Industry Committee on June 9th, 2009

[The Co-Chair, Conservative, Michael Chong]

I welcome our members and our witnesses to the joint meeting of the Standing Committee on Finance and the Standing Committee on Industry, Science and Technology this Tuesday, June 9, 2009. Pursuant to Standing Order 108(2), we are studying the credit card interchange system and the debit payment system in Canada.

Before us today we have four witnesses. Mr. Ian Lee is director of the MBA program in the Sprott School of Business at Carleton University. Mr. Barry Scholnick is associate professor in the School of Business at the University of Alberta. Mr. Roger Ware is a professor in the Department of Economics at Queen's University. Mr. Jack Carr is a professor in the Department of Economics at the University of Toronto.

Welcome to all four of you.

Mr. Menzies, go ahead.

[Ted Menzies, Conservative, Macleod, AB]

On a point of order, I don't mean to delay proceedings here, but we have a housekeeping issue. The finance committee has invited the finance minister to come specifically to that committee. Because he's travelling on the day we had asked him to come, he's only able to come on the morning of June 16. I beg your indulgence to convene the finance committee on the morning of June 16 from 9 o'clock to 10 o'clock to hear the Minister of Finance.

Perhaps we could reschedule the next meeting of the joint committee until later.

[The Co-Chair, Conservative, Michael Chong]

I believe discussions have been had with the various parties involved and members are amenable to that. We'll get the clerks of the two respective committees to reschedule our meeting of next Tuesday.

[Ted Menzies, Conservative, Macleod, AB]

Thank you.

[The Co-Chair, Conservative, Michael Chong]

Without further ado, we'll begin with opening statements from our four witnesses, beginning with Mr. Carr.

[Professor Jack Carr, Professor, Department of Economics, University of Toronto, As an Individual]

Thank you very much. I thank the committee for inviting me here today. I should tell you, and I'm sure it exists with my colleagues, that professors are used to speaking in fifty-minute segments, not five. So it's going to be a little difficult.

I have a paper that should be handed out. The things I leave out are in the paper. It's not a long paper. And I should also tell you that my research has primarily been financed by Visa.

Let me get to it, given the time I have. The key feature of the credit card system is that it's a two-sided market, and a two-sided market is somewhat different from the markets economists generally deal with. A two-sided market is a market where there's an interrelationship between the two sides, and in the credit card business the two sides are the merchants and the cardholders. You can't run the system without cardholders. You can't run the system without merchants. The more cardholders there are, the better it is for merchants. The more merchants there are, the better it is for cardholders. It's like a network and there are these interdependents on both sides.

Cardholder demand for system services depends on other things: the level of cardholder fees, the value the cardholder places on the convenience of using the cards over other means of payments, and the number and quality of merchants participating in the system. Essentially merchants' demand is very similar. They depend on merchants' fees, the efficiency of accepting cards over other means of payments, and on the number and quality of cardholders.

The point I want to emphasize from the beginning is that this two-sided nature of the market makes the economics somewhat different from what it normally is.

There are three important points about the payment system. First, it's important to remember that the issuing and acquiring identities are through the payment system organization jointly engaged in the production and supply of services. It's joint production. Second, it's important to understand the two-sided nature of this market.

Evans and Schmalensee give a real-world example. In Asia, particularly, there are dating clubs, and in dating clubs men and women can go and meet one another and see if they are suiting each other's needs. It seems to be that men value these clubs more than women, and what generally happens in these clubs.... It's just as costly for the owner of the club to service the women and the men in the club, and to bring them in, but it's generally the case that women are not charged; they're even given free drinks sometimes, and men pay all the costs. Seems fair. And it's done to operate an efficient system. It's done because men won't come if there are no women. Women won't come if there are no men. You have to balance the system, and the way you balance the system is through an interchange fee. You have men pay this fee, not related at all to cost.

The third economically important feature of two-sided markets is that both sides of the market benefit from the growth and demand of the other side. Recently there have been challenges to four-party systems, particularly in Australia and a number of other countries, and in this country too. There are two important points to understand. First, people who criticize the system argue that merchants should not be required to cover any of the costs borne by the issuers who are providing the services to cardholders, since retailers argue they don't receive any benefits from them. It's claimed that a collectively set interchange fee imposes such costs on merchants. Accordingly, retailers urge that the interchange fee should be calculated on the basis of an objective cost standard, which excludes costs not related to payment networks. Second, it's argued that rules such as honour all card rules and no surcharge rules effectively force retailers to accept Visa and MasterCard.

I'm going to argue that there are flaws in these arguments, and particularly I argue there are about five flaws.

The first flaw is that merchants do receive benefits from payment card systems. They get increased sales and increased convenience. Increased merchant sales rise because when people use credit cards to make purchases, and larger purchases, they bring in new types of purchases, and you get increased sales because there are lower transaction costs. When I go and fill up my car with gas, they don't need as many employees because I pay myself. I put my card into the machine. If everybody paid cash, you would have huge lineups. Also, the merchants don't have to hold cash balances, which generally are costly.

The second flaw is there's no economic justification for cost-based regulation. You don't want to just look at cost. Cost is one factor, but it's not the only factor. It's a more complex system, and by limiting the justification of interchange fees only to cost, the argument fails to account for the respective benefits that merchants and cardholders derive from interchange fees.

The third flaw is that retailers are not forced to accept credit cards as payment methods. They do so because there are benefits. It's less costly for them to use it, when you measure all costs. And merchants can refuse to accept them. There's a large number that do. Costco, a huge merchant, doesn't accept MasterCard and doesn't accept Visa. My wife and I both love Costco.

Four, there's another flaw. There is no subsidization of credit card users by cash users. There's this argument that people who use cash are subsidizing credit card users. Yes, there is a no-surcharge rule, but there's no rule prohibiting merchants from giving a discount for cash. There's no difference, from an economic point of view, between surcharging for credit cards or discounting for cash. Merchants do discount for cash, but it's very rare. A lot of times, I would argue, they do discount for cash in order to avoid paying all sorts of taxes. Cash is a method to get around paying taxes.

Flaw number five is that there's no rational economic basis to distinguish between three- and four-party systems. There's no difference to distinguish between the Amex system and Visa and MasterCard.

Let me conclude with the lessons from Australia, and let me read you a quote from a study by Robert Stillman et al. They concluded that:

Regulations should only be employed if there is clear evidence of a market failure and only if there is reason to believe that regulation is likely to benefit consumers.

The RBA's regulations have clearly harmed consumers in Australia by causing higher cardholder fees and less valuable reward programs and by reducing the incentives of issuers of four-party cards to invest and innovate. At the same time, there is no evidence that these losses to consumers have been offset by reduction in retail prices or improvements in the quality of retail service.

The empirical evidence does not support the view that consumers have derived any net benefits from the intervention. Generally, economists think of regulating an industry where there's some monopoly power and there's too little output produced and too high a price is charged. Regulation in Australia and regulating interchange fees causes a reduction in output and a higher price to consumers—it goes against what economists generally believe are the necessary conditions for regulation.

Let me conclude. Before analyzing two-sided markets such as the payment system industry, it's critically important to understand the unique economic considerations that drive this efficiency and its competitiveness. Foremost among these is the interdependence of demand among the acquiring and issuing sides. One must consider the cost and benefits provided to both sides of the market rather than focusing on one aspect of the market in isolation.

Thank you very much.

[The Co-Chair, Conservative, Michael Chong]

Thank you very much, Mr. Carr.

I believe Mr. Scholnick has a PowerPoint presentation.

[Professor Barry Scholnick, Associate Professor, School of Business, University of Alberta, As an Individual]

Thank you for having me.

I'm a professor at the University of Alberta. I should emphasize that I have no relationship with any of the various parties that have come before you in the last couple of weeks.

My role this morning is to give you some sense of what economists talk about when they think about this market. This is a very complicated market; it's very different from our standard textbook market. So maybe economists can give you some help in deciding how to approach the problem you have.

I think the key point, as my colleague has mentioned, is the notion of a two-sided market. This dominates economic thinking, and this is the key concept the committee should understand before deciding how to proceed. The idea of a two-sided market is the notion that you have a single platform—and this is the key word, “platform”—that brings together many buyers and many sellers.

What does this mean? What I've done on this slide is try to give you some examples—and there are countless examples—of platforms and how the economics work. The first example of a platform is precisely what you're discussing in these hearings. Visa and MasterCard provide a platform where they bring together lots of people on one side of the market, the retailers, and lots of people on the other side of the market, the consumers. By bringing these two sides together, they create some value. That's the value of their platform.

But there are many other examples, which I've shown you on this slide. For example, for real estate listings, real estate boards have websites all over the country. These websites bring together house buyers and house sellers. But the platform in the middle is the real estate board, and that's the key economic actor we care about.

Another example is shopping malls. A shopping mall can be thought of economically as a platform. What does it do? The owner of the shopping mall brings together two sides—side one, the store owners, and side two, the shoppers. So the shopping mall in itself doesn't do anything or sell anything, but it brings these parties together.

Other examples are the Yellow Pages and PDF files. A PDF file is a platform with readers and writers. And Google can be thought of as a platform; you have Google advertisers and Google searchers. One point to emphasize with these platforms is how their services are priced. How do Google or the Yellow Pages price their services? What you find very commonly with all of these platforms is that one side is highly subsidized—in many cases it's free—and the other side pays. So in the examples I've shown you, when you search on Google, for instance, it costs you nothing. But when you advertise on Google, when you're a seller, it costs you a significant amount of money. And for PDF readers, when you read a PDF document from Adobe, it's free. But if you want to write one of these things, it costs you a lot of money. Similarly with the Yellow Pages; on the one side the readers get it for free, etc.

So what you have as a standard outcome in the economics literature with the pricing of these platforms is that one side bears the costs and one side gets it for free. In fact, I would argue that in the credit card case, not only do the consumers get it for free, but they also actually get rewarded or more money when they use their credit cards. That, of course, is the notion of rewards—air miles and cash back, etc. This fits in very much with standard economic thinking about how these two-sided markets should work.

So what are the implications of these two-sided markets? The key point to emphasize, I believe, is the notion of winner takes all, or what we call “network effects” in economic jargon. What this means is that if you have a platform that everybody loves, if you have a platform that both the buyer side and the seller side use extensively, then you have a very valuable asset.

The second part of the winner-takes-all story is that once you get big, you get even bigger. So the big get bigger. There are built-in economies of scale, the way economists describe this. That, of course, is the situation that Visa and MasterCard find themselves in—and that is the situation every platform owner wants to be in. Another example is Microsoft as a platform. It's so big, everybody uses it. Nobody has a choice not to use it.

The key objective of the people who own the platform, whether it's Microsoft, Google, Visa, MasterCard, Yellow Pages, or whatever, is to get as much money as possible, like every business owner. But at the same time they have to balance and make sure they have enough on the buy side and enough on the sales side to keep the thing going. As soon as you have a situation where either one of these parties leaves the platform and goes somewhere else, the value of the platform gets less and eventually becomes zero. So they have to get as much money as they can, while at the same time keeping everybody using them.

So you have a situation--and this is standard economics and how we understand these two-sided markets--where you find yourself like the retailers you've heard in your committee. If you find yourself in a situation like in the Visa or MasterCard case, where you have a very successful and dominant platform, you're essentially stuck. You can't get out because all your customers demand that you use the platform, and there's nothing you can really do to reduce your fees.

So what do they do? Standard economics literature on two-sided markets says they do precisely what's happening at this meeting this morning. They lobby Parliament and go to the courts, the central banks, and the competition authorities. The economics literature tells us it is not possible for these guys to use standard economic mechanisms to escape the trap in which they find themselves.

So how do we get out of this? What is the threat to Visa or MasterCard, or any of these two-sided markets? I could be talking about Microsoft or Google; it's the same argument. The threat they face is a new and better platform that does things to make more people happy--new technology. I've given you the example of PayPal and the slow emergence of a platform on the web that might one day overcome Visa and MasterCard as a payment provider. That's the thing: once this new platform comes into being, Visa and MasterCard face the problem.

What are the implications of these two-sided markets? What does economics literature tell us to expect? First, the fight you've had before you for the last couple of weeks between Visa and MasterCard on the one side and the retailers on the other side is very predictable. This always happens. This identical fight has been happening around the world. My argument is that this will continue. These meetings will certainly not be the last ones this House hears on this matter.

Even if a new dominant platform overtakes Visa or MasterCard, this kind of conflict between the retailers on the one hand and the platform on the other hand will carry on. Even if, for example, the Reserve Bank of Australia imposes some sort of regulation, this will not solve the problem. There is no nice, easy answer based on economics literature as to how to fix this problem, because of the nature of these two-sided markets.

Thank you.

[The Co-Chair, Conservative, Michael Chong]

Thank you very much, Mr. Scholnick.

Mr. Lee, I understand you have a hand-out as well.

It is also in the other official language.

[Professor Ian Lee, Director, Master of Business Administration (MBA) Program, Sprott School of Business, Carleton University, As an Individual]

Thank you very much. As a former banker and a business school professor, I want to thank these two committees for inviting me. I clearly have a bias. I think you are the two most important committees in Parliament, finance and industry, because you're dealing with the most important issues of how we create wealth in our economy.

Just by way of background, I was in banking in the 1970s, in the bank right across the street, the Bank of Montreal, which I understand Parliament is now going to be using. It's a beautiful building. I hope you'll treat it well.

I was a consumer loan manager, a mortgage manager, a commercial loan officer, and I have a Ph.D. in public policy. Now I'm the MBA director in the Sprott School of Business. I do want to mention that I've taught over one hundred times in the Middle East, Asia, and Eastern Europe, including most of the former communist countries, where I saw, up close and personally, the impact of coercive government regulations in destroying the environment, the economy, and human rights.

Finally, I don't consult, advise, or invest in any firm, union, NGO, non-profit, government, or political party, so I come here with complete transparency.

I read all of the transcripts for the past two months in both your committee and the Senate committee. I really want to be somewhat provocative today and suggest that many of the witnesses—the Retail Council, CFIB—suggested that the payment system today in Canada is very expensive and inefficient, and I think this is really an urban myth.

Just to put some reality into the conversation, from time immemorial until the 1970s, even until the early 1980s, banks opened at 10 in the morning and closed at 3. If you couldn't get into the bank during that time, you didn't get your money. There were no debit cards, there was no Internet banking, there was no phone banking. Credit cards only emerged in the mid to late 1970s.

There were two payment systems: cash and cheque. Both were expensive, slow, and dangerous. Why were they so? Because cheques bounced regularly, every day. This was a very large risk to retailers. Cash was stolen in holdups or by workers. Although that risk wasn't so great, it drove every business person to invest large amounts of money to buy insurance, to bond employees, the due diligence, safes, costly cash custody, and so forth.

To endorse what Professor Carr and Professor Scholnick said, the transaction costs are very expensive. But today, debit cards provide instant payment, no recourse, no bad cheques, and the same thing with credit cards. So I'm arguing that the transaction costs are very cheap, at 0.5% to 4%.

This was borne out by a study by two think tanks very recently in Washington, D.C. The conservative American Enterprise Institute and the very liberal Brookings Institution did a study of payment types, and not surprisingly they found that cash was the most expensive form of payment. I heard some of the witnesses suggesting discounting for cash. If I was running a business, I would demand a premium for someone to pay cash because cash is very expensive. Bankers understand that. There are large hidden costs with cash. You have to have complex, elaborate accounting systems. You have to have, for example, two people counting the cash, if you don't want to get ripped off. By contrast, credit cards stimulate big-ticket purchases and stimulate impulse items.

I want to alert you to a study that was done only eight months ago by the Bank of Canada in this city. They did a large survey of businesses across Canada, and they had three findings in this survey of actual business people. They found that debit cards are preferred as least risky—I have no problem with that. Secondly, many businesses perceived that cash was the cheapest and most reliable. That is empirically false. Thirdly, the cards were seen as the most costly and least reliable. For the same reason that I argue the second finding is wrong, I argue this too is wrong. What this demonstrates is that a lot of small businesses are financially illiterate, or at least partially illiterate, and this points to the need for more literacy programs.

In fact, what happened over the past ten years? What was their actual behaviour? On both the consumer side and the commercial side, the use of credit and debit cards went up. In a study done by the Federal Reserve, I believe—I have the sources in my laptop—we're at the mid-point across some 10 or 15 countries in terms of the cost to the merchant for the use of cards.

So what is the problem? I'm arguing that the problem is the misperception of the cost of cash versus credit by business, producing, as my colleagues have suggested, rent-seeking by trade associations coming to Parliament and trying to get you to give them more profits instead of earning it the traditional way, through competition.

This is from the Federal Reserve, showing the profitability of credit cards, and you'll simply note that it's cyclical. It's on the screen. It is cyclical based on two variables: the cost of money and of course the credit losses.

What we're experiencing in Canada right now--this is from the DBRS, the bond rating agency--is that credit losses are soaring. As you can see, the red line, which is the weighted average, is pushing up to 6% for all credit card balances that are going to be charged off to bad debt in 2009. That is a horrific charge-off.

When I was a mortgage manager I had a zero charge-off, and on personal loans we had between a quarter to a half of one per cent. They're up to 6%, which is just off the charts.

Again, you can see this on the next one, the delinquency on loan losses in Canada is up to 35%, and the loan loss rate on credit cards is up to 44%.

I won't belabour the Australian solution. We already know it. You know it from the people who have testified. But I do have a couple of graphs you'll want to look at. These are from the Federal Reserve, which did a study. I believe Professor Carr quoted that study. After, I think it was four years, there was no change in the relative share of credit card use or debit card use. However, what did happen is that merchant fees went down and the banks recouped a very large amount through increased card fees.

You can see the two lines. The green line going up is the card fees charged on standard credit cards and the red line is the fees on the premium credit cards. What the Australians did was they simply shifted the burden from the merchants to the consumers. So what the Retail Council and the CFIB are asking you to do is to not stick it to them; they want you to stick it to the consumer, who is me.

The bank issuers, as this slide shows, recovered 30% to 40%, or a half billion dollars, from consumers. The irony is that the merchant costs fell on a transaction basis. When you run through the numbers, they dropped about four cents on a $40 purchase, which is really quite trivial. So there were no dramatic changes.

I won't summarize, because Professor Carr already dealt with this. The same Federal Reserve economist that Professor Carr spoke about reported that the regulations of the central bank, the Reserve Bank of Australia, failed to achieve their policy goals.

So what are the alternatives? I'll just wrap up.

I make three assumptions. One is that you, the legislators, face a choice of governing instruments from the least coercive, such as required information disclosure, to the most coercive, such as government ownership or the price controls advocated by the Retail Council or the CFIB. My second assumption is that you should select coercive instruments only when all else has failed, when there's clear evidence of market failure, and there is no evidence of market failure in the card systems.

My recommended policy solutions include much more rigorous information disclosure concerning rates, fees, benefits, costs, and interest charges; secondly, enhanced regulatory oversight to address deceitful or anti-competitive practices; and thirdly, financial literacy in the schools, in the education system. And I mention that because some witnesses expressed deep skepticism about literacy programs, but we do in Canada spend billions on primary school education, secondary, and post-secondary, so it would be a bit disingenuous for a professor to advocate against literacy programs.

Thank you.

[The Co-Chair, Conservative, Michael Chong]

Thank you, Mr. Lee.

Mr. Ware.

[Professor Roger Ware, Professor, Department of Economics, Queen's University, As an Individual]

Thank you, Mr. Chair.

Can I just clarify something?

I had prepared some of my remarks on debit cards. My understanding, and perhaps it's incorrect, was that this was going to be part of the discussion.

[The Co-Chair, Conservative, Michael Chong]

It is. That's correct. The study is on both the credit card and debit card systems.

[Prof. Roger Ware]

Thank you. Then I'll include those.

I'm a professor of economics at Queen's University, and I have had an interest in payment cards for quite a long time now, certainly dating back to when I was involved in the Interac hearing in the mid-nineties, which led to the creation of the current debit card system in Canada.

I'm going to begin by talking about interchange fees, as my three colleagues have, but I don't think you need to hear anything more about two-sided markets. Interchange fees, though, are set to balance the incentives of merchants to accept the card with the incentives of the issuer to issue it and the card holder to use it. The interchange fee, in effect, is paid from the merchant—strictly speaking, it's paid from the acquirer—to the card issuer and is not a conventional price.

This is a point, although my colleagues have been over this ground a little bit.... We think of high interchange fees as hurting merchants, because it's a price, and high prices hurt the people who have to pay them. But of course because it's a two-sided price, it's really not that simple. As I said, the interchange fee is designed to balance these networks, which have a joint interest in maximizing the acceptance by merchants, and of course merchants, who have an interest in large numbers of cards being available—as do card holders, so that when they go to buy a shirt they can find a merchant who will accept their card.

There are some theoretical conditions under which the interchange fee is completely neutral, in fact. Changes in the fee are balanced by changes in surcharges and in card fees, so that all parties are indifferent as to the actual level of the fee. Most academic economists who have studied this don't believe that we necessarily have that theoretical situation. The problem, though, in my opinion, is that we do not know enough yet about how the state of competition in acquiring and issuing really interacts to determine what that interchange fee is in the absence of regulation--in other words, from an economic welfare point of view.

You've heard quite a bit, both from my colleagues here and earlier I think about the Australian experiment. As we know, and we just saw some data on this, one thing we do know about it is that the reduction in interchange fees through regulation in Australia led to an increase in card fees and to a reduction in value of rewards to card holders.

There is a subtle and important question, which Jack Carr hinted at. That is, do the various prices and fees in these payment networks distort the pattern of payments? That is, if we think about credit cards, debit cards, and cash—and again my colleagues have talked about this—is there a tendency for, let's say, a higher percentage of payments to be made via credit cards relative to some kind of social optimum? It's an interesting question, and there are some academic discussions of this. My view is that we just don't know the answer yet. I would agree with my colleagues very much that in a case in which we don't know the answer, it's too soon to rush into regulation. Regulation is desirable when we have a clearly identified market failure and understand in which direction our intervention is going to improve things.

There is an important question on which Canada's situation is a little different from that of other countries, and that is the question of whether the credit card network is acting solely as a joint venture of the member banks or whether it's acting as an independent corporation in its own right in order to pursue its own profits. In Canada, as you know, the credit card networks have recently restructured themselves in order to be the latter, partly as a result of prompting from the Competition Bureau, which wanted that change in order to approve the duality—the change to allowing banks to offer both card networks, or to issue cards from both MasterCard and Visa.

Again, in the academic studies, one of the things that's likely to influence interchange fees is whether or not there's more imperfect competition at the issuing end or more imperfect competition at the acquiring end. There have been some studies suggesting that it's likely to be more at the issuing end, and the reason for that lies in the idea of switching cost. For the consumers who hold those cards, it can be difficult to change one card to another card, because first of all, you quite likely have a balance on it, and second, you have a bunch of card numbers in your online shopping networks—if you're me, you have, anyway. So consumers face some switching costs.

But again, I would say we do not know the answer to this. This is an interesting academic question, but we don't know the answer from the policy point of view.

Another question, which again my colleagues touched on, concerns “no surcharging” rules. There are some international differences here that are interesting. For example, in the U.K., where these issues have been studied quite a lot, the no-surcharging rule was abolished in the early 1990s, and yet there has been very little surcharging. As my colleague here pointed out, there's also very little cash discounting.

However, in Australia—at least, my understanding is—since they abolished their no-surcharging law, which was just about five years ago, I think in 2003, there has actually been quite a lot of surcharging. The number I saw is that 23% of credit card transactions through what are called large retailers are now surcharged, if you use a credit card. That's a pretty big number. I throw that out there to say that this is something that is interesting and possibly important, and we don't know a lot about it.

In conclusion on credit cards, just to restate what I've said earlier, I think it's much too early for us to have a definitive conclusion about any form of regulatory intervention in this market. I don't think we understand it well enough. We have the Australian example, and it's not at all clear that it was a success. It's possible there will be some intervention in the U.K. soon, and we may learn something from that.

Let me make just a few remarks on debit cards, if I may. We've had an unusual situation in Canada whereby we've had a single debit card network now for more than ten years—the Interac network. It's been regulated so that it's a not-for-profit organization. The question is, which system is preferable, a regulated natural monopoly, if it is a natural monopoly, or a competitive system in which merchants and consumers choose the debit network they want to use for each transaction? Ideally, a merchant could choose to subscribe to one or more debit card networks, and a buyer might have the choice, for any given transaction, to route it through network A, which might be Interac, or network B, which might be the new Visa debit network that is going to be rolled out, I believe, sometime in the near future.

Natural monopolies have the property that because of network economies and scale economies, a single supplier is the most cost-effective organization within which to supply the market. However, this conclusion is essentially a static one and ignores all the dynamic economies and incentives for innovation that come from a competitive system in which networks compete.

The policy concerns with debit cards mostly have to do with merchant fees, and to some extent with interchange fees. Interchange fees in the Interac debit network are currently set at zero. The concern I've heard is that when Visa debit enters, and possibly MasterCard debit as well, the cost to the merchant will go up.

One of the ways this has been expressed is through the concern that the current fee to a merchant for using an Interac debit card is about 12¢. It's a flat per-unit fee. When Visa debit comes, in I believe they're going to be using a more complicated fee structure, which is partly value based. It's partly a percentage of the value of the transaction.

To just finish up, my view of this is that competition is good. We have to start from where we are. Where we are is we have a monopoly. We should not be throwing up our hands and expressing alarm that we're going to get entry here. Entry is a good thing; entry is going to create competition. It's most likely that entry will create benefits for consumers, because that's what entry does. The concern has been expressed that somehow Visa debit will become a dominant firm in the debit market. It seems to me to be very premature. At the moment, Interac is, of course, the dominant firm.

Thank you.

[The Co-Chair, Conservative, Michael Chong]

Thank you, Mr. Ware.

Thank you to all of our four witnesses for their opening comments. We're now going to go to comments and questions from members of this committee for the next hour and a half.

We speak both official languages here. Members will be asking questions in both French and in English.

If you require translation, there are earpieces provided. The channels are listed on your desk.

We'll begin with Mr. McCallum.

[John McCallum, Liberal, Markham—Unionville, ON]

Thank you, Mr. Chair. Thank you to all four economists for being with us today.

Jack Carr began by saying that professors talk in fifty-minute sound bites. I used to, but now I have seven minutes, maximum, including your answers to questions. I shall try to be succinct.

The first question is that the two-sided market idea is appealing, but I wonder in the case of credit markets, given that banks are such key players as issuers, whether that's not a little oversimplified, and that in some ways there must be three sides. This is perhaps to Professor Scholnick.

[Prof. Barry Scholnick]

That's absolutely true. In fact, in economic literature they talk about many-sided markets. It doesn't have to be two. Two is just a simplification. Clearly, you would have in this situation multiple sides. As a simplification, the way I think of this game is between buyers and sellers. I would put together the banks, Visa, and MasterCard on the same side, as part of the platform. That's the key part. They are the middle people who try to bring together lots of buyers, who are consumers, and lots of sellers, who are retailers.

The way I envisage the issue before you is to think about retailers, who are the sellers, and consumers, who are the buyers, and the platform. For me, that's the key word when I'm trying to think about this issue. How does the platform work? Whether or not there are multiple parties within the platform, I think that's quite obvious in this case. It's quite possible to have multiple-sided markets.

[John McCallum, Liberal, Markham—Unionville, ON]

Thank you.

One of my colleagues suggested at some earlier meeting that we all want more competition. There are only two major card companies, Visa and MasterCard, and there are at least six banks or more. Would it make sense or would it be technically feasible for the interchange rates to be set by the banks rather than the credit card companies? That would seem to lead to potentially more competition, but it possibly wouldn't work. This is why I'm asking the question.

Maybe we'll go to Professor Ware on that one.

[Prof. Roger Ware]

As I said earlier, there is this key question. First of all, it is whether the credit card network is structured as a joint venture of the banks or whether it's an independent corporation. Let's assume, first of all, that it's the latter, which is true in Canada at the moment. In a sense, it is the credit card network that is representing the interest of the network. The banks, of course, are acting in their own interest. The banks have the interest of one side of that network, the issuing side, if you like.

It's the network that's interested in balancing the acceptance by merchants with the issuing of cards and the use of cards by cardholders. I would say giving the banks the right to set the interchange fee is sort of biasing the network in the direction of one side of it. It's not quite clear to me as a regulatory initiative exactly how one would do that.

[John McCallum, Liberal, Markham—Unionville, ON]

Do any of the other three disagree with that view? If not, I'll go on to another question. Okay.

This one, also for Professor Ware, is on the subject of Interac. My impression is that Interac has served Canadians well, at low cost, for a good number of years. I'm not opposed to new competition from MasterCard or Visa necessarily. But a lot of people think that international experience suggests that once they get in there, they will tend to raise rates, and consumers or merchants will end up paying more than they do at the present time. One of the problems is that Interac has been structured in a way that its governance model is not appropriate for dealing with the new competition. Interac, in a sense, is like the David, in my view, fighting these two new Goliaths. Maybe there's a role for government or Parliament to try to improve the situation for Interac so that it can better compete with these two new major global forces. Would you agree with that?

[Prof. Roger Ware]

Yes, actually, I do agree with that.

[John McCallum, Liberal, Markham—Unionville, ON]

Ah, the first one I've hit.

[Voices]

Oh, oh!

[Prof. Roger Ware]

Just to go back to the beginning of your question, absolutely, Interac has been a huge success. As you know, I'm sure, I think we're the second biggest debit card users in the world, right after Norway, I think. It's been a huge success, yes. Part of that is because of the standardization, the simplicity, and the openness that was created by the consent order from the Competition Tribunal in 1995 that allowed anyone to connect, basically. That's the first point.

The second point is whether the governance structure of Interac is serving it well now. The answer is no, it's not. If it's going to compete, and I certainly would support competition--we want competition--it needs to be flexible. It needs to be able to innovate. It needs to be able to, basically, make profits.

[John McCallum, Liberal, Markham—Unionville, ON]

Okay. Does anybody disagree or want to comment?