Debit cards have long been promoted as a replacement to cash.
But a complicated system of opaque fee charges has created a multi-billion-dollar revenue opportunity for the payments sector and left many consumers paying too much.
It is no longer the case that a debit card always attracts lower fees for a customer than a credit card when making a purchase. And if that card is in a digital wallet, stored on a smartphone, the charge could be different again.
The issue has become a political flashpoint amid rising cost-of-living pressures, prompting the Reserve Bank to bring forward its review of the system.
“The payments system is deliberately opaque and complicated because where that exists there is money,” says Brad Kelly, co-founder of the Independent Payments Forum, which is advocating to reform the system.
“Debit is the cheapest (compared to credit cards), but that’s not being reflected in the price being charged to merchants or consumers.”
Reform advocates want to reduce the annual $6.9bn in card fees charged by Australian banks, payment platforms and global card companies, and restructure the system to help small businesses and their customers.
Payments players argue the cost of accepting cash is higher for business than cards and fees are spent on necessary infrastructure and services including networks and fraud prevention.
How did we get here?
For several decades debit cards were pitched as a prudent alternative to credit cards, which gained notoriety in the 1990s for landing users in trouble in an era of relentless credit offers, usually unsolicited.
Debit cards traditionally relied on Eftpos, a domestic payment system dating back to the 1980s, with transactions requiring a card swipe.
The major credit card companies, Visa and Mastercard, bolstered their presence in the debit market through partnerships with Australia’s major banks from 2005 and went on to become the dominant players by utilising tap-and-go technology.
Most debit cards are now dual network, which means transactions can be routed through the card company networks or Eftpos although they tend to flow through the Visa and Mastercard systems; an issue the RBA will likely look at.
How do card transactions work?
Each time a customer taps a debit or credit card, a merchant is charged a cost to accept the payment, made up of several fees that ensure all financial parties involved in the transaction get paid.
Those parties include the banks and payment platforms the merchant has signed up with, such as Square or Tyro. The card holder’s financial institution and the card networks also get paid.
Major retailers negotiate ultra-cheap rates directly with the card networks and can therefore often absorb any costs, which is why shoppers don’t pay a card surcharge at major supermarkets.
But transaction costs to smaller businesses can be significant. They are allowed to pass that cost on to the customer via a surcharge, according to the competition regulator, but merchants are not permitted to make additional money.
In the eyes of the consumer, this makes the small business the fee collector, but the money is actually distributed to the banks, payment platforms and card companies.
“It’s not small businesses gouging customers,” Kelly says.
Big retailers have benefited from “a few sweetheart deals”, he says, and then the payments industry “can just load up the price for small business through the banks and the payment service providers”.
The cost of a transaction can vary widely, according to the RBA, which oversees the payments sector – from less than 0.2% to well over 2% of the transaction value.
Transactions through Eftpos are generally the cheapest, followed by Visa and Mastercard debit systems.
Credit cards, which are a form of unsecured debt, are the most expensive. Users also get the benefit of accumulating points and rewards and were traditionally charged a higher transaction fee for the privilege.
The difference in costs, however, are not necessarily reflected by the surcharge levied on a customer.
Frustrations and flaws emerge
If most debit card users were charged modest rates, the practice may have continued undisturbed. But more people began to notice they were often paying large fees.
This is usually due to “fixed”, “blended” or “bundled” payment plans offered to merchants, which means customers get charged a flat rate regardless of whether they use a low-cost debit card or exclusive rewards-generating credit card.
As the name suggests, the card types are blended.
“That Amex user standing next to you in the line should lean over and tap you on the shoulder and thank you for subsidising their next trip to Thailand,” says Warwick Ponder, co-founder of the Independent Payments Forum.
He says this means younger generations, who are the biggest debit card users, are subsidising high-cost credit card users.
Ponder says the fixed and blended models pervert an RBA-promoted policy called “least cost routing” which was designed to process payments via the cheapest network, usually Eftpos.
This was supposed to mean merchants, and in turn customers, would be charged the fair rate for their card type, including a higher fee for credit card users.
Under the blended model, the bank or payment platform like Square can charge a vendor a set transaction fee, such as 1.6%. The RBA review will look into whether they then send those transactions via the cheap Eftpos network, and pocket the difference.
Banking lobbyists argue that merchants should be free to choose their payment option and they say some businesses like the certainty of a fixed-price bundle.
Mark McKenzie, chief executive of the Australasian Convenience and Petroleum Marketers Association, says the fee structures are overly complex, leaving some retailers inadvertently signing up to packages that are bad for them and their customers.
“You need a master’s degree in financial services to be able to work through the complex structures,” McKenzie says.
“The goal of a small business is not to sit there and become a merchant fee expert.”
Should surcharges be banned?
At a recent parliamentary inquiry, the National Australia Bank chief executive Andrew Irvine said he paid an “outrageous” 10% surcharge on a cup of coffee. Such charges were inconsistent and lacked transparency, he said.
Some members of the banking sector support a ban on surcharges, in line with parts of Europe and some US states.
Small businesses, however, argue that would be an unfair burden that would advantage larger companies that have negotiated cut-rate deals.
Instead, reform advocates are calling for mandatory and true “least cost routing” that benefits the merchants and customers on all platforms including mobile and online.
Blended and bundled packages should be banned, and fee transparency needs to be vastly improved, according to those seeking change.
McKenzie says it’s vital the payments system becomes more transparent.
“The banks need to get a fair return for that service but the products need to be made in a way that allows a merchant to readily compare payment products,” he says.
“The lack of transparency at the moment around the structure of these systems means that it is not operating as a true market.”