Payment Cards Report

Report on the Brazilian Payment card industry Central Bank of Brazil Secretariat for Economic Monitoring – Ministry of Finance Secretariat of Economic Law – Ministry of Justice Report on the Brazilian Payment card industry The preparation of this document is the joint responsibility of the Central Bank of Brazil, the Secretariat for Economic Monitoring - Ministry of Finance, and the Secretariat of Economic Law - Ministry of Justice, under the technical cooperation agreement signed in July, 14th 2006. Copies are permitted if the source is cited: Report on the Brazilian Payment Cards Industry, 1st Edition, May 2010. Banco Central do Brasil – Department of Banking Operations and Payments System Address: SBS – Quadra 3 – Bloco B – Ed. Sede Banco Central do Brasil – 15º andar Caixa Postal: 08670 Brasília – DF 70.074-900 Internet: http://www.bcb.gov.br E-mail: [email protected] 1 ________________________________________________________________________ Executive Summary In July of 2006, the Central Bank of Brazil, the Secretariat of Economic Law of the Ministry of Justice (SDE), and the Secretariat for Economic Monitoring of the Ministry of Finance (SEAE) celebrated a technical cooperation memorandum aimed at carrying out joint studies relating to retail payment systems. This report, which is the first outcome of that effort, aims to identify potential market failures stemming from market’s organization and practices, so as to become a reference for possible steps towards social welfare improvements. The scope of the report comprises widely accepted credit and debit cards, namely those related to the following brands: Visa; MasterCard; Cheque Eletrônico; American Express; Hipercard; and Diners. Private label and pre-paid cards have not been considered, the former because they are dedicated for purchases at one particular business, and the latter because of their incipient use in Brazil. The analyses carried out in this report are based on the microeconomic theory concerning two-sided markets, which has been an object of academic studies and very often weighs upon regulators. The report also considers relevant steps taken in a number of countries – and their outcomes – by their respective central banks, antitrust authorities and other government bodies. On the supply side of the payment card markets, it is possible to highlight the following participants: Issuer – an entity, typically a financial institution, which maintains a direct relationship with the cardholder, and is responsible for identification and authorization procedures in each transaction, as well as for setting the corresponding credit limits and interest rates, charging the cardholder and receiving the relevant payment, and defining, if any, the reward program; Acquirer – an entity, usually a bank or an entity controlled by a bank, which is responsible for the relationship with merchants participating in the payment card arrangement; and Owner of the arrangement (payment card company) – an entity that owns the trademark and defines the general rules and functioning of the relevant payment card arrangement. 2 ________________________________________________________________________ Each payment card arrangement typically comprises three or four parts, depending on who plays the roles of issuing bank and acquirer. In the four-party system, shown in the following diagram, these roles are played by distinct entities. This is the case of Visa, MasterCard and Cheque Eletrônico. In the three-party system, which is the case of Amex, Hipercard and Diners, a single entity is the issuing bank and the acquirer at the same time. Scheme owner Scheme Scheme fee 1 fee 2 Banco Issuer Emissor Credenciador Acquirer Pays p – a where a = interchange fee Pays p + f Pays p – m where where f = cardholder fee m = MSC fees fees Comprador buyer Vendedor seller Sells good or service at price p One of the problems regarding the use of traditional microeconomic analysis in two-sided markets stems from the fact that it does not take into account the effects of one side of the market onto the other. It does not consider the importance of pricing structure as a strategic instrument to attract, in a balanced way, participants to both sides of the market (issuer-cardholder side and acquirer-merchant side). The analysis of a two-sided market using traditional microeconomic tools, which considers that prices and marginal costs should converge, may lead either to a regulatory framework that does not deliver the expected outcome or to a scenario in which undesirable side effects overcome the goals. In this report, interaction, interdependence and network externalities between the two sides of the market will play a major role not only with regard to the establishment of networks rules and the definition of relevant markets, but also to the assessment of price and profit margins. It should be noted that there is little support in the literature to the existence of optimal fees to be observed by market participants. In light of that, it is necessary to assess local idiosyncrasies to back the relevant public policy decisions. 3 ________________________________________________________________________ The Brazilian case The payment card industry in Brazil is regulated by several authorities. Financial institutions and payment clearing and settlement systems are jointly regulated by the National Monetary Council (CMN) and the Central Bank of Brazil. Antitrust issues are under the responsibility of the latter whenever they are related to financial institutions' activities, and also of the SBDC (Brazilian System for the Advancement of Competition), which is composed of three agencies: SDE, SEAE and CADE (Administrative Council for Economic Defense). Moreover, the payment card industry is subject to the National System for Consumer Protection and Defense (SNDC), integrated by SDE through its Department of Protection and Defense of Consumers and the so-called PROCON. SNDC is governed by the Consumer Defense Act. The analysis carried out in this report is based on information collected from four distinct sources: payment card companies; payment card issuers; acquirers and data processors; and merchants. Moreover, data from the National Information System for Consumer Defense, which consolidates consumers' complaints and denunciations, were also considered. Structure The volume of payment card transactions has consistently increased since 2002, from 275 million transactions on the first quarter of that year to 2 billion transactions in the fourth quarter of 2007. In the end of 2007, the number of credit cards and debit cards amounted to 66.6 million and 52.3 million, respectively. Combined, Visa and MasterCard, the main brands, accounted for more than 90% of the payment cards in circulation (credit and debit cards). Visa and MasterCard lead also the acquiring market, with a slight predominance of the former. Furthermore, the number of merchants accepting credit cards is slightly larger than the number of those accepting debit cards. Some 80% of merchants accepting payment cards recognize Visa as the most used brand, while some 71% of them have indicated MasterCard as the second brand. The degree of acceptance of the local brand debit card (Cheque Eletrônico) has decreased as a consequence of a 2005 strategic decision taken by Brazilian banks to discontinue its issuance. 4 ________________________________________________________________________ To measure and assess the payment card industry participants' market power, two possible scenarios were considered: a) each side of the market (acquiring market and issuance market ) of each payment card scheme is a distinct relevant market; and b) each side of the market as a whole is a distinct relevant market. In four-party systems, concentration in the issuance market is moderate and compatible with the banking system profile. Since payment cards are retail products, they are likely to be part of the service menu of most of retail banks. On the other hand, the outcome reflects also the participation of the issuers in the capital of the acquirer. In the fourth quarter of 2007, considering the volume of transactions, the four main Visa issuers accounted for 78.9% of the credit card market, while the five main Visa issuers accounted for 92.7% of the debit card market. Concerning the MasterCard brand, the four main issuers accounted for 66.4% of the credit card market, and for 77% of the debit card market. Considering all credit card schemes as a whole, the four largest issuers accounted for some 61% of the relevant transactions in the considered period, while the four main debit card issuers accounted for 70% of the market. Concerning the acquiring side, each payment card scheme counts on a single acquirer and, considering the acquiring market as a whole, the two largest acquirers accounted for 90% of all credit card transactions, and for 99.6% of all debit card transactions. Therefore, as compared to the first scenario, in the second one there is a little reduction in the concentration level of the issuance market, while in the acquiring side the concentration level shows a structure that is close to a duopoly, and thus it is possible to conclude that the two largest acquirers have market power even in the second scenario. The acquiring structure reaches the maximum level of vertical integration, which includes the clearing and settlement function. It is important to note that there is no interoperability between the network services, not even in the capturing and

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