A Theoretical Analysis of Credit Card Regulation

Melbourne Business School Working Paper No. 2002-11

38 Pages Posted: 16 Jan 2003

See all articles by Joshua S. Gans

Joshua S. Gans

University of Toronto - Rotman School of Management; NBER

Stephen P. King

Monash University - Department of Economics; Productivity Commission

Date Written: September 23, 2002


Credit card reform has been canvassed in Europe, the US and in Australia. The Reserve Bank of Australia (RBA) is in the process of implementing wide-ranging reforms to credit cards aimed at increasing entry, allowing merchants to surcharge for card payments and regulating the interchange fee - the payment made between financial institutions when settling card payments. In this paper, we develop a simple model of payment systems designed to analyse the impact of the RBA reforms. We build on the main assumptions used by the RBA and show that some of their concerns about excessive card use are justified. Allowing merchants to surcharge may eliminate much of the concern over the interchange fee. At the same time, increased competition between card association members need not lead to either improved transactions efficiency or lower interchange fees as claimed by the RBA. The socially optimal interchange fee depends on the nature of customer and merchant card fees, and on both issuer and acquirer costs. The RBA's regulated interchange fee only considers issuer costs and is only optimal in highly specialized circumstances.

Keywords: Credit card associations, payment systems, interchange fee, price discrimination, no surcharge rule

JEL Classification: G21, L31, L42

Suggested Citation

Gans, Joshua S. and King, Stephen Peter, A Theoretical Analysis of Credit Card Regulation (September 23, 2002). Melbourne Business School Working Paper No. 2002-11. Available at SSRN: https://ssrn.com/abstract=352220 or http://dx.doi.org/10.2139/ssrn.352220

Joshua S. Gans (Contact Author)

University of Toronto - Rotman School of Management ( email )


HOME PAGE: http://www.joshuagans.com

NBER ( email )

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Stephen Peter King

Monash University - Department of Economics ( email )

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Wellington Road
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Productivity Commission ( email )

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Melbourne, Victoria, Victoria 3000

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