Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 19 - Evidence - March 3, 2011
OTTAWA, Thursday, March 3, 2011
The Standing Senate Committee on Banking, Trade and Commerce, to which was referred Bill S-201, An Act to amend the Office of the Superintendent of Financial Institutions Act (credit and debit cards), met this day at 10:35 a.m. to give consideration to the bill.
Senator Michael A. Meighen (Chair) in the chair.
[English]
The Chair: Honourable senators, good morning. My name is Michael Meighen. I am a senator from the province of Ontario and I have the honour to chair this committee. I will now introduce the senators who are present. On my right is Senator Percy Mockler from New Brunswick; next to him Senator Larry Smith, from Quebec; Senator Vim Kochhar from Ontario; and Senator Oliver from Nova Scotia. To my left is Senator Ringuette from New Brunswick, and Senator Banks from Alberta. Other senators will arrive and, if I have a chance, I will introduce them. However, they normally have their correct names in front of them on the name plates.
Today we are resuming our examination of Bill S-201, An Act to amend the Office of the Superintendent of Financial Institutions Act (credit and debit cards). Our colleague Senator Ringuette is the sponsor of this bill.
[Translation]
This bill amends the Office of the Superintendent of Financial Institutions Act to confer new duties on the superintendent, namely to control the use of credit and debit cards and to make recommendations on the subject. It provides for the presentation of a report to the minister and a response by the minister to the superintendent.
[English]
The Banking Committee started its public examination of Bill S-201 on June 23 last year. Today will be our seventh meeting devoted to hearing the views of witnesses on this proposed legislation.
For those who watch these proceedings from their homes on CPAC, transcripts of previous meetings and copies of committee reports are available online by going to the committee business link of the Parliament of Canada's website at www.parl.gc.ca.
Before I introduce the witnesses, I ask your permission to call on Senator Ringuette, who has a document she would like to table before we begin our session this morning. The floor is yours, Senator Ringuette.
Senator Ringuette: As a follow-up to our witness from the City of Ottawa and the cost of credit card use within municipal governments, the week after, as a member of the Standing Senate Committee on National Finance, we had before us representatives from the Treasury Board Secretariat of the federal government. I asked them the following question: What is the cost to the federal government, its Crown corporation museum and parks, with regard to credit card acceptance fees and merchant fees? The answer that I received late yesterday afternoon is the following:
For fiscal year 2009/10, the Receiver General for Canada paid $12,956,176 to cover credit card merchant fees for federal government departments that accept payment for goods and services by Visa, MasterCard and American Express. This figure does not include Crown Corporations, who do their own credit card procurement. Merchant acceptance fees for Parks Canada totaled $799,370.
I would like to table the document that I received in both French and English so that all the members of our committee can have this information.
The Chair: Thank you, Senator Ringuette. Our clerk will have that distributed to all members. It will form part of the record of our hearings.
Colleagues, I will now return to the introduction of our witnesses. With us today, from the Bank of Canada, Currency Department, are Charles Spencer, Director, Business Knowledge and International Relations; and Carlos Arango, Principal Researcher. Our witnesses are the authors of a paper published in the Bank of Canada Review Winter 2008-09 entitled: "Merchants' Costs of Accepting Means of Payment: Is Cash the Least Costly?"
I think all members have received a copy of that paper.
Gentlemen, welcome to our committee. I should mention that, on my right, Senator Greene from Nova Scotia has just joined us, as has the deputy chair of the committee, Senator Hervieux-Payette from Quebec. Coming in right now is Senator Mac Harb from Ontario.
I understand both of you have an opening statement. Mr. Spencer will begin.
Charles Spencer, Director, Business Knowledge and International Relations, Currency Department, Bank of Canada: In the spirit of modesty and attribution, may I correct one aspect of your introduction? I do not have the honour of being a co-author of this report; it is Mr. Arango and his co-author, Varya Taylor, who is not here today. I work in the area that they work in, but I do not have their expertise in this field. Thank you for the thought, however.
Good morning, Mr. Chair and honourable senators. As the chair explained, I am a director in the currency department at the Bank of Canada. I am joined by Mr. Arango, who is the co-author of the Bank of Canada Review article on our merchant survey, which attracted the committee's attention to our work. We are pleased that the bank's research is proving to be of interest to the committee, and we hope we can assist your deliberations further this morning by summarizing it and discussing it with you.
[Translation]
Mr. Chair, I propose to review briefly the bank's mandate in this area and to explain why we conduct this kind of research. Dr. Arango will then provide a brief overview, from our perspective, of the use of cash relative to other means of payment in the Canadian economy, and that still means principally credit and debit cards. He will then summarize some key points from the merchant survey which we think may be relevant to your discussion, following which we are available for your questions.
I know that the committee hears regularly from the governor and senior deputy governor on monetary policy and the macro economy, so I am sure that I do not need to explain the Bank of Canada's role in those areas. However, the bank also has the responsibility under this act for issuing bank notes and for making all the necessary arrangements for their distribution across the country.
Because we are discussing retail payments today, it is probably useful to remind you that we are not responsible for coins, which falls to the Royal Canadian Mint.
[English]
While we are on the subject of what the bank does not do, I will point out that the bank has no oversight responsibilities over retail payment systems. It has that at the wholesale payments level, which includes most payments between financial institutions. The bank has an oversight role for those clearing systems that have been formally designated by the bank as systemically important. This is part of its responsibility for financial stability under the Payment Clearing and Settlement Act, under which the bank can designate a clearing system with the approval of the Minister of Finance. Before I hand over to Dr. Arango, I will explain why we do the kind of research that resulted in the article by him and his colleague, Varya Taylor, which led you to invite us here today.
As I mentioned earlier, the bank issues banknotes and makes arrangements for their distribution. In order to plan this work effectively, we have to understand how banknotes are used and how that use is likely to evolve in the future. Despite the expectations by some that cash would die out, the demand for banknotes has remained relatively stable over the last 20 years. The value of notes outstanding has grown more or less in line with the growth of the economy. Currently, there are approximately $58 billion in banknotes outstanding. However, as Dr. Arango will explain, the composition of the notes outstanding and their use have changed. Over the years, as part of its focus on banknotes, the bank has done a number of public surveys to study the use of cash compared to the use of other means of payment. We do this work in order to make long-term decisions about how to manage our banknote responsibilities, and to ensure that banknotes are meeting the needs of consumers, retailers and the economy. In doing this research, we also naturally learn things about the other payment instruments, and that was particularly true of the survey of merchants that Dr. Arango and Ms. Taylor conducted. Dr. Arango will provide a summary of the role of cash in Canada and the trends in retail payments; and he will highlight some of the conclusions from the survey of merchants, which might be helpful to the work of the committee. We have brought copies of the charts to which he will refer. I believe you have been provided with copies of the Bank of Canada Review article and a more technical paper that reports on the study in detail.
Mr. Chair, I ask Dr. Arango to make his presentation.
Carlos Arango, Principal Researcher, Currency Department, Bank of Canada: Good morning, Mr. Chair and honourable senators. I am pleased to have the opportunity to appear before you to present our research on merchants' acceptance perceptions and costs of retail payment instruments.
This presentation draws mostly from my joint research with Varya Taylor on a survey of 500 Canadian merchants that was commissioned by the Bank of Canada in 2006. I make the usual disclaimer that the views expressed in this presentation are those of the researchers and should not be attributed to the Bank of Canada. As well, I warn the committee that the retail payment environment has evolved over the last five years, and the results of a similar survey today likely would be quite different.
Developments worth noting in the past five years include: The introduction of chip cards, which increases security and enables payment features such as contactless card payments; the prospective introduction of mobile phone payment applications at the point of sale; the increasing use of premium reward credit cards with higher merchant acceptance fees; and the introduction of new regulations for the debit and credit card industries. I will discuss retail payments in Canada first.
Slide 2 shows that cash demand in Canada, expressed as the total value of notes outstanding as a percentage of GDP, gross domestic product, has remained fairly stable over the past 30 years at about 3 per cent. However, a closer look by denomination offers a different perspective. Higher denominations, such as the $50 note and the $100 note, relative to GDP, are represented by the top area in the graph.
Here we see an increase from 1.4 per cent to 2.5 per cent of GDP over the last three decades. Meanwhile, the demand for smaller denominations, such as the $5, $10 and $20 notes, has declined from roughly 2 per cent to 1.2 per cent. This decline may indicate a reduction in the use of cash for retail payments as smaller banknote denominations are associated typically with retail trade, especially given that $20 bills are the main notes dispensed at ATMs, automated teller machines.
Slide 3 provides some evidence that this may be the case. The decline in low-value denominations in circulation coincides with the growth in debit and credit card payments as a percentage of aggregate consumption from just 14 per cent in 1994 to over 50 per cent in 2009.
Unfortunately, unlike card payments there is no direct way to track cash payments. As a proxy for cash expenditures, slide 4 plots ATM cash withdrawals as a percentage of aggregate consumption over the last decade. The graph shows a decline in cash withdrawals from 16 per cent of consumption in 2001 to 12 per cent in 2009.
However, as reported in slide 5, cash is still the predominant payment method in terms of transaction volume according to preliminary results of our 2009 methods of payments survey of the public. This survey collects information on retail purchases, including payment method used, from 3,500 shopping diaries recorded by adult Canadians during a three-day period. Cash accounts for 54 per cent of total purchases recorded in the diaries. Based on a rough extrapolation, this could amount to at least 6 billion cash transactions compared to 2.5 billion for credit cards and 3.9 billion for debit cards in 2009.
One characteristic of retail payments that helps to explain some of the developments in the retail payment system is that they are two-sided markets. As depicted in slide 6, in two-sided retail payment markets, payment service providers require both consumers and merchants to be on board to create demand for their services. The key element of these markets are efficiency gains for both consumers and merchants if a third party coordinates their demands. Among the benefits of this coordination are the sharing of large set-up costs and the gains by both merchants and consumers if more of them adopt the payment instrument.
Payment service suppliers set up fees and network rules to influence the entry into the network of both consumers and merchants. Consumers choose their payment instruments based on convenience in terms of speed, record keeping, access to funds, payment delay, as well as safety, fees and rewards. However, merchants must consider consumer payment preferences and what nearby competitors accept. Merchants' acceptance decisions would depend on the costs and efficiency gains from accepting a payment method; how much of the costs can be passed on to consumers in final prices for goods and services; and the impact on merchants' revenues.
To better understand the merchant side of retail payments, the bank commissioned a national survey of merchants on their accepted means of payment for point-of-sale transactions in 2006. The objectives of the survey are presented in slide 7.
They were to consider how merchants perceive retail payments in terms of costs, reliability and risks; second, to estimate the share of transactions represented by each payment method; and third, to assess the costs of accepting different retail payment methods.
As stated in slide 8, Ipsos Reid, the consulting firm that conducted the survey, held over 500, 20-minute interviews across Canada with senior-level merchant representatives familiar with the payments methods accepted. The sample was drawn by firm size — defined by number of employees, region and subsector — to reflect the diversity of the retail sector.
Because most merchants in Canada operate as independent small businesses, roughly half of the sample consisted of small merchants. As well, three-quarters of businesses surveyed were independently owned and operated.
The survey included a variety of subsectors such as gas stations, grocery stores, restaurants and general merchandise stores, but excluded merchants who did not have a physical store and were hypothetically unable to accept all three methods of payment — cash, credit and debit cards. It should be noted that the margin of error is relative high at plus/ minus 4.4 per cent, with 95-per-cent confidence.
Slide 9 shows that, when asked which payment method merchants prefer their customers to use most often, 50 per cent of the respondents said debit cards. In comparison, 42 per cent favoured cash and only 6 per cent favoured credit cards.
In our research, we found that merchant preferences are significantly influenced by perceptions of risk and cost. In particular, as slide 10 shows, merchants perceive cash as the least costly, followed by debit cards, with credit cards perceived as the most costly of the three payment instruments. Debit cards, on the other hand, are perceived as the least risky in terms of counterfeiting, theft or fraud.
In spite of these differences in preferences and perceptions across merchants and payment methods, as shown in slide 11, close to 90 per cent of all merchants in the survey accept all major payment instruments — cash, debit and credit cards. The smallest merchants, measured by number of employees or by sales volume, are the least likely to accept card payments. Of those who do not accept debit cards, 52 per cent indicate set-up and processing costs as the main barriers. Merchants who do not accept credit cards cite lack of consumer demand and costs as the main barriers. These results confirm that merchant acceptance is influenced not only by costs, but also by what consumers like to pay with.
This is indeed the case in the survey, as stated in slide 12. We find that among merchants who accept all payment instruments, on average, annual sales are split almost equally between cash, debit and credit cards. However, payment shares vary across merchants.
Credit card payment shares are higher at stores with higher average transaction values, whereas cash and debit card shares are higher at low-transaction value stores. Furthermore, we found that credit card payments are more than one- third of annual sales for half of those merchants accepting all payment methods.
On the cost side, merchants usually face set-up costs and per-transaction and monthly fees when accepting card payments. As reported in slide 13, merchants pay around $40 a month per terminal for their banking and payment- processing services, which may include cash services, card processing, terminal leasing and other related services.
The typical transaction fee for debit cards in the survey is 12 cents, and the typical fee for credit cards is 2 per cent. However, in the sample, credit card fees vary between 1.75 per cent and 2.5 per cent, whereas debit card fees vary between 7 cents and 25 cents.
As reported in slide 14, our research shows that part of this variation in fees is related to merchant characteristics. We found that merchants in retail trades with low-transaction values have the lowest debit card fees in the sample. As for credit cards, we found that merchants with higher sales volumes and average transaction values have significantly lower fees than their counterparts.
Cost perceptions in the survey reflect this fee structure. As stated in slide 15, although, on average, cash is considered the least costly payment instrument to handle, we found that cash is perceived as more costly than debit cards by merchants with higher total sales and average transaction values. More broadly, we found that debit and credit cards are perceived as less costly by merchants with higher annual sales.
This is consistent with the economies that large merchants have as they can spread their costs among large transaction volumes. It also reflects the finding that large merchants face lower card-per-transaction fees, as we saw before.
Finally, we also found that debit cards are perceived as less costly than credit cards the higher the average transaction value at the store. This is due, in part, to the fact that the debit card fee is a fixed per-transaction fee, whereas the credit card fee is a percentage of the value of the transaction.
So far, we have talked about merchants' perception of the costs of cash. To further explore how cash fares compared with debit and credit cards in terms of costs, we estimated the different marginal costs associated with each payment instrument. Slide 16 illustrates the methodology for the typical cash transaction in the sample of $36.50.
For all payment instruments, the labour cost of tender time is included. We used the results of different studies on tender time conducted in 2004 and 2005, which show that cash transactions take the least time at the register, followed by pin debit and signature credit cards. For cash, we estimate the labour cost of the reconciliation time and the preparation time per transaction, based on average responses given by 33 retailers in follow-up interviews. We also included the value of time spent making cash deposits at the bank, which we assume is 20 minutes.
Bank fees include cash deposit fees and coin ordering, as reported by RBC, Royal Bank of Canada, in their public brochures. For debit and credit cards, we are taking the typical per-transaction fees as a benchmark. Theft and counterfeiting is based on a survey of retail crime, made by Ipsos Reid in 2008, and on counterfeits passed during this period.
Finally, float is the opportunity cost of funds in transit, based on short-term interest rates. For the survey's typical transaction value of $36.50, debit card payments are the least costly at 19 cents, followed closely by cash at 25 cents and credit cards at 82 cents, but this ranking depends on the value of the transaction.
Slide 17 illustrates the differences in per-transaction costs between cash and debit cards as transaction value increases. For cash, we assume that all cost items increase with the transaction value, except tender time, deposit time at the bank, and coin ordering. The graph shows that, as the per-transaction cost of cash increases with transaction value, it crosses debit card per-transaction fees at different thresholds as debit card fees rise.
We found that cash is cheaper than debit cards at stores with average transaction values that are below $12 if debit card fees are as low as 7 cents among the lowest in the survey; below $23, if debit card fees are 12 cents, in the middle range; and below $51 if debit card fees are as high as 25 cents among the highest in the survey. As for credit cards, at the survey values of the credit card fees, credit card costs are always above those of either cash or debit cards, depending on the transaction value.
To conclude, our research shows that the two-sided nature of retail payment markets is key to understanding the trade-offs merchants have in their payment instrument acceptance decisions. Merchants in low average value and small-scale retail activities are less likely to accept card payments. This is because consumers do not use cards as much for low transaction values and because it is relatively more costly to run electronic payments with low annual sales. Aside from acceptance, merchants have little influence over payment instrument shares and consumers' choices drive payment instrument usage at the point of sale with a strong dependence on transaction value.
Finally, our estimates suggest that debit card transactions are less costly than cash for a broad cross-section of merchants.
Thank you, once again, for inviting us to present this research. We will be happy to answer any questions that you may have.
The Chair: Thank you very much, Mr. Spencer and Dr. Arango. That is helpful. I think I speak for everyone when I say that it was very clear. It is much appreciated.
Before turning to my list of speakers, you cautioned us that this research was done in 2006. Am I correct?
Mr. Arango: That is correct.
The Chair: Therefore, things probably are different in 2011. Have you any research to indicate any trends between 2006 and 2011 of which we should be cognizant?
Mr. Arango: Currently, we are doing surveys to the consumers, not to the merchants. Unfortunately, we do not have a recent survey on the merchant side. On the consumer side, we had one survey conducted in 2009, where we actually have more accurate estimates of what is happening on the acceptance side on the lower transaction-value ranges. From the consumers' point of view, when they do transaction values below $15, they find that in 50 per cent of the cases they believe cards are not accepted at low-value transaction stores or purchases.
We also introduced a section in the Canadian Financial Monitor, which is an omnibus survey by Ipsos Reid on payment choices and behaviour by household. Unfortunately, we only introduced this survey in 2009, so we cannot have complete figures, year after year, on how things are changing now with the introduction of new technologies such as "contactless" payment. However, we will be able to have a close monitoring of current developments in the retail market with this survey.
Senator Ringuette: I have read your full report. It is very interesting. In your presentation, on slide 16 in regard to the variable cost, is the capital cost included in there or have you not added it to your figures because it might vary, or one merchant might buy or rent? Is the capital cost of the technology included in your costing here?
Mr. Arango: No, in this table we are reporting on only the variable costs of accepting different payment methods per transaction.
Senator Ringuette: We have heard in the last two meetings that we have had, especially from the witnesses from the treasury department of the City of Ottawa, about the huge cost for technology to meet the required security standards set by Visa and MasterCard. That would increase your cost here if it were included because it is not a cost that would be entailed in cash; it would certainly be required in regard to debit and the credit card system. The cost we have here would increase if you add the capital cost.
Mr. Arango: Right.
Senator Ringuette: Are you participating with the current task force on the payment system?
Mr. Spencer: The bank is represented at the round tables. We have not made a formal submission, but we have been consulted by the task force and we have a colleague who has sat on the round tables.
Senator Ringuette: Visa and MasterCard have indicated to us that they believe that their product is an electronic currency. Do you agree with that definition?
Mr. Spencer: I am not sure there is a definition of "electronic currency." Our research and our responsibility in the currency department is conducted for non-electronic currency, which is currently paper money. The Royal Canadian Mint, of course, is responsible for metal money. I am not aware whether there is a standard definition of other forms of currency.
Senator Ringuette: Would you agree that any form of payment would be equal to currency? That is, whether it is gold or whatever, it is a form of currency?
Mr. Spencer: I think you can define anything as currency. A transaction is really an exchange of value. That can be done in a number of different ways. One of them is by passing a banknote across a counter. I am not sure what the definition of "currency" would entail. It is not a concept that we use beyond that.
Mr. Arango: On the research side, we always make a distinction between money and how you access money. When we do these types of studies talking about payment instruments, we are doing research more on the means of accessing your different money holdings. It could be cash, or it could be demand deposits at the bank, and so forth. That is an important distinction.
Senator Ringuette: You are involved in providing some kind of consultation with the task force. We all know that the future of electronic payments, whether it is with what I call the fantastic plastic, or with your cell phone, or maybe even a chip in my wrist, will replace your paper currency. You will have to move to the new mode of payment that is not necessarily paper based, but is electronic. Therefore, you have an electronic currency that is now in the global marketplace.
When will you make that move?
Mr. Spencer: I am not sure I fully understand the move that you are talking about. As Mr. Arango explained, the currency is the item that holds value; a transaction is the movement of that value. In our terms in the currency department, "currency" is banknotes. A transaction is that thing that happens across a retail counter.
We are quite certain that ways to move value around are evolving. As we said when we did this survey, the dominant means of payment in Canada, other than cash, credit cards or debit cards, we are seeing, not importantly from the point of view of volume but interestingly at the margins of the market, the introduction of contactless payments, the mooting of mobile phone payments, et cetera. All of those tools facilitate transactions.
I am not sure that the concept of currency applies to those transactions. Certainly, we in the currency department are not responsible for that. Our mandate is to manage banknotes for Canada and to ensure that we understand the environment in which they are being managed.
Senator Ringuette: Would you envision Visa, MasterCard and Interac systems as clearing systems for electronic payments?
Mr. Spencer: I am not an expert on payment and clearing systems, so the question is a little outside my field. Certainly, we do not have any research in our area that would shed light on that question.
Senator Ringuette: No research is being done by the Bank of Canada on that issue.
Mr. Spencer: I did not say that. I said that we in the currency department do not do that research. I am not aware of what research there is.
The bank's direct responsibility with clearing systems is limited to those that are designated under the Payment Clearing and Settlement Act. They are very large-value systems that act between the financial institutions. They have nothing, except at a very aggregate level, to do with the transactions that occur at the retail level or in networks that serve the retail level.
Senator Ringuette: A very high value of transactions occurs on a daily basis using Visa, MasterCard and debit. Interac has voluntarily adhered to the payment act regulations, but Visa and MasterCard have not done so.
Mr. Spencer: There are two different payment acts: The Payment Clearing and Settlement Act and the Canadian Payments Act. The Bank of Canada is not involved in the latter.
Senator Ringuette: The bank is responsible for the clearing system.
Mr. Spencer: It is responsible for overseeing a systemically important clearing system. It is part of our responsibility for financial stability. It goes to the macroprudential issues around the solvency of financial institutions. We deal with the clearing systems between those financial institutions.
Senator Ringuette: The Reserve Bank of Australia, and the federal reserve banks of New Zealand, the U.K., France, Sweden Argentina and Venezuela, I believe, are in the process of studying credit card fees. The Reserve Bank of Australia legislated caps on these fees seven years ago. I suppose the Bank of Canada networks with its counterparts in other countries. Have you looked at any of those studies?
Mr. Spencer: Certainly, we are in those networks and aware of the things that they have done. I do not think it would be appropriate for me to comment on their actions. The Reserve Bank of Australia has published reports on their processes, which, if the committee is not aware of them, would be interesting for you.
Senator Ringuette: The committee will be in a conference call with them in the next two weeks.
I will return to slide 16, Dr. Arango. On the consumer side, you reported that a debit card system is the least costly for a merchant at 19 cents per transaction; a cash transaction in the amount of $36 costs 25 cents; and a credit card transaction costs 82 cents. Since 2006 when you did this survey, I do not think there has been an increase in cash transactions. My last conversation with people from Interac indicated that the processing fee for debit cards is 12 cents per transaction. On the merchant side since 2006, the processing fees for credit cards have had quite an increase. It has almost doubled since 2006.
How much of an increase does that represent for a $36 purchase? It no longer costs 82 cents to process that transaction. The processing fees that used to be at 0.76 per cent are now at least 2.5 percent.
Mr. Arango: I would have two points on this question. These calculations are done on a per-transaction basis. First, you are referring to the increase in the cost of accepting credit cards. That could be based on total numbers whereby the more people use credit cards, the total bill of credit cards will increase over time, but not necessarily the transaction cost of accepting the credit card fee.
Second, recently we have seen differentiated discount fees for different transaction types. That will make not one table but many different tables, depending on the various segments of the market, which will change the results; I agree with that.
Senator Ringuette: It will make a major increase. Do you expect to do a second survey so that we may have updated data on the real costs?
Mr. Arango: On the merchant side, we do not have plans for conducting a survey in the near future. Currently, we are working on the 2009 survey and conducting research on the consumer side of the use of different means of payment, which will form part of our projections for the demand for cash as we move into the new series of banknotes.
Mr. Spencer: Remember also, senator, that the objective of our research program is focused on cash. As you just said, it is unlikely that the merchant view of cash has changed significantly in the intervening period. We are more interested in focusing on places where the use of cash is likely to have changed, which means primarily the consumer side.
Senator Banks: I want to ensure that I understand correctly. The proportions on your slides 5 and 12 are different. I understand that slide 12 uses dollar values. Slide 5 says "volume." I presume that "volume" refers to the number of transactions regardless of their value.
Mr. Arango: That is correct.
Senator Banks: That explains the difference in the proportions.
Mr. Arango: That is correct.
Senator Banks: You said that you omitted online transactions.
Mr. Arango: Yes.
Senator Banks: I understand why, because you are dealing with currency and it is not currency, in the sense that you described it.
Have you any idea how significant that part of the market is? I do not know what I mean by the "market," but how significant online purchases are? I assume they are growing. I assume that it is the same approximate charges — I do not know whether you looked at this — obtained through the use of credit cards in online shopping that they do if I am standing in front of the counter; is that so, or do we know?
Mr. Arango: I think we are aware of some surveys done in that regard. Statistics Canada issues some of these surveys on Internet activity and access to the Internet.
There is also another survey we can follow up to the committee that is measuring what is the online activity and which means of payment are used. In our research, we do not have any idea of the growth or the developments in online shopping.
Senator Banks: When you were looking at the survey of merchants and their costs — if I were operating a credit card, I guess I would do the same thing — aside from the fact that they can do it and aside from the fact of profitability, is there an operational cost rationale that explains the difference between a flat-fee transaction for debit cards on the one hand and a percentage fee for credit card transactions on the other?
I would do it too, if I was the proprietor of Visa and could get away with it, but are you aware of a cost factor that would cause them to do that?
Mr. Arango: There are some studies that look into how to decompose the interchange fee and the discount fee that we can submit to the committee. Actually, they kind of disaggregate what is in the interchange fee and what else is in the total discount that is charged to the merchant.
What I can talk to in those studies is they assume that part of that is to fund the other side of the market, which is the rewards programs, and part of that could be covering some of the risk costs associated with credit card handling.
Senator Banks: And the cost of the money, because sometimes those transactions are larger.
Mr. Arango: Correct.
Senator Banks: As we heard yesterday, it is the cost of the money.
Mr. Spencer: I think you had an interesting answer to that question yesterday, that the services offered for those two cards to the consumer and to the merchant are different; therefore, presumably they have different inputs and different values and different costs. They are the best people positioned to explain to you why the business models for those two means of payment are different.
Senator Banks: And they did.
Mr. Arango, is it reasonable to infer to the reason that the larger the cost of the item or service being purchased, the less likely people are to use cash, simply because if we are going to buy an airline ticket for $3,000 or $700, we probably do not have that in our pocket. Is it as simple as that?
Mr. Arango: There are many reasons why people may prefer credit cards to cash for larger transaction items. In our 2009 survey, we disaggregate the different attributes of the alternative means of payment to consumers to estimate and pin down what are the marginal benefits to consumers of these different attributes.
We are still undergoing this research. Once we have final results, when it is public, we will provide that to the committee.
Senator Banks: I do not get any points when I use cash.
Senator Kochhar: I am looking at your slide 16, Mr. Arango. There are three modes of payment — cash, debit and credit. The cash payment is more expensive than debit for the merchant, but most small merchants, when they get cash, do not feel it is costing them any money — it is just a perception.
Debit, by virtue of what it means, you pay with your card and it is debited to your account right away and money is realized, so merchants like that, even though it costs them money to realize that instant cash. People pay by credit card because, unless they are paying within 25 or 30 days, they have leverage to expand their ability to finance anything.
In this electronic age, have you ever thought of giving currency notes? You give a card, loaded with $100 or $500 and you can take that card, which is as good as currency; it is easier to carry, much less chance of losing it, if there is a code or PIN number on that, when you make a payment. Do you think banks might consider that in the future?
Mr. Spencer: That is an interesting question. It is a large public policy question, and it comes down to when is a banknote not a banknote. It is a piece of paper that says $50. If we were to issue instead a card that said $50, would that still be a banknote?
All I can say about that is we are not there yet. We are planning to issue a new series of banknotes starting this year, which will still be banknotes and will not have any electronic components on them.
Senator Oliver: Any different denominations?
Mr. Spencer: No. I cannot tell you too much about the new series yet because we are going to be giving out a lot more information, but the denomination structure will stay the same.
Senator Kochhar: Do you think it is possible in the next 30 years, 40 years, that we will make it easier?
Mr. Spencer: Central bankers are trained not to answer hypothetical questions, especially ones that go out 30 years or 40 years.
The Chair: Politicians have no such constraints.
Senator Ringuette: Electronic currency is already here.
Senator L. Smith: In reading the reports, when you started the study and the study that you are doing now for consumers, what was your objective? What did you want to get out of it?
We have seen some of the learnings from it. However, regarding the purpose of the studies, what were you expecting to achieve?
Mr. Arango: Our main objective is to understand the demand for cash, the use of cash in the future. We are in the middle of innovation in retail payments; things are changing. Understanding the two sides of the market is important to us. Understanding what are the motivations for merchants to accept alternative means of payment that could be close substitutes to cash in the future is really important to understand what would happen with the demand for cash in making our annual and long-term plans for the issuing of banknotes at the bank.
Senator L. Smith: For the consumer side, now that you have started it as of 2009, is that a continuation of that?
Mr. Arango: It is a continuation on the other side to understand how incentives by consumers may change their decisions — how different fees, the structure of fees also on debit cards, how they matter for consumers, as we find debit cards are closer substitutes to cash, especially for lower-value transaction purchases.
Mr. Spencer: Mr. Arango has explained it well. It really comes down to the banknote business. We have a responsiblity to make the right decisions. We exist fundamentally to supply banknotes — it says in our mandate and our annual report — that Canadians can use with confidence and that they can get at when they need to. We have to make sure there is a supply of secure banknotes that people can use. To do that, we must make some long-term decisions. We only issue, for example, a new series of banknotes every eight years. We have been at work on the current series for five years. We had to decide then what it would look like and how it would be structured. We also operate cash processing systems at the central bank that have a lifespan of up to 20 years. It is important for us to have a good sense as to what the outlook for cash will be for the next 8 years or even 20 years to ensure we are positioned to meet that demand and to do it efficiently.
Senator Oliver: I want to go to the main reason that brings you before this committee today, namely, a bill that is before this committee. The bill's title is Bill S-201. The title of that bill reads as follows: Bill S-201, An Act to amend the Office of the Superintendent of Financial Institutions Act (credit and debit cards).
I would like to like to know if the bank — that is, you — has an opinion as to whether or not they see a role for OSFI, Office of the Superintendent of Financial Institutions, in the regulation of debit and credit cards.
Mr. Spencer: The short answer to your question is no. The bank participates with the Department of Finance and OSFI, as well as CDIC, Canada Deposit Insurance Corporation, and the Financial Consumer Agency of Canada, FCAC, in decisions on the financial regulation, if you like, the financial environment and the government's involvement in it. However, the bank's mandate touches this only in two areas. One is financial stability, which I described before, namely, the payment and clearing systems; the other is the supply of banknotes. Beyond that, it is up to OSFI, the Department of Finance and the other agencies to decide how best to handle an issue like this.
Senator Oliver: Fundamentally, do you not see a new role for OSFI in relation to debit and credit cards?
Mr. Spencer: No, I did not say that. I said that the bank does not have a view on that.
Senator Ringuette: Nice try.
[Translation]
Senator Hervieux-Payette: Earlier you mentioned fraud or theft involving cash. Credit cards previously had no personal identification numbers, or PINs, which limit the risk of fraud, counterfeiting and identity theft. Did you evaluate that fact from a security standpoint in your studies?
Your study was conducted in 2006, and PINs were not yet very widespread at that time. Banks implemented that system much later than Europe, for example. It seems to me this aspect is not included in your studies, and that surprises me. There were a lot of credit card thefts before PINs came in. Do you not want to analyze the impact of this new security tool?
[English]
Mr. Arango: The way we are calculating that is in the item charge backs. For debit cards, our assumption is that the liability is not on the merchant side if there is fraud, unless there is mismanagement of information on debit cards inside the merchant's premises.
For credit cards, most of what we are accounting as fraud is all the losses that retailers get when there is a charge back and they have to face the cost of a transaction that is disputed by a consumer.
[Translation]
Mr. Spencer: You are entirely right; as we said earlier, a number of things have changed since 2006, and the introduction of the PIN is an example of that. I also believe that one of the witnesses representing the credit card industry mentioned that liability shift was a game changer, especially for credit cards. However, all means of payment represent a risk to merchants. In some cases, it is very small, but there is nevertheless a risk of counterfeiting, and it is our duty to minimize that risk. There are risks of physical theft or loss, and there are also risks of fraud in other areas. With the technical developments in the card industry, the situation has appreciably changed, from my personal perspective, since 2006.
Senator Hervieux-Payette: I get the impression that thieves have modernized. They used to print money in their basements, whereas they are now involved in types of electronic money such as credit cards. That is the new trend.
The prime rate has been constant for some time now, and interest rates are quite low. I remember a time when the prime rate was 10 per cent and the credit card rate 19.5 per cent, whereas now the prime rate is 2 per cent and the credit card rate is still as high as 19.5 per cent to 29.5 per cent.
When you are talking about billions of dollars in transactions, this is money that is not productive; that is to say that it will not be reinvested elsewhere. It winds up in the hands of those who have collected it. Obviously, if we have more, we will buy more. We are not talking about small amounts here; we are talking about very large amounts. That is where we will see our next study, which will not give us the cost of credit column. My colleague tells us that this is in the order of $36.50. I bought a car with my credit card, and I can tell you that my dealer was not very happy. I took advantage of the points, knowing that I was paying for them, but I do not believe this kind of transaction would be acceptable everywhere.
It is hard to understand changes in the prime rate relative to what the credit cards charge us, particularly with a PIN that cuts down on fraud. Under the old system, in 2006, fraud was more frequent and counterfeiting more easily achievable.
However, I would like to know the reason why the interest rates applied are still so high today. How can a big store like The Bay, for example, justify its latest increase from 28.5 per cent to 29.5 per cent? Are those decisions based on the situation of the Canadian economy? How does the Bank of Canada explain this increase? People increasingly use cards; they find it reasonable to pay a cost to use a debit card, but we wonder about credit card costs. You conducted studies on taxpayer indebtedness. We all know that, if we have a $500 credit card balance to which an interest rate of 19.5 per cent must be applied, if we do not pay by the end of the month, it will be costly.
Have you conducted any studies that would explain this variance? Where do these additional costs come from?
Mr. Spencer: In response to your last question, no, we have not conducted any studies. I will go back to an answer that I gave to one of your colleagues. The interest rate on credit cards, like fees, is determined by the credit card providers. I advise you to ask them how their costs are constituted. As for the difference between those rates and the prime rate set by the Bank of Canada, you are entering the field of monetary policy there. I must emphasize that I am not a member of the Board of Governors and therefore not a member of the group that makes those decisions.
However, the rates set by the bank are based on our prime objective of controlling and ensuring a stable rate of inflation. There is definitely a relationship between the prime rate and the other interest rates in the economy, but other factors also enter into the determination of those variances. Fundamentally, it is the people who determine those various variances who should explain how they reach their decisions.
Senator Hervieux-Payette: I am going to accept your suggestion and put the question to others. We are unable to explain to our fellow citizens why this variance has grown so significantly.
[English]
The Chair: The last questioner on my list on the first round is Senator Gerstein.
Senator Gerstein: Thank you, witnesses. I would like to return, Mr. Spencer, to my colleague Senator Oliver's rather excellent question, in my view. I suspect that the bank looks at any bill that would be initiated by either the other place or the Senate when it comes to the issue of finance, which this is in some way or another.
Mr. Spencer, without expressing an opinion, either on behalf of the bank or, for that matter, personally, when you read Bill S-201, what came on your radar screen? Did you take a look at it and say, "Look, this just has nothing to do with us; I do not know why we are appearing here?" Is there something in it that twigged your attention? I am certainly not interested in your opinion, but I might be interested in what attracted your attention, if anything.
Mr. Spencer: Leaving aesthetic issues aside, what attracted our attention was not the bill but a request from this committee to appear. The research that Dr. Arango and Varya Taylor had done had attracted members' attention and they thought we could shed some light on this area and, in particular, on the perceptions of merchants. We have a number of studies on the use of cash but it was the merchants' perspective that we thought about.
Speaking personally, Bill S-201 was not on my radar screen at all until the committee's attention was drawn to our work and we received the invitation.
Senator Gerstein: Thank you. That was very helpful.
The Chair: The first questioner on the second round is Senator Ringuette.
Senator Ringuette: I will approach the issue from a different angle and ask you why the U.S. reserve bank has conducted a study and is looking at imposing caps on Visa and MasterCard debit cards in the U.S? Why did the reserve bank, which is your counterpart in Australia, do a study of credit card fees seven years ago and introduce legislation to cap these fees at "a reasonable rate?" Why, as of yet, has not the Bank of Canada looked into these same issues as your counterparts in New Zealand and the U.S. have done?
Mr. Spencer: There are two parts to that question. Any explanation as to why the fed and the RBA, Reserve Bank of Australia, did what they did coming from me would be second hand. As you are already planning to do, it would be much better to ask them directly and to amplify the reasons for why they published that. It is fairer to ask why we have not done the same. The answer I can give you to that is that the responsibilities of central banks are arranged differently in different countries. I am not an expert in this field, but my understanding is that both the Federal Reserve Board and the RBA have broader supervisory and regulatory responsibilities than does the Bank of Canada. In the Canadian regime, these responsibilities are divided among the Bank of Canada, CDIC, OSFI, FCAC, and the Department of Finance has the umbrella.
In the Canadian context, the bank, given its lack of involvement in the retail sector except for the provision of banknotes, is not the right body to ask that question.
Senator Ringuette: Except if, like in the U.S. and in Australia, the government would mandate you to do so?
Mr. Spencer: If the minister is interested in that, we would, of course, be all ears.
Senator Banks: I have a short supplementary. Do not interest rates contribute to the determination of inflation rates?
Mr. Spencer: Absolutely.
Senator Banks: You said you were concerned with the inflation rates, quite properly.
Mr. Spencer: Yes, we are. You are now getting into a technical field in terms of the determination of inflation. Being not an economist myself, I am not qualified to answer. Therefore, I would like to decline that question.
The Chair: As our distinguished colleague from the Library of Parliament pointed out this morning, while the bank can probably control inflation, it is difficult to see how it could produce inflation. The government can by perhaps printing money, but I am not sure the bank can. That might be something to discuss with the governor when he appears before us in April. We always look forward to his visits.
Senator Harb: First, I want to thank you very much. You have done the committee an excellent service in bringing forward that information because it helps us greatly to see where the money flows, where the transactions go, what the merchants like and do not like, and the costs.
I was interested in page 20 in your merchant costs of accepting means of payment. You took here $36.50 and you did some amazingly smart analyses in terms of actual costs to the merchant. You figured out that the most costly is the credit and the least costly is the debit. What really intrigued me was the float. Can you tell me what the float is and what the coin ordering cost is, as well as the cash deposit fee?
I think we have an idea in terms of what the cash deposit fee is. However, do merchants pay for the coin ordering?
Mr. Arango: They pay for that. It depends on the package that merchants have with their financial institutions. Some might have a fee to cover all these services, but there are also fees per order that they must pay with the financial institution or the other cash processors.
Senator Harb: What is the float?
Mr. Arango: We calculate the float, for instance for cash, as the time that merchants spend to bring cash sales to the bank. Merchants may do that in the same day, some merchants may do that the next day, and some merchants may keep the money for three or four days or a week. Looking at an average of the frequency of deposits, we calculate how much cash they hold on average and then we put an interest cost on that.
Senator Harb: You pay for printing the currency, you print the money and the banks, I presume, bring in their old, used cash and then they will give it to you and you give them new currency. Do you charge them for that service or is it done pro bono?
Mr. Spencer: It is primarily a public service. There are some fees to incent them to do this efficiently. For example, we have an interest in making sure that the notes in circulation are of good quality, so if they bring in worn notes, which is what they are supposed to do, we will happily give them new ones. If they bring in notes — and this is hypothetical because they are really quite good at this — simply because they do not want to carry them any more then we may charge them at least the transport and the processing, or some fee in relation to that.
By and large, we supply banknotes to meet the demand and we carry the costs of producing them and delivering them to the banks.
Senator Harb: I believe Canada ranks internationally among the highest in the world in the use of debit; would that be a correct statement?
In a sense, we do have a vested interest as you as a bank and we as a committee to encourage more people to use debit, because you can save money on not printing money; is that right? Every time you print money, in essence, you are paying for it; it is a cost for you.
Mr. Spencer: It is a little more complicated than that because we also make quite a lot of money on banknotes in the form of seigniorage, because it costs us currently about 9 cents to print a note and the $20 bill in your pocket represents a $20 interest-free loan to us. We paid 9 cents to get that note to you, we take the $20 and invest it and, if you look at the bank's income statement, you will see that the revenue from the securities in which we invest the proceeds of the sale or the loan of the banknotes is the largest source of income for the bank, and that far more than covers the bank's operating costs. The balance is turned over to the Receiver General.
Senator Harb: Now then, the merchants make more on debit and you make more on cash. If people use more cash, then you are making more money?
Mr. Spencer: That is true but we do not view ourselves as competitors in this business. We are providing a service of banknotes and we provide it to demand. We see our role as promoting the correct use of banknotes, the prevention of counterfeiting and the efficient running of a cash system, but our success measure does not include how many banknotes we have outstanding. That is a function of what the economy demands, and we simply meet that demand as efficiently as we can.
Senator Harb: I love this report, I think it is absolutely fabulous and I hope you publicize it more so the public will see the cost. You are doing a great service, both for the merchants as well as to Canadians so thank you.
Mr. Spencer: It is on our website.
The Chair: Perhaps we as a committee can help in that respect, Senator Harb, by publicizing it.
I think I speak for everyone when I say that we consider ourselves fortunate to have had the benefit of your input today, Mr. Spencer and Dr. Arango, and Canada is fortunate to have people such as you at our central bank. Thank you for fielding some challenging questions and numerous points of view. You did yourselves proud and we appreciate it.
Colleagues, this meeting is adjourned.
(The committee adjourned.)