Industry Committee on June 9th, 2009

[Prof. Jack Carr]

Taking a percentage of sales is a very astute observation. It's equivalent in economics to what we call sharecropping, another process in which you take a percentage. The percentage is done to give the right incentive to the mall owner to put in the right mix of stores. As a retailer, you don't want another restaurant right beside you. You don't want another store competing.

By giving the owner part of the rent in a share, they want to maximize the total revenue of the mall. Allowing them to take that percentage gives them the right incentive. It's almost like an interchange fee; it provides the correct incentives to the various parties.

[The Co-Chair, Conservative, Michael Chong]

Thank you, Mr. Carr.

Monsieur Vincent.

[Robert Vincent, Bloc, Shefford, QC]

Mr. Chair, I will be sharing my time with my friend Mr. Robert Bouchard.

Earlier, my colleague asked if any real action had been taken over the years. He also asked you if you had a study to support the position you hold, according to which everything is fine, life is great, and things should continue as they are. Yet, you have no study, and you did not answer his question. Therefore, we can deduce that since you have no study, your position is simply a personal opinion that you are sharing with us today.

Mr. Lee, you stated that merchants do not have enough competition to earn the 2%. What do you think Visa and Mastercard are doing? These two companies are in the market and are charging interchange fees of 2%. They do not need competition and they can charge any interchange rate they want, change it when they want, and there will be no state intervention.

If someone wants to open a restaurant and earn a 3.8% profit on the meals, they will really only earn 1.8% if a client uses a credit card. Since you are a banker, can you tell me if it would be advantageous for a bank to lend money to someone who wants to open a restaurant? You may answer that a restaurant is free to choose whether or not it will accept credit cards, but if it does not, people will go eat elsewhere.

We are caught up in a system that the banks and the caisses populaires have created by deciding that people's paycheques would systematically be deposited into accounts from which money can be drawn any time. If somebody wants to travel, a credit card is needed to make reservations. If someone wants to go somewhere, a credit card is needed to reserve a spot. This is a credit card monopoly, a spiral in which we are stuck that was created by the banks and the caisses populaires.

Therefore, Mr. Lee, when you say that we need to be more competitive, I cannot help but be a bit skeptical. I do not believe that we can get out of this.

Can you explain to us how we can get out of this?

[Prof. Ian Lee]

I will answer the question you said I didn't answer--what would happen?--and then I'll come to your present question.

What would happen if nothing is done in terms of price regulation? The trend is very clear. From the empirical data, the percentage of transactions accepted by cash or cheque is going to continue to decline. Some day, in the not-to-distant future, I believe cheques and cash will disappear. That's what I believe, based on the empirical data. That's point one.

Number two, in terms of Visa and MasterCard, I'm assuming we will not regulate prices in that section of the economy. The phrase I use with my own students about wage and price controls is that you cannot regulate, put price controls on one sector, because all the sectors are independent, or, to put it more colloquially, you cannot be half pregnant. It's all or not all. You cannot regulate one sector of the economy, because they're buying inputs from other sectors of the economy. The credit card companies hire people. They buy technology inputs. They buy broadcast wires, Internet wires. So because they're interconnected with everybody else, if you regulate the prices in one sector, you have to regulate everybody.

In terms of the third point, the merchant does not have to accept credit cards or debit cards. If they feel so strongly that this is really unfair, they can demand that every customer pay cash. They could have said to me when I bought my dishwasher, “You have to pay cash.” And I could have said, “I'm not going to patronize your business.”

[Robert Vincent, Bloc, Shefford, QC]

I'm sorry, Mr. Lee, but you can't turn a client away because you won't accept his credit card. He'll find another place to eat. It makes absolutely no sense to think in this way, Mr. Lee. That is not how people do business. And I think you are smart enough to know that.

[Prof. Ian Lee]

I agree.

[Robert Vincent, Bloc, Shefford, QC]

Did I ask you anything, Mr. Bernier? Mind your own business, and I will mind mine.

[The Co-Chair, Conservative, Michael Chong]

Mr. Vincent, you have the floor.

[Prof. Ian Lee]

Mr. Vincent, I want to answer your question.

I think you're recognizing what I'm saying. It is in the self-interest of merchants to accept business credit cards and debit cards because it enhances and augments their sales. If they didn't take them, their sales would go down and they would probably go bankrupt, and they don't want that.

[Robert Vincent, Bloc, Shefford, QC]

I agree with you, but you cannot say that we have to set the interchange rates at 45¢ or 50¢, for instance, each time a credit card is used, instead of paying 2%, because Visa and Mastercard, the credit card issuing companies, have established their rate at 2% for the time being, but there is nothing to prevent it from rising to 3%, 4% or 5% overnight. There is no competition in this field, there are only two players. Obviously, if the goal is profit-making, they work together and there will be no competition between them.

How can you expect there to be competition between merchants when credit card issuers can do whatever they please, when there are no regulations and when we accept that market rules remain unchanged? It doesn't hold water. We must regulate, and do so straightaway because credit cards are going to force merchants to go under because of costs.

[The Co-Chair, Conservative, Michael Chong]

Thank you, Mr. Vincent.

We'll hear briefly from Mr. Lee and then Mr. Carr, and then we're going to move to Mr. Menzies.

[Prof. Ian Lee]

You said there is no competition and there is no alternative. Well, somebody called Bill Gates was quoted only six months ago as saying he could go into the debit card business because he could do it more cheaply than anybody else.

If they set their fees too high, any of the companies, this is going to provide an enormous incentive to some entrant to enter the business and knock them dead with a lower, cheaper, better-value product. This happens all the time. Schumpeter called it creative destruction. If you put in price controls, you end creative destruction. You end innovation. Then we'll look like Cuba or some country like that.

[The Co-Chair, Conservative, Michael Chong]

Thank you, Mr. Lee.

We'll have Mr. Carr, briefly.

Mr. Carr, you have the floor.

[Prof. Jack Carr]

Mr. Vincent, you said there's no study of a system with no regulation. Well, we do have, currently, no regulation. We have our experience of the last 30 or 40 years. In the last 30 or 40 years, interchange fees have not changed at all. The nature has changed, but the average interchange fee is the same.

You talk about interchange. How do we know that it won't go up? It's stayed the same, and it's stayed the same because it's set to balance the system. Visa doesn't make more money by charging more interchange fees. It's done in order to take account of the fact that they want to provide the correct incentives to the card issuers. If it went to 10%, they would not make one cent more.

[The Co-Chair, Conservative, Michael Chong]

Thank you, Mr. Carr.

Go ahead, Mr. Menzies.

[Ted Menzies, Conservative, Macleod, AB]

Thank you, Mr. Chair.

Thank you for this lively debate. I'm quite excited to hear the fact that the marketplace still does work. It's not just me that believes that. We have some other people out there who believe that the marketplace can work.

In a previous meeting, I suggested to the Canadian Bankers Association and some of the banks that we didn't want to regulate this, and the media spun it as me chastising the banks. Well, if the truth be known, I was speaking broadly to all those involved in this industry. They shouldn't be ashamed to make money on this system, because customers demand it. They demand this system, and I'm glad to hear that there are some options out there.

When we hear about the 6% in debts that are written off.... We're proud of our banks. Our banks are in good condition, but they're carrying more risk now, and they have no collateral for that risk. We want to make sure that we don't put in a 5% maximum interest rate on these cards and that we don't over-regulate. Some of you have suggested that we've already gone too far, but others of you have suggested that what we're doing with financial literacy is important and that we make sure that consumers are treated fairly.

Have we gone too far? Is the market working?

I'd like some comments, if I could, from whoever might be interested.

[The Co-Chair, Conservative, Michael Chong]

Go ahead, Mr. Scholnick, and then Mr. Carr.

[Prof. Barry Scholnick]

In terms of regulation, I was reading the transcripts of the Senate hearings a few months ago on this issue, and I think the most interesting thing for me, certainly, that came out of that meeting was when the senators talked to people from the Competition Bureau. What came out was that the Competition Bureau, the competition authorities in Canada, are currently looking at the system, particularly under the Competition Act and the particular clause that talks about abuse of dominant position. I think this is completely appropriate, and I was intrigued to hear this.

In other words, if there is a problem in the system, the relevant authority to be looking at this is the Competition Bureau, whether it's abuse of dominant position or whether Visa or MasterCard are doing things illegally. Because if they are abusing their dominant position, this could be a criminal offence and they could be taken to court. Similar competition-driven court cases have happened in Europe and have happened in the United States.

So I think the playing field where things should be happening in terms of the role of government is in the Competition Bureau and the Competition Tribunal.

As I think the people from the Competition Bureau told the senators, these things take time. It's very data-driven. They have to examine the issues very carefully. But I believe the good news is that they are looking at that. I think this is the appropriate field for this to be happening in, rather than having Parliament or even the Bank of Canada being involved in regulation.

[The Co-Chair, Conservative, Michael Chong]

Thank you, Mr. Scholnick.

Mr. Carr, and then we'll go back to Mr. Menzies.

[Prof. Jack Carr]

Given that full disclosure is an issue, I should disclose that I did my Ph.D. under Milton Friedman at the University of Chicago, and I'm a firm believer in the principle of operation of markets.

The market is working, and if you take a look at the Canadian banking system, it's the envy of banking systems all over the world. We're being examined by the Americans, by the Europeans--as in maybe we should go towards the Canadian banking system. We have a few banks with a large number of branches, as opposed to the United States, which had a huge number of banks with no branches. Their system didn't work.

During the Great Depression, 5,000 U.S. banks failed; not one Canadian bank failed. We have a system that's working. Our payment system is working, our banking system is working, and it's regulated. We shouldn't put more regulation in it on such things as interchange fees, which make it not work, which make it inefficient. We have a system that is working. If it ain't broke, don't fix it.

[The Co-Chair, Conservative, Michael Chong]

Thank you, Mr. Carr.

Mr. Menzies.

[Ted Menzies, Conservative, Macleod, AB]

My next question would be to a reference Mr. Scholnick made to cellphones. I appreciate the fact that this system isn't broken, but can we make it better? I'm assuming you're referring to the African model, where they're using phone cards. Perhaps you could explain how that debit/credit system is actually working.

[Prof. Barry Scholnick]

Thank you.

That's a really excellent question, and I think it ties into my key point to this committee, which is that a change will happen not through regulation, but through innovation, through new developments, through technology.

The example you give is cellphones and the African model. In places like Kenya and South Africa, what you've seen in those countries is very poor people who don't have bank accounts, but everybody in those countries has a cellphone, or at least has access to one. There's one in a village, or a family, or something.

So what you've had in these very poor countries is essentially a payment system that is more sophisticated than what we have in North America. That's because when you buy something from somebody, you go to a store, you take your cellphone and you put it next to the store owner's cellphone. There's a program--or to use the economic jargon, there's a platform--on both of these cellphones. You push a few buttons and the money goes from one person's account that they've put onto the cellphone previously, so you don't have to walk around with cash. You load up your cellphone with some money and then it goes into the shopkeeper's account, so your account goes down and the shopkeeper's account goes up. This is in Kenya, this is in China. They are doing the same kinds of things.

So essentially what you have is that nobody has plastic; nobody has a bank account. You have the emergence of a brand-new, highly innovative competitor for the plastic credit cards from cellphones.

Will this happen in North America? Absolutely. The question is not if; it's when.

[The Co-Chair, Conservative, Michael Chong]

Thank you, Mr. Scholnick.

Thank you, Mr. Menzies, for those questions.

Mr. Mulcair.

[Thomas Mulcair, NDP, Outremont, QC]

Thank you, Mr. Chairman.

I'd like to quickly respond to my colleague and friend Mr. Dechert by saying that the example I gave was that of a professional. In most provinces, including Quebec, professionals, for the most part, cannot incorporate. So, the example given was that of a person using his or her own personal card. The same thing would apply when a person buys RRSPs with points. Again, it is a tax advantage that is granted and a net loss for the economy in general.

I would like to give Mr. Scholnick and Mr. Ware an opportunity to speak because I did not get an opportunity to ask them a question earlier on.

We'll do it in the language of Shakespeare instead.

I want you to tell me where the $2 came from to give to my lady with her shopping cart. There seems to be a little bit of what we'd say in French pensée magique here. We have our two ladies in the Scotiabank ad walking out with their shopping carts. One of them is boasting that she just made two bucks off her credit card. I suggest to you that they both paid a buck in more expensive groceries. But maybe you can set me straight and tell me where that money came from.

Mr. Scholnick.