Euro payment transactions: EU regulation on charges threatens to distort competition

DISCLAIMER: All opinions in this column reflect the views of the author(s), not of EURACTIV Media network.

  • The European Commission has plans for legislation that would drastically reduce charges for cross-border payment operations within the EU. According to its proposal for a regulation, charges for cross-border payment transactions up to EUR 50,000 are generally to be the same as those for corresponding domestic payments from January 1, 2002. The rule would apply to cross-border credit transfers and cheques from January 1, 2003.
  • Administrative price-fixing is not necessary, though, as institutions offering payment services have already taken far-reaching steps to make cross-border payment operations more efficient in future, and thus to lower their charges for these services. Some banks have already substantially reduced their charges for electronic payment orders.
  • With EU-wide bank identifier codes (BICs), international bank account numbers (IBANs) and standards for forms (IPI, MT103+), banks will very soon be able to introduce straight-through electronic processing in cross-border payments. If cross-border retail payment systems and centralised clearing and settlement structures are established this could bring further cost reductions.
  • The proposed EU regulation would disturb the development of the market by hindering market-driven pricing.
  • Even within a single euro-zone payment area it must be possible for customer charges to reflect the relevant settlement costs. These remain steep for crossborder operations, which is the reason why charges to customers are also still relatively high. In addition, reporting obligations via-à-vis national authorities make cross-border payments more expensive, as well as slowing them down. As soon as possible, these obligations must be reduced and restricted to payments of more than EUR 50,000.
  • The regulation would force banks to execute cross-border payments at less than cost price and to compensate the resultant losses through cross-subsidisation. This could prompt smaller institutions to withdraw from the market, which would reduce competition.
  • Administrative fixing of bank charges would be unlikely to withstand a judicial review by the European Court of Justice.

The European Commission has proposed a regulation in order to bring about a drastic reduction in charges for cross-border payments of up to EUR 50,000 within the European Union (EU). Such small-value transactions are in future not to be more expensive than similarly sized domestic payments.

Low, but cost-covering, prices are in the interest of consumers and providers alike. Surveys on cross-border payment operations in the EU indicate that the settlement of cross-border retail payments can be improved considerably in the future.

It is doubtful, though, whether the measures currently proposed by the Commission can help in attaining this goal. If payment service providers were forced by law to bring charges for cross-border payment transactions into line with prices for domestic operations, this would probably lead primarily to a distortion of competition among financial services institutions in the EU, eliminate incentives to enhance efficiency through investment, and thus ultimately run counter to the interests of consumers.

High charges for cross-border payments …

It is a fact that charges for cross-border small-value payments in the EU are high compared with charges for national payments. A survey1 carried out for the European Commission shows that total charges for a cross-border credit transfer2 within the euro area currently average EUR 17.36. The lion’s share – EUR 14.26 on average – has to be paid by the originator; the beneficiary pays EUR 3.10. If a bank customer withdraws EUR 100 at a cash dispenser in another euro-zone country, this costs him roughly 4.2% of that amount. Charges for retail purchases made using a ban k card are relatively low at EUR 0.16 per payment.3 Charges for cross-border payments differ greatly from country to country. They probably also vary widely from institution to institution.

Charges for comparable national transactions are generally considerably lower. Banks frequently even offer such services free of charge.

… not without reason

There are, however, specific microeconomic reasons for the wide gap between charges for national and cross-border payment operations.

Low demand:There is, first of all, very little demand for foreign payment operations. Whereas some 100 million domestic payments are settled daily in the euro area, cross-border payments probably number only a few hundred thousand.4 The institutions therefore cannot achieve anywhere near the same economies of scale in cross-border payments.

Expensive infrastructure:Secondly, the establishment and maintenance of the infrastructure required for cross-border payments, and the settlement of transactions, are relatively cost-intensive. The majority of cross-border small-value payments are channelled through bilateral account relationships, i.e. through the system of correspondent banks. Owing to the complexity of the system, it is very expensive for the individual institution to maintain a network that provides full geographical coverage.

In the past, projects to establish centralised structures in cross-border payments failed to get off the ground as they were not economic. The viability of investing in infrastructure for payment transactions has to be studied closely in advance, particularly because of the very low demand in cross-border business.

Lack of EU-wide standards: An even weightier reason is the costs that banks incur for data capture and for settlement. These costs are due to the fact that each EU member state has different technical standards. Formats for bank sort codes and account details still differ, making it necessary to process payment orders individually on the whole, and thus manually. Many orders also require additional work because the details given are either incomplete or contain errors. Straight-through processing (STP), i.e. almost complete automation, has not been possible so far because of the lack of standardisation, whereas it has been customary in national payment systems for years.

Extensive reporting obligations:Even in the EU single market, crossborder payments still have to be reported to the national central banks; the obligations are extensive and often differ from country to country. This makes payment operations more inconvenient for customers, more expensive for the banks, and lengthens the period required for processing.

These four factors make it clear that the value chain of cross-border payments is considerably longer and involves much higher costs than the chain for national payments. This is consequently reflected in current charges for cross-border payments.

The Commission proposal …

The purpose of the proposal for a regulation on cross-border payments in euros, presented recently by the European Commission, is to improve the functioning of the internal market and to encourage the transition to a “single domestic European payment area” in the European Economic and Monetary Union. The Commission aims “to ensure that charges for cross-border payments in Euro are no higher than those for payments in Euro involving no crossing of borders”.

The proposal therefore contains a series of measures that concentrate on regulating charges for cross-border electronic payment transactions. As a general rule, charges for cross-border payments up to EUR 50,000 are to be the same as the level of charges levied in respect of corresponding national payments from t he beginning of 2002. For two types of cross-border payment there is to be a transitional period: the rule is to apply to cross-border credit transfers and cheques from January 1, 2003 at the latest.

… not in keeping with the spirit of the single market

For customers, such a rule would be highly attractive in the short term. But there is reason to doubt that it would be beneficial in the long run, as it is hardly compatible with the goals of the EU single market on regulatory, microeconomic and legal grounds.

Regulatory:The fixing of charges by law would contravene the principles of the market economy, according to which prices are determined by supply and demand.

The proposal is based on the assumption that within a single European payment area charges for national and cross-border payments must be the same. But this appears questionable.

A single market is generally understood to be an economic area in which there are no internal administrative barriers to trade. The same applies to a single payment area. While administrative trade barriers do not represent a cost factor in such an economic area, there are other costs that are not eliminated and have a major influence on charges for services.

As long as service providers’ settlement costs for cross-border payments are higher than those for national payments, it should and must be possible for this to be reflected in the charges for the services rendered – as in the EU single market for transport or telecommunications services. A single payment area clearly does not imply uniform charges, but merely a uniform framework for the free development of supply and demand – and thus the charges – for payment services.

The proposed regulation would not lead to genuine EU-wide harmonisation of charges for cross-border payment operations either. Since charges for domestic payments differ between the EU member states, there would also be wide deviations between charges for crossborder payments even after the regulation came into force. This would tend to favour banks in countries where charges for national payments are high.

Microeconomic:If charges cannot be determined by market forces – which would be the case under the Commission’s current plans – this creates microeconomic distortions. As a look at the value chain shows (see table p. 3), the marginal costs for cross-border payments are considerably higher than those for national transactions. If equal charges were legally prescribed, banks would be compelled to provide crossborder payment services at less than cost price, i.e. at a loss, and this loss would have to be compensated through higher profits in other areas.

Such cross-subsidisation would be uneconomic. Since turnover in crossborder payments is low in any case, the proposed regulation could cause institutions – especially smaller banks – to withdraw from this field of business entirely. This would lead to greater market concentration, weaken competition, and ultimately hurt consumers.

The proposed regulation would also create negative incentives for the institutions in their pricing policy. The rule that charges must be uniform, for example, would spur institutions to raise prices for national payments. If this were not possible, institutions would no longer have the same motivation to let customers share in the benefits of improved efficiency in national payment operations by lowering their charges.

Just how strongly these negative incentives would work to the customers’ disadvantage would depend on the intensity of competition among the institutions providing cross-border payment services.

Legal:Administrative fixing of bank charges would be unlikely to withstand a judicial review by the European Court of Justice as it would conflict with the pr inciples enshrined in the EU Treaty, especially the principle of an open market economy with freedom of competition. Nor are there any discernible grounds relating to EU monetary law or the creation of the internal market that would justify such intervention.

All in all, the proposal to legally prescribe the approximation of prices for cross-border and national payments is therefore a problematic approach. It is to be feared that the resultant distortions of competition would ultimately be to the disadvantage of the consumers in the EU. This view is shared by the Bundesbank. In past statements, the European Central Bank has also seen no need for the state to influence the markets.

Market forces hold promise of a more efficient solution

Despite these reservations, a reduction in charges for cross-border payments is desirable. And this can be achieved without administrative price-fixing. While the necessary improvements in efficiency will require additional efforts by the institutions providing payment services, i.e. the banks, the authorities can also contribute by improving the regulatory environment for payment operations.

Automation:Charges for cross-border payments depend largely on the degree of automation. The aim is to achieve straight-through processing (STP), which is already practised in most EU countries in national payments.

Standardisation:For STP it is essential that the exchange of information in payment operations be very highly standardised. This applies to the format of account numbers and bank sort codes as well as the other information provided on forms.

Infrastructure:Further cost reductions could come if cross-border retail payment systems and centralised clearing and settlement structures are established.

Reporting obligations:National reporting requirements continue to slow cross-border payments in the EU and make them more expensive. The proposal rightly requires these reporting obligations to be restricted. It would be preferable and justifiable, though, to set the limit at EUR 50,000 right from the beginning of 2002.  

Transparency:Banks and consumers must observe the standards necessary for STP in cross-border payments in order to minimise settlement costs in future. There must be incentives for users to pass on all the necessary information.

Discernible progress

The banks in the EU have, for their part, already taken considerable action on these points. Knowing the stance of the EU9 , they have invested heavily since 1997 to increase efficiency in cross-border payments.

Cost pressure in this area has been dampened, as the recent report for the Commission also shows. Although charges for cross-border credit transfers in EMU have risen slightly between 1999 and 2001 (+1.6%), the increase was far below the general rate of price increase in the services sector (+4.3%) and in the financial sector (+8.4%) in the euro area. Charges for payments abroad by bank card actually dropped 17%. The fall in charges was particularly pronounced in Germany, where credit transfers to other EMU countries became 13.4% cheaper and charges for payments by card plunged 71%; the execution period for crossborder credit transfers was also reduced by 21%.

Examples based on individual banks show that, with high investment, it is possible to make enormous progress in cross-border payments. Deutsche Bank’s retail banking arm, for instance, has succeeded in slashing prices for electronic credit transfers to other European countries10 to EUR 1.50 per transaction, a reduction by up to 80%. Since July 1, 2001 customers of Deutsche Bank AG have been able to withdraw money free of charge from the cash dispensers of banks in the USA, the UK, Canada and Australia with which a corresponding agreement has been concluded.

But the introduction of settlement procedures based on STP is likely to bring even greater efficiency gains than those achieved by European payment service providers so far – and thus even greater potential for reducing charges. The main prerequisites have already been created:

  • Technical standardisation: Definitions have been agreed for the international sort code BIC (Bank Identifier Code), international bank account number IBAN, and standard forms IPI (International Payment Instruction) and MT103+ (updated version of the SWIFT format).
  • STP credit transfers will probably be widely possible from 2002.
  • With STP the foundations have been laid for the development of cross-border retail payment systems. STEP 1 – the pan-European, small-value payment system of the European Banking Association which has been in operation since November 2000 – shows that the market is making use of the new possibilities. The introduction of another private international payment system, WATCH (Worldwide Automated Transaction Clearing House), is planned for summer 2002.
  • The European providers of cross-border payment services are clearly taking great pains to make transactions in this increasingly important area of the single market cheaper, simpler and faster. This market-driven process would be severely disrupted by administrative price-fixing as proposed by the European Commission.

Cross-border payment charges and the euro: no direct link

With just a few months to go until the introduction of the euro is completed, consumers are asking about the advantages that can be expected from the single currency. Despite all the benefits of economic and monetary union, a reduction in charges for cross-border payments to the level for national payments will not come as a direct consequence of the euro, nor should it be expected as an indirect result. Even after the euro banknotes and coins have been introduced, the nationally oriented structures for handling cross-border payments will remain in place for the time being, giving rise to high transaction costs and thus relatively high customer charges.

A statutory reduction of these charges as foreseen in the Commission’s proposal for a regulation obviously looks politically attractive as a means of achieving a higher degree of identification of the EMU citizens with the euro in the short term. But it is not a way of bringing down charges for cross-border payments that is compatible with economic principles. This can best be achieved by continuing and intensifying the structural adjustments that are already in progress.


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