Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 16 - Evidence - October 30, 2014
OTTAWA, Thursday, October 30, 2014
The Standing Senate Committee on Banking, Trade and Commerce, to which was referred Bill S-202, An Act to amend the Payment Card Networks Act (credit card acceptance fees), met this day at 10:30 a.m. to give consideration to the bill.
Senator Irving Gerstein (Chair) in the chair.
[English]
The Chair: Good morning. Today our committee is holding its fifth meeting on Bill S-202, An Act to amend the Payment Card Networks Act (credit card acceptance fees), a bill introduced by our esteemed colleague Senator Ringuette.
Honourable senators will recall that the committee began by hearing from Senator Ringuette, the Department of Finance, the Financial Consumer Agency of Canada and the Competition Bureau of Canada. At the second meeting, we heard from a number of users and subsequently from the two payment card networks designated in the legislation — Visa and MasterCard. We have also heard from witnesses representing merchants and consumers.
This morning's meeting, colleagues, is divided into two sessions. On our first panel we have, from the Canadian Bankers Association, Mr. Darren Hannah. Welcome back; it is always a pleasure. Mr. Hannah is Acting Vice President, Policy and Operations, and he directs the CBA's policy development on banking issues related to retail payments, payment cards, interbank payments and emerging payment issues.
From AIMIA, we have Mr. Vincent R. Timpano, President and Chief Executive Officer, Canada, and Executive Vice President; and Mr. John Bragg, Vice President, Global Government and Regulatory Affairs. AIMIA is a global leader in loyalty management products. With headquarters in Montreal, the company operates programs in over 20 countries. Previously, Mr. Timpano served as president and CEO of Aeroplan.
I will now turn the floor over to Mr. Hannah to be followed by Mr. Timpano for their opening remarks.
Darren Hannah, Acting Vice President, Policy and Operations, Canadian Bankers Association: Good morning. It is my pleasure to be here today to participate in the committee's discussion on Bill S-202, which proposes amendments to the Payment Card Networks Act.
The CBA represents 60 banks, including domestic chartered banks, foreign bank subsidiaries and foreign bank branches operating in Canada. We are very proud that Canada's banks have been rated the soundest in the world for the last seven years by the World Economic Forum. Sound, strong banks help families buy a home and save for their retirement and help small businesses grow and thrive.
Banks contribute to the economy in many other ways. For example, banks employ 280,000 Canadians across Canada. Banks provide financing to about 1.6 million small businesses. Canada's six largest banks paid about $8 billion in taxes to all levels of government in 2013. And Canada's profitable banks provided $13.5 billion in dividend income to millions of Canadians in 2013 through their pension plans, RRSPs and direct share ownership. In short, banks help drive the economy, providing economic benefits to all Canadians today and into the future.
Canadians trust and value their banks. From our public opinion research, we know that 81 per cent of Canadians have a favourable impression of banks in Canada, and 90 per cent have a favourable impression of the bank they do their business with.
With this backdrop of how our banks are vital to the growth of the Canadian economy, I would now like to take a few minutes to outline the banking industry's perspective on the current payments market in Canada.
Canada has a highly developed payments system that has long offered customers and businesses the benefit of a variety of different competitively priced payment products. While we are focused on credit cards today, we should remember that they're not the only type of payment that consumers and retailers can choose from. They compete with cash, cheques, debit cards and mobile payments, as well as unregulated electronic payments services like PayPal. Retailers can choose which payment methods they wish to accept, and consumers can choose the form of payment that best suits their needs.
Canadians are embracing innovation in payments. Our research shows that consumers value contactless payments such as tap and go, and they value being able to use their smartphone or mobile device to pay for purchases. Credit cards are one part of that broader payments system, offering a safe, convenient and widely accepted form of payment that is used by millions of Canadians every day.
The current credit card system provides value for consumers and retailers in a number of ways. Both retailers and consumers benefit from fast, convenient and secure transactions which reduce lines at checkout. If every payment transaction took an extra 30 seconds, it would use up an additional 27 million hours of retailers' staff time every year. Retailers don't need to hold as much cash on hand, reducing cash handling costs, making it safer for them and their employees and certainly making it more efficient at the end of the day. Credit cards provide retailers with guaranteed payment, without worrying about customers' credit worthiness, insufficient funds or outstanding receivables. Credit card holders are advanced funds on an interest-free basis of up to 51 days from the purchased payment. Many Canadians take advantage of the rewards and benefits from credit cards such as travel points, car insurance, damage and loss insurance and extended warranty programs.
What is often not very well understood is the credit card transaction process. You will see from the illustration we provided to you that credit card issuers — banks and other financial institutions like credit unions — are one player, but there are other players in the transaction, and they all share in the costs and benefits associated with the card system.
As credit card issuers, banks' primary relationship is with their customer. Millions of Canadians have chosen to use a credit card as a convenient payment tool that offers the benefits I have mentioned and many others. Banks work hard to offer the best products and services to their customers, and customers expect this from their financial institution.
In this ongoing discussion about the proposed changes to the credit card market, it is important to remember the best interests of all stakeholders, including the millions of Canadian credit card holders. We are not supportive of Bill S-202. Aside from the numerous concerns about specific provisions and terminology in this proposed legislation, more generally, there are always unintended consequences associated with regulation when regulations are imposed on highly competitive and well-functioning markets.
These unintended consequences can have negative impacts for consumers. For example, the Reserve Bank of Australia regulated credit card interchange rates and permitted merchants to apply surcharges to customers paying with credit cards. While merchants received the benefit of reduced interchange fees, these savings have not been passed on to consumers in the form of lower prices by retailers. Where governments have intervened in the credit card market, it has resulted in higher costs and reduced benefits for consumers.
As I said at the outset, Canada's banking system is the soundest and strongest in the world. Part of that strength is the tremendous choice and competition benefiting all Canadians. We encourage the committee to carefully consider the interests of millions of Canadian credit card holders as you review the provisions of Bill S-202.
Thank you for inviting us here today. I will be pleased to answer your questions.
Vincent R. Timpano, President and Chief Executive Officer, Canada, and Executive Vice President, AIMIA: I wish to thank the chair and other members of the committee for the opportunity to speak today. This is my first appearance before Parliament, and I am glad to be here speaking with you — all the more so after the events of last week.
This is an extremely important matter for our company and for the 5 million Canadians who are members of the Aeroplan program. I hope that our participation today will help inform the committee's deliberations on public Senate Bill S-202, in particular regarding how the changes proposed would hurt consumers and Canada's loyalty industry.
Many of you know the Aeroplan brand and are long-time members. What you may not know is that our company, AIMIA, owns and operates Aeroplan as well as a number of other loyalty programs in 20 countries around the world.
With headquarters in Montreal, AIMIA is a Canadian-based, publicly traded company that is considered by many to be the global leader in loyalty management. We have over 1,800 employees in Canada and over 4,300 employees worldwide.
Even with this growing international footprint, Aeroplan remains the flagship program that anchors the AIMIA business. Last year, Aeroplan issued approximately 2.3 million rewards to members, including more than 1.6 million flights on Air Canada and Star Alliance carriers, in addition to thousands of other non-air rewards.
Aeroplan has a long, successful partnership with Canada's financial sector. In 1992, we introduced the CIBC Visa Aerogold credit card, a non-premium rewards credit card that remains available today to millions of Canadian. Over the last two decades, our involvement in payments has broadened to include American Express and, more recently, TD Canada Trust. These relationships have helped grow and improve the Aeroplan program. For example, the new TD partnership enabled AIMIA to invest in substantially enhancing value for our Aeroplan members.
We have reviewed Bill S-202 to understand its impact on Aeroplan and our members. We know that credit card acceptance costs for merchants are a major focus area for policy-makers. I'm not here to dispute or challenge their statements. Rather, I was hoping to use my time to talk about the consequences of Bill S-202 for Canadian consumers and the loyalty industry.
Consumer impact has tended to be considered as an afterthought, thus far. This is unfortunate because the experience elsewhere tells us that consumers will be the ones most hurt by dramatic cuts in interchange.
In Australia and the U.S., this has taken the form of reduced rewards, higher annual fees, reduced availability of credit cards and elimination of consumer-friendly products such as no-fee bank accounts. Additionally, the evidence suggests that whatever consumers theoretically save from lower merchant prices is outweighed by increased bank costs.
In the Canadian context, Bill S-202 would have a profound and negative impact on consumers, particularly the 14 million Canadians who participate in credit card affiliated loyalty programs.
The extreme reduction in interchange levels contemplated by the bill would force our company to fundamentally reconfigure the value to our members. The proposed limits on interchange would require us to significantly reduce benefits to all members, not just cardholders. The potential impact on our membership would have a profound implication for the Aeroplan program millions of Canadians know and value.
In essence, the value of the miles or points that our members have saved and have come to rely on would be diluted dramatically. Knowing our members as I do, I can assure this committee that these 5 million Canadians would make themselves heard.
For our company, this is clearly a business issue. Over the course of recent weeks, AIMIA has seen its market capitalization reduced by over 20 per cent, or close to $700 million, in large part due to the speculation about government intervention to reduce interchange rates. This underscores the impact the regulation would have on us and, by extension, on Aeroplan members.
It is important to understand who our members are and the value they derive from loyalty rewards. Aeroplan today reaches far beyond affluent frequent fliers. For millions of Canadian families, loyalty rewards are part of the economics of their household and part of their everyday life. Our research shows that 73 per cent of loyalty cardholders have redeemed a reward within the past five years, with one-third using points to save money on everyday items such as groceries and gas.
Our company is acutely aware of the concerns raised by merchants before this committee. We understand the need to address these, but it should not be done at the expense of consumers and, by extension, the loyalty industry. Based on what we know, the option before this committee would leave consumers paying the price. Whether intended or unintended, this is what will follow if Bill S-202 becomes law.
Thank you again for inviting me here today. I look forward to answering your questions.
The Chair: We have a lengthy list of questioners.
[Translation]
Senator Hervieux-Payette: I would like to come back to the basic question: what is the purpose of a credit card? In my opinion, the simple definition is the payment for a good or service without having to use paper money, and the bill is paid at the end of the month. The purpose is to make transactions easier and to help us avoid having to go to the bank regularly. So there is a goal, a service that banks provide through credit cards. However, I do not need points to get car insurance, medical insurance, travel insurance, a camera, a vacuum cleaner or other items. When I want something, I simply go and buy it. My question is for the two witnesses. I would like to know how this much-talked-about cost is shared. The bank takes a certain amount, Visa or MasterCard and Moneris take a certain amount, and Aeroplan and Air Miles take a certain amount as well. What percentage is charged to customers when they use their credit card? What percentage does the bank receive? How much do Visa, Moneris and Aeroplan get?
[English]
Mr. Timpano: I apologize; I missed a portion of your opening statement with my device. On the basis of the share of value that Aeroplan derives from interchange, the answer is that Aeroplan does not participate in the interchange process directly. We do not recover revenues through interchange.
The question is best served for Darren.
Senator Hervieux-Payette: Don't tell me that you send me gifts and nobody is paying for it. If I get a camera, if insurance for my trip or my car, all of this is coming from the owning the card. Who is paying for that, and who is being paid for that? Do you provide these services to the bank?
Mr. Timpano: We provide services for the bank, but we do not participate in the interchange process. The bank pays us for certain services, and it allows us to fund our Aeroplan program. As a result, anything that impacts the bank's revenue, of which interchange could be a piece, could impact our business as a result.
It is important to state that Aeroplan does not participate in the interchange rate in the process.
Senator Hervieux-Payette: You are part of the component of the percentage that —
Mr. Timpano: We provide a service to the bank through the program, which they pay for.
Senator Hervieux-Payette: The bank can answer to me.
Mr. Timpano: Sure.
Mr. Hannah: I'm glad you asked the question and framed it that way. What you framed out is an important point, which is that a number of parties are involved and they all benefit so they all pay. The bank has its own costs to deal with and derives a benefit.
It has to pay costs, manage the account, print the cards, forward the credit, deal with the losses, and it also has to pay the networks for their service. The networks benefit and they pay as well. They have their own costs associated with sending transactions for approval and authorization. The merchants have their costs and they benefit. They get the benefits associated with the card, they're able to sell products and they pay a cost to the acquirer for accepting cards. To your specific question of how that breaks down, it depends on the individual contracts and the individual cards people have.
Each merchant will have a contract with a merchant acquirer. Each cardholder will look at the choice of cards and decide to pick a card that may have an annual fee or it may not. It may have an interest rate. Each individual issuer will issue a different card. Maybe it's a card with a rewards program, and maybe it is not. Maybe it has a higher or lower interest rate.
Frankly, there is no one breakdown. It depends upon how the different players, who all benefit and participate, interact with one another.
All of them benefit and all of them pay. That's an important point.
Senator Hervieux-Payette: Countries that have reduced the interchange rate, first of all, need to have the network, the machine to operate at each restaurant or any stores we deal with because they need to have their own system.
Do they lose the insurance? Do they lose the possibility of travel? Do they lose the possibility to get a camera? There is a cost to that. Maybe you pay AIMIA for these gifts, but I want to know what will happen. What is happening in those countries where the interchange cost is reduced dramatically, not just a bit but in a very large way?
Mr. Hannah: Let me speak on Australia for a moment because it is a great example. In Australia, the government stepped in and decided they were going to cut interchange and introduce surcharging. What happened when they did that is merchants have seen their merchant service fee go down, but there has been no evidence anywhere that consumer prices have actually fallen.
As a consequence, consumers have not benefited from this. Merchants have been the only ones who received any benefit from what has happened in Australia. In addition, to complicate matters they chose to introduce surcharging. In that instance, the merchants took advantage. It got so bad that they were surcharging well above the cost of acceptance, and the government had to step in and rewrite the rules to try to deal with that.
Senator Black: Thank you for being here. Those were extraordinarily well considered presentations. As you can know from reviewing the transcripts to date, we are hearing a wide range and divergent points of view on this.
Mr. Hannah what is the top line amount of money that the banks would earn from the acceptance fees? Are you able to share that with us?
Mr. Hannah: I don't have that information. I want to back up. There are two points. The acceptance fees are paid to the merchant acquirers — the payment processors — and not to the issuers. The payment processors are a diverse group of entities. There is one that's owned by a bank and one that's jointly owned by a bank, but there are others that are not. They are their own business. That's where the merchant fees would be paid.
I'm here representing the banks as issuers — on an issuer basis — because that's always been our perspective.
Senator Black: We have consistently heard in the evidence that an acceptance fee is paid.
Mr. Hannah: Right.
Senator Black: We'll call it $100, to make it easy. We're told that the majority of that money flows to the chartered banks — the issuing banks. We are told that MasterCard, Visa and others earn a fee. But the majority of the money is going to the chartered banks. That's the evidence before this committee. Do you disagree with that?
Mr. Hannah: I think we are referring to the interchange fee. Is that correct?
Senator Black: Correct.
Mr. Hannah: It is certainly the case that there is a merchant acceptance fee among the merchants' costs. There are several, but among them is the interchange fee, which I admit is a significant one. That fee flows from the acquirer, then back to the issuer, whether it be a bank, a credit union, Desjardins or whoever. The reason that is done is to balance the costs and benefits in the system. I think Visa and MasterCard —
Senator Black: How much money goes to the bank? Can you give us an order of magnitude? Is it $1 billion a year? Is it $8 billion a year?
Mr. Hannah: I don't know. I don't have that information. I don't know how much the dollar value is.
Senator Black: Can you get that information for us?
Mr. Hannah: I don't have the information. I simply don't know how much flows—
Senator Black: You couldn't get that from your members?
Mr. Hannah: No, I don't have it. That's unfortunate, but I don't.
Senator Black: I'll finish up, and then I'm more than happy for my colleague to raise a question. I'm a lawyer so I'm just looking at the evidence that is before us.
Both of you have argued that higher costs will not benefit consumers, and if we were to reduce or recommend reducing the fees, then consumers would not benefit.
Specifically, you hang your hat on the fact that you do not believe that prices in a local grocery store would be reduced. We have continually heard evidence from retailers and business owners that while that may or may not be the case, what it would ensure is that they would renovate their stores, they would hire more people in the local community, they would support more local charities, that there would be more money in their purse to assist their operations.
To me that makes sense. Can you comment on this?
Mr. Hannah: I have not seen any evidence to back up the statements that they may be making. I have not seen any study coming out of Australia or any other jurisdiction that suggests that taking action to reduce interchange fees and merchant fees would result in any sort of benefit flowing either directly to consumers in the form of lower prices or in an indirect fashion in the form of an improved consumer experience.
Senator Black: This is the evidence we have heard. We haven't dreamt this. This is the evidence that we have heard here.
Mr. Hannah: Are these just statements they're providing saying that this is what they think will happen? Or have they been able to point to another jurisdiction where they can show that this is what happened and here is the effect? I have never seen that. Honestly, senator, I have never seen any third-party evidence that suggests that this is the case.
Senator Black: Thank you very much.
Senator Massicotte: To all three of you, thank you for being here. On this issue, I'm sure the research was well done and it shows there was no immediate direct link showing a benefit to the consumer. One could argue, and it would be my opinion, ''So what?'' If you have confidence in the market system and if you have confidence that there's adequate competition, eventually it will flow to whoever deserves that capital. It would be the adequate return on investment for the retailer or the consumer. That doesn't bother me.
I fully buy everything you have said on the benefit of credit cards. It is a very important payment system in our economy. It is very convenient with immense advantages. I have no difficulty with that. I acknowledge there's a lot of competition among issuers of credit cards. That's not the issue.
If you look at the Competition Bureau, although it is very technical, they made it clear: The problem is that the merchants are stuck in a corner with having to accept Visa and MasterCard. The problem is that a quasi-monopoly exists. That's where the competition is inadequate. I'm a big believer in the marketplace. It is the most efficient allocation of capital resources. The presumption of the marketplace is that there has to be adequate competition. In that sector, it is not there.
Taking into account what came from the Competition Bureau, which I think was well-founded, what is the solution? Some countries tried to allow the retailer to charge more or to give discounts. You referred to Australia, where it didn't seem to work well. With credit cards imposed they must accept all credit cards. They cannot delineate, and skip one or the other. You would argue that's for the convenience of the consumer. What is the solution?
If the status quo is not fully acceptable, then what is the solution to that problem?
Mr. Hannah: Senator, I'm glad you have raised this. There are a couple of points and I want to build on each of them. You raised the point about the discounting option available to merchants. Discounting has been and continues to be available here to merchants, if they choose to use it — but frankly they don't use it. To me, this is an interesting statement. It is a good question to ask. Why they don't use that option?
Second, I know the government has already taken some steps to try to address the credit and debit card code of conduct. I think it is a very wise code. They have set up a code of conduct that ensures that merchants, small merchants in particular, have clear and transparent contracts with their acquirers. They can effectively shop around among different acquirers to find the one that offers them the best value, with clear terms and conditions and a clear right to be able to opt out of that contract, without penalty, if an unanticipated or unexpected fee increase happens.
The third point I want to make, and I think it's important, is with respect to the question you raised about choice. I'm going to give you a fascinating little example. I flew in last night and I stayed at a hotel. My hotel is making a decision about what type of payment they can or cannot accept. They will only accept a credit card. Clearly that's the product that provides them with the best value. There is some choice, at some level, if a product is substantially better than another. I understand their interest. From their point of view, the advantage of that product is I can just check out and leave. If I have taken anything from the mini bar, it is covered. If I have done any damage to the room, it is covered. It is providing them with a value proposition that is clearly above and beyond anything else.
Senator Massicotte: That's not the issue. You want to make a brief comment?
Mr. Timpano: We haven't constructed a solution. It is a complicated issue. We understand this is an issue that policy-makers have been grappling with for some time. We have spent a lot of time trying to understand the outcome and the impact on our organization — the 5 million members — and frankly the 14 million Canadians that are on credit card loyalty programs.
We have focused more on what a solution should deliver against as a couple of core principles. The first principle is that we believe the consumers should be kept whole. Consumers should not be the group that is penalized as a result of what I would describe as excessive regulation. The second principle is that we have sympathy for merchants, who desire to lower their costs, and in particular for the small merchant community, where they don't have the benefits of scale to be able to negotiate like some of the larger merchants can. We want a principle to see that you can target any savings in a manner that the small merchant actually benefits from it.
To the extent that a solution can be built to satisfy those two principles — and I know it is a difficult one — it's really where we have spent our time and where we would argue that most of the effort and energy should go.
Senator Massicotte: Let me tell you the response to the comments. We had many witnesses. Small business is basically saying — and the documentation supports — that they have no choice. I know you said they have a choice, but they have no choice in their mind given the convenience of credit cards; I don't take away from that. You are coming back to the argument. I buy that fully. But given the convenience to credit card consumers, they have no choice but to accept MasterCard and Visa. They can't be in business without accepting that.
Here you have these large corporations, predominantly backed up by the banks because you are the major beneficiary of those fees, saying I have no choice but to accept it. As to the discount, they made it very clear to us that the competition is so immense and, like you said earlier, the arrangement of credit cards is different with Costco than it is for Walmart or a gas station. They have no choice in that if they provided a discount or have the right to charge a surplus, immediately competition will be such that the consumer will be disenchanted with them. They have no flexibility in the marketplace to do so. They're really stuck.
They don't have the flexibility or market presence to dictate the terms. They either say yea or nay to Visa or MasterCard, but there goes our business. So there is a problem.
It doesn't take away from all the benefits of credit cards. There's a problem, and thinking it is going to disappear without the banks or the credit unions getting involved is not going to happen.
The Chair: Thank you. I will put you down for second round.
[Translation]
Senator Bellemare: My question follows on Senator Black's. You said that you are unable to give us the amount in billions of dollars that is paid to the banks in interchange fees. However, do you know what percentage of these interchange fees goes to the banks? Not the total amount, but the percentage?
[English]
Mr. Hannah: The short answer is no. I will explain why. The challenge is that the interchange fee varies — in fact the merchant discount fee varies — depending upon the type of card you are talking about, and the merchant. Different merchants have different rates. There are special classes and some of them negotiate special deals. Depending how the card is processed, the merchant can process a credit card in a conventional chip and PIN way. You put it in, it does the transaction and you punch in your PIN. The merchants can do it by pulling the mag stripe and sign. The merchant can process it using a contactless option, tap and go. The merchant can process online using card not present or even go back to good old carbon paper. Each of those is priced differently because each of them has a different risk profile. That's the way the pricing structure works. It is designed to factor in risk.
The short answer is it depends a lot on the behaviour of the individual transaction and the individual merchant.
Senator Bellemare: You don't have any clue about an average.
Mr. Hannah: I wouldn't want to give one, senator. I really wouldn't.
[Translation]
Senator Bellemare: I have a concern. We can sort of understand the concerns of the financial institutions involved in the credit card process. Do you have any comments on the effects that credit cards can have on low-income consumers compared with high-income consumers?
I know that consumers will use points. They have a consuming strategy when they pay by credit card to accumulate points with Aeroplan, for example, to get trips. When we look at this situation as a whole, we see that there may be funding that is between income levels. I am wondering if there is an impact on income distribution.
In other words, basically, when a consumer buys something, taking everything into account, this thing might cost consumers with low incomes more because someone with a higher income will have benefited from more gifts and privileges. Have you looked into that aspect of the system?
[English]
Mr. Hannah: I have couple of points, senator, because you raised a couple of important things. I will come back to what I mentioned earlier. First, in jurisdictions where they have done this — primarily in Australia, which is the great example — the main benefit that was supposed to flow back to consumers, whether they are high-income or low-income, was a lower price. We haven't seen that. The second point is that discussion comes up a lot about the cost of individual consumers, cross-subsidization, for lack of a better term.
The reality is that you will never get a situation where two customers of any type cost the same to serve. If I go into a store and customer A takes an hour to decide what he wants and customer B takes five minutes, they cost a different amount to serve. If one is driving there, parked in the parking lot and one has taken transit, there's a different cost to serve. If one comes in on the weekday when staff is making the regular amount and one comes in on the weekend when they're making time and a half, it's the same price, different cost to serve. One comes in and buys a product downtown where rents are high, and the other one goes out and buys the same product at the same chain in the suburb for the same price; it's a different cost to serve.
You will never have a situation where two consumers have the same cost; otherwise a pricing structure would be untenable. It is a reality that different consumers, for different behaviour reasons, cost different amounts to serve.
[Translation]
Senator Bellemare: What I wanted to say is that you sometimes see reports that young, low-income families have credit card debt but, I admit, that is another matter.
Do you have any comments, Mr. Timpano?
[English]
Mr. Timpano: If I could, earlier on in your statement you talked about the impact to consumers. The reality is there is evidence that as a result of the regulation in Australia, consumers are impacted.
When you think about the development and importance of loyalty in Canada, I have a couple facts that are important. Nine in ten Canadians belong to at least one loyalty program. The average household belongs in at least eight programs, and 56 per cent of Canadians consider credit card rewards as part of their everyday life. Seventy-three per cent have redeemed in the last five years, and what is important here is that fewer than two-thirds have redeemed for travel. Travel isn't just luxury travel. It's to offset costs for family vacations. But one third of cardholders have actually redeemed to offset their everyday living costs. They apply it to gas, offset their cost of groceries.
It is just important to reinforce that regulation which impacts the ecosystem will —
The Chair: Thank you, Mr. Timpano.
Senator Tkachuk: On credit cards, do you have stats on the percentage of business that is driven by Visa and MasterCard, which are the two main credit cards in small business across Canada, versus cash, other types, cheques, phone, et cetera? How much of the business is driven by credit cards?
Mr. Hannah: I don't have them with me here. I'm working off memory, so forgive me if I'm wrong. I can certainly send you additional information if you like.
Senator Tkachuk: That would be good.
Mr. Hannah: I believe about 20 per cent of transactions are credit card based.
Senator Tkachuk: It's 20 per cent in most businesses?
Mr. Hannah: That's in aggregate. Clearly you will get great differences among different types of businesses, but in aggregate.
Senator Tkachuk: Right. In the credit card itself, Visa or MasterCard, are there different percentages taken from the business retailers' cost of service between different cards? I know there is between American Express and Visa, but say within the Visa stable of cards, are there low-transaction-fee-cost credit cards that don't have loyalty programs, et cetera, just a credit card?
Mr. Hannah: Sure. There are literally hundreds of varieties of cards. Some of them are rewards-based, some of them are not. Some of them differentiate based on annual fees, some have a higher fee and some have no fee. Some differentiate based on interest rates, a high or low interest rate. From the merchant point of view, what you are asking is whether all merchants pay the same amount based on the card or merchant?
Senator Tkachuk: No. Are there cards that are cheaper within that Visa stable?
Mr. Hannah: Yes.
Senator Tkachuk: How cheap?
Mr. Hannah: What the merchant pays would depend upon their agreement. Certainly, there are spreads. Visa and MasterCard would be better positioned to talk about their interchange rates; but there are spreads in there.
Senator Tkachuk: If you add a bunch of marketing things to the cost of a credit card, like Aeroplan, or Air Miles, the percentage is usually higher on that credit card. Is the cost of a transaction higher with that credit card than with another credit card?
Mr. Timpano: Can I clarify? Is this the interchange rate that the merchant would pay, or is it the fee that —
Senator Tkachuk: The total fee.
Mr. Timpano: — the consumer would pay?
Senator Tkachuk: The consumer.
Mr. Hannah: The consumer fee is very different.
Senator Tkachuk: Exactly.
Mr. Hannah: What the consumer pays is disclosed to them up front. Whether the card has an annual fee is an option. You can get an annual-fee card or a no-fee card. I can't speak to the specific breakdown on all that. Obviously, there's a variety. There are certainly no-fee cards that have rewards; and there are some no-fee cards that don't have rewards.
Senator Tkachuk: I have a lot of problems with this. We haven't seen, or at least I have not seen, any evidence that consumers benefit. I have a lot of problems with this bill because I see credit cards as an input cost like rent. If you go in business, you pay rent. Some people pay higher, some people pay lower. That's what it costs. We don't come to the government to say, oh, we are paying too much rent. Would you force this real estate guy to take his rent down because it is costing me too much? We are getting into an area where maybe the Competition Bureau should be involved but certainly not the government. I'm trying to convince myself that I'm on the right track, and like Paul, from time to time I do have some difficulty.
If credit cards are only 20 per cent of the cost overall, in other words 80 per cent of customers use a totally different form of payment, then the retailers are actually picking up extra margins on all the people that don't use the credit cards. We haven't heard any evidence about that, but I'm sure there must be. Some people pay by cheque and in other ways. Costs are associated, but there are extra margins. Really, the cost to the consumer isn't 2 per cent. The cost to the consumer overall of doing transaction business is maybe a lot less than that. If only 20 per cent of them use credit cards, then the cost is obviously a lot less. What they're trying to do to us is come to government to force them to get rid of one of their input costs rather than compete in the marketplace by advertising for people to use a different form of payment than perhaps offer a reduction in price.
I learned all of this from the people who are proposing the bill. I thought I would get into the action here a little. I don't usually do this, as you well know.
[Translation]
Senator Maltais: Canadian consumers are always looking for deals, discounts and rewards. Anyone my age surely remembers the famous Gold Star stamps, before credit cards were around. Gold Star had a good reason for that and had to make some kind of revenue. With a suitcase full of Gold Star stamps, you could buy a large box of baking powder, when a small box would have been enough for a family.
Now we have automatic debit cards. People buy lottery tickets with them and even with credit cards. If someone buys 10 lottery tickets with a credit card and wins $50, great. It will pay the bills.
Suppose now that all of that no longer exists. Consumers will surely look for something else. A part of your work is lacking on one point, and that is education. Credit cards can be useful for business people, travellers, consumers, but regardless of whether there is a reward or not, if you need a refrigerator, you buy it, as long as you can pay for it because if you pay for it over 10 months, at the end of it, you will have paid for a stove, as well.
Consumers are always looking for deals, rewards. Certainly, that is why companies like yours exist. However, when these cards and bonuses are issued, is the average consumer educated, not the consumers who use them properly, but consumers who tend to use them too frequently and not always wisely?
[English]
Mr. Hannah: Absolutely, it is something we are glad to talk about. Financial literacy is an important issue of the Canadian Bankers Association. We have run your money program for students to help them learn about how to effectively handle their money and how to deal with credit. We launched a new program for seniors as well to help with financial literacy and financial education, in partnership with the Financial Consumer Agency of Canada, FCAC. It's an important component for us. We have to give Canadians some credit because about 70 per cent of Canadians pay their balance off in full every month. They're not being charged any interest. Credit card debt only represents about 5 per cent of Canadian household debt.
Canadians use their credit cards pretty well. They manage their money well, but certainly we have tried to help embrace the move towards financial literacy and make it available to both young people and seniors.
Senator Ringuette: Mr. Hannah, welcome again to our committee.
Mr. Hannah: Thank you.
Senator Ringuette: I'm always anxious to hear all the spin that you have to provide and no answers.
The Chair: He is a guest at our table.
Senator Ringuette: Yes. Very important questions have been asked repeatedly since 2007. They have been asked every time that your association appears before this committee: What are the billions of dollars on a yearly basis that the Canadian banks get with regard to interchange fees? What is the percentage?
Mr. Hannah: As I said earlier —
Senator Ringuette: You never know.
Mr. Hannah: Senator, as I said earlier, the transaction cost depends upon —
Senator Ringuette: We're not asking about the cost. We're asking about the net profit.
Mr. Hannah: Senator, as I said earlier —
The Chair: Please respond.
Mr. Hannah: As I said earlier, the interchange fee varies depending upon how a merchant processes a transaction. It varies upon the merchant and the card. It varies upon all of these factors. Is money flowing there? Of course. There's an interchange. There is revenue flowing to all participants in the system because all of them benefit; all of them also pay costs because all of them benefit, including the merchants and the cardholders. Everybody, including the networks, has a role. It is a well-functioning market that way. That's the way the market works.
Senator Ringuette: Mr. Hannah, I appreciate that you don't want to answer the questions. I don't know if you know the answers. That being said, all of us are financial consumers. We read everything that has to do with financing and banking. We all know there's goodwill from Minister Oliver on this issue.
An article appeared on October 26 discussing this issue and that the Department of Finance has been trying to come to an understanding in regard to the exorbitant fees that are not acceptable in the European Union. Nor should they be acceptable in Canada. The last sentence of this article says:
''When someone gives you a year to find a solution, and you can't . . .,'' said a senior bank executive, ''It's kind of 'Shame on you."'
I'm quoting what has been said by a senior bank executive, one of your members: ''Shame on you.''
The Chair: Do you have a question?
Senator Ringuette: Yes.
Mr. Hannah: Can I respond to that?
Senator Ringuette: Yes, and then I'll have a question.
Mr. Hannah: I want to make this clear. It's an important point. The CBA, the Canadian Bankers Association, is not privy to nor part of any discussion going on between the networks and the government in respect of this issue. For commercial and competitive reasons, we simply cannot be, nor are we.
The Chair: Thank you, Mr. Hannah. Your question, Senator Ringuette.
Senator Ringuette: Maybe, chair, the next time we should invite the individual six major Canadian banks to appear and maybe we could have some answers.
The Chair: For the future. Do you have a question?
Senator Ringuette: I have a question for Mr. Timpano. Earlier in our hearings, a senior official from the Department of Finance told us that their data showed that only 13 per cent of Canadians who held Visa or MasterCard credit cards held premium cards with benefits such as Aeroplan. Is that the same data that you would have?
Mr. Timpano: I don't have a sense of how many premium credit cards relative to the total market would exist. I think that's a question more for the networks.
Senator Ringuette: If that is the reality — and I have no reason to doubt the senior official from the Department of Finance — that would mean that 87 per cent of all the other Canadian credit card holders are paying for the reward-based programs that you offer, through the banks.
Mr. Timpano: The only comment I would make is that I do know there are 14 million credit card loyalty reward type offerings out there. When you consider its percentage of the total population, it's a pretty high base where consumers are engaging with some form of loyalty rewards program, whether it is at the premium level or the mass affluent or the mass level.
Senator Ringuette: You also stated that you do business in other countries.
Mr. Timpano: Yes.
Senator Ringuette: Do you do business in Europe?
Mr. Timpano: Yes.
Senator Ringuette: What are you going to do in regard to the credit card rewards plan in June of 2015 when the interchange fees in Europe have gone to 0.3 per cent instead of 3 per cent like we have in Canada?
Mr. Timpano: Our business in Europe is very different from our business in Canada. In Canada you have a business that was born out of a frequent flyer program that generates revenue through its relationships with different banking partners. In the U.K. our business model is really a retail model that frankly doesn't have a high dependency on credit cards and interchange as a result.
Senator Ringuette: Maybe you will have to change your model, then.
Mr. Timpano: We're always taking a look at our business.
Senator Hervieux-Payette: Mr. Hannah, a few weeks ago, we had some people who came here telling us that Costco has issued a request for proposals to various banks, and eventually they ended up throwing out American Express and now they will deal with Capital One. We know the power of Costco with the possibility for them to negotiate a different rate, which is passed on by Costco to customers. That's the name of the game because the food sector is a very competitive one. The margin is around 1 per cent. Of course, if you can get half a point, it is already important. Is Capital One part of your organization?
Mr. Hannah: Capital One is a member of the Canadian Bankers Association, yes.
Senator Hervieux-Payette: I know that they are incorporated in Canada, but where is the main office of Capital One?
Mr. Hannah: Capital One is a U.S.-based bank.
Senator Hervieux-Payette: That means the benefit will go to Capital One, which will be reduced, probably, in the interests of the customers, but we have to change our credit card. You buy your gasoline, you buy your groceries and you will have to have another credit card.
In this case I just say that not only are we tied up — and this is the concern of Senator Massicotte — to have a very limited number of companies dealing with that, but, moreover, now with the big change they can also put you in a position where you cannot even choose the card.
I cannot use my American Express card anymore at Costco. What will happen if we continue in that direction, because it seems that they are not entitled to refuse other cards?
Mr. Hannah: I'm sorry, you're confusing me.
Senator Hervieux-Payette: If I have a TD card I won't be able to shop at Costco with my credit card.
Mr. Hannah: It is an interesting question, but it speaks to both the power and the ability of Costco to be able to decide what form of payment it is willing to accept. Yes, Costco entered into an arrangement before with American Express, and now it has entered into an arrangement with Capital One, but it speaks to the fact that there is a negotiation between two parties that have come to an agreement, and that's the way the market should work.
Senator Black: I have a short, snappy question further to what I asked earlier and what Senator Bellemare was checking with you. It has been drawn to my attention that a Financial Post article of October 28, 2014, referred to ''the estimated $6-billion to $7-billion in such now paid by retailers on each credit card transaction.''
Are you able to comment on that?
Mr. Hannah: The short answer is no, because the fees paid by the retailers would be paid to the merchant acquirers. I don't know. That would depend on what they've contractually negotiated with their acquirer.
Senator Black: You are not about to comment as to what portion if any the chartered banks and other banks, members of your association, would get from that $6 billion or $7 billion a year?
Mr. Hannah: What I can say is there will be interchange flowing to the bank. The bank will pay an assessment fee, as will the acquirer to the network, and the merchant will pay a fee to the merchant acquirer, and the cardholder may or may not pay a fee depending on the card they've selected.
I can certainly say all of them will pay fees, all of them will have expenses and all of them will have revenue. I cannot portion out who gets exactly what or how much.
Senator Massicotte: We talked earlier about credit cards not having to come to a conclusion with the federal government as to a solution to the problem highlighted by the Competition Bureau. The merchants made it clear they would like more flexibility but, at the same time, the small players say they can't compete with the Costcos, the Walmarts and these special deals that are being struck with MasterCard or whomever.
Would you agree that maybe the federal government will simply say they can't resolve the issue because it's too complex, but let's make sure we have a level playing field and they could legislate that the merchant pays the same total fees if you wish? This way nobody is disadvantaged. Would you agree with that?
Mr. Hannah: Can I offer a comment on that? I'm glad you've raised this point. In fact, small businesses have started to use their strength to actually negotiate better deals. CFIB, most notably, has an agreement that they offer their members, a special arrangement that they've made with a major merchant acquirer to get a special discount if you are a CFIB member. You have a number of small businesses that are banded together in order to try collectively to get a better deal.
In addition, the government has already taken steps in that direction through the debit and credit card code of conduct by requiring that contracts be clear, that terms be properly spelled out in order to help merchants be able to compare across acquirers and make an informed choice. So I don't need a lawyer to go through the contract and explain it to me in terminology from one to the other; I can do it in some clear fashion and I can opt out if there's something hidden in there that wasn't properly revealed to me.
Senator Massicotte: Would you agree with the government imposing a set fee to make sure it is the same for all parties no matter if you are able to negotiate a better or less attractive deal?
Mr. Hannah: Senator, my instinct on price control is that it always has unintended consequences. I'm always uncomfortable in that context.
Senator Ringuette: Mr. Hannah, I hope you will be able to provide us with an answer on this question. Out of the 60 banks that are members of your association, Chase, Global Payments and Moneris — all these technology providers that are you say are acquirers — how many are owned by your members?
Mr. Hannah: TD has an in-house acquiring business. Moneris is jointly owned by RBC and BMO. Chase has a different relationship. It is owned by a bank in the United States; it is not owned directly by Chase Canada. Global Payments is a different entity entirely; Square is a different entity entirely; Avion is different entity entirely. It is a mixed, blended market. You have some that are associated with financial institutions, some that are not. It is an interesting, dynamic, competitive market because it is very technology-intensive, to your point.
Senator Ringuette: The ones that are directly associated with the banking industry would probably be sole acquirers from that banking institution. Chair, this is reinforcing my request for us to invite individual bankers to our committee.
The Chair: Thank you very much for that suggestion.
To our panel, it is always a pleasure having you with us. On behalf of the committee, I express our appreciation for your appearance today. You have been helpful in our deliberations.
During our second hour today, we will hear from two academics whose research has been on payment card interchange fees. In particular, they focused on the U.S. experience with the Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act, which capped debit card interchange fees.
Joining us by video conference from New York City is Professor Julian Morris, Vice President of Research at the Reason Foundation. The Reason Foundation is a non-profit think tank out of Washington, D.C., and Los Angeles. He is also a senior fellow at the International Center for Law and Economics and the author of a number of scholarly articles.
Also joining us by video conference, from Arlington, Virginia, is Professor Todd Zywicki. Professor Zywicki is George Mason University Foundation Professor of Law, Senior Scholar at the Mercatus Center at the university and co-editor of the United States Supreme Court Economic Review.
Professor Zywicki will be making the opening statement, and then we shall proceed with questions for both of our witnesses. Welcome. The floor is yours.
Todd J. Zywicki, Professor of Law, George Mason University Foundation, as an individual: Thank you, Mr. Chairman and members of the committee. It is my pleasure to testify today via teleconference on Bill S-202 which would amend the Payment Card Networks Act and impose price controls on interchange fees set by two credit card payment networks: Visa and MasterCard.
Based on my own research and research with co-authors, and with familiarity of efforts to impose price controls elsewhere in the world, we can predict that the likely consequences of the act would be the following. First, there will be an increase in the fees charged for credit cards for consumers. For many people, especially those on lower incomes and those with poor credit scores, there will be a loss of access to credit cards. There will be a reduction in the benefits associated with credit cards such as reward systems. There will be a huge wealth transfer to large merchants as a result of minimal pass-through to consumers of the windfall reduction in interchange fees. There will be minimal or no benefit to small merchants and a stifling of innovation and data security in other consumer-friendly elements of the credit card market.
Moreover, based on my observations about the Canadian system, the adverse effects of these for consumers would probably be more severe and harmful to consumers than they have been elsewhere in the world. This is because of the unique relationship between credit cards and debit cards in Canada which has to do with the ability to use credit cards more effectively to make purchases online and overseas, such as for travel, than Canadian consumers can with the Interac-based debit scheme. The proposed price controls, therefore, would reduce those benefits.
Payment cards are an efficient device for making payments without the inconvenience and risk of cash or cheques. Credit cards are helpful to consumers and merchants, enabling consumers to make purchases on credit without requiring merchants to operate their own costly and risky credit operation. Interchange fees are the mechanism by which credit card networks balance the interests of consumers and merchants to try to maximize the value of all parties in the network.
The economic analysis of the external imposition of price controls on interchange fees is straightforward. Operating the extraordinarily complex, globalized, secure, instantaneous credit card network requires money. That money can come from either merchants who accept credit cards or from consumers who want to use credit cards. Thus, when government intervenes to reduce the amount contributed by merchants for the maintenance of the scheme, those revenue losses inevitably are passed on to credit card users in the form of higher prices, reduced access, or reductions in innovation or quality.
As noted by economist Jean Tirole, who was recently named the 2014 Nobel Laureate in economics, properly allocating the costs between consumers and merchants across the payment card platform is exceedingly delicate, and replacing market processes with central planning of interchange fees is unlikely to improve consumer welfare.
Consider the effects in the United States of the Durbin Amendment to Dodd-Frank. It imposes price controls on interchange fees for debit cards issued by American banks that hold over $10 billion in assets and not smaller banks, not credit cards and not prepaid cards.
In a paper published earlier this year, Professor Morris, Geoffrey Manne and I showed that the Durbin Amendment has been disastrous for American bank customers. Banks responded to the enactment of the Durbin Amendment by dramatically reducing access to free checking, which fell from 76 per cent in 2008 to 38 per cent of all bank accounts. In addition, banks subject to the Durbin Amendment have increased the required balance to be eligible for free chequing and have increased bank fees for those who are not eligible for free chequing. These offsetting measures have made bank accounts more expensive, especially for low-income consumers. Many low-income households have left the banking system entirely.
These effects have occurred only in banks subject to the Durbin Amendment. Smaller banks not subject to the Durbin Amendment have not hiked fees or reduced access to free chequing. Moreover, our study estimated that during the first year the Durbin Amendment was in effect, the forcible reduction in interchange fees substantially benefited large retails such as Home Depot and Amazon.com. They experienced large reductions in the merchant discount rates. In contrast, most small retailers saw no reduction in merchant discount rates. Retailers who made small transactions actually saw their overall merchant discount rates increase, as payment card networks eliminated many of the industry-specific discounts they had offered under market-based pricing.
Finally, in contrast to the large and immediate increase in fees felt by bank consumers, we found no evidence that large retailers had passed through any of their politically created windfall to consumers in the form of lower prices or other amenities.
In the end, we estimate that once all these adjustments are taken into account, the overall effect of the Durbin Amendment will be an annual transfer of $1 billion to $3 billion per year from low-income consumers to large retailers. Experiments with price controls in other countries, including Australia and Spain, have without exception had similar results: an increase in the cost and a reduction in quality of payment cards for consumers with no tangible evidence of any corresponding pass-through savings to merchants by consumers.
In a study of the Canadian market, Ian Lee, Geoffrey Manne, Julian Morris and I found that, prior to the Durbin Amendment, in Canada, bank accounts were already more expensive and less functional than those in the United States. In large part, these differences reflect the different debit cards systems in the two countries. The Interac system, which is a creature of government regulation and has a de facto interchange fee of zero, forces all the cost of Canada's debit card system be borne directly by consumers.
In America, consumers have been able to avoid some of the distorting effects of the Durbin Amendment by shifting transactions to credit cards or prepaid cards. In Canada, however, because of the Interac monopoly, if the act is passed, Canadian consumers will have less flexibility to offset the higher costs of credit cards. Using debit cards for online shopping is cumbersome and difficult in Canada, as many websites, especially for smaller vendors, do not accept debit cards. In addition, Interac cards are rarely accepted outside of Canada. The act will impose especially high costs on consumers who wish to travel abroad, including to the United States. There will be those who will choose not to have a credit card because of higher costs, or they will not be able to avoid it.
Finally, even the Durbin Amendment in the United States allows its basic price control scheme to be augmented by allowance for fraud losses and fraud protection. By contrast, the act imposes a flat fee of 0.5 per cent with no fraud allowance. With limited ability to recover fraud losses and investments in fraud protection, issuers are likely to be more restrictive about allowing the use of credit cards for transactions. This presents a higher-than-average risk of fraud loss, such as on-line transactions, with particularly adverse effects on small merchants.
The act is misguided in applying its price controls only to the Visa and MasterCard systems and excluding so-called three-party schemes such as American Express, Discover, and Diners Club. While these three-party schemes do not formally have interchange fees as the four-party schemes do, the merchant discount fees perform an identical function, namely to balance the interests of consumers and merchants. Thus, imposing price controls on interchange fees for cards issued by Visa and MasterCard while excluding three-party schemes will provide a competitive advantage to three-party schemes.
The experience in Australia, which similarly excluded three-party schemes, illustrates the consequences of disparate treatment. Since Australia's central bank imposed price controls on Visa's and MasterCard's prices, the market share of American Express and Diners Club has increased by 46 per cent. In addition, American Express and Diners Club tend to have higher merchant fees and cater to higher-income consumers, so many higher-income consumers have successively avoided the higher prices on Visa and MasterCard that resulted from interchange fee price controls, leaving lower-income consumers to carry most of the cost burden.
I appreciate your time listening to my testimony. Professor Morris and I would be happy to answer any questions.
The Chair: Thank you for your opening marks. Professor Zywicki, I have seen the study that you did with Ian Lee, who is located here in Ottawa at the Sprott School of Business. Could you give us some background of your exposure to the Canadian situation?
Mr. Zywicki: In the context of preparing that report with Professor Lee, as well with as Professor Morris and Geoffrey Manne, we looked extensively at the Canadian market. We came to understand the relationship between debit and credit cards, and we have continued to monitor the situation. That initial report was focused directly on the Canadian market and the impact of regulation that was being proposed at that time.
Senator Black: Thank you, professor, for being with us. It was extraordinarily helpful, and you obviously have tremendous expertise. Before I get to my questions arising from your testimony, can you tell me how your George Mason basketball team is doing this year?
Mr. Zywicki: Unfortunately, not as well as they were doing a while back. That's a touchy subject.
Senator Black: I'm sorry. I'm a fan.
It appears to us that Canada is an outlier with respect to the other G7 countries, the European countries, Australia others in terms of the fees that are being discussed here. I presume you would agree with that. That appears to be the reality. What would you recommend to this Senate committee? What should we be doing about this? Certainly one of your recommendations could be to do nothing.
Mr. Zywicki: The answer involves increasing competition and, I think in particular, eliminating restrictions on the ability to compete with the Interac system. The first step would be to allow more open competition and to allow more entry into that market. Essentially, create greater competition between debit and credit cards.
Senator Black: That's interesting. We have heard evidence that suggests that this particular aspect of the market is controlled over 80 per cent by Visa and MasterCard. You are telling us that this is really the root of the problem.
Mr. Zywicki: That's not at all what I'm saying. It is the way that interchange fees operate. Fundamentally, the size or the market share of the networks themselves are irrelevant. Those are just a platform for merchants and consumers to link up.
The only incentives for Visa and MasterCard are to maximize the transaction volume. They have no incentive to set rates too high or too low. They have an incentive to maximize the gains to trade across the platform. When I talk about competition, it is not Visa or MasterCard that is the issue, but it is the competition between credit cards, debit cards and others. It is in making Interac a more viable competitor. In some sense, it is to increase competition between debit, credit and other payment systems.
Julian Morris, Vice President of Research, Reason Foundation, as an individual: I agree entirely with Todd. Part of the problem is defining the market. If you define the market narrowly as credit cards, or even more narrowly as four-party credit card schemes, then Visa and MasterCard have a significant market share. If you broaden the definition of the market to include debit cards, then you are talking about a slightly different animal.
Clearly there is competition at the margin between debit and credit. Many people in Canada, and in most parts of the world, effectively use credit cards in the same way that they use debit cards. They pay off their credit card every month, so they're merely using it as a payment device.
The question is, how do you incentivize more competition in the payment card system? If you look back in history, you see the development of payment networks starting in the U.S. in the 1950s with the Diners Club card. The Diners Club card at the time charged a 7 per cent merchant fee. Clearly the introduction of competition, first from American Express and then from the banks that created these payment network systems, drove those fees down.
You are seeing right now the emergence of a variety of new competitors into the market. If you allow open competition without restrictions on the fees that companies charge, you will see a dramatic reduction in fees overall as innovation takes place. If you impose restrictions on fees, you actually dampen the competitive process.
Senator Black: That is very interesting. In a nutshell, what would you recommend that this committee do?
Mr. Morris: I would shift the focus away from merely the two cards that you are talking about now with regard to Bill S-202 and look more generally at the entire payments system. By doing that, you will come to understand the dynamic, competitive market process that emerges as a result of open competition.
I would look in particular at the restrictions on Interac. In our report that looked at the Canadian payments system, we recommended that the restrictions on Interac prohibiting the development of a more dynamic, open system be removed. That would be my recommendation.
Senator Ringuette: Welcome, gentlemen. I have been working on this issue for over six years. Unfortunately, I have never heard of your studies. This morning, I asked our committee clerk where your name as a witness came from. She said you had approached the committee clerk to appear as a witness.
May I ask who referred you to call our committee clerk to appear in front of us?
Mr. Morris: This came from me, but an email was sent to the International Center for Law and Economics by someone representing one of the payment cards suggesting that it would be worthwhile. Not surprisingly, clearly they have read our work and think it would be worth our views being represented to your committee. Thank you very much for inviting us to testify to your committee.
Senator Ringuette: Either Visa or MasterCard asked you to appear in front of our committee. Is that correct?
The Chair: I would like to interject. Senator, we have not turned down any witnesses that wish to appear before this committee, as you well know, including all that you wished to have before us.
Senator Ringuette: Yes. I'm not questioning that. I want to hear what the witnesses have to offer.
Mr. Morris: To clarify, I'm not being paid to testify before this committee.
Senator Ringuette: I don't think the committee has the funds to do that, either. Following questions, when I was made aware that you would appear, I printed your study published on June 2014. I understand that the debit system in Canada with Interac is very important to all Canadians because it is not percentage-based, unlike Visa, MasterCard and debit cards in the U.S. Interac offers a fixed price, and Canadian merchants are very happy with the current situation. That said, I have looked at your study, and of course I have followed the Durbin Amendment very closely over time.
The first page of your study refers to Mr. Zywicki as a member of the International Center for Law and Economics. The ICLE, which funded this study, has received financial support from MasterCard. Are you able to tell us about that financial support from MasterCard to do this study that you spoke about extensively? What was the amount of funding that you received from MasterCard?
Mr. Zywicki: I personally didn't receive any funding directly from MasterCard. I received my funding from the International Center for Law and Economics. I'm a senior fellow of ICLE, not the director. My understanding is that Geoffrey Manne, Director of ICLE, received funding from MasterCard. I received my funding from the International Centre for Law and Economics.
Senator Ringuette: Are you able to tell us the amount received by the International Centre for Law and Economics?
The Chair: I'm going to rule that question out of order.
Senator Ringuette: I think it is very important, chair.
The Chair: I am satisfied that we have accepted that they received funding from MasterCard.
Senator Ringuette: I have no further questions for these witnesses.
[Translation]
Senator Bellemare: The first question will be for Mr. Zywicki. Actually, I will ask my questions at the same time, so you can think about the second one. The first question has to do with your assessment of the impact of the Durbin amendment on the implicit transfers of cross-subsidization of low-income individuals compared with merchants. You said:
[English]
The overall effect of the Durbin Amendment will be an annual transfer of $1 billion to $3 billion per year from low-income customers to large retailers.
[Translation]
Does your research methodology enable you to provide a very approximate estimate of the possible impact of Bill S-202 on Canada in that respect? Perhaps my question is too specific, but I would like to hear what you have to say about that.
My second question is for Mr. Morris. You mentioned the need to look at all methods of payment from a much larger perspective. I know that this might be off topic, but I have to ask whether, in your studies, you incorporated digital methods of payment such as bitcoin. That currency is being studied right now.
[English]
The Chair: That is off topic, senator. Let us stick to the issue in front of us.
Mr. Zywicki: I will respond to the first question. The estimate that we came up with of $1 billion to $3 billion was based on data of the actual effect of the Durbin Amendment during the first year it was in operation. It wasn't just a guess or a projection before it was enacted; it was what came after we saw the savings to merchants in the reduction in interchange fees and the increased cost to consumers, especially low-income consumers, in higher bank fees.
Trying to come up with an estimate depends a lot on local circumstances, for example on how competitive banking markets are versus retail markets and on what the other options are for consumers, et cetera. Studies of pretty much every country, including the European Union, which was done by David Evans, the United States and others suggest that by and large the pass-through of higher costs to consumers is larger, more complete and more rapid than the pass-through savings to retail consumers would be.
There's a large delay and a much smaller pass-through percentage to retail consumers. Trying to put a dollar number on it would depend on factors such as what is the actual size of the reduction in interchange fees and how much of that would get passed on to consumers. Australia suggests it was a large amount passed on to consumers. Australia may be an example of this because they capped credit cards. There's a large increase on the fees of credit cards to consumers, and to date there's still no evidence of any measurable pass-through of lower costs to consumers.
I don't have the data in front of me right now to give an estimate. I would have to know how large the cuts are, what the competitiveness of the market is and that sort of thing. The general rule is that the cost to consumers is much larger than the savings to retail consumers.
[Translation]
Senator Bellemare: What you are presenting here is an approximation of the short-term impact on the United States; it is not the final effect, is that correct?
[English]
Mr. Zywicki: All we have so far is the short term. There are other studies, such as David Evans' study, that takes into account the long run, and I don't remember the exact number but using what is called an event analysis of stock markets. Julian can refresh my memory, but I believe David Evans estimates that over the expected life of the Durbin Amendment there will be a transfer of $27 billion to merchants as a result of the Durbin Amendment, as reflected in the stock market capitalization of these companies after the Durbin Amendment went into effect.
Senator Massicotte: I'm quite aware of the Durbin Amendment, but I'm not very much aware of papers like yours basically documenting the consequence of this legislation. Maybe you can summarize for me.
This is obviously a hotly debated issue in your country. I'm sure before the government decided to do such a thing they must have had research papers or intellectuals like you saying this would be a good idea. Am I correct in assuming that? Is the debate in your country very divided on this issue, or is the intellectual community saying this is a bad thing to occur?
Mr. Zywicki: I don't know if you know the history of the Durbin Amendment, but the truth is it was far from highly debated. The DC circuit, the federal circuit court in the United States, often called the second-highest court in the land, recently in upholding the Federal Reserve regulations implementing the Durbin Amendment talked about how slipshod the process was and how poorly drafted the legislation was, calling it poorly drafted even by the standards of poorly drafted legislation.
The reality is there were proposals for modest interventions into the payment card system for credit cards and the like. The Durbin Amendment was added as a last-minute amendment to the Dodd-Frank legislation. It was passed through without any real discussion; there were no hearings on it and no estimates as to the impact. In fact, Barney Frank himself, for whom the Dodd-Frank legislation is named, has been highly critical of the Durbin Amendment since it was enacted. While one would wish that our Congress and our Senate had taken the care that your body, to your credit, has been taking in studying this for many years, the reality is that this was just a special-interest provision jammed to the Dodd-Frank legislation at the last moment without any serious study, unfortunately.
Senator Massicotte: I appreciate your comments as to the superiority of our Senate over yours but, having said that, let me go back. After the fact, have there been many intellectual papers on this issue? Is it quite divided, or are all of you saying ''bad thing''?
Mr. Zywicki: The reality is that the way the debate has shaken out in the United States, Australia and Spain, and replicated in a lot of places, with several studies in the United States, they all show that fees to consumers go up, period. You can estimate those in different ways.
There is some debate over to how large the pass-through has been. One paper in the United States that I critiqued claims there's pass-through on the retail side, but I don't think it is methodologically sound.
Most of the studies that have come out have been critical of the Durbin Amendment, and they all universally found increase in bank fees as a result of the Durbin Amendment.
Senator Massicotte: Does your colleague agree with that summary?
Mr. Morris: Yes, that's a very accurate summary. Clearly there are some studies out there that purport to show benefits to the Durbin Amendment in terms of pass-through through retailers, but a fair, independent assessment would conclude that those studies are not typically methodologically sound and that right now there is not substantial evidence of that pass-through. At the same time, there's considerable evidence of costs.
There have also been claims that the increase in bank fees occurred before Durbin was implemented, which is true, but the reason for those increases in bank fees occurring before the implementation of the Durbin Amendment is that it occurred immediately after Durbin was passed. We show this in our paper clearly.
There's a rapid tick-up in bank fees immediately after the passage showing quite clearly and categorically that this is a consequence of the Durbin Amendment, and consumers on average are being charged somewhere in the region of between $50 and $100 extra per year to have bank accounts in the United States as a result of this. That forms a significant part of our estimate of the costs of the Durbin Amendment to lower-income consumers.
Senator Massicotte: I don't doubt the accuracy of your statements. Let me talk about economic theory. It looks like the merchants are significant benefactors of any change in fees in that respect. If you can make the presumption that there's adequate competition in the merchants using the credit cards, which I presume there is in most sectors in your country like ours, why would we get very disturbed where that excess or that profit gets accumulated in a short term?
If there's adequate competition, eventually the consumer will benefit because someone will take advantage of it. It's like an increase in your cost structure. Why would you presume that will not be the case? Are you saying that the retail sector is not competitive enough? Most studies would indicate that you have a very competitive retail sector.
Mr. Zywicki: It really depends a lot on the country-by-country basis. You've asked exactly the right question, senator. The first question you have to look at is the competitive structure of the banking market essentially and the competitive structure of the retail market to determine how much gets passed through on one side or the other.
There is a second question, though, which is in my view that this really isn't just about that. It also has to do with financial mainstreaming of consumers, at least in the United States, for the Durbin Amendment. The real tragedy of the Durbin Amendment is not just that consumers are paying more for bank fees, but the low-income consumers got thrown out of the banking system completely. To the extent that you transfer costs for credit cards, for instance, the effect is going to be that consumers who would have had credit cards won't have credit cards. They're going to have to come up with other means for trying to get credit and that sort of thing.
It's not just a wealth distribution in that sense. There are also systemic effects that affect low-income consumers especially, and their access to particular payment systems and that sort of thing. There is an additional variable in addition to just trying to tweak the numbers on the pass-through between the two.
Senator Massicotte: You have a lot of banks in your country compared to Canada. If you can make the presumption that they're dealing in a competitive environment, won't the efficiency they gain eventually flow through to the consumer and to the balance of the players in the marketplace?
Mr. Zywicki: It will be with a delay, but obviously some of it will. What we don't know — and it depends a lot on different country factors — is how much of it will get passed through in the end. This is why, for instance, the estimate that David Evans did of what we call a ''market event study'' tries to capture all of those long-term consequences.
Basically, his study says that the only way retailers' profits would be expected to go up would be if they are expected, over the long run, to keep a large percentage of the cost savings, and so the fact that there's this $27 billion estimated increase to stocks of those retailers affected by the Durbin Amendment suggests they will capture a lot of it over the long run.
Obviously, it is an estimate. Obviously, some of it will be passed through. A lot of it depends on the local market dynamics, and so one of the questions you would want to ask in Canada would be to try to figure out what the pass-through rates of this might be before one thought that this could increase consumer welfare.
Mr. Morris: It seems that we're debating here when the net costs of the legislation will decline. That's a fair presumption.
Over time, the net costs of the legislation, in terms of pass-through, will decline. However, the costs of suppressing competition in the market for payment cards will continue. That wasn't factored into David Evans' analysis. I was asked the question earlier: Did we consider new forms of payment, like bitcoin and so on? We didn't specifically address the way that bitcoin works in our analysis, but we did posit that, if you want to encourage the introduction of these new payment systems, you don't want to suppress the price that might be available in the short term against which those payment systems are competing. If you do, if there are significant initial start-up costs to developing that payment system, by suppressing the amount that the payment system can charge, you will slow down the introduction of that payment system.
Senator Massicotte: That's a very good point you raise. My understanding is that if the environment is competitive — that's obviously the major assumption made with a capitalist marketplace — eventually, costs will flow through. You have to do a case-by-case study, asking, is the banking system competitive? Is retail, by sector, competitive? If it is, it will eventually go through. You are saying that in some cases the competition may not be adequate, depending upon the locality or the circumstances of that industry. Is that a good summary?
Mr. Zywicki: Yes, I think that's accurate. If I could elaborate on something Mr. Morris said, there are also other non-price things, like investments in security and investments in innovation, all these sorts of things that consumers also benefit from on the payment-card side of the market.
Mr. Morris: One of the things that have driven the structure of the pricing in the payment networks is a desire on the part of the system, in a sense, to expand. Expanding electronic payments has been shown, in study after study, to have benefits in terms of reduced cost, reduced fraud and reduced tax evasion. As representatives of Canadian taxpayers, you, presumably, should be concerned about the ability of payments to be tracked and traced, which has a significant benefit to the overall system in terms of ensuring that you avoid tax evasion.
So getting more people to make payments electronically is a good thing. The question is how you achieve that. Our analysis suggests that by imposing price controls, you throw people out of the electronic payments system. That's going to be a bad thing, surely.
The Chair: To our witnesses, that concludes our questions, but I would like to ask each of our witnesses if they have any concluding observations or remarks that they would like to make not in response to a question.
Mr. Zywicki: I will just elaborate. Mr. Morris made a good point at the end that I want to elaborate on, which is that there are social benefits to mainstreaming electronic payments. This relates to something I said earlier about price controls reducing access to electronic payments for many consumers. It takes them out of that market, which not only hurts them but also, as Mr. Morris just said, has social costs. It is estimated that shifting to a completely electronic payments world might save as much as 1 per cent, 3 per cent or 5 per cent of GDP in many countries, not to mention the other benefits that Mr. Morris said, and that seems to be one of the effects of capping interchange fees.
The Chair: Thank you. Professor Morris, any concluding thoughts?
Mr. Morris: Just to reinforce this point that expanding electronic payments has benefits. It has benefits in terms of increasing competition and enabling both producers and consumers to benefit from what's called the long tail, the availability of and the ability to supply goods to only a minority of consumers.
You have seen the expansion of access to this long tail, these minority products, as a consequence of electronic commerce in the United States, the United Kingdom and so on. You have seen it less in Canada, and, in part — not in total, but in part — that can be traced to the difficulty of making electronic payments using debit cards in Canada, which remain a dominant source of payment because of the way that merchants prefer those systems. I don't want to dismiss the idea that it would be possible to create a lower-cost payment mechanism that would be usable online, but that is more likely to occur if you allow open competition than if you continue to suppress competition.
The Chair: Thank you. Before the meeting ends, Senator Ringuette has asked to make a brief statement of clarification. I would like to understand if it's a clarification of you.
Senator Ringuette: No, it is a clarification with regard to the study that has been brought forth during this time frame.
The Chair: We will make sure that everyone around the table has a copy of this.
Senator Ringuette: I would like to draw their attention to page 24, where it says that all the data used to do the study was from the MasterCard transactions.
The Chair: That will be noted.
Senator Massicotte: The witness is shaking his head. He probably wants to make a comment.
The Chair: Do you have a comment on that? Please go ahead.
Mr. Morris: Just to clarify, not all of the data in the study came from MasterCard. We were given a set of data that enabled us to estimate the pass-through rate. That is the only data that we received and were able to utilize to evaluate the extent to which the consumer had benefited from the Durbin Amendment. But the other data was all publicly available.
The Chair: Thank you for that clarification of the clarification.
To our witnesses, on behalf of the members of the committee, I would like to express our great appreciation for your participation today. You have been very helpful in our deliberations. Thank you. This meeting is concluded.
(The committee adjourned.)