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Integrating European Retail Payment Systems: Some Economics of SEPA

Integrating European Retail Payment Systems: Some Economics of SEPA. Kari Kemppainen Bank of Finland ECB-CFS Research Conference, Prague 20 October 2008. Background . Single Euro Payments Area, SEPA Starting point: European retail payment systems have been based on national standards

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Integrating European Retail Payment Systems: Some Economics of SEPA

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  1. Integrating European Retail Payment Systems: Some Economics of SEPA Kari Kemppainen Bank of Finland ECB-CFS Research Conference, Prague 20 October 2008

  2. Background Single Euro Payments Area, SEPA • Starting point: European retail payment systems have been based on national standards => no interoperability between national systems • Goal: a single domestic market for cashless euro retail payments (credit transfers, direct debits, card payments) => “national borders to be eliminated in European retail payment markets”

  3. Paper in nutshell • Application of a spatial competition model of retail payment networks (debit card markets) • Analysis on economic effects of SEPA formation • A stylized view on SEPA: • Expansion of positive network externalities on the demand side due to common standards • Fixed adjustment costs for SEPA compatibility on the supply side • Finding: Introduction of SEPA may not lead to fully-competitive and integrated retail payment markets if Pre-SEPA markets are segmented.

  4. Related literature • consultant studies, European Commission works; a summary by Schmiedel (2007) • Schaefer (2008) Model of SEPA-effects • Network effects and compatibility: * Katz & Shapiro (1985), Farrel & Saloner (1985) * Mason (2001) Internet pricing, Gandal & Shy (2001) Standardization policy and international trade • Applied Hotelling models: * Rochet (2007): Horizontal mergers of payment systems, various telecom, internet and ATM studies • Two-sided markets literature: Chakravorti & Roson (2006), Guthrie & Wright (2007), Rochet & Tirole (2007)

  5. Research questions Given Pre-SEPA segmented national retail payment markets as a starting point, • what are the effects of SEPA introduction on the prices consumers have to pay? • how will the sizes of payment networks (i.e. number of participating consumers) react? • how do service providers’ profits and consumer surplus change? • what will be the total effect on social welfare?

  6. Model (1) • Considers horizontally-differentiated payment card networks in two countries • Consumers have a unit demand and are uniformly located along a Hotelling line with two card payment networks at {0,1} • Consumers can choose between: (i) cash, (ii) national payment card, (iii) foreign payment card • Networks maximize profits, market sizes solved in equilibrium, perfect foresight assumed

  7. Model (2) 0 x1 x2 1 x1 1-x2

  8. Model (3) Parameters: • V = “base utility” of having a payment card • p = price (annual fee of payment card) • t = transportation cost /differentiation parameter • x = size of payment card network • epsilon = network utility parameter • k = indicator function for compatibility • a = fixed SEPA-adjustment cost for PS providers SEPA-formation: • Pre-SEPA: no compatibility, no adj.cost => k=0, a=0 • Post-SEPA: perfect compatibility, adj.cost => k=1, a>0

  9. Pre-SEPA segmented markets as the starting point • Corresponding to the real-life situation, the condition for Pre-SEPA segmented markets: • Assumption 1: sets limit to the relation between “the base value” of having a payment card (V) and “effective transportation cost”

  10. Post-SEPA potential market outcomes Three possible equilibria (Salop 1979, Ireland 1987, Economides 1984,1988): • Segmented markets • “Kinked” equilibrium markets • Fully-covered markets

  11. Main results (1) “SEPA as such is not enough for full-scale integration” • SEPA does not lead to fully-covered and integrated retail payment markets, if the Pre-SEPA markets are segmented (like they are in real-life). • Instead, possible Post-SEPA markets: i) remain still segmented ii) are characterized by “kinked” equilibrium

  12. Main results (2) • In both cases (i and ii), the introduction of SEPA leads to • increased prices • larger network sizes • higher consumer surplus • Profits and total welfare also increase (provided the SEPA adjustment costs are not prohibitively high) • Threshold values for fixed adjustment costs can also be established

  13. Tentative policy conclusions • Overall economic effects of SEPA can be positive (due to positive network effects) => SEPA project is worth undertaking! • But: the cost-side deserves a lot more attention (c.f. real-life discussions) • If potential economies of scale were incorporated, the positive SEPA effects would be strengthened in the current model => more research on topical SEPA issues is warranted!

  14. Thank You! Kari Kemppainen Bank of Finland Monetary Policy and Research Department Tel. +358 10 831 2249 Email: kari.kemppainen(at)bof.fi

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