPEAKS

Central bank governors, worldwide, are preoccupied with "safe and sound" objectives for national payment systems and rarely, if ever, address issues affecting the efficiency of retail payment systems.

An exception to this general disinterest was a one-off contribution to the debate made by Governor Fraser in 1994.  In a short prescient commentary on the issues, Governor Fraser  remarked on:

•	The lack of competitive pressure on the major national banks stemming from the unwillingness of the customers to shop around for banking services.

•	The endemic and extensive cross-subsidisation inherent in the marketing of packages (bundles) of retail banking services, evidenced by loans and deposit products being overcharged (or underpaid) so as to enable banks to give other, expensive, transaction services away largely free of charge; and

•	Progress in achieving efficiency gains would be frustrated by customer reaction to bank branch closures; bank staff reductions; higher bank fees and the "forced" shift to using different payment technologies.

Prescient or not, the implied challenge was left on the table with no purposeful effort being made to address the task of turning attitudes around in the community; in the banks and among the regulatory authorities.

A DIVERSIONARY FOCUS: RTGS

The Reserve Bank sees its major recent contribution to the payment system being the operational establishment of the so-called real-time gross settlement system (RTGS). 

RTGS is an institutional arrangement ensuring that high-value funds transfers between bank accounts are settled immediately between the participating banks -- rather than settlement of the transaction being held over until the following day.

RTGS is an essential technology-based innovation consistent with world standard best practice and helpful, to a degree, in fostering the stability and safety of national and (next year) international payment systems -- a major concern of central banks.

The comfort, in terms of "safe and sound", is nonetheless more apparent than real.

RTGS is no panacea for removing risk from the payment system. It is, moreover, likely to be the catalyst in crystalising community perceptions of a range of other risks in the payment system. Other risks remain disguised, especially by the flawed, international regulatory framework for bank supervision. 

Among other things:

•	The prior real-time settlement of high-value payments puts the settlement of other payments at greater risk. A bank bereft of settlement funds to complete high-value payments is equally unable to settle other payments still in the system that are scheduled for settlement the following day.

•	The payments then at most risk of not being settled are, of course, small retail payments, especially cheque payments.  For cheque payments the settlement risk is, technically, never absorbed within the banking system but, rather, continues to be carried by the customers – the payees holding worthless cheques and payers still owing the payees, but without access to their deposit funds held in a bank that has failed.

•	More generally the systemic management of payments flows in the RTGS system conserves the need for liquidity. This is achieved  by the use of a queue jumping arrangement to avoid gridlock: a large payment due to be made from a customer's account with a bank not having adequate settlement funds, may be repositioned in the queue behind a smaller payment that can be finalised.  It is a moot point as to the rights of the larger payer if their bank were to fail before any of their available  funds on deposit with the then failed bank were withdrawn

The immediate-settlement protection of high-value payments is at the expense of small-value transactions then unable to be settled, on schedule, the following day.  Unless, of course, the government (or its agents) were to step in and bale-out the bank unable to meet its obligations.  The pressure for a government bale-out would be irresistible in the case of a major national bank, but very resistible in the event of the failure of a smaller bank, the failure of which had no material consequences for systemic stability. This reality is a major barrier to the effective entry of new competitors in retail banking.

RTGS reinforces the prevailing competitive imbalance. It further fosters the market dominance of the major national banks that are too big to fail. It weakens the market position of smaller institutions, supposed to provide the competition, but handicapped in their appeal to depositors by not meeting the test of "too big to fail".

To offset this disadvantage, smaller banks have developed industry-based liquidity support arrangements to address an unwarranted loss of confidence in particular member institutions. These arrangements, however, stop well short of the comfort given to the customers of the major banks and their certain knowledge that the government will protect them. 

An innovation, RTGS, which the Reserve Bank would regard as a major achievement is, in its practical working in the current enviironment, likely to add to the range of impediments to efficiency reforms in the retail payment system. 

Giving the Reserve bank a charter to pursue payment system efficiency is, in many ways, the antithesis of its more fundamental charter to deliver systemic stability -- a safe and sound financial system. The conflict between these objectives has some parallels in the juxtaposition of price stability and full employment as the " dual objectives" of the monetary policy pursued by Reserve Bank.

In the context of the payment system, this inherent conflict of objectives coupled with the Reserve bank's natural preoccupation with safe and sound does not bode well for the RBA making an effective contribution to the efficiency of the retail payment system.

A SLEEVE CARD

More by good fortune than good management, the monetary authorities in Australia have not had to play the deposit insurance card to stem a crisis of confidence in retail banking institutions.

They will when they feel they have to. The card is in the sleeve.  

They have come close on previous occasions.  In the late 1970s when customer confidence in some building societies faltered, a national deposit insurance scheme was mooted in the lead up to a Federal election, subsequently established and then allowed to wither as the need for the scheme passed.  In the early 1990s state governments owned the banks that failed and the national authorities were able to stay their hand on the deposit insurance issue, leaving the States to clean up an internal mess. 

Somewhat surprisingly the Reserve Bank itself then raised the prospect of deposit insurance in the context of the Wallis committee. This intervention reflected concern about depositor protection arrangements coupled with the then growing inclination in the committee to separate responsibility for bank supervision from the Reserve Bank.  

In resisting this prospective change in the scope of its responsibilities, the Reserve Bank floated the case for a deposit insurance scheme in a supplementary submission to the Wallis committee. The thinking apparently being that the conduct and management of such a deposit insurance scheme, and disbursements from it, would best reside with the central bank that should then retain responsibility for bank supervision in a natural, inseparable combination of "depositor protection" functions.

In the event Australia has a new Prudential Regulatory Authority for the banking system and it is probably unlikely that the Reserve Bank would retain a keen appetite for managing a deposit insurance scheme.

The deposit insurance card remains in the sleeve of the banking authorities.  The discipline of RTGS will almost inevitably ensure that this card is played in the future to address some crisis of confidence in retail banking.  

Be that as it may, in the meantime small retail banking institutions, which many regard as the hope of the competition side, remain vulnerable and disadvantaged relative to their major national bank counterparts. The customers of the too-big-to-fail, major national banks enjoy the valuable benefit of an informal, unstructured, community-funded deposit insurance scheme -- a scheme on which a blank cheque would be drawn on the public purse to cover possible depositor losses in some banks.

This part of playing field needs leveling up -- preferably by ensuring that all banks are properly, privately capitalised rather than imposing the vagaries of discretionary (taxpayer funded) deposit insurance arrangements and their attendant moral hazards and distortions to the competitive market environment.

THE CONSUMER LOBBY

A wide range of consumer groups exercise a disproportionate influence on public policy, when that influence is assessed relative to the financial and personnel resources at the disposal of organisations representative of consumer interests 

The influence which the consumer lobby brings to bear on public policy processes in the financial services area is, almost invariably, beneficial. Surprisingly so in circumstances where they are under-resourced. 

There is considerable waste of taxpayer funds inherent in existing payments system arrangements -- especially the subsidising of the major national banks in their provision of expensive and inefficient retail banking services -- often delivered with a touch of arrogant disinterest in the situation of their customers.  Against that it is remarkable that little in the way of government funds is provided to bolster the resources of consumer organisations to properly conduct necessary research, customer education and policy development.  What little government funds that have traditionally been provided to private consumer organisations have, moreover, been largely withdrawn over last couple of years.

One bright spot in all this, is the re-orientation and augmented resources of the Australian Securities Commission (now the Australian Securities and Investment Commission) with a brief to develop and pursue consumer protection issues across the spectrum of retail banking, funds management and financial services.

THE MAJOR BANKS 
--the self regulation of the banks, by the banks, for the banks

The major national banks effectively control the key defacto public policy body -- the Australian Payments Clearing Association (APCA)-- and, when they permit it to operate, the ABA (Australian Bankers Association) -- sometimes jocularly referred to in the trade as the Australian Burglars Association.

It is essential and proper that the banking industry has a semi-official, self-regulatory role in managing the payment system, through the Australian Payments Clearing Association (APCA).  The industry performance that is evident in the output of APCA has, however, been found wanting -- the unwarranted delay in shortening that cheque clearing cycle being but one example. It seems that not much purposeful progress towards a better retail payment system will be made at APCA with its current attitudes and in the current failed market. 

Needed reforms in the public interest run counter to the individual and collective current interests of the major banks, and other payments service providers.  The dividing line between beneficial cooperation and efficiency-sapping collusion can be a fine one.  APCA is not working effectively in the public interest.

While an industry body like APCA is essential, it has some operational features the community could do without. The operation of APCA could be constrained in the public interest by changes to relevant tax and trade practices policies, but there is also attraction in ensuring that the governing board has "public interest" representatives, including the chairman.   

THE MAJOR BANKS MORE GENERALLY

It is appropriate to discuss the role of the major banks in the general context of "public policy". 

The nature of the industry is such that it is essential for the industry as a whole to be the major formulator and administrator of the practical policy framework under which the industry must uniformly operate.  The poor performance of the retail banking industry nonetheless points to the need for industry "policy" work to be done in a setting more tightly constrained by proper public policy objectives.

There is, however, no point in simply blaming the banks for the problems besetting the retail banking industry.  The banks do what is best for them in a market environment, and a compliant public policy environment, that fails to serve the community properly in the general public interest.

The banks cannot be expected to volunteer insights into the ways that the retail banking market fails to work in the public interest, nor into the shortcomings of public policy that allow them to play the game to benefit themselves.  The banks play to win: it is not for them to identify rules of the game that, while inappropriate, serve their interests. After all, the banks set most of the rules to suit themselves.

Even so, some of the ways banks play the game are deserving of censure.  Not least the day-to-day observation of patterns of common behaviour that the senior executives of banks would know is unlikely to meet the test of scrutiny against reasonable, public-interest criteria.  They do what they are allowed to do and they tend to do the same things the same way together.  

Collectively the major banks often show a good measure of disrespect for the Australian community. The banks seem to operate outside the legal framework that is supposed to define basic constraints on acceptable commercial behaviour -- including, no tax-avoiding bartering, which offsets personal customer income against bank costs, and no agreements on pricing and marketing practices that are untested against the public interest.

Among other things, banks would be unlikely to welcome scrutiny of their behaviour, against public-interest criteria, in a number of product areas.

The relevant products include:

•	credit cards and their attendant marketing strategies;

•	debit cards and the withholding of facilities giving access to linked accounts; 

•	the BPay, bill payment facility and the associated diversion of payments activity from direct debit facilities; and 

•	the supply of inefficient cheque payment facilities at prices (if any) which bear no relationship to the private and social costs of providing the facilities.

The provision of these facilities is, or should be, overseen by APCA, the self-regulating industry body owned and managed by the banking industry.
 .
Any prospect of establishing proper market disciplines on the provision of the products would, no doubt, be strongly resisted by the banking industry.

The resistance movement in the banking industry is led by two major national banks.  These two banks have developed considerable expertise in playing a, stop-it-I-like-it game ("bank-bashing") with the general community. 

The general community is given to knee-jerk reactions to changes in the established order in retail banking. The community reacts predictably to higher fees and charges for bank transaction services, where there were none previously; the closure of convenient but often unnecessary bank branches; the withdrawal of customer services from remaining bank branches and the tough enforcement of contracts with bank borrowers -- among many other things.

Given a choice between giving proper, rational explanations of the need for service reforms or making provocatively insensitive remarks that fuel the fire of community angst -- two of the major banks often opt for the latter.  Without repeating a litany of such provocative remarks, some come readily to mind. These include -- references to the provision of expensive branch banking facilities said to be conducive to a community social gathering, and lamentations that the community writes letters of complaint to banks about branch closures rather than letters of congratulation for exceptionally good performance. On one, memorable, earlier occasion credit card customers who paid their credit card bills on time were described as "free-loaders" when, in truth, it was they who were being loaded with expensive charges indirectly. The banks apparently see such provocative remarks as good sport at the expense of the community.

There are reasons for this repeated, deliberate, public misbehaviour of banks. 

One explanation is the pressure thereby put on political government to be wary of intervening in banking policy issues and otherwise to treat the major banks gently. The banks have a capacity to precipitate that special kind of political unrest where the heat in the debate is inversely proportional to the fundamental importance of the issue raised. The banks rarely raise the hard issues in public -- they do not like to be drawn into proper debate.

There is a reward to the major banks for this misbehaviour: it buys time for them to resist, delay and obfuscate reforms that might threaten their current commercial interests and their dominant market position.

Those who doubt this could reflect on the likely outcome of public policy decisions that would restore proper market disciplines in the retail banking industry. For example:

•	the likely outcry if banks were denied access to soft income flows originating in the uniform industry practice of not paying proper market interest rates on customers transaction deposit balances; or 

•	if banks were required to modify the high and uniform pricing arrangements underpinning credit card schemes (and the withholding of better, cheaper services).

The major banks stand ever ready to make necessary changes in the way they operate, but only in their own good, chosen time  -- unless the need to change is forced upon them.

A better public policy framework would expose the major banks to more effective competition from smaller retail banking institutions.  That said, the prospect of greater competition coming from small banks is often greatly overstated.  

The way the market is structured, it usually suits smaller banking institutions to play much the same game with the customers as the major banks.  However, it is also likely that the smaller institutions are wary of proper competitive markets for some retail payment services such as credit cards. Small banks are better focused on providing payment services other than cheques and credit cards and, among other things, more willing to expand their direct entry processing of direct debit and credit transfers -- this could be a competitive advantage if the market environment were reformed.

The major banks are usually resistant to change at a pace quicker than they would choose themselves.  One current preoccupation is to extract what they can from the market imperfections underpinning the cheque and credit card payment systems.  Both the ABA and APCA are ever ready to disparage criticism of the soft income banks make from the unduly long cheque clearing cycle.  They deny an advantage to banks in terms of interest income, saying that interest on deposit accounts is paid from "day one" when the cheque is deposited.  What they fail to say is that most cheques are deposited in transaction accounts on which, if interest is paid, it is paid at a fraction of 1% per annum.  

Australia has two (rare) case studies of the banks under competitive pressure.  One was the cash management trust initiative in the early 1980s. The other, more recently, the competition offered by the housing mortgage originators. In both cases the majors did not adapt quickly to the changed market circumstances. The majors were nonetheless ready to attack be newcomers once they realised the competition was effective; their business was being eroded and particular aspects of the game that they were playing had reached their use-by-date. 

A lot less talk about the dubious benefits of further mergers among the major banks and good deal more focus by them on collectively providing efficient payment services would be a very useful outcome of purposeful, official scrutiny of prevailing arrangements.       

A danger however is that there could be a further round of sycophantically compliant public policy posturing supposedly aimed at pressuring the major banks to perform properly while knowing full well that, unless constrained by market circumstances, the banks will do nothing that is not clearly in their commercial interest. Why would they volunteer to do the right thing? 

THE CAPTAINS SPEAK

Over recent years, when not making provocatively insensitive remarks, two of the chief executives of the major banks have turned their hand to more philosophical observations designed, in roughly their own words, to improve the public image Australia's major banks.

These chief executives are perhaps entitled to put a "gloss" and "spin" on their views, to balance up criticism of the banking industry that they consider is a bit harsh.  "Gloss and spin" are one thing but flawed defensive claims and assertions, without proper regard for underlying truth are quite another.  The thought that they may believe that what they say is true is equally troubling: either way, the views that these captains of the industry are wont to trot out in public is a lamentable reflection on the public accountability of the banking industry. Silence can be accepted but when these chief executives choose to speak publicly, the community is entitled to some respect for commonsense.

What follows is a sequence of extracts from considered pieces publicly offered by David Murray and Don Argus, followed by a comment which hopefully puts the issues in perspective.

In respect of both contributions from the chief executives that are discussed, it is salutary to note that each concluded their remarks as follows:

•	By getting together with the regulators and articulating our vision for the future, we can help create the best of futures for our customers, for our shareholders, and for Australia.

•	Importantly, there needs to be an acceptance on the part of government that bank profitability is entirely consistent with providing a world-quality service in competitive environment.  Finally, I believe it is time government and the banking industry joined forces.

Given the free run that the major banks already seem to enjoy, with the implied acceptance of government, one can only wonder what else these chief executives may have it in mind to do when they "get together" with the government regulators. They have shown no inclination to get together with government to actively pursue needed public policy reforms in the retail banking industry.
.

 -- selected extracts (and an alternative view)

David Murray

First, David Murray speaking as Chairman of the Australian Bankers Association in mid 1995 in an address titled "Creating banks for the 21st Century: are we on the right track?" 

The banks are financial intermediaries in the community.  They hold funds for some people, and lend them out to others.

Actually, in terms of bank costs, I am looking forward to the imminent release of the PSA's report into bank fees because it will show banks are not directly recovering their transaction processing costs at present -- we're not even close.

The great bulk of banks non-interest costs can be booked to the provision of transaction services that are not necessarily part of a broader financial intermediation, borrowing and lending, business.  The word "directly" in the foregoing extract carries great weight: most of bank transaction service costs have typically been covered by unreasonably wide intermediation margins -- reflecting the under-payment of interest on deposits and the over-charging of interest on loans.

The more important point is that the Australian banks conduct an unnecessarily high-cost, retail payment system.  The banks have been very slow in substituting electronic payments technology for cheques.  Where the banks do use electronic payments technology there are grounds for suspecting that they are withholding the supply of more efficient electronic payment services (e.g.: debit cards over the phone) to protect the high free structure which they have in place for credit card transactions.  

David Murray might, on reflection, have been grateful that the PSA report did not enlighten the community about the average cost of cheque transactions. Cheque services, for example, cost around $3.00 each for banks to provide. The reaction would have been interesting if the community was told by the PSA that the banks most popular transaction service -- the cheque -- costs some $3 each to provide and that the banks were regretting not passing on this cost fully and explicitly to the customers.  In the event the PSA declined to identify either the cost or the banks' ambitions.

Subsequently the report of the Wallis Committee did both identify the cost of processing cheques and recommended that banks charge prices for transaction services that reflect the full cost -- the silence since has been golden.

We are employers, providing jobs for 150,000 Australians and paying $6.5 billion in salaries.

We are contributors, paying taxes of $1.9 billion a year -- that is around 15% of all corporate taxes paid in Australia.

One can only hope that the banking industry is not intending to continue to provide jobs for 150 000 Australians doing what they were doing then.  While the community dislikes unemployment, it is unlikely to be amused to know that it pays high costs (in a way not made clear to them) to employ people in jobs in banks that properly should have disappeared long ago.

About the $1.9 billion a year paid in taxes, it is worth bearing in mind that because the banks choose to cover the cost of providing transaction services with cross subsidies originating, in part, in the underpayment of interest on deposits, the taxable income of their depositors is understated.  Personal income taxes to the tune of $1.5 billion per annum are not being collected.  Bartering arrangements - free bank transactions in exchange for interest free bank deposits - has made the avoidance of income tax an art form in Australia.

Moves towards re-regulation are confusing our role as competitive operators in a dynamic financial services market, with the deliverers of community service obligations.

Take, for example, the budget change to the pensioner " deeming" rules.  Previously, bank accounts would be deemed to learn 4%, which pressured banks to pay that amount as interest, regardless of market rates.

There are reasonable doubts about the commitment of banks to operating competitively in a market for payment services that could be described as dynamic.  As well one can only wonder what David Murray would regard as an appropriate interest rate to pay on transaction deposit balances, and whether he regards the distorted market for bank transaction deposits as a fair market.

The deeming system transfers income from one group in the community to another without the transparency of a budget appropriation, done with convenience of banks as agents for the transfer.

The arguments for deeming are inconsistent.  They run at a strong cross current to the most of the economic thinking and planning in this country.

The implied respect for transparency in the way community money is handled could hardly be much further from the truth in terms of the way the Australian banking industry recovers the cost of the payments transaction services it provides to the community.  As noted above, the provision of basically free transaction services in exchange for basically free transaction account balances, is a shield of confusion behind which the Australian banks operate an unnecessarily high-cost retail payment system. The details of the implied redistribution of income in the community engineered by banks is anything but transparent.

As noted earlier, the commonsense of deeming provisions applies much more broadly than to banks relationships with their pensioner customers, at the behest of a government concerned about the cost of providing social security benefits. The Commonwealth government would do well to consider providing for the deeming of a proper market rate of interest to be paid on the transaction deposit balances of all bank customers.

We find ourselves in the middle of the debate on the cost of banking, when the single most significant step in reducing the cost of banking would be to remove the repressive FID and BAD taxes.

Many customers with low balance/high transaction accounts -- the very people at the heart of the current controversy over fees and charges -- paid more transaction tax than bank fees.  Avoidance of BAD and FID is distorting banking behaviour.

While carrying no brief for FID and BAD transaction taxes, one can only wonder at the truculence of the banks misleading the community on this matter.

The principal reason why the value of BAD and FID taxes collected is more than bank fees, is that banks basically give their transaction services away free. They do not disclose the (high) cost of those transactions, which is largely met by underpaying interest to depositors and overcharging interest to borrowers.  If the Australian banking industry pays salaries of some $6.5 billion to its staff (not to mention banks' other costs) -- is it not a direct contradiction to then say that transaction-tax collections of some $1.5 billion, exceed what is recovered from customers (one-way or another) to cover costs of providing transaction services.

The reluctance of the Commonwealth authorities to deal properly with the tax-avoiding bartering arrangements prevalent in the retail banking industry is one thing. It is hardly grounds for complaint that at another political level, tax revenues equivalent to those avoided by the bartering of free transactions for free deposit balances, is being recovered in a different way.  The Commonwealth government has a responsibility here.

That is, incidentally, not to say that the FID and BAD taxes should not be reformed or abolished.

The business of a bank is financial intermediation -- that's matching people's need to borrow money, with the surplus funds in the community -- and we do it by processing information.  The buildings, the machines, the people are all part of one big information processing system.

The ability of a David Murray to correctly identify one function of banks -- financial intermediation -- while commendable, points up his failure to recognise other realities. Most of the costs banks incur in respect of staff, buildings and equipment, are actually deployed in delivering transaction services which are not necessarily part of the intermediation business. To the extent banks process information (mainly correctly) they mainly do it inefficiently while using too many buildings; too many machines that process paper and too many employees.

We need to look further than the same old model of inquiries into prices of products -- a model which is not only adverserial and negative but focuses on the wrong issues.

The inquiry processes used to date have certainly not delivered proper outcomes for retail banking efficiency.  Nonetheless what the banking industry has been doing over the last couple of decades is surely not the best that they can do. One might hope a more effective process of inquiry and public policy reform can be found and that some in the banking industry might find it adverserial and, from their perspective, negative.

Don Argus

Around the same time, mid 1995, Don Argus as managing director and chief executive of National Australia Bank, wrote an article published in the Australian Financial Review, under the headline, "banks must show a greater degree of political savvy" and a by-line claiming, recent attacks on banks had been unreasonable.

The issue of fees needs to be resolved before it damages the reputation and on-going performance of one of the world's most efficient and secure banking systems.

Describing the Australian banking system (primarily its retail payment system in this context) as one of the worlds most efficient reveals a lack of knowledge about world best practice. There are dramatically more efficient payment arrangements widely in use in some other parts of the world. 

Recent criticism of banks has moved from an acceptable level of rebuke for clumsy public relations and communications to wholly unsubstantiated claims of unethical and inequitable behaviour.

The challenge of substantiating the assessments of banking practices as bordering on being unethical and inequitable, it is not a task that would be beyond many prepared to research the ingrained, commercial behaviour of the banks.  One could, for example, question the underpayment of interest on deposits and the overcharging of interest on loans and the use of those "soft" revenues to finance the provision of high cost transaction services to others, largely free of charge. And one should not forget the credit card game.

I said there was doubt about some of the pricing practices used in our industry.....

I also noted that a more deep-seated concern for many is uncertainty about the real value for low-income groups of the deregulation of the banking and financial services sector in Australia.

Now my company is convinced that these concerns are misplaced.  But that is not enough.  We need to ensure our convictions are shared by most members of the community.
One can only hope that the Australian community never shares the conviction of Mr Argus that prevailing banking industry pricing practices are in any way fair or appropriate.  Does Mr Argus believe that that the community accepts that current credit card pricing arrangements are "fair"? - that it is "fair" for banks to withhold the provision of comparable, but cheaper, transaction services using debit cards? - that it is fair to the community for the only available payment facility in many cases, to be a high cost cheque payment service which is basically given away free. More generally was it "fair" that housing borrowers, for some years paid a rate of interest some 2% per annum higher than was reasonable, so the banks could finance the free-of-charge provision of inefficient, high-cost cheque services to the rest of the community.

If you rate the services provided by banks in Australia with those in other countries, we compare more than favourably in terms of price, range and our ability to "tailor" products for customers.

If Mr Argus is genuinely of this view it might reasonably be suggested that travel to Japan, Scandinavia and parts of Europe might be added to the usual itinerary of the UK and the USA.

The community would have every right to be reasonably frightened of any ability of the major national banks to  "tailor" payment products for their customers. What the Australian community needs is a simple, basic, and cheap system that would allow customers to make electronic funds transfers from their account at one bank to any other account at another bank.

Companies such as National Australia bank are "exporting" their expertise into highly competitive markets such as the UK, United States, Asia and New Zealand.

One is tempted to say -- buyer beware. 

It was reported in February 1999 that a Fijian Government committee of inquiry had said there was evidence of "price leadership and group behaviour patterns that indicate that the banks (including the two dominant Australian banks) have a tendency to replicate the practices of each other.

We have also stepped up our consultation with the broad range of community and consumer groups in a genuine effort to understand their views.

It could be expected that the National Australia Bank (among others) would have put considerable effort into market research which, if properly done, would have revealed deep-seated concerns in the community about the way banks conduct their payments transaction business.  It is not difficult to understand that the customers are restive about deficiencies in the cheque payment system, including the need to wait five days for cleared funds.  Even a few on-the-spot discussions with customers waiting in roped queues would reveal some quite understandable discontent about customers perceptions of the way their banking needs are being met, with a technology more befitting the 1950s than the late 1990s.

What I am questioning is the consistent failure of bank critics to note that the clear majority of consumers have access to banking on terms they can afford.

The Australian community cannot afford to continue paying (albeit in a non-transparent way) for the inefficient retail payment system conducted by the Australian banks.

For the National Australia Bank, our social responsibility encompasses our obligations to our 26,000 local employees; more than three million customers; nearly 200,000 shareholders; suppliers; and the community in general.  

Many would suspect that the three million customers and the community in general, are paying well over the odds in support of the employees and the shareholders -- and they would be right.

Equally, I believe it is fair to ask of government that they address the impact of their fees and taxes on bank-services access and afford ability. It has been demonstrated that government charges represent up to four times the impact of bank fees.

The nonsense inherent in this remark was covered in respect of the comparable observation made by Mr Murray.  One can only repeat an expectation that Mr Argus should know a lot better than to make a remark of this kind.  It treats the community with disrespect – standard practice, unfortunately.

-- attitudes unchanged

While resisting the temptation to labour the general point, an article in the Australian Financial Review in mid December 1998, under the headline "National vows to sell pro-merger case to politicians, community", included the following remarks attributed to Mr Argus (or the chairman of the board of National Australia Bank): 

•	The merger ban could inhibit competition in the local financial services industry;
•	We see no logic in the anomalous restraints for which the financial services sector has been singled out;
•	Public debate had been overtaken by an emotional refusal to acknowledge the operating principles of the country's big banks;
•	A challenge....  will be to seriously address the need to build more effective consultation processes with stakeholders.

The press report concluded with the observation that the bank's annual general meeting approved a resolution to allocate 750,000 options to Mr Argus. 

PART THREE: 

END PIECE - A WAY FORWARD? 

It is now more than three years since the Commonwealth government recognised the need for a banking inquiry. It is two years since the "Wallis Committee" reported, pointing out its assessment of substantial inefficiencies in the Australian retail payments system. Not much has been done since to correct the situation. It is time that the debate was rejoined.  

Given the steady publicity presaging change in retail banking, the community probably feels that the way they interact with the payment system is changing quite rapidly enough.
 
This publicity, while affecting the mood of the community, is at odds with the underlying realities. The proper development of the payments system is lagging far behind the pace of change taking place in other day-to-day activities involving communication and access to information. 

Notwithstanding the reservations about public inquiry processes, there is scope for a properly informed public inquiry into retail banking and the operation of retail payments systems in Australia.  

The retail payments industry could sensibly be further reviewed to consider:

•	the apparent misuse, as random cross-subsidies, of the substantial "soft" revenues flowing from the bartering by banks of "free" (under-priced) transaction services in exchange for consumer transaction deposit funds on which "no" (very low) taxable interest is paid;

•	the apparent scope for payments service providers to engage in a range of undisclosed agreements, express and implied, about the common terms, conditions and prices on which various classes of payment services are provided (or not provided) -- including payment services using credit cards; debit cards and the Bpay facility;

•	apparent attitudes in the public and private policy agencies that share responsibility for the perceived softness in the administration of "public-interest" policies that may, as a consequence, bear unfavourably on the efficiency and good-conduct of the market for retail payments services. These agencies include the ATO, the ACCC, the RBA and APCA;

•	clearing the way for the establishment of a publicly accountable body charged with developing and administering industry agreements covering necessary  common service standards and, where appropriate, uniform pricing  practices. Such a body could bring together the banking industry and relevant public and private sector agencies to develop agreements that are demonstrably in the public interest and the general, commercial interests of existing and potential providers of payments services;

•	the scope for establishing an agency of government  charged  with overseeing the development of a national, electronic money scheme including the development of proposals for the provision of public funding to assist its practical implementation; and

•	the restructuring of the present framework for the protection of bank depositors so as to make such protection more clearly dependent on privately subscribed capital and subordinated debt, and less of a barrier to new entrants proposing to provide payments services and conduct related transaction deposit accounts. 

                                                                                     APPENDIX

RETAIL PAYMENT ACTIVITY: USAGE, COSTS, PRICES

This appendix briefly summarises current patterns of retail payment activity in Australia, together with some "ball-park" assessments of industry costs in providing the services at as well as the prices paid, or not paid, by customers using those services.  

The pattern of retail payment activity in Australia in 1997 was, in broad terms:

       Payment Instrument                        Number of payments per annum

•	Cheque payments                                      1 billion
•	Credit card purchases                               300 million
•	Debit card purchases                                500 million
•	Direct entry credits                                   500 million
•	Direct entry debits                                    100 million
•	Cash payments                                          20 billion
•	Stored value card (SVC) purchases                 NIL

The respective "costs" and "prices" incurred and charged for providing this range of payment services vary greatly.  The following "ball park" assessment is indicative.

Cheque payments are by far the most expensive payments service for banks to provide and for customers to use.  

The average cost to the banking industry of each cheque written can be put, indicatively, at some $3. Customer costs/prices can be difficult to assess as cheque-writing facilities are provided to most individual customers either free of any explicit charge, or at "prices" well below cost. There are relevant costs-- both explicit and implicit -- incurred by customers using cheques.  These costs include forgoing interest on deposit balances; time; postage; cheque processing; inconvenient delays in access to funds etc.  

Banks are good at the mechanical operation of the cheque payment system, and bank customers are less so. It would not seem unreasonable to assess customer costs (payers plus payees) of using cheques at about same average cost as banks incur, that is $3. All up the cost of each cheque written probably runs, on average, to some $6 and the total annual cost of the cheque system, some $6 billion. The substantial resources so used are largely wasted.

Credit card transactions registered electronically are among the cheapest payment services for banks to provide but -- indirectly-- the most expensive for customers to use (apart from cheques).  The cost to banks of electronic credit card transactions is likely to be relatively low, because these transactions are accumulated in the electronic files and processed in bulk overnight, using the direct entry system. Bank costs of providing credit card facilities are unlikely to exceed 30 cents per transaction. 

While credit card purchase facilities are advertised to be free of charge, the implied, indirect costs imposed on retail customers are substantial. Customers pay, indirectly, an average of $2 plus per transaction as merchant service fees (2%plus of the value of purchases averaging $100).  This cost, as are other merchant costs, is recovered from customers - it is built into final retail prices charged for goods and services. All up the cost to customers for using credit card purchase facilities runs to some $2.50 per transaction.  

Debit card transactions cost the banking industry some 40 cents each; an assessment based on what are reportedly standard industry interchange fees charged to card issuers by the bank sponsoring the EFTPOS facilities available at merchants.  Again, a substantial part of EFTPOS transaction costs is passed on to (recovered from) the merchant directly -- transaction fees, equipment charges, account management fees, etc. -- and to the customers of merchants, indirectly.  A rough guess would put the after-tax costs passed-on to customers at some 20 cents for each transaction, in addition to the usual customer costs of waiting time, including the time to insert their PIN number and for the transaction to be approved and completed.

Direct entry payments, both credits and debits, cost service providers some ten cents each.  The cost to customers is markedly different as between individuals and participating businesses.  The cost to individuals is negligible once the facility has been established (at no direct cost): however, the benefit of such automatic -- no cheque, no cash -- payments is considerable to both payers (and payees) which together save time, postage costs, physical processing costs etc.  Businesses using the direct entry system incur costs to manage their participation but, again, the transfer of funds is an automatic, computerised process, marginally extending the use of customer account databases in banks and businesses.  Assuming participating businesses incur the same costs as banks do, the total cost of a direct entry transaction averages some 20 cents.

Cash payments are not charged for explicitly but cash payments do have very real costs to retailers, and cash customers, implicitly, pay a price.  An, indicative, all-up cost for retailers providing cash purchase facilities would be some 15 cents per transaction.  The price paid by customers is implicit and essentially relates to their time waiting for change and waiting in queues -- some 15 seconds or more per transaction.  The implicit price to customers is higher if the customer needs to make a special trip to acquire and present cash for payment at post offices, banks or retailers.  Considering both retailer and customer (implied) costs/prices, the all up cost of cash transactions might run to 30 cents on average.  The total cost of 20 billion transactions per annum runs to some $6 billion plus per annum.  

Stored value card (SVC) transactions offer the prospect of very cost-effective payments for what would otherwise be cash or (other) card payments.  Neither signature nor PIN is required to authorise SVC transactions and there is less transaction time wasted waiting for change.  Both merchant and customer costs -- direct and indirect -- would be relatively small.  The cost of SVC transactions would likely be less than half the cost of cash transactions.  Costs, assessed against comparable transactions, would be even less once SVC could be used on-line to make payments over the phone and on the Internet.

In summary, the broad order of magnitude of average service provider costs (explicit and implicit) incurred by customers would be:

                                                      cost to service providers          cost* to customers   
Cheque                                                         $3                                             $6                  
Credit Card                                                  80 cents                                    $2.50  
Debit Card                                                   40 cents                                     60 cents 
Direct Entry (credit/debit)                           10 cents                                     20 cents
Cash                                                             15 cents                                     30 cents
Stored Value Card                                         7 cents                                     14 cents

*direct and/or indirect, including bank costs.

These cost estimates are "ball park" figures. That roughness does not matter much: the important focal point is the broad consensus which exists on relative costs. Cheque, credit card and cash transactions are relatively expensive: direct entry, EFTPOS and (potentially) SVC transactions are relatively very cheap.

The noteworthy points to be drawn from a comparison of bank and customer costs, and usage of the different retail payment instruments, are:

•	The most used, non-cash instrument -- the cheque -- is by far the most expensive;

•	The cheapest, by far, non-cash instrument -- direct entry credits/debits -- is underutilised;

•	Credit and debit card transactions are, relatively, cost-effective but the uniform marketing arrangements for credit cards means that the total price paid by customers is excessive; and

•	Cash transactions are relatively cheap in the face-to-face circumstances appropriate to them, but are not a practical option for many payments customers need to make;

•	SVC schemes offer the prospect of relatively very cheap "cash" transactions and substantial cost savings to service providers and to the community generally.

Ideally a properly promoted expansion of facilities for direct debits and credits, and proper promotion of EFTPOS purchases using debit cards, would see dramatic declines in the use of both cheques and credit cards.  Substantial savings would accompany such change -- savings to the community in the resources now being misused to provide these inefficient or expensive retail payment services.  The substantial community benefit that would flow from the widespread use of SVC, voluntarily displacing notes and coin used for small "cash" purchases may well need the catalyst of government continuing its role as the issuer of the national medium of "cash" transactions.