Payments innovation under threat from RBA

Buy now, pay later, which revolutionised Australia’s highly concentrated payments system, is under potential threat from increased regulation.

Tony BoydContributor

May 12,

2024 – 3.48pm

When it comes to the award for the most successful global innovation to come out of Australia’s highly concentrated financial services sector over the past decade, the clear winner is Afterpay’s buy now, pay later.

By allowing customers to pay for products in four equal instalments over six weeks – with no fees, unless they were late with payments – Afterpay’s founders, Nick Molnar and Anthony Eisen, revolutionised consumer credit.

The product not only appealed to Millennials, Gen Zs and Gen Xers, who were sick of the usurious interest rates charged by MasterCard and Visa, it was embraced by merchants who benefited from higher sales.

It had the added advantage of shaking up the credit card oligopoly by forcing down fees paid by merchants to credit card schemes and triggered a significant reduction in those using credit cards for revolving credit.

The average balance accruing interest on each credit card in Australia has dropped from about $2300 when BNPL was introduced to about $1500.

At the heart of the innovation that made Molnar and Eisen billionaires, was the decision to charge merchants for the cost of providing the six-week period of credit offered to the consumer.

The intriguing story behind how Molnar and Eisen arrived at this breakthrough in global payments is adroitly captured by Jonathan Shapiro and James Eyers in the gripping book, Buy Now, Pay Later: The extraordinary story of Afterpay (Allen & Unwin).

Afterpay is the greatest single ASX-listed success story of the past decade having risen in value from $28 million when listed in 2016 to $40 billion when sold to Jack Dorsey’s Square, which trades under the name Block.

Now, eight years after Afterpay’s disruption, the centrepiece of their innovation – no merchant fees charged to consumers – is under threat from the payments system regulator, the Reserve Bank of Australia.

New legislation, which was given the tick of approval on Friday by the Senate Economics Legislation Committee, will expand the RBA’s payments powers to designate and regulate a much broader range of payment systems including BNPL, Apple Pay and Google Pay.

This expansion in powers is overdue given that the unregulated Apple Pay and Google Pay are at the forefront of the explosion in the use of digital wallets for payment. Tap and pay using digital wallets now accounts for a third of card payments.

It looks as though BNPL will suffer collateral damage from the payments systems changes included in an omnibus bill called the Treasury Law Amendment (Better targeted Superannuation Concessions and Other Measures) Bill 2024.

The RBA told the Senate Committee it has not decided on whether to designate BNPL and thereby enable surcharging of consumers by merchants.

But the RBA’s long-standing and rigorous commitment to “payments efficiency” points to that being the likely outcome, notwithstanding the negative consequences for competition.

Bringing BNPL into the surcharging net would undermine the economics of the business models pursued by Afterpay and its peers, including Latitude Financial, Zip, Klarna, Brighte, Payright and the copycat products offered by CBA, Westpac and NAB.

Profit margins for BNPL are typically less than 10 per cent whereas Visa has a profit margin of 71 per cent and MasterCard’s is 62 per cent, according to data compiled by Citi.

The biggest winners from increased regulation of BNPL would be MasterCard and Visa, as well as the big four banks which account for 80 per cent of credit card balances outstanding.

That makes the concentration of power in Australia’s card issuing market about double that of the UK, and more than double that of the United States.

One of the most concerning aspects of the potential imposition of additional costs on the BNPL business model is that the RBA, which is maker of the rules and enforcer of the rules, does not consider the impact of its actions on competition.

The RBA confirmed this when responding to questions on notice published during the Senate committee legislative review.

“The RBA has not undertaken analysis on the effect on competition and market concentration in the consumer credit market of requiring BNPL providers to remove their no-surcharge rules,” the RBA said.

“Such analysis would be outside the RBA’s payments system policy mandate. The RBA does consider competition when making payments policy.”

The RBA said it had “a mandate to contribute to promoting efficiency, competition and safety in the payments system, and the overall stability of the financial system”.

It deserves credit for being at the forefront of making credit card schemes more efficient and fairer with the introduction of surcharging a couple of decades ago.

But its preference for the use of debit cards, which have lower fees and no credit risk, could blind it to the powerful competitive advantages of alternative payment options such as BNPL

Although they have minuscule market share, BNPL players have helped deliver a more competitive payments environment.

BNPL payments made up 0.7 per cent of the number of consumer payments in 2022, up from 0.5 per cent in 2019, according to the Consumer Payments Survey.

Data separately collected by the RBA from payment service providers suggest that BNPL services were equivalent to 2.4 per cent of card purchases and 4.7 per cent of retail purchases, by value, in the December quarter 2023.

NSW Liberal Senator Andrew Bragg, who is deputy chairman of the Senate Economics Legislation Committee, is concerned that the RBA’s expanded powers are beyond the control of parliament and could be used to lessen competition.

“I think it is very dangerous to give so much delegated power on something as important as payments,” he tells this columnist.

“Payments policy has not been a major economic lever in the past, but I think it will be in the future. We are a nation of oligopolies, so competition is good, that’s my starting point.

“I am not against regulation, but I don’t think the RBA should be given sovereignty over significant economic policy.”

Bragg and fellow Liberal senator Dean Smith issued a dissenting report on Friday when the Senate Economics Legislation Committee issued its final report giving its approval to the new laws.

Bragg and Smith recommended that the bill be amended so that the Parliament could “disallow” the rules and standards that the RBA creates.

“This is an important accountability and oversight measure, particularly given the RBA’s concession that they do not consider competition in the market for consumer credit products when creating their rules,” the two senators said.

When New Zealand’s Ministry of Business, Innovation & Employment reviewed BNPL earlier this year, it did not interfere with the essence of the business model including merchants being charged a fee for using BNPL.

Instead, it brought BNPL into the same net as other consumer credit contracts, thus affording consumers the same protections as those using credit cards or taking out personal loans.

“However, obligations will be applied proportionately, having regard to the nature of BNPL and the lack of interest and credit fees, to allow the benefits of BNPL to be retained,” the MBIE said.

Afterpay’s international head of public policy, Michael Sadaat, says imposing surcharging regulation on BNPL would erode competitive tension, push consumers back to high-interest charging, and cause a substantial economic transfer away from consumers to the big four banks.

The RBA says BNPL involves a cross subsidy between older consumers and younger consumers, which is almost the reverse of the cross subsidy between lower income earners with big slabs of revolving credit card debt and higher income consumers who pay off their cards quickly.

If merchant surcharging of BNPL users does occur it won’t happen until the RBA’s holistic review of retail payments regulation which will include extensive industry consultation.

Disclosure: The author owns shares in Zip Co Ltd.