Reserve Bank of Australia (RBA) Governor Philip Lowe has called on the payments industry to deliver least-cost routing (LCR) as a default function for mobile wallet transactions by the end of 2024, with digital wallet payments among the more high-cost payments options for merchants.

Speaking at the Australian Payments Network Summit 2022 today, Lowe described in-store mobile wallet transactions as the “next frontier” for LCR, with mobile wallet transactions – offered by bigtech mobile hardware and software developers Apple Pay, Google Pay and Samsung Pay – today representing more than one in four of all card transactions (debit and credit collectively) made in Australia. This is up significantly from just one in 10 card transactions made in 2020.

This growth in mobile wallet use has ultimately led to an increase in the market share of the – more expensive – Mastercard and Visa debit networks, which are typically set as the default payments networks by the three bigtech developers.

While the RBA mandates LCR for in-person payments made using physical cards, smartphone-based mobile wallet transactions were originally not included in this requirement due to apparent technical difficulties of applying LCR as a default setting – an issue which the bigtechs appear to have resolved.

According to Lowe, the RBA’s Payments System Board, during consultations with the major mobile wallet providers, issuers, acquirers and terminal providers over recent months, had “formed the view that it would be both feasible and desirable” for the industry to deliver LCR functionality for mobile wallet payments by the end of 2024.

“The next step is for the mobile wallet providers to finalise their plans and share these plans with the industry so that the necessary investments across the payments ecosystem can get underway,” Lowe said.

He added that the Payments System Board also expects to see LCR made available for online payments by the end of 2022.

Least-cost routing (LCR), also known as ‘merchant choice routing’, enables merchants to select the lowest-cost card network to process their debit transactions (between the three current debit card scheme networks: eftpos, Debit Mastercard or Visa Debit), effectively increasing competition in the debit card market and putting overall downward pressure on payment processing costs.

Currently, debit card transactions processed through Apple Pay, Google Pay and Samsung Pay default to international debit networks run by Mastercard and Visa, which typically charge higher fees to retailers for most transactions.

Merchant fees for debit card transactions totalled $1.3 billion in 2019, according to RBA figures, and are likely to have grown since then.

Payments made through the domestic debit card network, eftpos, are generally the least expensive, costing merchants an average of 0.3 per cent of the transaction value; on the Mastercard and Visa debit card network, these charges are currently around 0.5 per cent of the transactions, which, according to the RBA “have trended down in response to LCR and the policy measures” enacted by the regulator.

American Express and Diners Club fees, while also declining significantly over the past decade, according to the RBA, remain the most expensive networks, with average merchant fees of around 1.3 per cent and 1.7 per cent of the transaction value, respectively.

By contrast, Mastercard and Visa credit card transactions attract an average merchant fee of 0.9 per cent.

“Overall,” Lowe said, “we are optimistic that least-cost routing will help counter the forces that are adding to merchants’ payment costs, particularly for small businesses.”

Small businesses are bearing the weight of the cost of these transactions, with SMEs, on average, paying twice what large businesses pay to process the same transaction. This is often because small businesses typically cannot negotiate discounted fees with these card schemes, Lowe said.

Despite LCR being available to 85 per cent of merchants for in-store transactions, only around half are making use of it it.

“This low take-up suggests that the industry has more work to do in promoting the benefits to merchants,” he said.

“Some financial institutions also have more work to do to complete their rollout and have not met the expected timetable.”

Beginning from next year, Lowe also confirmed that the RBA will publish institution-level data on LCR availability and take-up in a bid to “provide greater transparency on how individual institutions are progressing” on this expected timetable.

Lowe added that other regulatory and market developments are also expected to help increase competition and maintain the downward pressure on payment costs.

“Modernisation of the Payment Systems (Regulation) Act 1998 (PSRA), as proposed by the Farrell Review, would open up the possibility of regulating newer entities in the payments ecosystem.

“Greater transparency of merchant payment costs through an expansion of the Consumer Data Right could also help drive increased competition between acquirers.

“And new payment methods could emerge over time to compete with card payments, including through the use of QR codes for account-to-account payments at retailers.”

Payments regulation reform a key priority

Governor Lowe also highlighted the RBA’s push to increase competition in the local payments sector, with the Reserve prioritising the establishment of a new licencing regime and a set of common requirements for payment service providers (PSPs). The aim is to lower the barrier to entry for emerging paytechs to Australia’s payments systems and to enable international payments businesses to tap into the domestic fast payments rail, the New Payments Platform (NPP).

Lowe said the new licencing regime “could help overcome some of the challenges faced by PSPs seeking to enter the Australian market”.

“The aim is to create a more level playing field for non-ADI payment service providers in a way that balances the needs of the payment system operators and PSPs.”

The RBA, he said, is also developing a new regulatory regime for industry bodies that set technical standards for the payments industry.

Payment stablecoins are also on the radar, with the RBA exploring the development of regulatory arrangements for the digital currency.

“[We] can envisage a possible future in which stablecoins are used for payments, as long as they are well designed and well regulated.

“In many ways, the regulatory issues are similar to some stored value facilities, such as pre-paid travel cards and digital wallet services.”

A third payments regulation priority for the Reserve, he said, is the modernisation of the Payment Systems (Regulation) Act 1998.

“A lot has changed in the payments system since the PSRA was introduced over 20 years ago. The payments ecosystem is now much more complex, there are many new business models and new technologies are continuing to emerge.

“The changes proposed by the Farrell Review would allow the Payments System Board to help shape that complex world in the public interest more effectively.”