During the 1980s, Norwegian banks introduced direct pricing of customers' use of payment services. Direct pricing of payment services is relatively uncommon in other countries and Norway thus stands out in relation to the most widespread international practice in this respect. This article provides an account of the transition from free services to direct pricing of payment transactions, and the benefits of the transition. The article draws on theory where relevant, but the focus is on actual events in the period 1970-1993. During the last 8-10 years of the period, a pronounced transition from payment by cheque to payment by card occurred in Norway. Central factors behind this development are also described.
1.1 Prices and cross-subsidisation
Prices provide important signals about the value of a product or service and therefore have a strong bearing on consumer choices. Rational consumers will choose the product that meets their needs at the lowest possible cost, and this in turn will contribute to economic efficiency. Prices generate revenue for producers. In the short term, the price of a product should cover the variable costs of production, but firms may also choose to operate at a loss for a period. In order to avoid bankruptcy, a firm's income must cover both variable and fixed costs in the long term. The price of each product must not necessarily cover the variable and fixed costs. The price of individual products can be set at below cost price. This means that the price of other products must be set higher than their production cost. This is called cross-subsidising. Such pricing results in lower consumption of higher-priced services than would have been the case without cross-subsidisation. Similarly, consumption of low-priced services will be higher. The impact on consumption of a given price change depends on the price sensitivity of demand for the service.
1.2 Prices for payment services
Pricing of payment services varies across countries. The most common practice is that banks do not price payment services directly, but cover their costs in other ways, for example via float revenue. Float is a result of the fact that money in transit between payer and beneficiary is not interest-beating for either party for a number of days. Interest income accordingly accrues to the banks. In Norway, Section 27 of the Financial Contracts Act regulates the calculation of interest, and in practice this provision prevents float in the Norwegian payment system. In a number of countries, payment system costs are covered through fixed account management fees charged to customers. In other countries, an interest rate of zero is usual on typical current accounts. Cross-subsidisation of payment services with income from other bank products is also usual.
The introduction of unit prices for payment services can benefit banks both directly and indirectly. They benefit directly through increased revenue. Moreover, prices that reflect the relative differences in production costs will encourage customers to choose the most cost-effective services. This will yield indirect benefits by allowing banks' costs to be lowered in the long term. Unit prices for payment services can also reduce the need for cross-subsidisation by other services, and thereby contribute to more correct pricing and hence also more correct consumption of these services. Why then is direct pricing of payment services not more common?
1.3 Obstacles to the introduction of prices
Many customers will find the transition from free services to direct pricing dramatic, even if the prices are low. The bank that first introduces prices will therefore be faced with dissatisfied customers and negative media coverage, probably resulting in a loss of customers. Although the introduction of transaction prices may potentially yield gains, it may be so costly for the bank that takes the initiative that it is not regarded as an option. It is therefore not very likely that a single bank will decide to introduce prices without other banks doing the same. On the other hand, if all the banks support a decision to introduce prices, none will lose customers, and they will all increase income and/or reduce costs.
There are two challenges to such a strategy. First, it is not certain that all banks will follow up. One or more banks may see it as being in their interest not to take part, in a bid to increase their market share. If a bank does not introduce pricing, it will be able to "take over" discontented customers from the banks that loyally abide by the decision. For the individual bank it will therefore be more attractive not to observe the joint decision, even though for banks as a whole it is best for all to comply with the decision. (2) The other challenge is banks' relationship with the competition authorities. Competition legislation in most countries places stringent restrictions on price cooperation.
The banks may therefore be deadlocked in a non-optimal situation. They would all benefit from the introduction of transaction prices, but no bank wants to make the first move.
2 The introduction of transaction prices in Norway
2.1 Wage and salary payment free of charge via banks
Direct pricing of payment services is widespread among Norwegian banks today. However, this has not always been the case. On 1 January 1960, a wage account service was established for all commercial and savings banks, and the use of banking services increased through the 1960s as it became more common to pay wages and salaries into a bank account instead of the classic wage packet.
The Norwegian Confederation of Trade Unions (LO) and the Norwegian Employers' Association (NAF) included provisions on payment of salaries by way of bank accounts in the wage agreement of 1966. They informed the Norwegian Banking Association and the Norwegian Savings Banks Association of the provisions. In their response to LO and NAF regarding the wage account arrangement, the two banking associations stated that banks would continue to perform services free of charge for employer, trade union or employee. However, they reserved the right to revert to the question of charging employers and trade unions once they had more experience of the wage account arrangement, particularly how costly it would be.
The Basic Agreement of 1969 between LO and NAF provided for payment of wages and salaries through banks (the wage account agreement) if the enterprise wanted this arrangement. Cheques provided easy access to wages. A joint record of objection was entered in the Basic Agreement of 1974 to the effect that wage payment via banks was based on the assumption that employees could access their wage account free of charge by means of cheques. Changes that broke with this assumption would lead to each of the parties having a right to demand renegotiation of the rules concerning salary payment via banks. The banks were interested in the wage account arrangement, and therefore felt that this record of objection limited their opportunity to introduce charges. Any subsequent attempt to introduce transaction prices on payment services led to protests from both employee and employer organisations.
2.2 Increased focus on the costs associated with payment services
Both banks and public authorities realised fairly early that the processing of all the cheques entailed high costs. In autumn 1969, the Credit Policy Committee held negotiations between authorities and banks on changes in interest rates. At the time, banks' deposit and lending rates were both regulated, and quotas were imposed on banks' lending (both the price and the volume of the loans). In connection with these negotiations it was stated that banks should to a greater extent cover their operating expenses, and particularly expenses in connection with payment services, by pricing services instead of covering their expenses through interest income.
Focus on the costs of payment services increased during the 1970s. In his annual address in 1973, Knut Getz Wold, then Chairman of Norges Bank's Board of Directors, criticised banks for supplying free payment services. This was also followed up in an article in Penger og Kreditt later that year: "Hvorfor skal det koste noe a bruke sjekk?" (Why should it cost anything to use a cheque?). (Magnussen 1973.) In the National Budget for 1973 (Storting Report no. 1 (1973-74) p. 29), it was pointed out that payment intermediation (cheques) accounted for a considerable share of banks' costs, and that payment for banking services could contribute to curbing a further rise in interest rates, while at the same time the scope of banking services would be more correct from an economic perspective.
In connection with the renegotiation of the Basic Agreement between LO and NAF in autumn 1973, the banking associations stated that they had no plans to introduce charges on cheques in the four-year period for which the agreement was to apply. However, the banking associations planned an information campaign to reduce the use of cheques for less than NOK 100 and assumed that LO and NAF would take part. If the campaign did not have perceptible effects, the banking associations would consider limiting the number of cheques that were free of charge. Nevertheless, LO and NAF included a formulation about use of cheques free of charge in the Basic Agreement of 1974.
In 1973, the Ministry of Finance appointed a committee to consider various issues relating to payment services (the Payment Services Committee). Both cost and efficiency were specifically mentioned in the mandate. A subcommittee estimated banks' unit costs for account-to-account giro payments at between NOK 2 and NOK 5, while unit costs for cheques used for payment were estimated at about NOK 2. The low costs associated with cheques were explained by the fact that shops did much of the work of inspecting cheques when they were received, and that they could deliver a number...