Case No: 58717 Event No: 454106

RETAIL BANKING SECTOR INQUIRY

CONCLUDING REPORT

JANUARY 2008

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Rue Belliard 35, B-1040 Brussels, tel: (+32)(0)2 286 18 11, fax: (+32)(0)2 286 18 00, www.eftasurv.int

Page 2 Table of contents 1 INTRODUCTION................................................................................................................................. 5

1.1 PURPOSE AND LEGAL BASIS OF THE SECTOR INQUIRY ..................................................................... 5 1.2 THE AUTHORITY’S SECTOR INQUIRY INTO RETAIL BANKING .......................................................... 6 1.3 THE METHODOLOGY OF THE SECTOR INQUIRY................................................................................ 6 1.4 FORMAT OF THE REPORT................................................................................................................. 7

PART I – COMPETITION IN THE MARKET FOR CURRENT ACCOUNTS AND RELATED SERVICES ...................................................................................................................................................... 8

2 MARKET CHARACTERISTICS OF RETAIL BANKING IN THE EEA .................................... 9 2.1 SUPPLY SIDE CHARACTERISTICS OF RETAIL BANKING MARKETS..................................................... 9

2.1.1 Fragmented market infrastructures .......................................................................................... 9 2.1.2 Traditionally high level of co-operation ................................................................................... 9 2.1.3 Varying degrees of price transparency................................................................................... 10 2.1.4 Significant barriers to entry.................................................................................................... 10

2.2 DEMAND-SIDE CHARACTERISTICS OF RETAIL BANKING MARKETS ................................................ 10 2.3 DIFFERING DISTRIBUTION MODELS FOR RETAIL BANKING PRODUCTS ........................................... 10 2.4 REGULATION OF RETAIL BANKING................................................................................................ 11

3 MARKET STRUCTURES AND FINANCIAL PERFORMANCE IN RETAIL BANKING ...... 12 3.1 MARKET CONCENTRATION AND INTEGRATION IN RETAIL BANKING ............................................. 12 3.2 FINANCIAL PERFORMANCE OF THE RETAIL BANKING SECTOR....................................................... 13 3.3 GROSS INCOME FROM RETAIL BANKING ACTIVITY........................................................................ 13 3.4 PROFITABILITY AND COST-INCOME RATIOS IN RETAIL BANKING................................................... 13

3.4.1 Long-term trends in banking sector profitability .................................................................... 14 4 FORMAL INDUSTRY COOPERATION ........................................................................................ 16

4.1 OWNERSHIP AND MANAGEMENT OF PAYMENT SYSTEMS .............................................................. 16 4.2 DATA SHARING THROUGH CREDIT REGISTERS .............................................................................. 16

4.2.1 Differences in credit registers in EFTA States........................................................................ 17 4.3 COMMERCIAL JOINT VENTURES.................................................................................................... 18 4.4 CONCLUSIONS .............................................................................................................................. 18

5 SETTING OF POLICIES AND PRICING....................................................................................... 20 5.1 BANKS’ PRACTICE OF PRODUCT TYING ......................................................................................... 20

5.1.1 The definition of product tying................................................................................................ 20 5.1.2 Possible anticompetitive effects of tying ................................................................................. 20 5.1.3 The Authority’s market survey data on product tying............................................................. 21

5.2 SETTING OF PRICES ON CURRENT ACCOUNTS ................................................................................ 22 5.2.1 Account management fees and fees for selected payment transactions .................................. 22 5.2.2 Closing fees............................................................................................................................. 23

5.3 CONCLUSIONS .............................................................................................................................. 24 6 CUSTOMER CHOICE AND MOBILITY ....................................................................................... 25

6.1 SWITCHING COSTS IN RETAIL BANKING ........................................................................................ 25 6.2 POSSIBLE MEASURES TO REDUCE OBSTACLES TO CUSTOMER MOBILITY AND STRENGTHEN COMPETITION.............................................................................................................................................. 26 6.3 ANALYSIS OF CUSTOMER MOBILITY IN RETAIL BANKING.............................................................. 27

6.3.1 Customer churn....................................................................................................................... 27 6.3.2 Longevity of the banking relationship..................................................................................... 28 6.3.3 The extent of cross-selling in retail banking ........................................................................... 30

6.4 CONCLUSIONS .............................................................................................................................. 32 7 INTRODUCTION............................................................................................................................... 34

7.1 CASHLESS PAYMENT TRANSACTIONS IN THE EEA........................................................................ 34 7.2 ORGANISATION OF POS CARD PAYMENT SYSTEMS....................................................................... 34

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7.3 THE INQUIRY’S DATA AND METHODOLOGY ON PAYMENT CARDS ................................................. 36 8 MARKET CONCENTRATION AND INTEGRATION................................................................. 38

8.1 CONCENTRATION IN ACQUIRING AND ISSUING MARKETS.............................................................. 38 8.1.1 Acquiring in international payment card networks................................................................. 38 8.1.2 Acquiring in the Bankaxept network....................................................................................... 39

8.2 INTEGRATION OF CARD PAYMENT SYSTEMS ................................................................................. 39 8.2.1 Different degrees of vertical integration of card payment systems in the EFTA States .......... 39

8.3 JOINT VENTURES FOR ACQUIRING SERVICES ................................................................................. 40 8.4 CONCLUSIONS .............................................................................................................................. 41

9 CARDHOLDER FEES....................................................................................................................... 42 9.1 INTRODUCTION............................................................................................................................. 42 9.2 FEE PER CARD............................................................................................................................... 42 9.3 CARD ISSUANCE FEE..................................................................................................................... 43 9.4 ACCOUNT STATEMENT AND BILLING INFORMATION FEE............................................................... 43 9.5 FEE PER TRANSACTION ................................................................................................................. 43 9.6 CONCLUSIONS .............................................................................................................................. 44

10 MERCHANT FEES............................................................................................................................ 45 10.1 INTRODUCTION............................................................................................................................. 45 10.2 LEVELS OF MERCHANT SERVICE CHARGES.................................................................................... 45 10.3 BLENDING .................................................................................................................................... 46 10.4 CONCLUSIONS .............................................................................................................................. 46

11 INTERCHANGE FEES...................................................................................................................... 47 11.1 TYPES OF INTERCHANGE FEES APPLIED IN INTERNATIONAL NETWORKS ....................................... 47 11.2 SETTING OF INTERCHANGE FEES................................................................................................... 47 11.3 LEVEL OF INTERCHANGE FEES IN THE EFTA STATES ................................................................... 47

11.3.1 Credit cards ....................................................................................................................... 48 11.3.2 Debit cards......................................................................................................................... 48

11.4 CONCLUSIONS .............................................................................................................................. 49 12 PROFITABILITY............................................................................................................................... 50

12.1 ISSUING ........................................................................................................................................ 50 12.2 PROFITABILITY VS. INTERCHANGE FEE ......................................................................................... 51 12.3 ACQUIRING................................................................................................................................... 51 12.4 CONCLUSIONS .............................................................................................................................. 51

13 INTEREST-FREE PERIODS AND FLOAT IN POS CARD TRANSACTIONS......................... 52 13.1 INTRODUCTION............................................................................................................................. 52 13.2 ANALYSIS OF FREE FUNDING PERIOD AND NET FLOAT PER CARD BRAND ...................................... 52 13.3 ANALYSIS OF FREE FUNDING PERIOD AND NET FLOAT PER EFTA STATE...................................... 53 13.4 CONCLUSIONS .............................................................................................................................. 54

14 MEMBERSHIP AND GOVERNANCE RULES ............................................................................. 55 14.1 SELECTED MEMBERSHIP CONDITIONS ........................................................................................... 55

14.1.1 Financial institution requirement....................................................................................... 55 14.1.2 Local establishment requirement ....................................................................................... 55

14.2 JOINING FEES ................................................................................................................................ 56 14.3 GOVERNANCE IN CARD PAYMENT SYSTEMS.................................................................................. 57 14.4 CONCLUSIONS .............................................................................................................................. 57

15 CROSS-BORDER COMPETITION IN ACQUIRING................................................................... 58 15.1 CROSS-BORDER ENTRY INTO THE EFTA STATES’ MARKETS......................................................... 58 15.2 ENTRY INTO FOREIGN ACQUIRING MARKETS ................................................................................ 58 15.3 CONCLUSIONS .............................................................................................................................. 59

16 PAYMENT INFRASTRUCTURES .................................................................................................. 60 16.1 THE TYPICAL OPERATION OF PAYMENT INFRASTRUCTURES.......................................................... 60 16.2 METHODOLOGY AND SCOPE OF THE INQUIRY INTO PAYMENT INFRASTRUCTURES ........................ 61 16.3 MAIN FEATURES OF THE SURVEYED PAYMENT SYSTEMS .............................................................. 61

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16.4 OWNERSHIP AND MANAGEMENT OF PAYMENT INFRASTRUCTURES ............................................... 62 16.5 ACCESS ISSUES ............................................................................................................................. 62 16.6 FEES CHARGED TO USERS ............................................................................................................. 63

16.6.1 Joining fees ........................................................................................................................ 63 16.7 CLEARING FEES ............................................................................................................................ 63

16.7.1 Economies of scale due to fee structure ............................................................................. 64 16.8 COMPETITION ANALYSIS .............................................................................................................. 64 16.9 CONCLUSIONS .............................................................................................................................. 64

PART III – CONCLUSIONS....................................................................................................................... 66

17 CONCLUSIONS ................................................................................................................................. 67 17.1 FINDINGS ON RETAIL BANKING MARKET STRUCTURE AND PERFORMANCE ................................... 67 17.2 FINDINGS ON CURRENT ACCOUNTS AND RELATED SERVICES ........................................................ 67 17.3 FINDINGS ON PAYMENT CARDS AND PAYMENT SYSTEMS.............................................................. 68

18 GLOSSARY......................................................................................................................................... 70

Page 5 1 Introduction 1.1 Purpose and legal basis of the sector inquiry Well functioning, integrated and competitive financial markets are essential for the efficient and dynamic development of the European Economic Area. Despite measures taken to promote the integration of financial markets within the EEA, retail financial markets in particular have continued to show lack of integration. Furthermore, indicators such as market fragmentation and entry barriers as well as a limited choice for retail banking customers may suggest that competition may be restricted or distorted within the EEA, in particular with respect to the provision of retail banking products and services to consumers as well as small- and medium-sized enterprises. For this reason, on 22 June 2005, the EFTA Surveillance Authority (the “Authority”) launched a sector inquiry (the “Sector Inquiry”) into competition in the retail banking markets of the EFTA States. The EFTA States are Norway, Iceland and Liechtenstein.1 According to Article 17 of Chapter II of Protocol 4 to the Agreement between the EFTA States on the establishment of a surveillance authority and a court of Justice (the “Surveillance and Court Agreement”), the Authority may decide to conduct an inquiry into a particular sector of the economy or into particular types of agreements across various sectors, where the trend of trade between the Contracting Parties to the EEA Agreement, the rigidity of prices or other circumstances, suggest that competition may be restricted or distorted within the territory covered by the EEA Agreement. The Authority has previously published its preliminary findings in the form of two interim reports. The first interim report, containing the Authority’s findings relating to card payments (hereinafter referred to as “Interim report I”), was published on 27 June 2007.2 This was followed by an interim report dealing with retail banking (hereinafter referred to as “Interim report II”), published on 21 November 2007.3

The Sector Inquiry has been carried out in co-operation with the European Commission (“the Commission”) which launched a sector inquiry into the retail banking sector in the EU25 on 13 June 2005. On 12 April 2006, the Commission published an interim report on the results concerning payment cards,4 followed on 17 July 2006 by an interim report dealing with current accounts and related services.5 After a period of consultation, the Commission published a final report on 31 January 2007.6

1 Norway, Iceland and Liechtenstein are the EFTA States that are signatories to the EEA Agreement. Whilst

Switzerland is a member of the European Free Trade Association, it is not a signatory to the EEA Agreement.

2 The public version of the interim report is available at: http://www.eftasurv.int/information/reportsdocuments/competitionreports/dbaFile11844.pdf

3 The interim report is available at: http://www.eftasurv.int/information/reportsdocuments/competitionreports/dbaFile12704.pdf

4 The public version of the interim report (hereinafter referred to as the “Commission’s interim report I” is available at:

http://ec.europa.eu/comm/competition/sectors/financial_services/inquiries/interim_report_1.pdf 5 The public version of the interim report (hereinafter referred to as the “Commission’s interim report II” is

available at: http://ec.europa.eu/comm/competition/antitrust/others/sector_inquiries/financial_services/interim_report_2.pdf

6 Hereinafter referred to as the “Commission’s report”. Available at: http://ec.europa.eu/comm/competition/antitrust/others/sector_inquiries/financial_services/sec_2007_106.pdf

Page 6 1.2 The Authority’s sector inquiry into retail banking In its sector inquiry, the Authority has examined two complementary aspects of retail banking: Firstly, the markets for payment cards and payment systems; and secondly, the markets for current accounts and related services. The detailed analysis and findings from both parts of the inquiry are presented together in this concluding report. The sector inquiry has identified competition concerns that may require investigation and remedy under the EEA competition rules. The inquiry should provide a sound basis for a coherent approach to antitrust practice carried out by the National Competition Authorities (NCAs) and the Authority. Should there be evidence, after further investigation, that particular practices or arrangements violate EEA or national competition law in an individual case, these practices or arrangements can be addressed by individual antitrust actions. 1.3 The methodology of the sector inquiry The core of the evidence base for the retail banking sector inquiry is provided by detailed market surveys of: (i) issuing and acquiring banks in the payment cards market; and (ii) banks providing retail banking services to consumers and small and medium-sized enterprises (SMEs) in the EFTA States. Both of these market surveys were based on a sample which was intended to be representative of banks active in retail banking in the three EFTA States and relating to their activities from 2000 onwards. The methodologies for the market surveys firstly on payment cards and payment systems and secondly on current accounts and related services, are described in detail in Chapter 3 of Interim Report I and Chapter 1 of Interim Report II of the sector inquiry. The European Commission’s Joint Research Centre provided siginificant assistance to the sector inquiry’s economic and econometric analysis of the markets for payment cards and payments systems, and current accounts and related services. In addition, the Authority gathered information from bank associations, banking regulators, national central banks and payment system operators. In addition, the public consultations conducted in connection with the publication of both interim reports has provided valuable factual input. As regards Liechtenstein, it proved difficult to obtain reliable data on several aspects of the sector inquiry. This is due to the fact that because of the close integration of the Liechtenstein banking market with that of neighbouring Switzerland, separate statistics are in many cases nonexistent. Furthermore, the small overall number of market players meant that in many instances it was impossible to obtain statistically reliable data in the required format. As a consequence, the Authority had to exclude Liechtenstein from its statistical analysis contained in Part I of the present report. The Authority’s sector inquiry has been conducted in such a fashion as to give results comparable to those for the EU25, thus enabling a complete overview of the state of play in the retail banking markets across the EEA. In order to maintain that comparability, the Authority’s present report follows the same methodology as the Commission’s final report and its structure is analogous to the Commission’s. The Authority’s report is thus intended to complement the Commission’s report. The report will, however, confine itself to issues that are deemed to have a relevance for the retail banking markets in the EFTA States and,

Page 7 hence, some chapters in the Commission’s interim report will not have a counterpart in the present report. 1.4 Format of the report This concluding report consists of three Parts: • Part I sets out the main findings and analysis concerning the market for current accounts and related services; • Part II sets out the main findings and analysis concerning the market for payment cards and payment systems; and • Part III summarises the inquiry’s conclusions.

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Part I – Competition in the market for current accounts and related services

Page 9 2 Market characteristics of retail banking in the EEA 2.1 Supply side characteristics of retail banking markets The markets for retail banking across the EEA do not present a uniform picture regarding concentration of supply. National differences in concentration are still large with, for instance, Germany having one of the less concentrated national banking sectors while concentration ratios in some of the smaller countries in Europe can be quite high. As will be further explained in Chapter 2, the retail banking markets in Iceland and Norway are characterised by a high degree of concentration with a handful of large banks accounting for the bulk of the market share. Consequently, the market structure in these countries tends to be oligopolistic. 2.1.1 Fragmented market infrastructures The retail banking markets in the EEA still tend to be fragmented along national lines. This fragmentation is further entrenched by the fact that essential market infrastructures (payment systems, credit registers) remain country-specific and lack interoperability. Furthermore, legal obstacles to further market integration remain in the form of differing regimes relating to e.g. tax and consumer protection. As regards market infrastructure, firstly, the organisation and management of payment infrastructures varies significantly from country to country. Whereas payment systems are run by central banks on a non-profit basis in some countries, others are operated by joint ventures of banks in various forms. Consequently, access conditions and fee structures differ considerably, and widespread entry barriers remain. Secondly, there are major differences in the market structure and operation of credit registers across the EEA. This fragmentation has consequences for the volume and type of customer data that is available to credit providers and for the ability of credit providers to access registers, especially in other countries.7

In relation to legal infrastructure, tax policies on company earnings, VAT treatment and capital gains vary between EEA States. These varying tax regimes clearly influence the investment decisions of banks (for example, on whether and how to enter new markets) and the consumption, saving and borrowing decisions of retail banking customers. Banking regulation is discussed in more detail in Chapter 3 below. It is worth noting here that while prudential rules have been largely harmonised at European level, significant differences remain in areas such as the ownership structure and the geographic scope of certain banks. Lastly, consumer protection rules for retail banking still vary considerably across the EEA, which raises the cost of entering new markets and maintains market fragmentation.8

2.1.2 Traditionally high level of co-operation In general, banking markets at national level are characterised by extensive co-operation between (incumbent) banks, notably in infrastructure-related areas such as payment systems, clearing houses, etc. Also of note is the fact that as most retail banks are multi-product firms offering a range of products and services, contacts between banks take place in a multitude of fora. In theory, such multi-market contacts may induce collusion 7 Commission’s report, pp. 13-14. 8 Commission’s report, p. 14.

Page 10 behaviour, as retaliation against deviating firms can take place on multiple markets.9 Whether this is, in fact, the situation on a particular market must be established on a case-by-case basis. 2.1.3 Varying degrees of price transparency For some retail banking products, such as deposits or mortgages, prices are relatively easy to compare, as the interest rate is a good proxy for the ‘price’ (though some significant charges or fees may apply to mortgages).10 In other instances, however, consumers may face considerable difficulty in comparing products due to the heterogeneous nature of the services provided by different banks or because of complex pricing structures that make it difficult to ascertain the ‘real’ price of a particular product.11

2.1.4 Significant barriers to entry Prudential rules and supervisory regulation can be used to hinder market entry. In addition, some EEA countries restrict takeovers regarding certain types of credit institutions, e.g. savings banks. Market entry barriers may also result from market structures and the conduct of incumbent market players, in particular with respect to co-operation agreements and the functioning of networks such as payments systems or credit bureaus. In the context of networks, natural, regulatory and behavioural barriers can be distinguished. Whereas natural barriers are the result of the ‘inherent’ economies of scale of networks such as payment systems, access to networks may also be rendered difficult by artificial barriers such as regulatory provisions or incumbents’ behaviour. Fee structures that disadvantage smaller banks or newcomers may be the result of both, natural or artificial barriers.12

2.2 Demand-side characteristics of retail banking markets The demand-side of retail banking markets is, as would be expected, fragmented. Bank customers are often faced with information asymmetry, i.e. lack of full information about the products and services on offer and hence cannot make meaningful comparisons. Moreover, there are numerous barriers to customer mobility (e.g. tying and bundling of products, switching costs such as closure charges, etc.) that result in a certain reluctance to switch suppliers, hence making price competition less efficient.13

Customer churn, i.e. the percentage of customers switching banks in a year, appears to be even lower in Iceland and Norway than the average for the EU25 (see further chapter 5 below), or around 5% per year for private individuals. 2.3 Differing distribution models for retail banking products

9 ibid. 10 ibid. 11 Competition in Nordic Retail Banking – report from the Nordic competition authorities (2006), p. 76. The

report is accessible at: http://www.samkeppni.is/samkeppni/upload/files/skyrslur/samnorraenar_skyrslur/norraen_skyrsla_um_bankamarkadin_-_competition_in_nordic_retail__banking.pdf

12 Commission’s report, p. 15. 13 For further analysis of bank customer mobility in the Nordic countries see the 2006 report by the Nordic

Council of Ministers, available at: http://www.norden.org/pub/velfaerd/konsument/sk/TN2006507.pdf

Page 11 Although the need for branch networks has decreased somewhat with the advent of phone and internet banking, branches seem to remain an important distribution channel for a number of retail banking products, in particular the more complex ones such as mortgages. In order to provide a full range of retail banking services, a bank thus still needs a branch network to a certain extent. However, there have been reductions in branch density and staffing in Iceland and Norway in recent years, reflecting changing customer habits. It is also of note that some “niche” service providers have entered the market in Iceland and Norway without relying on the establishment or acquisition of a branch network (e.g. banks offering internet-only current accounts). 2.4 Regulation of retail banking Across the EEA, competition authorities are increasingly turning their attention to banking markets. Competition authorities in both Iceland and Norway have dealt with several cases involving retail banking markets over the years.14 It is by now firmly established that EEA competition law applies to the banking sector. One tool of prudential regulation is entry regulation by means of bank license requirements. This is explainable by the rules on own funds adequacy. However, the promotion of stability and the avoidance of a systemic crisis cannot justify all occurring entry restrictions. Such restrictions may also be used by governments to prevent foreign entries or takeovers and thus impede effective competition. The Authority scrutinises advantages provided to certain financial institutions by means of State aid control in order to ensure a level playing field for all market participants and to enhance undistorted competition (Articles 61 to 64 EEA). In particular, the Authority ensures that public and private institutions operate under similar conditions by removing unlimited state guarantees or fiscal advantages favouring particular banks and by applying the so-called Market Economy Investor Principle (MEIP).

14 It will be recalled that Liechtenstein does not have a competition authority.

Page 12 3 Market structures and financial performance in retail banking 3.1 Market concentration and integration in retail banking The Authority´s inquiry estimated concentration ratios in retail banking in Iceland and Norway at national level. The purpose of this exercise was to compare the differences in banking concentration between Iceland and Norway and with the EU-average. The calculation of concentration ratios provides a useful estimate for market concentration. It should be emphasised, however, that such analysis has limitations. Firstly, the Authority’s inquiry did not cover 100% of market volume, and hence no exact calculations were possible. Moreover, due to data limitations the choice of the indicators that could be used for the calculation of the market concentration ratios was limited.15

For the purpose of estimating concentration ratios, a number of indicators were used, i.e. gross retail income, gross income on current accounts and number of current accounts. To measure the level of concentration, the combined market share of the three (CR3) and five (CR5) biggest companies has been calculated. In general, the concentration levels of Iceland and Norway turned out to be higher than the EU averages and resemble the levels seen in the most concentrated EU Member States, such as Finland, the Netherlands, Lithuania and Sweden. The least concentrated countries in the EEA, with CR3 at or lower than 50%, are Poland, Latvia, Ireland, Italy, Spain and Germany. It is thus fair to say that the retail financial sectors in Iceland and Norway are among the most concentrated in the EEA.

Figure 1: Concentration ratios: CR3 and CR5. Year 2004 Intra-sample share (total retail income) extrapolated with deposits

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%

Iceland Norway EU25 Average EU15 Average

CR3CR5

Note: The EU15 and EU25 Average data have been obtained from page 48 of the European Commission’s “Interim Report II: Current Accounts and Related Services”.

As highlighted in the previous findings of the Authority and the Commission,16 retail banking markets remain extremely fragmented. With the exception of the Benelux and the 15 See further Interim Report II, p. 18. 16 See Interim Report II, p. 8 and the Commission’s Interim Report II, p. 47.

Page 13 Nordic countries, there are very few players that have a leading market share in more than one of the EEA States. In general, the number of non-domestic banks among the leading banks in each EEA State is limited. Of the EFTA States, only Norway counts a foreign bank among its top five retail banks. 3.2 Financial performance of the retail banking sector

The Authority’s inquiry examined different aspects of the retail banking sector’s financial performance, i.e. gross income per product line and cost-income ratios. Due to limited data, it was not possible to examine all markets in all instances.17

3.3 Gross income from retail banking activity Table 1 below summarizes the gross income share per product line for personal consumers. In Norway, mortgages appear as the most significant source of income for retail banks, generating about 75 per cent of total gross income from personal customers.18 This corresponds to the findings in the EU25, although the numbers are significantly higher than the average in EU25 (more than 40 percentage points) and higher than the highest observation in any of the EU Member States (about 60 per cent in Portugal). All other sources of income seem less important in Norway than in both EU25 and most EU Member States. In Iceland, current accounts and consumer loans are the main sources of bank retail gross income, while mortgages play a relatively minor part. It should be borne in mind, however, that the Icelandic home loan market has traditionally been dominated by the state-owned Housing Loan Fund, and that commercial banks only made any significant inroads into this market in mid-2004. It is therefore to be expected that the importance of mortgages has risen as a source of income for the Icelandic banks subsequent to the surveyed period.

Table 1: Balanced gross income share per consumer product line, 2004, weighted average

Current

accounts

Deposits and

savings Consumer

loans MortgagesCredit Cards Total

Iceland 37.68% 0.00% 44.91% 13.67% 3.74% 100.00%Norway 5.26% 9.03% 5.49% 75.03% 5.19% 100.00%EU15 Average 26.50% 15.94% 17.05% 32.85% 7.66% 100.00%EU25 Average 27.82% 17.16% 17.66% 30.06% 7.25% 100.00%

Note: The EU15 and EU25 Average data has been obtained from Table 16 on page 64 of the European Commission’s “Interim Report II: Current Accounts and Related Services”.

3.4 Profitability and cost-income ratios in retail banking 17 For further explanation concerning limitations linked to data and methodology see Chapter 5.2 of Interim

Report II. 18 In the comments received by the Authority during the public consultation period it has been pointed out

that a reason for the high share of bank income in Norway stemming from mortgage lending is that banks account for a high proportion of the mortgage market. In other European countries, banks are less dominant in this market. It has also been pointed out that interest margins on mortgages in the Norwegian market have been falling since the beginning of 2004. It should be underlined, however, that the Authority’s data is based on information provided by the banks themselves.

Page 14 Table 2 shows weighted country averages of the ratio of pre-tax profit to banks’ gross retail income from 2001 to 2004. In 2004, compared to previous years, the bank profitability ratio in Norway increased with almost 40 per cent, while in Iceland it dropped by half compared to the results two years earlier.19

Table 2: Profitability ratio, 2001-2004, weighted average 2001 2002 2003 2004 Iceland 23.80% 23.70% 17.70% 12.30% Norway 30.80% 28.20% 28.40% 39.50% EU15 Average 23.3% 25.1% 28.9% EU25 Average 21.6% 24.5% 28.8%

Note: The EU15 and EU25 Average data has been obtained from Table 16 on page 64 of the European Commission’s “Interim Report II: Current Accounts and Related Services”.

Table 2 shows that profitability ratios in Norway were systematically higher than the EU25 average over the period, while Iceland had a comparable profitability ratio in 2002, but a significantly lower average than the EU25 average in 2003 to 2004. Table 3 shows the cost-income ratios, which is the country level weighted average of the ratio of total operating costs as a share of banks’ gross retail income. The figure shows that the value of the ratio over the four-year period stayed relatively stable in Iceland and Norway. In both cases the ratios are below the EU25 average of 63% of total income.

Table 3: Cost income ratio, 2001-2004, weighted average 2001 2002 2003 2004 Iceland 57.20% 54.50% 54.70% 55.20% Norway 59.40% 63.00% 63.10% 56.90% EU15 Average 64.2% 65.9% 65.8% EU25 Average 65.8% 66.2% 62.6%

Note: The EU15 and EU25 Average data has been obtained from Table 24 on page 75 of the European Commission’s “Interim Report II: Current Accounts and Related Services”.

It should be noted that the data relating to profitability and cost-income ratios is subject to numerous caveats. As the observation period is rather short, the economic cycle is bound to influence the findings. Furthermore, profitability is influenced by factors such as overall savings ratio and development of credit markets, as well as industry-specific factors. 3.4.1 Long-term trends in banking sector profitability In addition to the analysis above, the Authority examined the long-term profitability in the banking sector, relying on OECD data. The OECD’s data covers only Norway and Iceland and has the same advantages and disadvantages as the analysis of OECD data as mentioned in the Commission’s interim report.20

As regards the ratio of pre-tax profits to gross banking income21

from 1981 to 2003, Iceland has seen a circular trend with negative results in 1984 and 1992. However, the trend has been rising in recent years. In Norway, one can observe negative results around the banking crises in the late ‘80s and early ’90s, but stable positive results in the last ten 19 The period of observation used in this section is clearly too short to cover a whole business cycle, and can

therefore not be used to draw conclusions about longer-term profitability. 20 Commission’s interim report II, p. 58. 21 Gross banking income is the sum of banks’ net interest and net non-interest income from all banking

activity.

Page 15 years. According to the OECD data, the ratio of pre-tax profits to gross banking income in Iceland and Norway was 31 and 26 per cent, respectively, in 2003, which is in the middle or at the low end of the interval from 20 to 40 per cent found in the EU25. As in most of the EEA, Iceland has experienced a rise in the ratio of pre-tax profit to banks’ assets from 1992 to 2001. In Norway, the trend has been positive but unstable after 1992. In 2001 the banks in Iceland and Norway report rates of return on assets of 0.62 and 0.91 per cent. This is within the interval found in EU25 (0.5 to 1.5 per cent).

Page 16 4 Formal industry cooperation The banking industry in general and retail banking in particular is characterised by a high level of cooperation between market players. Cooperation frequently occurs with respect to ownership and management of payments systems or credit registers as well as the development of codes of conducts and other forms of self regulation. Usually, cooperation takes place at the level of banking associations, but it can also go wider; for instance, when nationwide payment systems or credit registers require cooperation between specific associations. A large part of the rather extensive co-operative activity in the banking sector can be explained by the industry’s standardisation and compatibility requirements. In order to handle non-cash payments, for instance, banks have to agree on issues such as technology formats or mutual cost compensation.22

The present chapter will examine three common forms of bank co-operation in the fields of payment systems, credit registers, and commercial joint ventures. 4.1 Ownership and management of payment systems Payment systems in the EEA are characterised by their heterogeneity in matters such as governance, infrastructure, access etc. Furthermore, national legislation relating to such systems may vary. As a result, payment systems in the EEA tend to be fragmented along national borders. It goes without saying that access to payment systems is crucial for any bank wishing to enter a particular national market. Extensive co-operation between competitors such as the operation of a payment infrastructure may lead the participants to share business information in a way that harms competition. Given that interbank systems, by their nature, handle sensitive information and are frequently jointly owned by incumbent banks, their operation may entail barriers to entry. Such barriers may consist of discriminatory access or fee conditions for newcomers. There is, however, no evidence of this kind of entry barriers in either Iceland or Norway. 4.2 Data sharing through credit registers Credit registers operate in almost all EEA States and collect various kinds of financial information on individuals. Subject to data protection rules, members of the registers are able to access this kind of data for commercial purposes such as bank lending. Banks and credit providers require access to good quality credit data in order to overcome information asymmetry when they set prices for new or potential borrowers. Thus credit registers are an important element of retail banking market infrastructure. To ensure strong competition among credit providers in retail banking markets it is vital that credit registers enable open and non-discriminatory access to credit data.23 In particular, an important concern regarding credit bureaus’ tariffs are potential entry barriers in the form of excessive or discriminatory fees.

22 Commission’s report, p. 39. 23 Commission’s report, p. 25.

Page 17 4.2.1 Differences in credit registers in EFTA States In all three EFTA States, banks can access credit information databases in order to obtain information on the creditworthiness of their clients. However, the legal nature and characteristics of these credit registers varies, as is the case elsewhere in the EEA.

4.2.1.1 Ownership and governance structure In Iceland, there are two complementary structures. Firstly, the Icelandic Banks’ Data Centre, which is jointly owned by the Icelandic Central Bank and a consortium of retail banks, provides credit reports containing positive data (i.e. data concerning all financial commitments of a prospective borrower). In addition, Lánstraust hf., a private for-profit company, provides credit reports based on negative data (i.e. data on credit arrears, defaults, bankruptcies and other such information). Lánstraust’s parent, Creditinfo Group, is owned partly by Icelandic banks. In Liechtenstein, there is no single national credit register. Instead, lenders contract individually with Swiss-based private credit registers such as Teledata or Deltavista. In Norway, there is no single national credit register. However, there are several private for-profit credit reference agencies, in particular Credit Inform, Dun & Bradstreet and Lindorff Decision.

4.2.1.2 Type and quality of data held The nature of information collected by credit registers may vary considerably. Some registers only contain negative data. By contrast, other registers may collect positive data about the totality of the subject’s financial obligations, thus giving a more detailed picture of his/her financial situation and capabilities. It has been argued that access to both types of data is pro-competitive as it enables new loan providers to compete on an even footing with incumbent lenders. Also, better credit assessment should result in more responsible lending and consequently lower rates due to a reduced default rate.24

In Iceland, positive data can be shared between banks with the subject’s consent via the Icelandic Banks’ Data Centre. Negative data, sourced from debt collection agencies and from public sources (e.g. court proceedings), is available from the privately-run credit bureau Lánstraust. Such data is deleted from the bureau’s database once the underlying claim has been settled, or when the data becomes more than four years old. Liechtenstein banks appear to use the services of various Swiss credit bureaus, whose services may vary. In Norway, the credit bureaus offer both negative data (information on debt arrears collected from debt-collecting agencies), as well as a variety of positive data. With regard to information on debt arrears on individuals25, such information can only be used one

24See further a paper published by Oxera Consultants: Accentuating the positive: Sharing financial data

between banks, Oxera, December 2005. 25 Or companies not registered in the Company registry. With regard to registered companies, such

information can be used one month after the debt-collecting company has claimed repayment of the debt. In accordance with the Act of 14 April 2000 no. 31 relating to the processing of personal data, and connected regulations, credit bureaus need a licence in order to provide credit information. The conditions mentioned above follow from the licence conditions set by the Norwegian Data Inspectorate.

Page 18 month after the debt-collecting agency has taken legal steps. Information on debt arrears has to be deleted as soon as the claim has been settled. 4.3 Commercial joint ventures Joint ventures among banks are commonplace in the operation and ownership of payment systems. Throughout the EEA, clearing systems are predominantly owned either by national banks or by a joint venture among banks. Cooperation among banks in the operation of payment systems can bring a range of efficiency benefits in terms of economies of scale and in overcoming often substantial start-up costs. On the other hand, joint ventures in payment networks may also pose certain threats to competition. Payment systems will be dealt with in more detail in Chapter 15 of this report. In some EEA countries, savings banks and co-operative banks engage in various forms of co-operation. In particular, such institutions may set up joint enterprises that provide specialised financial services that may subsequently be sold to consumers via the participating banks. Also, development of new products and services may be undertaken jointly. For example, savings banks in Iceland co-operate extensively in areas such as product development and marketing whilst keeping ownership and management of each savings bank separate. The Norwegian savings banks practice similar extensive co-operation through alliances of savings banks. Various services in the market for payment card services are provided jointly by banks. In particular, acquiring services are frequently offered collectively in the EFTA States.26 Although certain economies of scale may be realised via such jointly offered services, they may also have a negative effect on customer choice by reducing the number of service providers in the acquiring market. 4.4 Conclusions As is the case elsewhere in the EEA, in the EFTA States banks co-operate actively within several areas of retail banking, through ownership and management of payment systems, data sharing through credit registers, and commercial joint ventures. The level and areas of co-operation vary from country to country. Although significant economic benefits may result from such co-operation, it can also potentially create competition problems, such as for instance, foreclosure of new entrants or it could lead to collusive action. Access to credit databases can be an important source of information for banks and new entrants to minimise credit risks. Depending on how such credit bases operate, in particular concerning the conditions for access, foreclosure problems might arise. The Authority´s inquiry did not, however, reveal any specific problems of this kind in the EFTA States. It should be noted that the Consumer Credit Directive 93/13/EC, which has been incorporated into the EEA Agreement,27 is currently under revision. In the area of credit

26 See p. 26 of interim report I. 27 Decision No 7/94. OJ L 160, 28.6.1994, p. 1, and EEA Supplement to the OJ no. 17, 28.6.1994, p. 1.

Page 19 registers, the Commission’s most recent proposal aims to guarantee mutual access to existing private and public databases on a non-discriminatory basis.28

28 See http://ec.europa.eu/consumers/cons_int/fina_serv/cons_directive/2ndproposal_en.pdf

Page 20 5 Setting of policies and pricing Using data gathered in the Authority’s market survey, this chapter examines the setting of banks’prices and policies, particularly in relation to current accounts. Firstly, banks’ practice of product tying will be examined. Secondly, certain pricing practices in relation to current accounts will be analysed. 5.1 Banks’ practice of product tying 5.1.1 The definition of product tying The Authority’s Interim report II discussed banks’ practices of product tying and bundling. They are distinct practices. Bundling occurs where two or more products are sold together in a package, although each product is also available separately. Tying occurs when two or more products are sold together in a package, and at least one of these products is not sold separately. That is to say, the customer is forced to buy extra products in order to secure the single product they wanted.29 The present chapter focuses specifically on the practice of product tying since, unlike bundling, it involves coercing customers to take on additional - and perhaps unnecessary - products. Product tying is a common strategy for retail banks throughout the EEA. Because it is relatively expensive and difficult for banks to win new customers, they often decide to focus their growth strategy on increasing cross-selling to existing customers. Product tying offers a simple way of increasing cross-selling. Such product ties are found in a range of core retail banking products, e.g.: • selling a current account to a consumer buying a mortgage or personal loan; • selling payment protection insurance or life insurance to a mortgage customer; or • selling a current account to an SME taking out a business loan.30

5.1.2 Possible anticompetitive effects of tying From a competition viewpoint, product tying in retail banking may weaken competition in several ways. Firstly, since it binds customers into buying more products from the same bank, product tying raises switching costs and therefore is likely to reduce customer mobility. Secondly, by binding customers into buying several products from the same bank, tying is likely to discourage the entry of new players, especially mono-line providers. Thirdly, by introducing additional – perhaps unnecessary – products into the transaction, tying reduces price transparency and comparability among providers. The possible anticompetitive effects described above are likely to be strongest in markets where one or more large banks tie products.31

Product tying by one or more undertakings in a particular EFTA State may constitute an exclusionary abuse under Article 54 EEA, where such undertakings have a dominant position in a product market that is subject to tying. Clearly the assessment of a particular

29 Commission’s report, p. 49. 30 ibid. 31 Commission’s report, pp. 49-50.

Page 21 tying practice would depend on the specifics of the case; e.g., the products being tied; the extent of dominance; and the extent and effect of product tying.32

5.1.3 The Authority’s market survey data on product tying In its questionnaire to banks in the EFTA States, the Authority asked banks to report data on whether they tied certain sets of retail banking products together. Table 4 shows the percentages of tying for different products. The weighted average is calculated using country-level percentages weighted by the corresponding country population.

Table 4: Tying, percentage of tying, Year 2005. Customers

Mortgages+ current accounts33

Mortgages+ salary into current account34

Mortgage+ life insurance35

Loans+ current accounts36

Loans + salary into current accounts37

Iceland 67% 67% 0% 33% 20%Norway 17% 13% 0% 33% 22%EU15 Average 43% 13% 6% 41% 12%EU25 Average 47% 12% 8% 43% 12%

Note: The EU15 and EU25 Average data has been obtained from Table 43 on page 109 of the European Commission’s “Interim Report II: Current Accounts and Related Services”.

In Iceland, tying is rather common between mortgages and current accounts (67%), and mortgages and salary into current account (67%) in the consumer market. This is substantially higher than the average within EU. In Norway, tying appears to be on average with, or lower than, EU15. The exception is loans and salary into current accounts (22%). Table 5 shows the percentages of tying for different products in the SME market. The weighted average is calculated using country-level percentages weighted by the corresponding country population.

Table 5: Tying, percentage of tying, Year 2005, SMEs

Loans+ current accounts

Loans + Invoices to current accounts

Iceland 60% 25%Norway 29% 0%EU15 Average 51% 10%EU25 Average 58% 13%

Note: The EU25 Average data has been obtained from Table 44 on page 110 of the European Commission’s “Interim Report II: Current Accounts and Related Services”.

32 For a more detailed discussion on the compatibility of product tying with competition law see the

Commission’s report, pp. 53-55. 33 Percentage of banks requiring mortgages customers to open a current account 34 Percentage of banks requiring mortgages customers to pay their salary into this current account 35 Percentage of banks requiring mortgages customers to take out a life insurance policy through that bank 36 Percentage of banks requiring loan customers to open a current account 37 Percentage of banks requiring loan customers to have their salary paid into this current account

Page 22 In Iceland, tying is rather common between loans and current accounts (60%), and loans and invoices to current accounts (25%). This is higher than the EU25 average. In Norway, tying appears to be lower than in EU25. Taken together with findings in the EU25, it is furthermore clear that the practice of current account tying, both in the consumer and SME segments, is much more widespread throughout the EEA than tying of life insurance products. It should be borne in mind that the above data merely presents a “snapshot” of current bank policy in the EFTA States. Marketing strategies may, of course, be adapted and revised over time. Furthermore, there may be nuances in an individual bank’s policy. For example, tying is perhaps not insisted on for all categories of clients or sub-types of product. 5.2 Setting of prices on current accounts In the Authority’s questionnaire, banks were asked to indicate the number of payment transactions per current account for a range of services (namely credit transfer (including standing orders), direct debit, and automated teller machine (ATM) withdrawals). POS (Point of sale) transactions were excluded. Banks were also requested to report total income coming from account management fees and fees charged for specific payment transactions. The Authority’s findings, together with the Commission’s, indicate that the number of transactions per account varies widely across countries and that both Norway and Iceland are below the EU25 average in this respect. This can be explained by different payment habits as well as by differences in pricing.38

5.2.1 Account management fees and fees for selected payment transactions Banks apply various pricing formulae for payment services, separately or in combination with other services. These formulae include explicit pricing for a single product, in the form of transaction related fees; fees for a package of products; charges for currency conversion; and other elements. In addition, there are some less visible prices – or costs for customers - including value dating (or ‘float’) practices and cross subsidisation with other products. In this sense Norway poses an interesting example, as float revenues connected to payment transfer are prohibited by law39, and the government promotes a policy of direct charging of payment transaction services40. The promotion of direct pricing is done to promote an effective payment system which gives the customer the opportunity to choose the most effective method of payment transaction at all times. In figure 2, the banks’ income on account management and the fees charged for payment transactions are compared. The results are an indication of the consumers’ costs. For the calculation of the fee charged for payment transactions, a weighted average of a selected

38 See further Chapter 6 of Interim Report II. 39 See Lov om finansavtaler og finansoppdrag (finansavtaleloven) no. 1999-06-25, § 27. 40 See for example ENGE, A and ØWRE, G. (2006): Tilbakeblikk på innføringen av priser i norsk betalingsformidling, available at: http://www.norges-bank.no/upload/import/publikasjoner/penger_og_kreditt/2006-03/enge.pdf

Page 23 group of payment transaction types (excluding ATM and POS transactions) is used, applying the relative importance of each type of transaction at a bank’s level as weight.

Figure 2: Estimated income on current account management fees and on selected payment transactions (Weighted average. Year 2004)

Iceland

Norway EU avg. € 16

EU avg. € 0,12

0

10

20

30

40

50

60

0 0.2 0.4 0.6 0.8 1

Estimated income per payment transaction (€)

Est

imat

ed in

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e on

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ount

man

agm

ent p

er a

ccou

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)

Note: The EU25 Average data has been obtained from pages 86 and 87 of the European Commission’s “Interim Report II: Current Accounts and Related Services”.

As can be observed, the pricing strategies followed by surveyed banks vary considerably across the EFTA States. Also, the pricing strategies in the EFTA States deviate from the EU average. In Iceland, income from per-transaction fees is higher than both in Norway and the EU-25 while earnings from account management fees are low in an European context. In Norway, both transaction and account management earnings are above the EU-25 average. The evidence presented above suggests that a simple analysis on the basis of individual prices for individual payment services could be misleading. In reality, some payment services that banks appear to offer cheaply or at no cost may be charged in a different way, for example through higher account management fees. 5.2.2 Closing fees Closing fees are the direct financial cost that customers must pay when closing their bank account. The Authority has not found any evidence of closing charges in Iceland, but in Norway banks, on average, charge consumers € 3.7 and SMEs € 4.7 for account closure (simple average). Practices regarding closing fees vary considerably across the EEA. In more than half of all EEA States, no fees are levied for closure of current accounts. There is also a high degree

Page 24 of variability in fee levels between the countries where such fees are charged. In some countries, fees may reach €60 or €100.41

5.3 Conclusions In Iceland, making use of tying is a fairly common practice (between mortgages and current accounts (67%), and mortgages and salary into current account (67%) in the consumer market). The findings concerning average number of transactions in Iceland and Norway further underscore the high degree of variability in payment behaviour across the EEA, which is no doubt influenced by different pricing policies. There is a high variation in prices for payment services across the EFTA and EU States. The large dispersion in prices suggests that greater cross-border competition could bring down prices, particularly in those countries where payments prices are still relatively high.

41 Commission’s report, p. 60.

Page 25 6 Customer choice and mobility Retail banks typically compete on a range of product characteristics such as quality of services, price (the interest rates and fees for particular products), location and reputation. Customers consider all of these characteristics when choosing the most attractive offer. Thus more efficient providers, who will offer cheaper or better quality services, should see their market shares rise as customers tend to choose their products. For competition to be effective customers need to have clear information with which to choose the best offer on the market, and they need to be able to switch providers when a significantly better offer appears. In this way customer choice and mobility in retail banking markets exerts competitive pressure on existing and potential suppliers to continually improve their performance. Therefore customer mobility should be seen as an important contributor to competitive retail banking markets.42

6.1 Switching costs in retail banking Switching costs are costs that existing customers have to incur when they change their suppliers. Before deciding to switch their business to a competitor the customer has to decide whether the benefits of such a move outweigh the costs, including the financial and other costs arising from changing providers. Thus the presence of switching costs will, other things being equal, reduce the propensity of customers to change bank. The Authority’s interim report discussed five main factors that reduce customer mobility in retail banking:

1. Administrative burden: switching financial service providers is sometimes perceived as a complex administrative operation, requiring time and effort, and may risk disruption to customers’ financial affairs.

2. Information asymmetry and low price transparency: the information provided to retail banking customers for current accounts and other products may be inadequate or complex, making it difficult to compare banks’ prices and products. As the bank with an established relationship with a particular customer will have a better knowledge of the financial history of that customer, and therefore has a better understanding of the credit risk connected to that particular customer, this bank will be in a better position to give more precise pricing than any other bank.

3. Cross-selling and bundling of banking products: Cross-selling is the strategy to sell additional products or services to existing customers. Bundling is selling two or more products together in a package. Cross-selling and bundling may reduce price transparency and deter potential new retail banks from entering the market. Cross-selling and bundling may also constitute an abuse of a dominant position.

4. Customer preferences and choice: Customers may choose to stay with a bank, even if they have a better offer elsewhere, e.g. because of trust etc.

5. Closing charges: For several reasons banks might charge customers for terminating services. These closing charges reduce the mobility of customers. The Authority’s inquiry did not find evidence of any substantial closing charges in the EFTA States.43

High levels of switching costs in the retail banking industry may result in increased bank market power and enable banks to extract extra rent from their customers. High switching 42 Commission’s report, p. 65. 43 Cf. Chapter 4.2.2., above.

Page 26 costs may also constitute barriers to entry, as they make it harder for new entrants to attract customers and hence discourage new market entry. Finally, high switching costs may discourage product innovation, as customers would be reluctant to switch to new products and services. Low customer mobility need not imply the existence of high switching costs. Survey evidence consistently indicates that the main reason for not switching service providers is that customers are generally satisfied with their current bank. 6.2 Possible measures to reduce obstacles to customer mobility and

strengthen competition As discussed in interim report II,44 several measures are possible in order to reduce switching costs, some of which have already been set in motion in the EFTA States. The administrative burden might be reduced if switching regulations, which would require banks to use certain procedures and deadlines when transferring a customer’s account details to a new bank, are provided. In addition, switching codes between banks may be delivered through industry self-regulation. In Norway, the Norwegian Financial Services Association (FNH) and the Norwegian Savings Bank Association are in the process of developing a Switching code which will set up a binding set of rules between banks from 1 January 2008. The target of the Switching code is to reduce the administrative burden on customers when switching banks. The code is a result of a working group appointed by the Financial Supervisory Authority of Norway in the summer of 2007.45 In addition to the adoption of switching codes, consideration should also be given to how to raise customer awareness of such switching arrangements, and ensuring that procedures are in place for reviewing the content of the arrangements and handling complaints. As regards information asymmetries, two issues were identified. Firstly, comparing complex prices across providers may make it difficult for customers to weigh the offer provided by the current bank against others in the market. Secondly, it may be difficult for banks to give the customer an offer which may lead the customer to switch, as the present bank connections have more information about customer specific risks and are therefore, in a better place to price the services requested. Several measures have been put forward to amend the first issue. Providing transparent comparable information ex ante on prices of banking products would enable customers to quickly and easily compare offers between several providers. One example of this is the Norwegian Consumer Council’s plan for an internet site with information on financial products and prices.46 This may also increase consumers’ price awareness in connection with retail banking products. Another possibility could be to require banks to disclose prices and charges applied ex post for particular products. This may increase transparency and consumers’ price awareness. To relieve the second issue, i.e. the information asymmetry faced by a bank seeking a new customer, the availability of information from credit registers where banks share customer

44 See Chapter 7.3 of Interim Report II. 45 See http://www.regjeringen.no/upload/FIN/fma/rapport_kontonummerportabilitet.pdf 46See http://www.finansportalen.no

Page 27 data may help. In the absence of effective solutions of this type, other solutions in the form of a portable credit record or credit history, may solve the problem. 6.3 Analysis of customer mobility in retail banking The Authority’s inquiry examined customer mobility for the current account market, looking separately at mobility for consumers and SMEs. Two main measures for mobility were applied. The first one is referred to as “churn” and tries to capture the number of customers who switch banks within a year. It is calculated as the ratio of the sum of the current accounts opened at the beginning of a year and the current accounts closed in the same year, divided by twice the total number of accounts at the beginning of the year. The second measure captures the length of the existing banking relationships and is called “longevity”. Both measures described above are influenced by two factors other than mobility, the general growth rate of the retail banking market, and natural demographic changes in the population. These demographic changes include, for consumers, the ratio of younger people entering the market and the mortality among older people; and for SMEs, the rate of formation of new firms and the departure of established firms relative to the total stock of SMEs. Based on the results of the inquiry, the churn measure will be controlled for the industry growth rates in each country. However, some remaining differences in demography might still influence country comparison. In the case of longevity, such correction was not possible. 6.3.1 Customer churn Table 6 contains the country-level weighted average of churn per country. For the country averages, the banks’ number of current accounts at the beginning of the period has been used as weight.

Table 6: Customer mobility (Churn), Weighted average, 2002-2005, Consumers 2002 2003 2004 2005 Average Iceland 5.60% 7.10% 9.50% 13.50% 9.00% Norway 7.10% 8.00% 6.40% 7.60% 7.30% EU15 Average 9.04% 9.18% 8.85% 8.72% 8.91% EU25 Average 9.85% 9.94% 9.30% 9.11% 9.40%

Note: The EU15 and EU25 Average data has been obtained from Table 34 of the European Commission’s “Interim Report II: Current Accounts and Related Services”.

As these results are not corrected for the market growth, the growth rate was used to control for this effect. The growth rate is defined as the difference between the number of accounts at the end and the beginning of the year divided by the number of current accounts at the beginning of the period.

Page 28

Table 7: Customer growth rate, weighted average, 2002-2005, Consumer 2002 2003 2004 2005 Average

Iceland 1.50% 2.80% 5.10% 3.90% 3.40% Norway 2.90% 1.10% 2.20% 2.20% 2.00%

EU15 Average 2.58% 1.85% 1.41% 2.08% 1.94% EU25 Average 3.40% 2.48% 1.86% 2.42% 2.41%

Note: The EU15 and EU25 Average data have been obtained from Table 35 of the European Commission’s “Interim Report II: Current Accounts and Related Services”.

The values corrected for market growth for consumers and SME are summarized in Table 8.

Table 8: Churn, weighted average, Year 2005, Consumers and SME churn before control growth rate churn after control consumer SME consumer SME consumer SME

Iceland 13.50% 6.60% 3.90% 0.90% 11.55% 6.15% Norway 7.60% 15.10% 2.20% 3.80% 6.50% 13.20%

EU15 Average 8.72% 12.91% 2.08% 1.42% 7.55% 12.21%EU25 Average 9.11% 13.49% 2.42% 1.72% 7.78% 12.63%

Note: The EU15 and EU25 Average data has been obtained from Table 36 on page 102 of the European Commission’s “Interim Report II: Current Accounts and Related Services”.

Unlike in most of the EU Member States, correcting the churn for growth rates in Iceland and Norway had a somewhat more visible impact on the churn numbers. In Norway and Iceland, the mobility must be considered as moderate compared to the EU average, especially considering consumer customers in Norway and SME customers in Iceland. In Norway, as in most EU countries, SMEs have higher churn ratios than consumers. This may simply be due to shorter SME lifetimes. However, it may also suggest that SMEs devote greater resources than consumers to finding the right banking arrangements, and are hence more mobile customers for retail banking services. In Iceland, however, the consumers have a higher churn than SMEs. In addition, the churn measure for SMEs and consumers in Iceland and Norway does not seem to follow a similar pattern, unlike the EU. 6.3.2 Longevity of the banking relationship As a second measure, the average length of the existing relationships were measured. As a proxy, the Authority used each bank’s reported number of accounts that have been active for a given range of years (e.g. less than one year, between 1 and 5 years, etc.). The weight used to calculate the longevity is the median value of each range. Table 9 and figure 3 illustrate the differences of average customer mobility (longevity) between Iceland and Norway compared to the EU averages.

Page 29

Figure 3: Customer mobility (longevity), Weighted average. Year 2005

0.00

2.00

4.00

6.00

8.00

10.00

12.00

Iceland Norway Weighted Average EU15 Average EU25 Average

Country

Year

consumer

SME

Note: The EU15 and EU25 Average data has been obtained from Table 37 of the European Commission’s “Interim Report II: Current Accounts and Related Services”.

On average, Norwegian consumers maintain their current account with the same bank for around ten years. This mirrors the average the Commission found for the EU Member States, but is less than the other Nordic countries. In Iceland, the average longevity is even shorter. The longevity for SMEs in Iceland is among the shortest in EEA. As in the EU, the average age of current accounts for SMEs is lower than for consumers. On average, Norwegian SMEs maintain their current account with the same bank for around seven years. This is a bit shorter than the average the Commission found for the EU Member States, and significantly shorter than in the other Nordic countries. The longevity for SMEs in Iceland is among the shortest in EEA. Again, this pattern may reflect the shorter lifetimes of SMEs compared to consumers but may also indicate the greater potential for SMEs to overcome the costs of switching banks. Figure 4 below illustrates the distribution of active current accounts in age brackets for the length of the consumer’s relationship. In Iceland and Norway 40% of current account relationships are longer than 10 years old, about the same as in EU25.

Page 30

Figure 4: Age of current accounts, Year 2005, Consumers

0%

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Country

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s

less then 1 between 1 and 5 between 5 and 10 between 10 and 20 more then 20

6.3.3 The extent of cross-selling in retail banking This section analyses on a country-level the cross-selling ratios. Cross-selling is measured as the average number of products that customers purchasing a specific product (hook product) are purchasing from the same bank. This measure is calculated in reference to three hook products: current accounts, deposits and mortgages. Table 10 below shows the relative cross-selling ratios for each consumer banking product. The country-level averages are averages of all banks within a country using the number of hook products as weight.

Table 9: Cross-selling ratio, weighted average, Year 2005, Consumers

Hook product: Current

accounts

Hook product: Deposits accounts

Hook product:

MortgagesAll hook products

Iceland 2.65 1.97 4.04 2.29 Norway 2.15 2.22 3.46 2.33 Average 2.18 2.20 3.50 2.33 EU15 Average 2.24 1.86 3.07 2.07 EU25 Average 2.14 1.81 2.97 1.99

Note: The EU15 and EU25 Average data has been obtained from Table 40 on page 106 of the European Commission’s “Interim Report II: Current Accounts and Related Services”.

In Iceland and Norway, the cross-selling ratio is highest for mortgages, indicating that mainly customers who have a mortgage at a specific bank are willing or obligated to purchase other products from the same bank. This is consistent with the Commission’s findings, but this tendency is clearer in Iceland and Norway than in the EU. The Commission offers two possible explanations for this concentration of banking activities with a single supplier: firstly, mortgage customers are likely to be long-term customers and during this relationship they may purchase more services; and secondly, tying by banks (discussed below) may force the customers to purchase a product (e.g. a current

Page 31 account) which they would not otherwise have bought, and which may tie-in the customer further to their relationship with the bank. The evidence indicates that current accounts are by far the most common product consumed jointly with mortgages. Deposit and current accounts have the lowest cross-selling ratios, possibly because these products are not easily tied to other types of accounts, and banks compete more effectively on interest rates, targeting each other’s customers. Figure 5 shows the products that are most likely to be sold to a customer together with a mortgage in Norway and Iceland.

Figure 5: Mortgage cross-selling, Year 2005, Consumers

0.00

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Iceland Norway Weighted Average

Country

Cro

ss-s

old

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ucts

investment funds(outside groups)investment funds(within group)Non-life insurance(outside group)Non-life insurance(within group)Life Insurance(outside group)Life Insurance(within group)Consumer loans(non-mortgage)Credit cards

Deposit andsavings accountsCurrent accounts

Table 11 provides cross-selling ratios for the SME customers in 2005. In both Norway and Iceland, loans are an important product that SME clients purchase, while current accounts and credit lines are much less important as hook products in Norway than in the EU Member States. In Iceland, both current accounts, loans and credit lines have a higher cross-selling ratio than the average in EU25.

Table 10: Cross-selling ratio. Weighted average, Year 2005, SMEs

Hook product: Current

accounts

Hook product: Loans

Hook product: Credit lines

All hook products

Iceland 2.26 3.03 3.39 2.63 Norway 1.64 2.72 2.05 1.84 EU15 Average 2.15 2.88 3.12 2.42 EU25 Average 2.02 2.81 3.03 2.27

Note: The EU15 and EU25 Average data has been obtained from Table 42 on page 108 of the European Commission’s “Interim Report II: Current Accounts and Related Services”.

Page 32

6.4 Conclusions The inquiry has examined five factors that may reduce customer mobility in the retail banking market: administrative burden, information asymmetry and price transparency, cross-selling and bundling of banking products, customer preferences and choice, and closing charges. Some of these difficulties may be mitigated by initiatives such as the adaptation of switching codes and credit data portability. In the EFTA States, tying is widespread and thus likely to discourage customers from switching banks. On the other hand, there do not seem to be prohibitive costs involved with closing current accounts. Customer mobility in retail banking appears fairly low and banking relationships are long. Consumers hold their current accounts with the same bank for an average of 9.94 years in Norway and 7.94 years in Iceland. For SMEs the corresponding figures are compared to 7.94 years in Norway and 4.87 years in Iceland. In both Norway and Iceland, the cross-selling ratio is highest for mortgages, indicating that mainly customers who have a mortgage at a specific bank are willing or obligated to purchase other products from the same bank.

Page 33

Part II - Competition in the market for payment cards and payment systems

Page 34 7 Introduction 7.1 Cashless payment transactions in the EEA Having efficient systems for payments is of vital importance to all sectors of the economy. Cashless payment transactions in the EU have shown a clear tendency of growth and amounted to 65.3 billion transactions in 2004.47 Also in Iceland and Norway, the number of cashless payment transactions has shown a clear increase.48

A retail bank payment involves the payer, the payee and their respective banks handling the transactions, but must also include some form of payment arrangement between these two banks. Such payment arrangements can be based on bilateral agreements between banks, or on multilateral arrangements or inter-bank payment systems. Such inter-bank systems often take the form of an automated clearing house or a clearing association.49 At national level, the number of multilateral payment systems tends to be limited, which can at least partly be explained by the network effects found in payment systems. The organisation of such major national payment systems, including the rules concerning access to, and use of, the system, are therefore particularly important and have received increasing attention in recent years. In 2006, the Nordic competition authorities issued their report “Competition in Nordic Retail Banking”, which concluded that terms and access conditions to the Nordic payment system may include elements that could form a barrier to entry into the payment systems and banking markets.50 7.2 Organisation of POS card payment systems POS card payment systems enable consumers to use plastic cards for payment transactions at the point of sale (POS), which normally is a payment terminal in a merchant outlet. There can be said to be three main groups of players in POS card payment systems: (i) cardholders and merchants, (ii) scheme owner, (iii) issuers and acquirers. Cardholders and merchants engage in a payment transaction through the intermediary of banks and scheme owners. The cardholder receives payment services and credit services from the entity that issued the card (the issuer). The merchant receives payment services from the entity that deals with the merchant (the acquirer). Acquirers may also be issuers.51 It should be noted at the outset that card payment systems exhibit a varying degree of integration. An important distinction is to be made between so-called four-party card payment systems, where card issuing and acquiring are typically carried out by distinct entities, and three-party systems, such as American Express and Diners Club, where issuing and acquiring are carried out by the same entity. Payment card issuing consists of the distribution of payment cards to consumers while acquiring is the business of contracting merchants for payment card acceptance. Both 47 Commission’s report, p. 81. 48 Report on Nordic Banking structures, Annex table 6. 49 See further the Commission’s interim report pp. 121-122. 49 Report on Nordic Banking structures, Annex table 6. 49 See further the Commission’s interim report pp. 121-122 50 See the report at page 46. 51 Commission’s Report, p. 83.

Page 35 activities entail certain risks with respect to transaction settlement and are frequently restricted to credit institutions by the owners of the payment card scheme.52 However, it is normal that issuers and acquirers use subcontractors, e.g. data processors, for some functions of their activity. The scheme owner is responsible for: (i) granting licenses (and membership status) to independent financial institutions for the use of a card logo and for performing issuing and acquiring services within the network; it may also (ii) certify non-financial institutions for performing technical activities such as clearing and processing within the system; it usually (iii) sets the network rules and the technical (message) standards; and it (iv) implements these network rules and standards by executing audits at member banks and certificate holders and by organising arbitration in the case of settlement disputes.53

Graph 1

Issuer Acquirer

Card holder Merchant Sells goods at price p

Pay p + f, where f equals

cardholder fees

Pay p - m, where m

equals MSC

Pay p - a, where a equals interchange

fee

Scheme Owner

The above graph depicts the flow of fees relating to a POS transaction. When the cardholder uses the card to buy from the merchant, the merchant receives from the acquirer the retail price minus a merchant service charge (MSC). The issuer pays the acquirer the retail price minus or plus any interchange fee. The issuer also receives from the customer the payment, any annual fee, any interest payment on debt outstanding, and/or late payment fees.54 Consequently, the costs associated with services provided by a payment system may be borne by either of two customer groups, i.e. cardholders (via cardholder fees) or merchants (through merchant service charges). The stated object of the interchange fee is to balance revenue and cost on the “two sides” of the market (issuer-cardholder and acquirer-merchant), but has lately been criticised for being a way to extract extra revenue from the merchant. Specifically, it has been argued that as payment cards have become more and more widespread, a normal merchant does not really have a choice but to accept them. This makes it possible for the payment card network to subsidise cardholders using revenues earned on the acquiring side, thus making cardholders more inclined to use payment cards and merchants still more dependent on accepting them. It has been claimed that this dependence, and the alleged power of issuing banks to decide 52 See further Commission’s Report, p. 84. 53 Ibid., p. 84. 54 Ibid., p.85.

Page 36 interbank fees, has made issuing banks able to extract non-cost related, extra revenues from merchants through the interbank fee. In its interim report, the Commission has discussed the main elements of the economics of

.3 The inquiry’s data and methodology on payment cards

August 2005, the Authority sent out questionnaires to around 60 acquirers and issuers

The Authority also consulted various other available materials in order to obtain

he questionnaires were modelled on questionnaires sent out by the Commission. Hence,

the payment cards industry, to which a general reference is made.55 In its survey of the academic literature, the Commission has inter alia pointed to three conditions which have to be fulfilled if the choice of an interchange fee is to have no real economic effect (i.e. is to be neutral); 1) issuers and acquirers pass the corresponding charge (or benefits) on to the cardholder and the merchant; 2) the merchant can charge two different prices for goods or services depending on whether the consumer pays by cash or by card (no imposition of a no-surcharge-rule by the scheme owner); and 3) the merchant and the consumer incur no transaction cost associated with a system of double prices for each item. 56 7 Inin the three EFTA States. Additionally, questionnaires were sent out to domestic and international card payment systems operating in the three EFTA States.

background information concerning the payment card market in the EFTA States, including empirical evidence in the form of decision practice by national competition authorities.57 Also worth mentioning is a pan-Nordic study of competition in retail banking, including payment cards, which was published jointly by the competition authorities of the five Nordic countries in 2006.58 Finally, the Norwegian Financial Supervisory Authority released a report in 2004 concerning the competitive conditions in the Norwegian market for international payment cards.59

Tthe questions put to acquirers and issuers addressed only debit and credit cards (deferred debit cards were treated as credit cards).60 Moreover, they focused only on transactions made at physical points of sale (POS) and did not cover automated teller machine (ATM) transactions. In contrast, the questionnaire to payment card systems covered a wide range of rules and activities developed by these institutions, including ATM services and the relevant price and cost data. The market survey also gathered information on non-price variables affecting competition between payment card networks. The inquiry’s data and findings on non-price competition variables are not reported here but are presented in Chapter XIV of Interim Report I.

55 See Chapter II of the Commission’s Interim Report I. 56 See for example Rochet and Tirole, “Two-Sided Markets: An Overview”, IDEI Working Paper (2005). 57 Icelandic and Norwegian competition authorities have both dealt with payment cards and related services

in their decisional practice. Liechtenstein does not have a national competition authority, but the practice of the Swiss Competition Authority (Wettbewerbskommission, or WEKO) was also considered in light of the close ties between the Swiss and Liechtenstein payment card markets.

58 Competition in Nordic Retail Banking. Report from the Nordic competition authorities, 2006. The report is available at:

http://www.konkurransetilsynet.no/iKnowBase/Content/407037/06_RETAIL_BANKING.PDF59 “Regulation of the international card companies’ fees”. Report by the Norwegian Financial Supervisory

Authority, 2004. The report is available (in Norwegian) at: http://www.kredittilsynet.no/archive/f-avd_word/01/04/Regul011.doc

60 Store cards (cards issued by non-banking institutions for use for payment in specified stores) were explicitly excluded from the scope of the questionnaire.

Page 37 Information was mainly collected on a yearly basis over the period 2000-2004. Some data,

he dataset concerning issuers and acquirers was checked for completeness and assembled

s regards the selection of addressees, it was attempted to include all market players in the

n unavoidable consequence of surveying three relatively small national markets is the

further consequence of the aforementioned small number of addressees is that the

however, were collected on a quarterly basis. A significant amount of the requested information concerned financial aspects (e.g. prices and costs). In order to harmonise the financial data, respondents were asked to convert their data into euro currency. Some of the requested data required an allocation of revenues and costs based on accounting data. This allocation was made by the respondents themselves. Tinto a database. This task, as well as the econometric analysis of the data, was carried out by the Commission’s Joint Research Centre.61 This unit had also carried out corresponding tasks for the Commission’s inquiry. Athree EFTA States active on the acquiring side, as these were fairly limited in number. As regards issuers, the sample included all major market players accounting for the bulk of market share in each of the three countries. In addition, the sampling aimed at including a statistically representative sample of smaller issuers taking into account turnover and geographical location, thus achieving a fair representation of different-sized issuers. Afact that the overall pool of responses will be small. Consequently, the data set is liable to suffer from certain imbalances where some information is not available from all market players. The Liechtenstein market’s small size and close integration with the Swiss market also posed challenges in relation to data collection.62 Hence, the Authority’s data from three jurisdictions is possibly less precise than those of the Commission’s twenty-five jurisdictions with almost one hundred times as many inhabitants. AAuthority in some instances is not able to make public its findings in as much detail as the Commission. Where confidential information is involved, the Authority has thus chosen to only summarise its findings.

61 http://www.jrc.cec.eu.int/ 62 See further Interim Report I, pp. 9-10.

Page 38 8 Market concentration and integration Market structures in payment cards markets vary considerably across the EEA. In particular, card acquiring markets in the three EFTA States show evidence of high concentration. High market concentration may provide incumbents with the opportunity to erect barriers to entry in either issuing or acquiring, or to exercise market power in the setting of card fees. When assessing market concentration, guidance can be found in the Herfindahl-Hirschman Index (HHI), which sums up the squares of the individual market shares of all competitors. 8.1 Concentration in acquiring and issuing markets The analysis of concentration levels on the issuing side did not reveal any significant degree of concentration in the three EFTA States. The majority of all retail banks are active in issuing both VISA and MasterCard cards, and, in Norway, BankAxept cards. In Liechtenstein, local banks may act as intermediaries for foreign (principally Swiss) card issuers, rather than having their own licence to issue VISA/MasterCard cards. There were no instances of markets dominated by a single issuer. Hence, the remainder of this chapter will focus on concentration in the acquiring markets. 8.1.1 Acquiring in international payment card networks

8.1.1.1 Iceland In Iceland, three acquirers are active on the markets for acquiring international payment cards, both debit and credit. Furthermore, during the surveyed period, the two major market players each acquired only one of the major schemes (MasterCard and VISA). Consequently, if acquiring in either one of the major international payment card schemes is looked upon as a separate market, it can be assumed that the major incumbent acquirer has a market share of not less than 80%, which leads to an HHI index in excess of 6 400. In comparison, the average HHI level in the EU25 for one of the international credit cards networks in 2004 was around 5 800.63

8.1.1.2 Liechtenstein The Liechtenstein acquiring market is peculiar in the sense that there is no domestically established acquirer, but merchants in Liechtenstein are acquired by a number of foreign acquirers. The international payment card networks generally include Liechtenstein in their licence for acquiring in the territory of Switzerland and hence Swiss undertakings can acquire Liechtenstein merchants on the basis of their domestic acquiring licence, while acquirers elsewhere would do so by virtue of a cross-border acquiring licence. The Liechtenstein acquiring market hence has some inherent parallels with the Swiss one. The Swiss acquiring market is dominated by two domestic market players, and is highly concentrated. Judging from available data,64 HHI values for acquiring of VISA and MasterCard in 2003 were 4 200 and 8 150, respectively. The value for the overall market of acquiring stood at 5 400.

63 Commission’s report, p. 88. 64 The Swiss Competition Authority (WEKO), has estimated the market shares on the Swiss acquiring

market in its 2005 decision concerning interchange fees. See further p. 65 of the decision, available at: http://www.weko.admin.ch/news/00008/Verfuegung-KK-Anhaenge.pdf?lang=en&PHPSESSID=cfb8e524b8f06ab64da99b47d74c6d7b

Page 39 The two main Swiss acquirers also seem to be the most important market players in Liechtenstein, although there seems to be some market presence by acquirers based elsewhere. Due to lack of reliable data it is difficult to draw conclusions about the concentration ratio of the Liechtenstein acquiring market. However, given the above-mentioned close relationship of the Swiss and Liechtenstein markets, it seems likely that the high concentration of the Swiss market also applies to Liechtenstein. In any event, it is unlikely that cross-border entry into Liechtenstein is higher than for the much larger Swiss market. Consequently, the concentration ratio for Liechtenstein is presumably at least as high as for the Swiss acquiring market.

8.1.1.3 Norway Four undertakings offer acquiring services for the most important international payment cards schemes, i.e. VISA and MasterCard. In 2003, the HHI for the overall market for acquiring of international payment cards in Norway was 4 255,65 which is lower than the aforementioned EU25 average but still quite high.66 The HHI was 2 958 in 2001. The trend in the Norwegian acquiring market has been towards increased consolidation and hence it is likely that the HHI index has increased further since 2003. 8.1.2 Acquiring in the Bankaxept network In contrast, it is notable that the Norwegian domestic debit card scheme, BankAxept, appears to have a low degree of concentration, as acquiring is not centralised. Most of the scheme’s members, which include the majority of financial institutions in Norway, are active both as card issuers and acquirers in an individual capacity. Consequently, the BankAxept scheme differs from many domestic debit card schemes in the EU25, where acquiring is carried out by few, and sometimes even a single, entity.67

8.2 Integration of card payment systems 8.2.1 Different degrees of vertical integration of card payment systems in the EFTA

States In the EFTA States card payment systems differ with regards to vertical integration. According to the degree of vertical integration, various services may either be reserved for one or a few entities or be subject to competition among banks and non-bank institutions. At the outset, a distinction should be made between “open” or “four-party” card payment systems and “closed” or “three-party” card payment systems.68 The latter are sometimes referred to as “proprietary” or “T&E card” systems as these systems predominantly target cardholders who use cards in the travel and entertainment (T&E) industry. However, degrees of integration vary within these categories. It may thus be more appropriate for a competition analysis to categorise POS card payment systems by their 65 Source: Kredittilsynet (The Financial Supervisory Authority of Norway), see

http://www.kredittilsynet.no/archive/f-avd_excel/01/01/Kopia068.xls 66 It should be noted that HHI values for acquiring of one specific international scheme may be higher, as not

all acquirers are necessarily active in acquiring of that type of card on the Norwegian market. 67 Commission’s report, p. 90. 68 Cf. Chapter 1.2, above.

Page 40 varying degrees of vertical integration as opposed to adopting a rather rigid classification into “closed” and “open” systems. With the above in mind, the Commission proposed the following categorisation in its sector inquiry. Systems where the entity owning the card brand essentially does not engage in any activity other than setting the parameters for access to the network and the technical standards operate at level “1”. Here, scheme ownership is legally separated from network ownership and the financial business of issuing and acquiring. Where a scheme owner engages in further — technical or financial — parts of the cards business, further integration levels are reached as follows: + 1 level: scheme owner switches authorisation requests itself + 1 level: scheme owner authorises and processes transactions + 1 level: scheme owner clears and/or settles transactions + 1 level: scheme owner acquires merchants + 1 level: scheme owner sells and/or rents POS equipment Thus, the minimum integration level is “1” while the maximum is “6”.69 If the above-described categorisation is applied to the only domestic payment card system in the EFTA States, BankAxept in Norway, it should, strictly speaking, be rated at 1. BankAxept is owned jointly by the two service bureaus – Finansnæringens Servicekontor and Sparebankforeningens Servicekontor. These entities do not engage in any further operation of the scheme in their own capacity. BankAxept is operated by Bankenes Betalingssentral AS (BBS), through its division BBSPos, according to a framework agreement with Finansnæringens Servicekontor and Sparebankforeningens Servicekontor. On the other hand, it could be said that the above categorisation is only formal due to the fact that most of the banks that co-own the Bankaxept scheme also appear to co-own the network operator. If the activities of the scheme owner and network operator are viewed together, the result would be an integration level of 4.70

As regards the international card payment systems, the level of integration across the EEA varies from country to country. The four-party systems Visa and MasterCard generally have an integration degree of 3.71 Based on the Authority’s data, there are no instances of higher integration in these schemes in the three EFTA States. The scheme owners of the three-party systems (American Express and Diners Club) typically carry out issuing and acquiring themselves. Consequently, they should be classified at level 5. It should be noted, however, that these systems have mainly relied on licensing agreements with local undertakings rather than on establishing their own presence in the EFTA States.72 8.3 Joint ventures for acquiring services

69 Commission’s report, p. 91. 70 A similar situation exists as regards the Dutch and Danish domestic schemes, cf. the Commission’s

interim report p. 89. 71 Commission’s report, p. 92. 72 American Express has licensing agreements with local undertakings for issuing and/or acquiring for its cards in all three jurisdictions. Diners has a subsidiary in Switzerland which covers the Liechtenstein market and a subfranchisee in Norway. In Iceland, Diners has an agent but no card issuing activity.

Page 41 In the Commission’s report, it was noted that in many of the EU25 countries, acquiring of merchants is concentrated in the hands of a joint venture typically owned by the majority of the incumbent national banks. Hence, merchants may face one single offer, rather than several offers from competing banks. Furthermore, the existence of such joint ventures for acquiring may in various ways impede market access for foreign banks. 73

In Iceland, acquiring for each of VISA and MasterCard is predominantly carried out by two companies that have until recently been jointly owned by the major commercial and savings banks. This ownership structure changed somewhat in 2006, with one commercial bank acquiring control over one acquirer and selling its stake in the other.74

In Liechtenstein there is no single national acquirer, but there is market presence by the two main undertakings active for the acquiring of Visa and MasterCard in Switzerland. Both are ultimately owned by (different) consortia of Swiss banks. There is also some market presence by cross-border acquirers. In Norway, one major acquirer is run as a joint venture between commercial and savings banks. However, there are other acquirers in the market which are privately owned and compete in the acquiring business for the major international payment card brands. 8.4 Conclusions The markets for acquiring debit and credit cards in the international networks are highly concentrated in all three EFTA States. Acquiring is much more concentrated than issuing. This pattern is similar to what has been observed for the EU25.75 Acquiring activity in the Norwegian Bankaxept network is, on the other hand, much less concentrated with the majority of financial institutions acting both as issuers and acquirers. As in the Commission’s report, an assessment of the degree of vertical integration in the card schemes active in the EFTA States has been carried out using a scale from 1 to 6 with 1 being the lowest degree. This classification is only a starting point for a complex assessment, as the separation of scheme ownership from the technical/financial aspects of the business may not be sufficient by itself to realise the full potential of competition in a card payment system. For a competition analysis, however, it is important to note that vertical integration may also be the source of efficiencies. On a scale from 1 to 6 the only domestic payment card system in the EFTA States, BankAxept, has the lowest degree of 1. The levels of integration for the international payment card systems broadly mirrors what has been observed for the EU25. The acquiring market in all three EFTA States is characterised by a high degree of concentration and the presence of acquiring joint ventures between banks. Although there have been some changes to this landscape in recent years, it is possible that market entry is made more difficult due to this structure.

73 Commission’s report, p. 93. 74 See decision 32/2006 by the Icelandic Competition Authority. 75 Commission’s report, p. 96.

Page 42 9 Cardholder fees 9.1 Introduction Cardholders have a contractual relationship with the card issuer; the bank whose name is on the card. By charging cardholders for card services, issuing banks can recoup the costs of services provided (e.g. transaction processing and billing) and earn a profit margin. Issuers usually charge several fees to cardholders, such as annual fees and transaction fees. Furthermore, issuers may use payment cards as a way to attract costumers to purchase other products, such as current accounts or loans, which may imply that cardholder fees are not determined in a fully autonomous manner. All these factors imply that different issuing institutions may have different pricing policies and, consequently, a comparison of cardholder fees across countries needs to be undertaken carefully.76

In the present chapter, a range of fees paid by cardholders for credit and debit cards in the EFTA States will be examined. It will be assessed whether and to what extent fees differ across EFTA States and networks, and comparisons with EU25 averages will be made. All issuing banks have been asked to provide data on a list of fees paid by a typical cardholder using a “standard” or a “classic” payment card, i.e. a cardholder enjoying standard conditions and no special rules or rebates, and excluding special cards such as gold, platinum, or affinity cards. Apart from the abovementioned data, banks have been asked to provide the level of cardholder fees applied to corporate and consumer clients. All data has been requested for each year over the period 2000-2004 for all networks. 9.2 Fee per card The fee per card is the annual fee charged by banks to the cardholder. It is notable that more respondents provided data for the fee per card than for the issuance fee (see infra), which might indicate the latter fee is less widespread. As in the EU25, fees for debit cards tend to be lower than for credit cards. Within each EFTA State, debit card fees are invariably set at a considerably lower level than credit card fees. As regards credit cards, the fees recorded for American Express are considerably higher than for the other networks for which data is provided, which is in line with the Commission’s findings.77 Also, the fees for American Express are significantly above the EU25 average for this network. It is also notable that in two EFTA States, Visa charges a considerably higher fee than MasterCard. This is contrary to what was found to be the case in most of the EU25, where the pricing of these two major networks tended to stay at about the same level within the same country.78 In all three countries, credit card fees are higher than the EU25 average (€24). Fees for debit cards are also, in general, somewhat higher than the EU25 average although one EFTA State reported quite low fees per debit card. Debit card fees tend to be similar for both the major international brands. It is however notable that the national debit card

76 Commission´s report, p. 97. 77 The Commission found that fees for American Express and Diners Club were on average considerably

higher than for Visa and MasterCard, while the fees for the latter two tended to stay at the same level. See Commission’s report, p. 98.

78 Ibid.

Page 43 scheme in Norway, Bankaxept, charges on average over 50% lower fees than the average fee per card for the international schemes in that country, even though Bankaxept does not feature an interchange fee. As explained previously,79 the stated object of the interchange fee is to balance revenue and cost on the two sides of the market (between the merchant side and the cardholder side). The fact that the international schemes charge considerably higher fees per card than Bankaxept seems to indicate that the revenue from interchange fees is not passed on to cardholders in the form of lower cardholder fees. 9.3 Card issuance fee The card issuance fee is the fee charged only when the card is issued. The Authority´s inquiry found instances where such a fee was charged in all three EFTA States and in all credit and debit card schemes on which data is available. This finding is interesting in comparison with the Commission’s sector inquiry, which found that in most EU Member States, a card issuance fee was not charged to debit card holders. 80

The issuance fee data for American Express indicates considerably lower issuance fee levels than what is charged for Visa cards in the same market. This is in line with the trend in the EU25, where the issuance fees for American Express and Diners Club are lower than those for Visa and MasterCard. There are significant differences in the levels of issuance fees for credit cards in the three EFTA States but, in general, the fee levels are high compared to the EU25 averages. In one EFTA State the issuance fees for Visa appear to be the highest in the EEA, or over €60, whereas the highest fee recorded in the EU25 was around €30. Fees for debit cards likewise tend to be higher than the EU25 average.81 Issuance fees in one EFTA State are almost identical for both networks and for debit and credit cards. This is contrary to the prevailing practice across the EEA to charge lower fees for debit cards. 9.4 Account statement and billing information fee This fee is an annual fee paid by banks’ clients, and seems to be more widespread in the EFTA States than in the EU25, where it appears that this fee is not charged in the majority of EU Member States, neither for credit nor for debit cards.82 All responses that contained information on this point indicated that an account statement and billing information fee was charged for MasterCard and Visa credit cards. In two EFTA States, such fees are also charged to holders of debit cards. 9.5 Fee per transaction Finally, some systems charge their cardholders a per-transaction fee which is either expressed as a fixed amount or as a percentage of the transaction value. This fee is relatively uncommon within the EU25.83

Per-transaction fees have chiefly been reported for debit cards (both international and domestic schemes) in two EFTA States and are, in all cases, a fixed value. As regards

79 See chapter 6.2, above. 80 See Commission’s report p. 99. 81 The average credit card issuance fee charged to cardholders in the MasterCard and Visa networks in the EU25 was 14 euros. The average debit card issuance fee was 6 euros. See Commission’s

report p. 99. 82 Commission’s report, p. 99. 83 A fee per transaction was reported for credit cards in 6 EU Member States and for debit cards in 8.

Page 44 credit cards, the available data indicates that, in general, per-transaction fees are not applied to their use in the EFTA States. 9.6 Conclusions In general, it is noticeable that issuance fees and fees per card charged to cardholders in the three EFTA States tend to be higher than the EU25 average. Moreover, per-transaction fees and account statement fees are more widely seen than across the EU25. Fees per card and issuance fees in the EFTA States vary according to card type and network. Debit cards typically carry a lower fee than credit cards. The Norwegian Bankaxept system charges on average over 50% lower fees than the average fee per card for the international schemes in that country, even though Bankaxept does not feature an interchange fee.

Page 45 10 Merchant fees 10.1 Introduction A merchant service charge (MSC) is the price that is paid by a merchant per transaction to the acquirer, which processes the merchant’s transaction through the payment card network and obtains the funds from the cardholder’s bank (issuing bank). The transaction is considered to be executed when the transaction amount is debited from the consumer’s account and, after deduction of the MSC, is credited to the merchant’s account. A significant proportion of the level of the MSC derives from interchange fees, which are paid by the acquiring to the issuing bank. The MSC thus allows the acquiring bank to pass on the cost of the interchange fee to the merchant. Other elements of the MSC cover other acquiring costs as well as a profit margin.84 Some acquiring costs may or may not be included in the MSC. For example, some acquirers in the EFTA States may charge a separate charge for lease of a POS terminal, while others reported that this was included in the MSC. 10.2 Levels of merchant service charges The MSC fee levels in the EFTA States can broadly be said to follow the same pattern as in the EU25, i.e. the fee levels are higher for American Express and Diners Club than for the other schemes. Another common feature is that Visa fee levels have tended to be lower than those for MasterCard throughout the observed period.85 For most networks, changes in fee levels over time have tended to be limited. In Norway, the MSC fee levels for the national debit card scheme, Bankaxept, are significantly lower than the prevailing levels for other schemes.86 This tallies with the findings in the EU25 concerning national debit card schemes operating without an interchange fee. In the three such systems in the EU25, two charged an MSC, albeit at a much lower rate than the prevailing one for the international networks, while in one instance (Denmark), acquirers were prohibited by law from applying any ad valorem service fee.87

Furthermore, the Authority’s inquiry found that in most cases where data is available, there are substantial differences in fee levels between the top and bottom merchants, in some cases exceeding 300%. While absolute MSC levels are higher for the American Express and Diners Club networks than for Visa and MasterCard, the latter tend to have greater differences in fee levels. The results for the international card networks are consistent with the Commission’s findings for the EU25, which found considerable differences for weighted average MSC levels for larger and smaller merchants.88 As regards the national debit card scheme in Norway, BankAxept, a variety of responses were received, suggesting that not all acquirers employ the same pricing model. Many acquirers for this scheme seem to charge a combination of a per-transaction fee and a fixed monthly fee. Consequently, costs per transaction are substantively higher for 84 Commission’s Report, p. 102. 85 Commission’s interim report I, pp. 45-46. 86 Merchant Service Charges for this scheme were reported by banks both as a percentage and as a fixed fee

paid by merchants in Euros every month. For the purpose of the present comparison, the fixed fee was adjusted to a percentage.

87 Commission’s report, pp. 105-106. 88 Commission’s Report, p. 103.

Page 46 merchants with a low turnover, resulting in a considerable difference between the top and bottom merchants. 10.3 Blending The Commission’s findings revealed that the practice of ‘blending’ is quite widespread across the EU25. Blending refers to a practice whereby an acquirer charges identical MSC for acquiring payments from different networks, e.g. charges the same MSC for MasterCard and Visa payments. Effectively, this removes price competition between the different networks.89

For Liechtenstein it has not been possible to obtain data about this practice from the acquirers (mainly Swiss) that serve the Liechtenstein market. In Iceland, the issue of blending is largely irrelevant as the two major acquirers only acquired either Visa or MasterCard during the surveyed period. In Norway, some acquirers reported blending to 100% of their customer base while others provided no data on this issue. This indicates that blending is widespread in Norway. 10.4 Conclusions The Authority’s findings show considerable differences in MSC levels between smaller and larger merchants within the major payment card schemes. Smaller merchants typically pay higher rates than larger merchants. It is possible that the difference reflects the existence of market power. Levels of MSC in the EFTA States appear to follow similar patterns as have been observed for the EU25. The lowest MSC levels are observed for the Norwegian BankAxept scheme. This corresponds to the Commission’s findings that domestic debit card systems that operate without an interchange fee also have lower MSC levels. Blending of MSC has primarily been observed on the Norwegian market, however the extent of this practice is unclear.

89 See further Commission’s report, p. 106.

Page 47 11 Interchange fees As outlined in Chapter 6.2, a POS transaction may involve the payment of an interchange fee. An interchange fee is defined as the fee paid by the merchant's bank (the acquirer) to the cardholder's bank (the issuer) whenever the cardholder uses a card to make a purchase at a merchant. The interchange fee, in turn, is believed to be a large component in the merchant service charge (MSC) which is levied on the merchant by the acquirer. 11.1 Types of interchange fees applied in international networks As already noted in the Commission Decision on Visa cross-border interchange fees,90 the international systems distinguish between three types of interchange fees: national; intraregional; and inter-regional fees. National interchange fees apply to transactions in the same country in which the card is issued. Intra-regional interchange fees (hereafter referred to as cross-border interchange fees) apply to transactions made at a retailer outside the country but within the geographical region in which the card is issued. Inter-regional interchange fees apply to transactions between differenct geographical regions, e.g. Europe and Asia or the US. These fees are not discussed in this chapter. Interchange fees may also differ according to the method of processing (e.g. on-line, offline, card present/not present etc.) and the type of card used (e.g. consumer or corporate cards; and magnetic stripe card or chip card).91

11.2 Setting of interchange fees In the international card schemes, domestic interchange fees are typically set by national member banks or a local body comprised of them. As regards domestic systems in the EFTA States, the Norwegian BankAxept system does not charge an interchange fee for POS transactions, similar to some domestic schemes in the EU25.92 There are indications that the setting of interchange fees in the international systems may have the object and/or effect of creating market entry barriers to competition between local and foreign member banks. Both MasterCard and Visa allow the parallel existence of multilaterally set (´fallback´) and bilaterally set (´on us´) interchange fees. While multilateral fees apply to all national payments in a given country (irrespective of the bank’s identity), bilaterally agreed fees only apply between the parties to the bilateral agreement. Furthermore, the co-existence of bilaterally and multilaterally agreed interchange fees is relevant for competition within the MasterCard and Visa systems. In countries where an inter-bank association acquires transactions from an international card network, local banks that are co-shareholders of this inter-bank association may be able to offer lower fees to the association. Thus parties to these agreements can offer lower merchant fees and thereby prevent new competitors from entering a market.93

11.3 Level of interchange fees in the EFTA States This section describes the interchange fee levels of the two major international card brands Visa and MasterCard, on a nominal basis as well as their evolution over the time period surveyed. As outlined above, the interchange fees may differ according to the method of processing and the type of card used. For the domestic transactions it is also common to 90 Commission Decision of 27 July 2002, OJ L 318/17 of 22 November 2002, pt. 9. 91 Commission’s report, p. 109. 92 The schemes in question are Finland’s Pankkikortti, Luxembourg’s Bancomat, Denmark’s Dankort and

the Netherlands’ PIN. 93 Commission’s report, p. 116.

Page 48 have different rates according to the merchant segment. For cross-border fees, sufficient data were available for only two EFTA States. 11.3.1 Credit cards Domestic fees: Domestic interchange fees applied for credit cards are generally higher than those for debit cards. The fee levels vary considerably between the EFTA States. In two cases they are higher than the EU25 average, but in one instance they are relatively low in a European context. Having regard to the Commission’s findings on this subject, it seems that there is a wide dispersion in fee levels between countries across the EEA. The Authority’s inquiry also found considerable differences in fee rates between different merchant sectors. In two EFTA States, there is a convergence trend in the level of fees between Visa and MasterCard, with the two brands’ fees being at a similar level in 2004. In one EFTA State, however, there was a noticeable difference between fee levels of the two networks. This difference remained the same throughout the surveyed period. In its interim report, the Commission identified a gradual fall in the weighted average interchange fees for Visa credit cards across the EU.94 This trend is less pronounced in the EFTA States, where only slight reductions in fee levels are observed, and fee levels have tended to remain rather static as a whole. Cross-border fees: In one EFTA State, cross-border fee levels for MasterCard increased significantly over time while Visa fee levels declined. The latter phenomenon has similarities with observations for cross-border fees in the EU25 and can perhaps be attributed to the Commission’s 2002 Visa decision, which imposed certain constraints on Visa fee levels.95 Just as with domestic fees, cross-border fees for credit cards are higher than those for debit cards.

11.3.2 Debit cards The debit card markets in each of the three EFTA States differ considerably. In Norway, the most widespread means of domestic payments is by far the national debit card scheme BankAxept (which does not feature an interchange fee). In Liechtenstein, Swisspost’s Postcard is present in the market alongside MasterCard’s Maestro. In Iceland, on the other hand, the international card brands Visa Electron and Maestro are the prevailing means for domestic debit transactions due to the absence of a national debit card network. The importance of the surveyed card schemes Visa Electron and Maestro is thus greater in Iceland than in Liechtenstein and especially Norway. Domestic fees: The reported interchange fee levels for Electron/Maestro debit cards in the EFTA States are, in general, comparable to or lower than the EU25 weighted average. The fee levels for most debit card schemes in the three countries have remained stable throughout the period observed. This contrasts with the weighted average fees in the EU25, which exhibited a drop during the same period, especially for Visa.96 On the other hand, interchange fees in the EFTA States appear to have been considerably lower than the EU25 average at the start of the surveyed period. 94 Commission’s interim report, p. 24 95 Commission’s report, p. 111. 96 Commission’s report, p. 114.

Page 49 Cross-border fees: In both surveyed countries the interchange fees of the credit card systems are higher than the ones for debit card systems. 11.4 Conclusions The effect of interchange fees is a transfer of revenue from the acquiring to the issuing side.97 In its past decision practice, the Commission has considered multilateral interchange fees to be restrictive of competition,98 as have some national competition authorities within the EEA. In Norway, the dominant payment card, BankAxept, operates without an interchange fee, as do certain national payment card schemes in the EU25. This fact suggests that interchange fees are not intrinsic to the operation of card payment systems. As regards cross-border interchange fees, the limited data shows similar trends and levels as have been observed in the EU25, both for debit and credit cards. The levels of average domestic interchange fees for the major international networks vary considerably among the three EFTA States, particularly for credit cards. Taken together with the Commission’s findings, it appears that there is wide dispersion in fee levels across the EEA. The available data generally shows less pronounced downward trends for fee levels in the EFTA States compared to the EU25. In general, interchange fee levels have been stable in the observed time period. In most cases, there is a tendency towards similarity in fee levels between the major credit card schemes within a given country. This applies both to cross-border and domestic interchange fees for credit cards.

97 Cf. Chapter 1.2, supra. 98

Page 50 12 Profitability The Commission’s sector inquiry revealed several important findings concerning profitability in the issuing and acquiring sectors. It found, inter alia, that issuing of payment cards was highly profitable across the EU25 and that these profits were bolstered by interchange fees. Acquiring, however, was found to be considerably less profitable, both for debit and credit cards. In a majority of EU Member States, the level of profit ratios remained fairly stable throughout the period surveyed.99

Sustained high profit ratios, especially in mature markets, may indicate the existence of market power and are thus of interest for a competition analysis.100 Therefore, in order to obtain a comparable picture of the situation in the EFTA States, a profitability analysis was carried out from available data on issuing and acquiring services in these markets. Acquiring and issuing banks were asked to report their income and costs for their credit and debit cards for the years 2000 to 2004. It should be noted at the outset that the calculation of profitability for payment card issuing and acquiring is fraught with some difficulty, as the undertakings active in this field tend to be multi-product firms (for example, a typical card issuer is a retail bank that has a range of other activities). Thus, allocation of common and/or shared costs can become an issue. The data used in the Authority’s analysis were based on the respondents’ own allocation of costs, thus relying on the criteria of those who have first-hand knowledge of the business.101

12.1 Issuing In order to study the magnitude of profitability of card issuing in the EFTA States, a simple profit-to-cost ratio is used. This is given by

100,

,, ×−

AtB

AtB

AtB

CostCostIncome

,

where B stands for the issuer; A for the country at time t. This measure of profitability is used throughout this chapter. In order to calculate the overall country profit-to-cost ratio for credit and debit card issuance, a weighted average (using the total income of the issuer as weight) of all the issuers in the country in question was used. In two EFTA States, debit card issuance appears to be equally profitable as, or more profitable than, issuance of credit cards. In one instance the profits significantly exceed the EU25 average, with weighted average profitability sustained at about 100% throughout the period observed. This contrasts with the findings in the EU25, where the weighted average profitability of credit card issuance was significantly higher than for debit card issuance (65% versus 47%). On the other hand, profitability for credit card issuance is in all cases lower than the EU25 average.

99 Commission’s report, pp. 120-121. 100 Ibid., p. 118. 101 This approach mirrors that used by the Commission, see Commission’s report, p. 118.

Page 51 12.2 Profitability vs. interchange fee Numerous arguments have been put forward claiming that interchange fees are necessary to redress imbalances in a two-sided market such as that for payment cards. In essence, such arguments claim that it is necessary for the acquiring side to subsidise card issuing in order to build up a critical mass of cardholders. Most of the respondents also reported data in the income obtained through interchange fees. In order to quantify the importance of the interchange fee on the profitability, the profit ratio was recalculated excluding the income due to interchange fees. If income from interchange fees is removed, it appears that a majority of surveyed institutions would still retain a profit ratio above zero and that the country average profit ratio for two out of three EFTA States would remain positive. These results point in the same direction as the Commission’s findings for the credit card issuing business, which indicated that in the absence of an interchange fee, credit card issuing would remain profitable for the majority of the surveyed institutions in the EU25.102 As previously mentioned, it has to be borne in mind that the number of surveyed institutions in the Authority’s inquiry was far lower than in the Commission’s exercise and the results consequently less statistically robust. 12.3 Acquiring For the acquiring activity in the three EFTA States, the amount of data available is scarce. Hence it is difficult to draw conclusions about the profitability of acquiring with any certainty. The main reason for this is the very limited number of undertakings active in acquiring in the three countries,103 which makes it difficult to identify any general trends apart from the circumstances of individual undertakings. The available data indicates that most of the surveyed acquiring businesses operate with a profitability ratio that is modest compared to the figures observed for the issuing side. 12.4 Conclusions On a country-level basis, card issuing appears to be profitable in the EFTA States, especially for debit cards. In two out of three countries, card issuing would probably remain profitable even in the absence of interchange fees. Due to the limited data available, it is difficult to draw any firm conclusions concerning the profitability of acquiring activity in the EFTA States. The available data does indicate that profitability here is lower than for issuing and in some cases profit ratios appear negative. This tallies with the Commission’s findings that there are significant differences in profitability between the issuing and acquiring activities, in favour of the former.104

102 Commission’s report, pp. 121-122. 103 Apart from the Norwegian Bankaxept scheme, where participants are typically both active as issuers and

acquirers. 104 Commission’s report, p. 127.

Page 52 13 Interest-free periods and float in POS card transactions 13.1 Introduction Banks may delay the settlement of a card transaction on the current bank account of a customer by days or even weeks. This results in a cost for the issuing bank, if the cardholder is not charged interest for this time period (“free funding period”). It has been argued that such a free funding period stimulates card use in the merchants’ shops and consequently the latter should bear a part of the resulting costs via an interchange fee.105 This chapter will examine the following:

• the number of days that lapse on average between the moment a POS card transaction is authorised at a terminal and the moment the money is finally deducted from a cardholder’s bank account;

• the extent to which card issuing banks delay the transfer of funds to the merchant’s bank in order to earn a return on the transfer amount and to recoup part of their costs for funding delayed payment by cardholders.

For the purpose of this chapter, the following definitions will be employed: Free funding period: The time delay (measured in days) between the time a POS

transaction is authorised and the time the issuing bank debits the cardholder’s bank account.

Transfer period: The time delay (measured in days) between the time a POS

transaction is authorised and the time the issuing bank transfers the corresponding funds to the acquiring bank.

Net float: The sum of the ‘transfer period’ minus the ‘free funding period’

(measured in days). From the perspective of the issuing bank, net float occurs if there is a divergence between the time it debits the cardholder and the time it transfers money to the acquirer. Net float may be positive, zero or negative. It is:

1. negative if the bank debits the cardholder after the transfer 2. positive if the bank debits the cardholder before the transfer 3. zero if the bank debits the cardholder the same day the transfer occurs.

Where the net float duration is positive, the issuing bank has the opportunity to earn a return on the transfer amount. Where the net float duration is negative, the issuing bank is required to advance the transfer amount, which will create a cost for the issuing bank. In the next section, we will analyse the results of data from 82 banks across the EFTA countries. The averages given are simple arithmetical averages.106

13.2 Analysis of free funding period and net float per card brand The graph below sets out the average free funding periods (also referred to as “grace periods”) for payment card transactions with the main card brands in the EEA: VISA, 105 Commission’s report, p. 129. 106 The above-described approach and definitions mirror those employed by the Commission’s enquiry, cf.

Commission’s report, p. 129.

Page 53 MasterCard, VISA Electron, Maestro, as well as the domestic debit card system in Norway, BankAxept.

Graph 2

Free funding period and net float

-10.00

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

30.00

MasterCard Visa Visa Electron Maestro BankAxept

Average free funding period Average net float

The following remarks may be made from the above data:

1. Across Norway, Iceland and Liechtenstein, MasterCard has an average free funding period of 25.50 days and the net float, financed by issuing banks, is -4.09 days on average.

2. Visa has an average free funding period of 19.37 days for Visa branded cards, where the net float is -1.84 days.

3. Visa Electron, Maestro and BankAxept have net floats close to zero. This differs from the Commission’s findings, where Visa cards have the highest average free funding period, of 14.87 days, with an average net float of -13.62 days. The average free funding period of MasterCard was found to be 8.74 days, with a net float of -6.68 days.107 Visa and MasterCard in the EFTA States thus feature longer grace periods and less negative float compared to the EU25. As regards debit cards, the grace period is shorter in the EFTA States than in the EU25, where the average free funding period of Visa Electron was found to be 3.58 days, with a net float of -2.03 days, and the average free funding period of Maestro was found to be 2.03 days, with a net float of -0.53 days. In the EFTA States, the float observed for these brands is at zero or very slightly above. 13.3 Analysis of free funding period and net float per EFTA State In the following, a country-by-country comparison will be made of average free funding periods, transfer periods and net floats and the results will be compared to EU25 averages. For this analysis, data from VISA, VISA Electron, MasterCard and Maestro have been averaged together. It was not possible to calculate averages for Liechtenstein due to insufficient data. In Norway, the average transfer period connected to international cards was 2.77 days, the average free funding period was 5.91 days, and the average net float -3.14 days. For the 107 Commission’s report, p. 130.

Page 54 national payment card system, BankAxept, the average transfer period was 0.56 days, the average free funding period was 0.5 days, and the average net float 0.06 days. The average transfer period for international cards is quite long in Norway compared to the EU 25 average (which is approximately 1.8 days), while the average transfer period for BankAxept is less than the EU 25 average for domestic payment cards (also about 1.8 days). The average free funding period in Norway is shorter than the Commission found in the EU 25 (average of 7.39 days). Net float is also less negative than the EU25 average of -5.57 days for international systems and -1.99 for domestic systems. In Iceland, the average transfer period was 14.65 days, the average free funding period 15.82 days, and the average net float -1.18 days in the international card systems. The average transfer period in Iceland is substantially longer than the EU25 average, as is the average free funding period. 13.4 Conclusions As in the EU25, one observes a considerable variation in the free funding period for international cards in the EFTA States, depending on the card brand. MasterCard branded (credit and charge) cards carry, surprisingly, a longer free funding period than Visa (credit and charge) cards, contrary to what the situation is in the EU25. Visa and MasterCard cards, in turn, both typically carry longer free funding periods than Visa Electron and Maestro branded cards. The average transfer and free funding period for the Norwegian national payment card, BankAxept, is shorter than for most national payment card systems in the EU25. A reason for this may be that float revenues connected to payment transfers are prohibited by law in Norway.108 In general, there were no observations of substantial positive float. The EFTA States’ banks thus do not use delayed transfer of funds to finance all of the costs associated with the provision of a free funding period. This is similar to the findings for the EU25.109

108 See Lov om finansavtaler og finansoppdrag (finansavtaleloven) no. 1999-06-25, § 27. 109 Commission’s report, p. 134.

Page 55

14 Membership and governance rules Membership conditions and joining fees in payment card networks may, under certain circumstances, impede new entrants from joining the network and thus constitute a barrier to entry. By dissuading potential entrants or raising their costs significantly, such conditions may hamper or even hinder effective intra-system competition by dissuading entrants or raising their costs significantly.110 In this section, some issues relating to membership will be examined. 14.1 Selected membership conditions 14.1.1 Financial institution requirement Both international and domestic card payment systems in the EEA reserve the financial aspects of the payment cards business, i.e. the issuing of cards and acquiring of merchants, to credit institutions. One of the international systems restricts membership to financial institutions that are organised under the commercial banking laws of its own country and licensed to accept demand deposits or deposits which are controlled by another such organisation. The other system likewise reserves membership to financial institutions, which are defined as entities authorised to engage in financial transactions under the laws of the country where they principally engage in business. The concept of “financial institution” in the latter case is somewhat wider than that of “credit institution” within the meaning of Article 1 of Directive 2000/12.111 It also includes entities that do not take deposits, but which substantially conduct all of their business by executing “financial transactions”. It likewise allows non-credit institutions to apply for membership if banks are “directly or indirectly” controlling such entities.112

In the Norwegian domestic payment card system, BankAxept, membership (issuing and acquiring) is reserved for entities holding a banking licence113 that are members of either the Financial Services Association or the Norwegian Savings Banks Association. Either association may furthermore grant non-member banks access to the scheme. 14.1.2 Local establishment requirement In general, the international card schemes allow their members to operate cross-border without establishing a physical presence in the country where they issue cards and/or acquire merchants.114 The wording of the rules governing the Norwegian domestic payment card system, BankAxept, indicate that scheme membership is available to ‘Norwegian subsidiaries of foreign banks and credit institutions.’115 The scheme´s owners

110 Commission’s report, p. 135. 111 Directive 2000/12/EC of the European Parliament and of the Council of 20 March 2000 relating to the

taking up and pursuit of the business of credit institutions, cf. EEA Joint Committee Decision 15/2001, OJ 2001 L 117 26.4.2001, p. 13 and EEA Supplement to the OJ No 22 26.4.2001, p. 8

112 Commission’s report, p. 135. 113 According to Art 3 of the 2004 BankAxept rules, the rules apply to ‘banks’, including Norwegian

subsidiaries of foreign banks and credit institutions. Card issuance is limited to banks covered by the rules, cf. Art. 4.1. As for acquiring, the rules use the term ‘transaksjonsbank’. It hence appears as if membership is limited to credit institutions, i.e. entities accepting deposits from the public.

114 See further Commission’s report, p. 136. 115 Article 3 i.f. of the 2004 BankAxept rules.

Page 56 have however stated that there is no de facto local establishment requirement and that the wording of the rules will be amended to reflect this. 14.2 Joining fees In “open” card payment schemes (i.e. those that are open for membership to independent financial institutions) there is generally a requirement to pay a fee for joining the system, either as an initial payment or a recurrent one. Throughout the EEA, joining fees are determined on a variety of factors, such as type of membership, activities of the member, assets of the member or the volume of his activities.116

In the open international payment systems the joining fee for two of the international payment systems increases with the assets of the member. For instance, one of the international payment systems charges their Principal Members 7 EUR for every million euros of assets, with a minimum fee of 108,500 EUR and a maximum of 542,300 EUR. Participant Members pay a flat rate fee of 10,850 EUR. The joining fee for the other international payment system increases in three steps for both Principal Members (PM) and Affiliate Members (AM) depending on whether their total assets amount to less than 50 billion EUR, between 50 billion and 100 billion, or more than 100 billion. This results in a joining fee for PMs of 30,000, 90,000 and 150,000 EUR, respectively, i.e. between 0.60 and 1.50 EUR per million euros of assets. Similarly, the joining fee for AMs amounts to 15,000, 45,000 and 75,000 EUR, respectively, i.e. between 0.3 and 0.75 EUR per million euros of assets. In addition, both PMs and AMs pay a one-time application fee of 10,000 and 20,000 EUR, respectively.117

In the Norwegian domestic payment card system, BankAxept, the joining fee/licence fee for Norwegian banks is 550,000 NOK (68,337 EUR pr. Q2 2005) pr. million EUR capital base at time of access, with a ceiling of 5.5 million NOK. Banks with a capital base of less than EUR 10 million at the time of joining shall pay 550,000 NOK (68,337 EUR) until the total amount reaches 5.5 million NOK or for a maximum 5 years after joining the scheme. The fee will amount to a sum up to 683,370 EUR. The joining fee for foreign banks with branch(es) in Norway and foreign banks having cross-border activities in Norway is 5.5 million NOK or 683,370 EUR. In addition, all banks with more than 17,500 issued cards, two years after joining the scheme, shall pay a one time fee of 250 NOK (31 EUR) pr card exceeding 17,500 cards. 118 It is interesting to compare BankAxept’s joining fee levels to those of other domestic payment card systems in the EEA. The European Commission’s study found that joining fee levels broadly fell into a few clusters. Consequently the open domestic systems could, in principle, be divided into four categories depending on the level of the joining fee.119 The first category has no or very low joining fees (less than 15,000 EUR). BankAxept falls between the second (30,000 to 150,000 EUR) and third category (1.1 million and 1.9 million EUR) in the Commission’s report. The international schemes are either within the second category or between the second and third.

116 Commission’s report, p. 137. 117 Commission’s report, p. 137-8. The same fees are applicable throughout the EEA. 118 The fee scales are publicly available. See Publication no. 6: Collection of contracts and rules for domestic

payment transfers, Finansnæringens Servicekontor og Sparebankforeningens Servicekontor, September 2003.

119 Commission’s report, p. 138.

Page 57 14.3 Governance in card payment systems The large international card networks active in the EFTA States, VISA and MasterCard, feature different categories of members, most importantly principal and affiliate/associate members. Principal members participate in the decision-making process of the network in question, while affiliate or associate members depend on a principal member to ‘sponsor’ their membership.120 Such distinctions between categories of members may cause competition problems, for instance where decision-making within a card scheme is reserved to a (small) group of incumbent banks. Information exchanges via principal members of a card scheme may also be problematic from a competition viewpoint, since associate members are forced to communicate sensitive business information via entities that are also their competitors.121

As regards domestic payment systems, the above-mentioned considerations do not appear to be an issue in the EFTA States. The only national payment scheme, the Norwegian BankAxept, does not operate with different classes of membership in the manner described above. 14.4 Conclusions Membership conditions The payment card schemes active in the EFTA States reserve card issuing and merchant acquiring for credit institutions or entities controlled by credit institutions. This financial institution requirement may inhibit processors from entering the acquiring business and from competing with banks. Joining fees There are considerable differences in the joining fees between the two international schemes. The joining fee for the Principal Members of one international payment system is approximately three times higher than that of the other international payment systems, whereas Affiliate Members of the latter pay almost seven times as much, relatively, compared with the Participant Members of the former.122

The joining fee for BankAxept is medium to high in a European context. The fee is structured, to a certain extent, so as to rise with increased volumes in terms of cards issued. It is also noteworthy that foreign market entrants wishing to join the system are automatically charged the maximum joining fee. All of these elements may possibly act as a barrier to cross-border entry, especially given the relatively small size of the Norwegian market.

120 See further Commission’s report, pp. 138 et. seq. 121 Ibid., p. 139. 122 Ibid., p. 138.

Page 58 15 Cross-Border competition in acquiring Cross-border acquiring refers to the acquiring of transactions from merchants located in a country other than the country in which the acquiring bank is physically established. It also includes “central acquiring” (MasterCard terminology). At present, cross-border acquiring activity in the EEA is almost exclusively confined to the international payment networks, Visa and MasterCard, while cross-border acquiring is virtually nonexistent in domestic card acquiring markets.123

In its questionnaire to market actors, the Authority inter alia inquired about attempted and successful cross-border activity, corresponding to the Commission’s questionnaire. It should be noted at the outset, however, that as the respondents in the Commission’s questionnaire were not asked about their experiences with market entry into the EFTA States, the responses of market actors in the latter can only give an incomplete picture. Moreover, the overall number of acquirers active in the three EFTA States is quite small. Notwithstanding this limited information, some remarks can be made concerning the extent of cross-border activity of undertakings in the EFTA States. 15.1 Cross-border entry into the EFTA States’ markets As previously remarked, acquiring markets in all three EFTA States are highly concentrated. The presence of cross-border acquirers may thus benefit merchants by creating an alternative to the incumbent acquirer(s). Cross-border acquirers have, in recent years, to some degree established a market presence on all three markets. It remains to be seen, however, which effect this will have on competition in those markets. 15.2 Entry into foreign acquiring markets All EFTA acquirers that operate cross-border do so under cross-border programmes (i.e. by virtue of a licence which allows the licensee to acquire transactions from abroad without establishing physical presence there). This corresponds to the Commission’s finding that becoming member of a cross-border acquiring programme is the preferred method for entering foreign markets, rather than e.g. establishing a subsidiary or forming a joint venture with a bank in the target country.124 The percentage of EFTA State acquirers having attempted cross-border market entry is higher than in the EU25, 60% as opposed to 9%. Although the numbers are too small to be representative, the figures could perhaps be read as an indication that acquirers in the EFTA States have a greater incentive to seek business abroad from their relatively small, mature home markets than many acquirers in the EU25. In all cases, the cross-border acquiring activity appears to have commenced relatively recently. There can be no doubt that this is influenced by recent relaxation of conditions for cross-border licences by the international card networks125 as well as other developments, e.g. the growth of e-commerce. It furthermore appears that in most or all cases the acquired merchants are multinationals, which corresponds to findings in the EU25.126 123 For an analysis of possible reasons for the lack of cross-border acquiring in domestic systems, see

Commission’s report, pp. 142-144. 124 Of the respondents in the EU25 who had made a successful cross-border market entry, 86% had done so

by means of a cross-border licence. 125 Both Visa and MasterCard have since 2001 lifted previous restrictions on the categories of merchants for

which cross-border acquiring was available. 126 In 2004, almost 90% of turnover generated by cross-border acquiring in the EU25 stemmed from large

multinational companies, cf. Commission’s report, p. 142.

Page 59 15.3 Conclusions Cross-border activity plays a role on the acquiring markets in all three EFTA States, both in terms of market entry by undertakings from the EU25 and in cross-border activity by undertakings based in the EFTA States. However, as there is no available data concerning the experiences of undertakings from the EU25 in entering the EFTA States’ markets. It is therefore not possible to draw any conclusions about the presence or absence of barriers to entry in the three EFTA States. Cross-border activity by EFTA-based acquirers conforms to the patterns that have been observed in the EU25, i.e. chiefly offering acquiring services to multinational merchants on the basis of a cross-border acquiring programme.

Page 60 16 Payment infrastructures Access to payment systems is necessary for any bank considering entering a retail banking market and intending to offer customers core banking services, such as current accounts or payment cards.127 The analysis in this chapter is therefore relevant not only to the payment service markets themselves, but also to wider issues of competition between banks. 16.1 The typical operation of payment infrastructures In principle, each cashless form of payment involves five different parties: the payer; the payee; two intermediaries (banks or other payment service providers) offering customers transaction facilities; and an inter-bank payment arrangement for executing funds transfers between the two intermediaries. Figure 6 illustrates this structure.

Figure 6: Typical organisation of a payment infrastructure

Source: Commission’s report, p. 145. To make payment services available to consumers, banks and other payment service providers need access to facilities to conclude the payment transaction. The way a payment is executed between two banks requires a number of supporting activities. Two activities are particularly important: • payment transmission, clearing and settlement of payments (normally referred to as the ’payment infrastructure’); and • agreements to fix standards covering technical, operational and sometimes commercial aspects as well as financial aspects of the inter-bank relations (normally referred to as the ’payment scheme’). When the payer and the payee have an account at the same bank (or the same group) the exchange of information and balance calculation occur normally within the institution. These transactions are referred to in this report as “on us” payments. When the payer and payee are customers of a different bank, some kind of inter-bank arrangement is required. Such arrangements may be bilateral or multilateral. In the case of multilateral arrangements, financial institutions present and exchange data and/or documents relating

127 Commission´s report, p. 145.

Page 61 to funds transfer to other financial institutions under a common set of rules and procedures established at central level and compelling for all participants to the arrangement. These payment arrangements can have targeted membership, i.e. they may be open only to institutions belonging to special categories, or they can be open systems. In this category of payment arrangements, two main models have developed in the EEA: either a centralized payment system, generally organised in an ACH (Automated Clearing House) or a decentralised payment system, where the clearing system is not based on a centralised infrastructure in common ownership but rather is based on bilateral infrastructures provided by each member. The company managing the network is a coordinating body for collective governance purpose only.128

16.2 Methodology and scope of the inquiry into payment infrastructures The scope of the analysis is limited to multilateral clearing arrangements with open membership. Infrastructures that clear only payment card transactions are also excluded. Therefore the inquiry does not consider all types of payment infrastructures. A questionnaire, similar in scope to that used by the European Commission, was sent to the operators of clearing infrastructures in the EFTA States where applicable, i.e. Iceland´s Fjölgreiðslumiðlun (FGM) and the Norwegian Interbank Clearing System (NICS). Liechtenstein does not have an own system for payment clearing, but Liechtenstein banks use a number of foreign systems for clearing transactions. The majority of transactions are cleared through Swiss payment systems. 16.3 Main features of the surveyed payment systems In most EEA countries there is only one open clearing infrastructure for domestic retail payments. Where there is more than one, they are usually not in direct competition but are rather complementary.129 In Norway, NICS is the main clearing infrastructure. In addition, DnB NOR AS acts as the private settlement bank for many smaller banks, taking over the participating bank’s positions in the clearing of retail transactions in NICS.130 Both NICS and DnB NOR AS have a licence from the Norwegian Central Bank. In both systems, the majority (over 50%) of cleared transactions are payment card transactions, and these together with credit transfers account for the bulk of transaction volume. Transactions based on cheques and similar paper-based instruments are negligible in volume. As in most EEA countries, the clearing systems in both Iceland and Norway handle the majority of their country’s domestic credit transfers and direct debits.131

Total operational costs of payment systems are normally related to both the number and type of transactions handled. Paper-based transactions, such as cheques, are more expensive than electronic ones. In both Iceland and Norway, there has been a rapid decrease in the use of paper-based transaction instruments in recent years, and as a result

128 Commission’s report, pp. 145-146. 129 Commission’s report, p. 147. 130 For a further description, see “Annual report on Payment systems 2006” from the Norwegian Central

Bank. 131 In this context, credit transfer means a payment order (or sometimes a sequence of payment orders, which

is referred to as standing orders) made for the purpose of placing funds at the disposal of the beneficiary. Direct debit means a pre-authorised debit from the payer’s bank account initiated by the payee.

Page 62 the overwhelming majority of transactions are today paperless. In light of this fact, the clearing infrastructures in these countries enjoy a rather favourable operating costs ratio in an EEA context. 16.4 Ownership and management of payment infrastructures In many EEA countries, clearing infrastructures were traditionally created on a non-profit basis, often with the involvement of National Central Banks. Ownership of the system by central banks had the explicit objective of fostering financial stability and promoting the soundness of payment and settlement systems. This ownership arrangement has evolved over time and, currently, some systems are moving towards a profit-oriented organisational structure.132

An example of the latter is Iceland’s FGM, which was organised as a for-profit limited liability company upon establishment in 2000. Its shareholders are the three main retail banks, the association of savings banks and the two major payment card acquiring firms, as well as the Central Bank of Iceland. On the other hand, Norway’s NICS is a non-profit association jointly controlled by two associations of financial institutions, Finansnæringens Servicekontor and Sparebankforeningens Servicekontor. Both systems, however, can be said to follow the so-called ‘mutual governance’ model, where the clearing infrastructure is jointly controlled by the major users of the system. Both in Iceland and Norway, the day-to-day operation of the clearing system is entrusted to a third party.133 16.5 Access issues Banks wishing to make use of a clearing infrastructure have to obtain membership of the organisation that provides the clearing services. Several clearing systems within the EEA choose to distinguish members according to classes of membership. The most common distinction is between direct and indirect participants. Direct members have the exclusive benefit of direct contact with the clearing operator. Indirect members, on the other hand, access the clearing system indirectly, often through a bilateral agency agreement with a direct participant and settle their positions in a Real Time Gross Settlement system134 (RTGS) account (typically) held at the National Central Bank by the latter. Indirect members may or may not be recognised as members of the network and in most cases the indirect member does not get involved in collective decision-making processes of the system, which exclusively involves direct members.135

A condition for membership of the clearing infrastructure in Iceland is that a participating bank has a settlement account at the Central Bank and participates in that bank’s gross settlement system.136 The applicable rules also envisage the membership of intermediaries, and hence presumably indirect membership for a bank is possible. However, no such indirect members exist at present.

132 Commission’s report, p. 148. 133 Reiknistofa bankanna (RB) in Iceland and Bankenes Betalingssentral (BBS) in Norway. 134 A real-time gross settlement (RTGS) system is a settlement system in which processing and settlement

take place on an order-by-order basis (without netting) in real time (continuously). 135 Commission’s report, p. 149. 136 Cf. the Icelandic Central Bank’s Regulation on the operation of clearing systems no. 313/2007, Art. 2.

Page 63 NICS has two types of membership depending on whether a bank has a settlement account in the Norwegian Central Bank (“Level 1 bank”), hereinafter referred to as direct members, or settles its transactions on a settlement account held in a level 1 bank (“Level 2 bank”), hereinafter referred to as indirect members. A considerable number of banks have chosen to settle their transactions through another bank. As elsewhere in the EEA, membership of both the infrastructures surveyed is restricted to institutions holding a banking licence, although in Iceland, securities firms may also become members. In addition, direct members of both systems need to have a settlement account with the central bank. In Norway, banks wanting to join NICS, whether as a direct or indirect member, have to pay the entry fees for the so-called Access Area 1 in the Norwegian banking industry’s joint payment system infrastructure, which also includes other services, such as for instance, the joint multilateral infrastructure for cheques.137 16.6 Fees charged to users Fees charged to banks for the use of the payment infrastructure could be an important determinant of the overall cost of certain retail financial services. Not only the size of the fees per transaction but also the structure of the fee schedule in the payment systems may imply significant cost differentials depending on individual bank characteristics. Fees charged can generally be divided into two categories: joining fees and clearing fees.138

In addition, it should be noted that it is typically necessary for a payment system member to have an account at a central bank (or make other settlement arrangements) and to participate in a gross settlement system, which may entail both initial and periodic costs. These costs, however, will not be dealt with in the present analysis. 16.6.1 Joining fees In Iceland, the joining fee for FGM is €127.000 regardless of the size of the bank. On the other hand, there are no joining fees as such for Norway´s NICS system. However, as mentioned above, in order to have access to NICS, a bank must have paid access fees to the so-called Access Area 1 in the Norwegian banking industry’s joint payment system infrastructure. This fee is linked to the size of the banks in terms of capital liability and ranges from €43.700 to €686.710. The access fee for foreign banks with branch(es) in Norway is €436.997, which corresponds to the maximum fee for the smallest banks. 16.7 Clearing fees For FGM, an annual fee is applicable. This fee has two tiers of €32,000 or €44,000, depending on volume. In addition, a per-transaction fee of about €0.03, covering both clearing and settlement, applies. For NICS, the annual fee is €9,227 for direct members139 and €4.619 for indirect members140. A per-transaction fee ranging from about €0.0056 to €0.0033 applies

137 Membership of FNH or Sparebankforeningen is not a requirement to participate in NICS. However,

banks which are not members of these organisations will have to pay an additional annual fee to take part in the joint payment system infrastructure. This fee corresponds to 5 % of the annual membership fee that the bank would have had to pay to the respective organisation.

138 Commission’s report, p. 150. 139 I.e. Level 1 banks. 140 I.e. Level 2 banks.

Page 64 depending on the volume of transactions. As regards NICS, it is noteworthy that the fee structure features a ceiling which seeks to ensure that very small banks are not burdened with disproportionately high fixed costs. Thus, it is envisaged that the sum total of fixed and per-transaction fees shall not exceed the equivalent of €0.374 per transaction. 16.7.1 Economies of scale due to fee structure Both of the surveyed systems have some type of “regressive” fee structure. The fee structure for FGM is partly regressive in nature, as joining fees are independent of volume. It should also be mentioned that FGM is currently reviewing its tariffs in order to accommodate the possibility of offering volume-linked discounts. For NICS, per-transaction fees are marginally lowered with increasing volumes. As a consequence, the cost of membership in both systems is proportionally lower for larger banks that process larger volumes of transactions. 16.8 Competition analysis Access to payment systems is necessary for any bank considering entering a retail banking market and intending to offer customers core banking services, such as current accounts or payment cards. Given this indispensability, infrastructure arrangements could also act as a barrier to entry to retail banking markets. In the Icelandic FGM system, decisions are taken by a board of directors elected by the system’s owners, while in Norway, the NICS system is ultimately controlled by the national associations of banks and savings banks. In both cases, it appears that crucial decisions, such as tariffs and the admittance of new members, are taken by the incumbent banks or their associations. However, neither in Norway nor in Iceland have there been any refusals of a request for membership. As in the EU, the clearing systems in Norway and Iceland require members to be banks. In Iceland, securities firms may also be members. Other direct or indirect network users cannot thus participate directly in the network, nor in the network’s decision making, which might entail that the network will not cover the needs of a significant sector of the users. The fee structure of the clearing systems in Iceland and Norway is partly regressive. However, in Norway, the fee structure also includes elements which should ensure that smaller players can also participate in the network. In Norway, unlike domestic banks which have to pay a joining fee calculated based on the bank’s capital liability, foreign banks have to pay a fixed fee for jointing NICS.141 16.9 Conclusions As in the EU, both Iceland and Norway have one national clearing infrastructure and the structure, organisation and costs vary from network to network. Banks operating in different EEA States will have to join and adapt to the various national systems. The corporate governance of the payment systems and the structure of the fee systems may

141 The joining fee refers to the access fee for the so-called Access Area 1 in the Norwegian banking

industry’s joint payment system infrastructure.

Page 65 raise barriers to entry for new or small players, although this only seems to apply to a very limited extent in Iceland and Norway.

Page 66

Part III – Conclusions

Page 67 17 Conclusions In the following, the Authority’s main findings in the various aspects of the sector inquiry will be summarised. 17.1 Findings on retail banking market structure and performance The retail banking markets in the EEA continue to be fragmented along national lines. This fragmentation is further entrenched by the fact that essential market infrastructures (payment systems, credit registers) remain country-specific and lack interoperability. Furthermore, legal obstacles to further market integration remain in the form of differing regimes relating to e.g. tax rules and consumer protection. As regards market concentration, the inquiry’s findings indicate that Iceland and Norway have highly concentrated retail banking markets and that concentration ratios are among the highest within the EEA. Integration in EEA banking markets remains low, and few countries feature foreign banks among their five biggest. The main exceptions are the Nordic countries and the Benelux countries, where cross-border integration is seen to a larger extent than elsewhere. Financial performance of banks varies considerably across the EEA. As regards the EFTA States, the profitability of retail banking in Norway was significantly higher than the EU25 average over the surveyed period. Iceland had a profitability ratio in the beginning for the period comparable to the EU25 average, but which subsequently dropped significantly below that average. The overall long-term trend across the EEA seems to have been one of increased bank profitability. It should be noted, however, that the surveyed period did not include the year 2007, the latter part of which has been dominated by volatility in financial markets. 17.2 Findings on current accounts and related services As elsewhere in the EEA, banks in the EFTA States co-operate actively within several areas of retail banking, through ownership and management of payment systems, data sharing through credit registers, and commercial joint ventures. The level and areas of co-operation vary from country to country. Although significant economic benefits may result from such co-operation, it can also potentially create competition problems, such as for instance, foreclosure of new entrants or collusive action. The findings of the inquiry, combined with the Commission’s findings for the EU25, show a high degree of variability across the EEA in terms of customers’ bank account use. There is a high variation in prices for payment services across the EFTA and EU States. The large disparity in prices suggests that greater cross-border competition could bring down prices, particularly in those countries where prices are still relatively high. The practice of tying current accounts to other products such as mortgages or loans appears to be common throughout the EEA. Such practices are liable to reduce customer mobility through increased switching costs. Furthermore, extensive use of tying by incumbent banks may render market entry more difficult and also render price comparisons of individual products more difficult. Tying may thus be suspect from a competition law point of view, although this has to be assessed on a case-by-case basis.

Page 68 Both in Iceland and Norway, the level of customer mobility appears to be low, even compared to the rest of the EEA. In 2005, it is estimated that only 4,89% of consumers and 9.10% of SMEs moved their accounts in those two countries. Banking relationships tend to be long. Consumers hold their current accounts with the same bank for an average of 9.94 years in Norway and 7.94 years in Iceland, compared to 7.94 years in Norway and 4.87 years in Iceland for SMEs. The inquiry examined several factors that may reduce customer mobility. The aforementioned practice of tying is likely to discourage customers to switch banks. Furthermore, there are reasons to believe that factors such as other types of administrative burden, information asymmetries and lack of price transparency may reduce mobility. The inquiry also looked at potential and actual measures to mitigate the effects of these factors. On the other hand, the inquiry did not find evidence of elevated closing charges. 17.3 Findings on payment cards and payment systems The Authority’s findings confirm that, across the EEA, acquiring of debit and credit cards in the international card networks is highly concentrated. In addition, the acquiring markets for the international card schemes in all three EFTA States are characterised by the presence of joint ventures between banks. Acquiring in the Norwegian BankAxept system is decentralised, unlike several other domestic card schemes in the EEA which have a single acquirer. Issuing, both for national and international card schemes, is significantly less concentrated. The levels of vertical integration for the international payment card systems broadly mirror what has been observed for the EU25 using a rating system to assess the degree of integration. On this scale, the BankAxept scheme receives the lowest ranking indicating a low degree of integration. However, it should be borne in mind that the ownership of the scheme and of the network operator is mostly in the same hands and consequently the scheme is more concentrated in practical terms. The sector inquiry examined four types of fees that are charged to the cardholder: The card issuance fee, the fee per card, the fee per transaction and the account statement and billing information fee. In general, it is noticeable that issuance fees and fees per card charged to cardholders in the three EFTA States tend to be higher than the EU25 average. Moreover, per-transaction fees and account statement fees are more widely applied than in the EU25. The Authority’s findings show considerable differences in the levels of Merchant Service Charges (MSCs), i.e. fees paid by merchants accepting cards to the card acquirer. Smaller merchants within the major payment card schemes tend to pay higher MSCs than the larger ones. It is possible that this difference reflects the existence of market power, rather than being entirely justified by factors such as economies of scale or generally different risk profiles of larger merchants. There is also considerable variation in MSC levels from sector to sector. Levels of MSC in the EFTA States appear to follow similar patterns as has been observed for the EU25. The lowest MSCs are charged by Norway’s BankAxept system. This corresponds to the Commission’s findings that domestic debit card schemes operating without interchange fees also tend to have lower MSCs than the international networks.

Page 69 The practice of blending by acquirers, i.e. charging identical MSC for acquiring payments from different networks, has primarily been observed on the Norwegian market, however the extent of this practice is unclear. For the most part, the findings as regards interchange fees charged by the international card schemes in the three EFTA States correspond to what has been observed in the EU25. Interchange fees are paid by the merchant’s bank (the acquirer) to the cardholder’s bank (the issuer) whenever the cardholder uses the card to make a purchase at a merchant. The Authority’s findings further underline that there is a wide dispersion in fee levels throughout the EEA. On the other hand, the Norwegian domestic debit card scheme, BankAxept, operates without an interchange fee and nonetheless has a high degree of market penetration. The fact that BankAxept and other domestic debit card schemes in the EEA operate successfully without an interchange fee suggests that interchange fees are not as indispensable to the operation of card payment systems as some academic literature has suggested. Although the available data is limited, the overall findings concerning profitability point in the same direction as the Commission’s observations, i.e. that the business of issuing cards to customers is significantly more profitable than the business of acquiring card payments from merchants. Apparently, card issuing would remain profitable for a significant number of issuers even in the absence of an interchange fee. Interchange fees thus seem to magnify the profits from card issuing. For the international payment card schemes active in the EFTA States, the membership and governance rules are set at a pan-European level and hence arouse the same concerns as already voiced by the Commission. Those concerns are inter alia that card issuing and merchant acquiring is restricted to credit institutions and that there are potential barriers to entry related to fee levels or structures. The joining fee structure of the BankAxept scheme may also act as a disincentive to cross-border entry. Due to the high degree of concentration of the EFTA States’ acquiring markets, the presence of cross-border acquirers is important to the development of competitive markets. While all three markets have experienced some degree of cross-border activity, information is lacking about the ease or difficulty of entering these markets. Acquirers in the EFTA States have, to some degree, pursued cross-border activity within the EEA. This has in all cases been done via membership of a cross-border acquiring programme. This conforms to the patterns that have been observed for acquirers in the EU25. Retail payment systems in the EEA remain fragmented along national lines. In both Iceland and Norway, the payment infrastructures are run on a mutual governance model involving the systems’ main users. The need to gain access to a separate payment infrastructure in order to offer retail banking in each EEA country may act as an impediment to market entry for certain market players due to factors such as governance or fee structures. No concrete issues in this respect have however surfaced in the Authority’s survey in the EFTA States.

Page 70 18 Glossary Automated teller machine (ATM): point where consumers can use plastic cards for withdrawing money. Cardholder: the holder of a payment card, who uses it as a payment instrument. Card acquirer (or acquiring institution): credit institution or other undertaking, and member of a card scheme that has a contractual relation with a merchant. Cardholder fee: the one-off or recurrent fee (or a set of fees) paid by a typical cardholder for the ownership and/or use of a classic/standard debit and/or credit payment card (where no special conditions apply), as well for other ancillary services (e.g. account statement information). Card issuer (or issuing institution): credit institution, and member of a card scheme, that has a contractual relation with a cardholder for the provision and use of a card of that card scheme. In a closed system, the card issuer is the scheme owner, while in open systems several credit institutions act as card issuers. Card scheme owner: defines standards, rules, specifications and access policies and governs the card scheme. Cheque: debit instrument in the form of written order from one party (the drawer) to another (the drawee; normally a bank) requiring the drawee to pay a specified sum on demand to the drawer or to a third party specified by the drawer when the instrument is presented to the payer’s bank. Clearing: process of transmitting, reconciling and, in some cases, confirming payment orders between financial institutions prior to settlement, possibly including the netting of instructions and the establishment of final positions for settlement. Credit transfer: payment order (or sometimes a sequence of payment orders, which is referred to as standing orders) made for the purpose of placing funds at the disposal of the beneficiary. Direct Debit: pre-authorised debit on the payer’s bank account initiated by the payee. Interchange fee: fee paid by an acquiring institution to an issuing institution for each payment card transaction at the point of sale of a merchant. In certain networks, this may be positive in others it is zero. Large-value payment: a payment, generally involving a very large amount, which is mainly exchanged between banks or between participants in the financial markets and usually requires urgent and timely settlement. Merchant: the entity that accepts payments by means of cards. Merchant service charge (MSC) (or merchant fee or merchant discount rate): fee paid for each transaction by a merchant to an acquirer, who processes the merchant’s transaction through the network and obtains the funds from the cardholder’s bank (issuing institution). The transaction is considered to be executed when the corresponding funds,

Page 71 equal to the price of the sold item, are debited from the consumer’s account and, after deducting the merchant service charge, are credited to the merchant’s account. “On-us” transactions (as opposed to “off-us” transactions): in a narrow sense, on-us transactions are payment card transactions where the issuing bank and the acquiring bank are identical. This situation is prevalent in closed payment card systems. In a wider sense on-us transactions occur where the issuing bank and the acquiring bank are separate entities but pertain to a common group of banks. This situation typically arises where issuing banks set up a joint venture which acquires merchants. Transactions between this acquirer and its shareholders are often labelled "on-us" transactions, although strictly speaking issuing and acquiring banks are separate entities. Payment card: card that allows the cardholder to make payments for goods and services at POS (point of sale) terminals or remotely (mail order, telephone order, internet). It may be one of the following:

• Debit card: a card that allows the cardholder to charge purchases directly and individually to a current account at a deposit-taking institution (serves as an access device to funds stored in bank accounts). It is recognized that debit cards may also be closely linked to other products offered by banks.

• Credit card: a card that allows the cardholder to make purchases up to a certain credit amount, which can then be settled in full by the end of a specified period or only in part, with the remaining balance taken as extended credit and being charged interest; credit cards may be linked to a current account at a deposit-taking bank, but also may be linked to an account that has been set up specifically for the use of the credit card.

• In this report deferred debit card, which is defined as card that allows the cardholder to make purchases but does not offer extended credit (the full amount of the debt incurred has to be settled by end of a specified period), is treated as a credit card.

Payment card system (or payment card scheme or payment card network): technical and commercial infrastructure set up to serve one or more particular card brands and which provides the organisation, framework and rules necessary for the brand to function. Point of sale (POS): point where consumers can use plastic cards for payment transactions at a merchant outlet (often a payment terminal). Retail payment: payment between various consumers, businesses and governments of relatively low value and urgency. It is a payment which is not included in the definition of large-value payments. Retail payment system: set of instruments, banking procedures and inter-bank funds transfer systems, which handle a large volume of retail payments. Settlement: an act which discharges obligations in respect of funds transfers between two or more parties. A settlement may be final or provisional.