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Debit cards have long been touted as a replacement for cash.
But a complicated system of opaque fee collection has created a multi-billion dollar revenue opportunity for the payments industry and left many consumers paying too much.
It is no longer the case that a debit card always generates lower fees for the customer when making a purchase than a credit card. And if that card is in a digital wallet, stored on a smartphone, the charge could be different.
The issue has become a political flashpoint amid mounting pressures on the cost of living, prompting the Reserve Bank to bring forward its review of the system.
“The payments system is deliberately opaque and complicated because where there is money there is money,” says Brad Kelly, co-founder of the Independent Payments Forum, which advocates for reform of the system.
“The debit card is the cheapest (compared to credit cards), but that is not reflected in the price charged to merchants or consumers.”
Proponents of the reform want to cut the $6.9 billion in annual card fees charged by Australian banks, payment platforms and global card companies, and restructure the system to help small businesses and their customers.
Payments industry players argue that the cost of accepting cash is higher for businesses than accepting cards and that fees are spent on necessary infrastructure and services, including networks and fraud prevention.
How did we get here?
For several decades, debit cards were touted as a prudent alternative to credit cards, which gained notoriety in the 1990s for causing problems for users in an era of relentless, often unsolicited, offers of credit.
Debit cards have traditionally relied on Eftpos, a domestic payment system dating back to the 1980s that required swiping transactions.
Major credit card companies Visa and Mastercard strengthened their presence in the debit market through partnerships with major Australian banks from 2005 onwards and went on to become the dominant players using tap-and-go technology.
Most debit cards are now dual-network, meaning transactions can be made through the card companies’ networks or Eftpos, although they tend to flow through both Visa and Mastercard systems – an issue the RBA is likely to look at.
How do card transactions work?
Every time a customer uses a debit or credit card, the merchant is charged a fee to accept the payment, made up of various fees that ensure all financial parties involved in the transaction receive payment.
These parties include banks and payment platforms that the merchant has signed up with, such as Square or Tyro. The cardholder’s financial institution and card networks also receive payment.
Major retailers negotiate ultra-cheap rates directly with the card networks and can therefore often absorb any costs, which is why shoppers don’t pay a card surcharge at major supermarkets.
However, transaction costs for smaller companies can be significant. According to the competition regulator, they are allowed to pass that cost on to the customer through a surcharge, but merchants are not allowed to make any additional money.
In the eyes of the consumer, this makes the small business the one collecting the fees, but the money is actually distributed among banks, payment platforms and card companies.
“It’s not small businesses that are ripping off customers,” Kelly says.
Big retailers have benefited from “some good deals,” he says, and then the payments industry “can simply increase the price for small businesses through banks and payment service providers.”
The cost of a transaction can vary widely, according to the RBA, which oversees the payments sector: from less than 0.2% to more than 2% of the transaction value.
Transactions via Eftpos are generally the cheapest, followed by Visa and Mastercard debit systems.
Credit cards, which are a form of unsecured debt, are the most expensive. Users also get the benefit of accumulating points and rewards and were traditionally charged a higher transaction fee for that privilege.
However, the difference in costs is not necessarily reflected in the surcharge charged to the customer.
Frustrations and defects arise
If most debit card users were charged modest fees, the practice might have continued unchallenged, but more people began to notice that they were often paying high fees.
This is usually due to “fixed,” “combined,” or “bundled” payment plans offered to merchants, meaning customers are charged a flat fee regardless of whether they use a low-cost debit card or a dedicated rewards-earning credit card.
As the name suggests, the card types are mixed.
“The Amex customer next to you in line should lean over, tap you on the shoulder and thank you for subsidising their upcoming trip to Thailand,” says Warwick Ponder, co-founder of the Independent Payments Forum.
He says this means that younger generations, who are the biggest users of debit cards, are subsidizing high-cost credit card users.
Ponder says the fixed and blended models pervert a policy promoted by the RBA called “least cost routing”, which was designed to process payments through the cheapest network, usually Eftpos.
This was supposed to mean that merchants, and in turn customers, would be charged the fair rate for their type of card, including a higher rate for credit card users.
In the blended model, the bank or payment platform such as Square can charge a seller a fixed transaction fee, such as 1.6%. The RBA review will examine whether they then route those transactions through the cheap Eftpos network and pocket the difference.
Bank lobbyists argue that merchants should be free to choose their payment option and say some businesses like the certainty of a package with a fixed price.
Mark McKenzie, chief executive of the Australasian Petroleum and Convenience Marketers Association, says tariff structures are too complex, leading some retailers to inadvertently sign up to packages that are bad for them and their customers.
“You need a master’s degree in financial services to be able to work with complex structures,” McKenzie says.
“The goal of a small business is not to sit back and become an expert on commercial rates.”
Should surcharges be banned?
At a recent parliamentary inquiry, National Australia Bank chief executive Andrew Irvine said he had paid an “outrageous” 10% surcharge for a cup of coffee. Those charges were inconsistent and lacked transparency, he said.
Some in the banking sector support a ban on surcharges, in line with what is happening in parts of Europe and some states in the United States.
Small businesses, however, argue that it would be an unfair burden that would benefit larger companies that have negotiated deals with reduced rates.
Instead, reform advocates call for mandatory, real “least-cost routing” that benefits merchants and customers across all platforms, including mobile and online.
Those seeking change say bundled and packaged pricing should be banned and tariff transparency needs to be greatly improved.
McKenzie says it is vital that the payments system becomes more transparent.
“Banks need to be fairly compensated for this service, but the products need to be made in a way that allows the merchant to easily compare payment products,” he says.
“The current lack of transparency around the structure of these systems means they are not functioning as a true market.”