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2011- 01

www.kif.re.kr

January 2011

Jae-Youn Lee

Korea’s Credit Card System:Issues & Potential Measures

Author Jae-Youn Lee Senior Research Fellow 02-3705-6356 [email protected]

01

Ⅰ. Issues

Summary 02

Ⅰ. Introduction 05

Ⅱ. Comparison of Credit Card Systems 07

1. Types of Credit Card Systems

2. US Credit Card System

3. Credit Card Systems of Other Countries

Ⅲ. Korea’s Credit Card Industry 18

1. Credit Card Market Structure

2. Characteristics of Korea’s Credit Card Industry

3. Problems with the Transaction Scheme for Korean

Credit Cards

Ⅳ. Potential Measures for Improvement 30

1. Mandating a Merchant Member Pool System

2. Limits on Merchant Fees

3. Promoting Debit Cards

02


■ Korea’s credit card industry contains both 3-party and 4-party

schemes, but unlike most countries, the share of 3-party schemes

centered on independent card companies is markedly higher.

○ In a 3-party scheme, the card companies performing both member

services such as card issuance, and acquiring transaction from

merchants, while in a 4-party scheme these are separated.

○ BC Card is the only company to have adopted a type of 4-party

scheme in Korea, performing acquiring business for 11 member

card companies, but unlike a typical 4-party scheme, it does not

determine merchant fees, and only collects an agency fee from

member banks.

■ The dominance of the 3-party scheme presents the following

challenges.

○ Individual credit card companies recruit card user members and

issue cards, while each card company must recruit merchant

members separately, which entails high costs for recruitment and

management, making it hard for new card companies to enter.

○ Merchants are only able to ask acquiring transactions to the

relevant credit card company, so they have low bargaining power

in the determining of the merchant fees that can be called the

cost of processing credit card transactions.

03

Summary

○ Merchants must enter into contracts with all credit card companies

to prevent card user members using credit cards from going

elsewhere, which produces management-related costs and

complications.

○ Since card companies hold the power to determine merchant fees,

they compete by using this to offer excessive beneficial services for

card user members.

■ It will not be easy to switch to a 4-party scheme, but mandating a

merchant member pool system should alleviate the problems under

the 3-party scheme.

○ Allowing card companies to use other companies’ merchants as

a pool will alleviate the problems of redundant contracts with

merchants.

○ When using a credit card at a non-affiliated merchant member,

the joint interchange fee can be calculated appropriately and

imposed on merchants.

○ It is necessary to stimulate the use of a merchant member pool

system by lowering inconveniences such as time lags when

disbursing payment for non-contracted merchant members.

■ With merchants obligated to join and accept credit card payment,

limits on fees would be the most effective and direct means of

tempering dissatisfaction among smaller merchant members about

fee levels.

04


○ If such limits are established, most fees would be determined to

match these limits, so establishing an average fee limit instead of

a fee cap may be considered.

○ It’s been pointed out that, if merchant fees are capped, this sets a

precedent of the government interfering with the market pricing

mechanism, but given the mandatory merchant participation,

some government intervention is needed.

■ In Korea, credit cards are used far more than debit cards, which has

brought about overconsumption and credit delinquency, so debit

cards need to be promoted.

○ Considering that debit card use is markedly lower than credit

cards, the income deductions for both need to be readjusted in

addition to other measures to stimulate debit card usage.

05

Ⅰ. Introduction

■ Korea’s credit card market (including debit cards) took off

following the 1998 currency crisis, buoyed by government

policies designed to spur consumption and make taxable income

more transparent.

○ The government introduced income deductions to individuals

for credit card use, and required merchants to become credit

card merchant members and accept card payments (Regulation

on Supervisor of Specialized Credit Financial Business, Article

19, Clause 1).

○ The result was that credit card usage (goods and services

purchases) has grown seven-fold between end-1999 (43 trillion

won) and end-2009 (290 trillion won).

■ However, while growth and competition in the credit card market

led to an expansion in benefits for card user members, the costs

of these benefits have been excessively passed on to merchant

members, sparking complaints especially from small merchants.

○ Korea’s credit card market features eight network companies

(brands), more than other countries, which compete by

offering discount charges or interest-free financing plans to

attract card members.

* In most countries, there are four network companies, i.e. Visa,

MasterCard, Amex, and Diners.

Ⅰ. Introduction

06


○ In Korea’s credit card system, card companies conduct both

card issuance and acquiring transactions, for which they directly

set both fees for user members and merchant members. With

merchants mandated to accept card payments, an excessive cost

burden has become passed on to them.

■ This paper shall examine the issues facing the Korean credit

card market by comparing different types of credit card systems

to explore measures for resolving the persistent dissatisfaction

among merchant members, despite merchant fees being lowered

multiple times since 2007.

07

Ⅱ. Comparison of Credit Card Systems

1. Types of Credit Card Systems

■ Credit cards have become widely used around the world as the

main payment instrument that allows for purchasing goods and

services without cash.

○ In a credit card system, when card user members purchase

goods or services from card merchant members, the card

company settles payment (after deducting the merchant fee),

then collects payment from the card user members on the

settlement date.

○ Card companies offer this system to card user members and

merchant members, while they impose annual fees on user

members and merchant fees based on sales for merchants.

■ Credit card systems consist of a 3- or 4-party scheme depending

on whether the same company handles card issuance and

acquiring transactions.

■ The 3-party scheme involves card user members, merchant

members, and card companies in credit card transactions.

○ Credit card companies recruit card user members and merchant

members to build a card network, and conduct card issuance

and acquiring transactions from merchants.

○ Card companies not only collect member fees and monthly

payment from card users, but also settle payment by deducting

industry-specific commissions.


08


○ Card companies selecting a 3-party scheme include Amex

(American Express) and Diners Club, and all Korean card compa-

nies except for BC Card.

* In the US, some large banks have issued Amex cards since 2004,

weakening the nature of the 3-party scheme.

<Figure 1> Settlement Flow Chart in a 3-Party Scheme

■ In contrast, in the 4-party scheme that predominates in most

countries, credit card transactions consists of card user members,

merchant members, card issuers, acquirers, and card network

company.

○ Credit card network companies such as Visa and MasterCard

provide a network for issuers, who issue cards to members,

and acquirers, who acquire card transaction from merchants.

○ Card issuers take part in the network by offering user member

management services, such as recruiting user members and

Three-party scheme

License fee

Card scheme/franchisor

Setting the rules for the interchange,

rules and regulations between

the different franchisees

Franchisee/Issuer & Acquirer

Cardholder Merchant

Payment

Product/service

Payment

Invoicing

Service-fee

Settlement offunds

09


issuing cards (account opening), billing and collecting payment,

and loan services.

○ Acquirers offer merchant member management services such

as recruiting merchants and entering into contracts to be able

to process card transactions normally, and forwarding payment

to merchants for card transactions received from issuers.

○ When card user members purchase goods or services by credit

card at merchants, the issuer collects payment from the user

member on the settlement day and settles the deducted

interchange fee with the acquirer. Then the acquirer dispenses

the additional commission-deducted payment to the merchant.

<Figure 2> Settlement Flow Chart in a 4-party scheme

■ In the 4-party scheme, the interchange fee refers to the share

of the merchant fees that belongs to the issuer, and is set by

network companies such as Visa and MasterCard.

Four-party scheme

Card schemes

Setting the rules to applied within

the Network. Acting as switch

and router between the issuer

and acquirer

Cardholder Merchant

AcquirerIssuer

Card Payment

Service/Product

Interchange fee

Invoice Payment Service-fee

Settlement offunds

Legend:Electronic informationMonetary funds

Settlement of funds

010


○ The interchange fee is the fee paid by the acquirer (merchant

bank), which acquires the transaction from the merchant, to

the issuer of the card that was used by the customer, and is the

most important element of merchant fees.

○ The higher the interchange fee, the better for the issuer and

the lower the costs for the card user member or the more

beneficial services are able to be offered. Conversely, the lower

the interchange fee, the better for the acquirer and the less

burden for the merchant members, allowing it to keep fees

low.

○ Visa and MasterCard set the interchange fees to be able to

spread the costs between card user members and merchant

members in a balanced way.

■ In a two-sided market like the credit card market, the card

company (the network company) must set the price by spreading

the costs of providing the service appropriately between parties

so that transactions between card user members and merchant

members can be maximized.

○ If card companies impose high fees exceeding expected gains

on the purchaser for card usage, then card user members will

leave, and the same is the case for the merchant members,

which will reduce revenues from card usage, ending up eroding

card companies’ returns.

○ Therefore, 3-party scheme card companies and 4-party scheme

network companies consider both markets and try to maximize

returns by setting a balanced price that can consistently

produce the highest amount of transactions.

011


2. US Credit Card System

1) Credit Card System

■ Credit cards began in the US as two-party cards that would allow

creditworthy customers to use at individual companies only.

○ To get rid of the inconvenience at hotels, department stores,

gas stations and restaurants, etc. of having to carry around

large amounts of cash, store cards began to be used in the US

from the early 20th century.

■ Credit cards used at multiple merchants appeared from the

1950s with the creation of the Diners Club card, and Amex.

After that, Visa, MasterCard, and Discover cards also became

used.

○ The Diners card (1950) and the Amex card (1958) were issued

with the main purpose of use at hotels, restaurants, travel

companies, and selected stores, and had the 3-party scheme in

which the issuer and the acquirer belong to the same entity.

○ Visa and MasterCard began in the late 1950s centered on

banks. For small banks, it was hard to invest the massive

amounts to build a network between merchants and

cardholders, so they agreed to licensing contracts and took the

form of a 4-party scheme separating the issuing bank and the

merchant bank.

■ Today, the US credit card system comprises four card network

companies (brands), around 6,000 issuers, around 8,000

acquirers, and multiple third-party processors.

012


○ Issuers are mostly banks, which issue credit cards to customers,

while acquirers consist of both banks and specialized acquirers,

and acquire transaction from the merchant members.

○ Since it is hard for the acquirer to manage the tens of

thousands of merchant members, they pay a fee and entrust

this to processors (similar to the VAN (value-added network)

companies in Korea).

○ There are two forms of processors: one serves issuers by

conducting user member’s credit management, card issuance

and user risk management, etc., and the other serves acquirers

by approving transactions and making deposits for merchant

members.

2) Credit Card Market Structure ■ There are four major US credit card brands, namely Visa, Master

Card, Amex, and Discover, with Visa having the highest market

share.

○ In 2008 in the US, goods and services purchased using commercial

or consumer credit cards and debit cards totaled 3.069 trillion USD.

* Unlike with credit cards, when purchasing goods and services with

debit cards, payment is immediately deducted from the customer’s

account.

○ Among consumer cards, market share was as follows: Visa,

56.60% (1 trillion 415.98 billion USD); MasterCard, 29.11%

(728.39 billion USD); Amex, 10.13% (253.56 billion USD);

Discover, 4.16% (104.01 billion USD).

013


○ Among commercial cards, market share was as follows: Visa,

39.78% (225.5 billion USD); Amex, 37.34% (211.67 billion

USD); MasterCard, 22.51% (127.62 billion USD); Discover,

0.37% (2.12 billion USD).

■ Both 3-party and 4-party schemes exist in the US, though the

latter is far more prevalent.

○ Amex and Discover have adopted a 3-party scheme, while Visa

and MasterCard adopted a 4-party scheme.

○ Among consumer cards, the share of 3-party scheme cards

like Amex and Discover was 14.29%, while those of 4-party

scheme cards like Visa and MasterCard was 85.71%; however,

for commercial cards, the respective shares were 37.71% and

62.29%.

<Figure 3> Market Share by Credit Card Brand

consumer card commercial card

Source: Nilson Report, Sep. 2009.

Visa56.6%

Master Card29.1%

Amex10.1%

Discover 4.2%

Master Card22.5%

Amex37.3%

Visa39.8%

Discover 0.4%

014


■ On the other hand, for the overall issuance market, combining

credit cards, debit cards, and prepaid cards, the concentration

ratio (CR4) of the above 4 companies was 49.7% for all

payments to merchants (3 trillion 285.9 billion USD).

○ Payment cards such as Visa, MasterCard etc. issued by

JPMorgan Chase spent 476.99 billion USD at the merchant

members and took the highest share of total payment card

receipts at 14.5%.

○ Bank of America was next at 463.76 billion USD.

■ The reason the US credit card market is oligopolistic is that the

initial investment in the credit card industry is very high, so

economies of scale exist.

○ The greater the number of card user members and merchant

members, the larger the economies of scale and network

effects there are in the credit card industry.

<Figure 4> Market Share of Spending at Merchants by USPayment Cards (2008)

Source: Nilson Report, July 2009.

$3.285Tril.

Chase14.5%

the rest35.0%

BofA14.1%

Amex13.9%

Wells 6.4%

Discover 2.8%

CapOne 3.0%

U.S.Bank 3.1%Citi

7.2%

015


3. Credit Card Systems of Other Countries

■ European countries such as Germany, France, and Switzerland

made their own Eurocard credit card system from 1965, but this

merged with MasterCard International in 2002.

○ Eurocard was created in 1964 by Swedish bankers to stand up

to the Amex card, and was developed in 1965 as a federation

of European banks, called Eurocard International NV.

○ In 1968, Eurocard International entered into a strategic alliance

with MasterCard International to accept each others’ cards and

became used internationally, and acquired the sole license to

be able to issue MasterCards in Europe.

○ In 1992, the credit card company Eurocard International

merged with the direct payment company Eurocheque

International, and Europay International was founded.

○ In 2002, Europay International and MasterCard International

merged, founding MasterCard Worldwide, and its name was

subsequently changed to MasterCard Europe.

■ In Australia, the 9 large banks jointly issued the country’s first

mass-market credit card, called Bankcard, in 1974, though this

was discontinued in 2006.

○ Bankcard was a joint brand credit card issued in Australia

between 1974 and 2006, expanding to New Zealand from

1984, and securing as many as 5 million card members.

○ However, in 1984, as Bankcard member banks launched Visa

and MasterCard products, Bankcard usage fell, and issuance

was discontinued in 2006.

016


■ In Spain, local banks developed a credit card network jointly.

○ Banco de Bilbao introduced its BankAmericard (now Visa card)

in 1971, helping make credit cards widely available.

○ Spain’s top credit card network, ServiRed, was established as

an independent entity by 29 financial institutions in 1979,

and is jointly owned as of end 2009 by some 102 financial

institutions (banks, savings banks, credit unions), and are used

internationally through joint brands with Visa and MasterCard.

* Number of cards issued: 40.30 million(21 million credit cards, 19.3

million debit cards); number of merchant members: 724,000.

○ Sistems 4B was founded in 1974 by Banco Santander and two

other Spanish banks, and has 11 banks as shareholders as of

2010, as well as 9 financial institutions including ING Direct as

members.

* Number of cards issued: 20 million(includes credit and debit cards);

number of merchant members: 460,000.

○ Euro 6000 was founded by savings banks as a credit card

network, with 35 member savings banks as of end 2009.

017


<Table 1> Credit Card Usage in Major Countries

Asia-Pacific Americas Europe

Country Australia Canada US Mexico EU UK Denmark Spain

Market Share1) 2.2% 23% 23% 10%

not applicable

15% 1% 14%

4-partycards

BankcardMC, Visa

MC,Visa

MC,Visa

MC,Visa

MCVisa

MC,Visa

MC,Visa

MC,Visa

3-partycards

AmexDinersJCB

AmexDiners

AmexDiners

DiscoverJCB

AmexAmexDinersJCB

AmexDiners

AmexDinersJCB

Note: Share among non-cash transactions.

Source: Weiner, Stuart E. and Julian Wright, “Interchange Fees in Various Countries: Developments and

Determinants”, Review of Network Economics Vol.4 No.4, December 2005.

018


1. Credit Card Market Structure

■ Credit cards in Korea began to be introduced in 1969 in the form

of department store cards, while credit cards able to be used at

other merchants were introduced by banks from 1978.

○ Store cards were two-party cards only for use at the given busi-

ness, and after being issued in 1969 by Shinsegae Department

Store, were offered in 1974 by Midopa Department Store, and

in 1979 by Lotte Department Store.

○ Credit cards able to be used at other merchants were first

issued in 1978 by Korea Exchange Bank as Visa cards, then

Kookmin Bank issued KB cards in 1980, and 5 commercial

banks jointly established BC Card in 1982.

○ Corporate groups such as Samsung and LG managed to enter

the card industry through acquiring existing companies, in spite

of government guidelines against the establishment of new

card companies by such groups.

■ Korea’s credit card market consists of 8 credit card networks and

21 card companies including card issuing banks, with the share

of the top 4 at 56.4% (end March 2009).

○ The 8 networks (brands) are Kookmin, Korea Exchange Bank,

Samsung, Shinhan, Hyundai, Lotte, Hana SK, and BC.

○ Credit card issuing companies are divided into independent

card companies and card issuing banks.

Ⅲ. Korea’s Credit Card Industry

019


○ Independent cards are 7 cards including 3 cards, issued by

non-banks - Samsung, Hyundai and Lotte- 3 cards issued by

the banks Shinhan, Hana SK, BC, and 1 card issued by KDB

Capital.

○ There are 14 cards issued by banks, which mostly were

independent card companies until the 2003 credit card crisis

and merged with parent banks in the process of clearing up

defaults. Recently Hana Bank established an independent credit

card company with a separate credit card business, and KB and

NACCP are considering it too.

* Independent card companies merged with parent banks, such as

KB Card (September 2003), KEB Card (February 2004) and Woori

Card (March 2004). LG Card combined with Shinhan Card (October

2007).

<Figure 5> Market Share of Card Company

Lotte 6.3

independentcardcompany(47.1%)

cardissuingbank(52.9%)

BC 0.1 KDB Capital 0.1

Kookmin 15.8

Hana 6.8

Woori 6.8

NACCP 6.7

IBK 5.6

City 3.1

SC First Bank 1.5etc. 6.6

Samsung10.6

Shinhan20.2

Hyundai9.8

020


■ Payment card settlements as a share of private consumption

(goods and services purchases) was just 15.5% in 1999, but with

policies to stimulate credit card use, this figure rose sharply, and

was 51.4% as of end 2009.

○ Korea’s credit card usage as a share of GDP was 44.5% as of

end 2008, sharply higher than other countries such as the US

(14.9%) and Canada (18.3%), but the same figure for direct

payment and check card usage was just 2.6%, below that of

the US (9.3%) and Canada (10.5%).

<Table 2> Credit & Debit Card Use/Private Consumption(Unit: 100 billion won, %)

1999 2002 2004 2005 2006 2007 2008 2009

Credit Cards(A)1) 426.3 1,518.9 1,425.9 1,586.1 1,758.4 2,008.4 2,300.9 2,524.1

Debit Cards(B)

1.0 0.8 27.1 79.5 124.4 189.1 268.6 365.1

Private Consumption

(C)2,749.3 3,998.5 4,246.2 4,540.3 4,826.2 5,165.4 5,467.3 5,616.8

(A+B)/C 15.5 38.0 34.2 36.7 39.0 42.5 47.0 51.4

Note: 1) Excludes cash service and corporate purchasing cards.

Source: Bank of Korea.

<Table 3> Credit & Debit Card Use/GDP (2008)

Korea US UK Canada Germany Switzerland Japan

Credit Cards (%) 44.5 14.9 7.9 18.3 0.1 5.0 7.51)

Debit Cards (%) 2.6 9.3 17.5 10.5 4.7 9.8 0.2

Note: 1) 2007 data.

Source: BIS, Bank of Korea.

021


2. Characteristics of Korea’s Credit Card Industry

■ In terms of the structural characteristics of Korea’s credit card

industry, while both 3-party and 4-party schemes exist, unlike

most other countries, the former is far more prevalent.

○ Most independent card companies, excepting BC Card, have

adopted 3-party schemes, in which the issuing bank and

merchant bank are the same entity.

○ Conversely, BC Card is adopting a 4-party scheme by acquiring

transactions from merchant members for member card compa-

nies, but the merchant fees are set by the issuing company itself

and it only collects an agency fee.

○ In Korea, Visa and MasterCard do not offer a credit card network

like the 4-party scheme in other countries, and only provide such

a network for use outside of Korea.

■ Under the 3-party scheme of Korea, settlement agency services

(VAN companies) approve card member transactions and acquire

them.

○ VAN companies offer terminals and VAN networks to recruit

merchant members and provide credit card inquiry services,

and calculate settlement data for card companies, charging a

VAN fee.

○ There are 13 VAN companies currently in operation, including

KICC, KS Net, NICE, KOCES, KIS, KOVAN, KFTC, Smartro, CCK

VAN, TCI, and KMPS.

022


■ BC Card is separate from an independent card company, but

generally it manages merchant members and performs acquiring

services on behalf of member companies, adopting a 4-party

scheme.

○ BC Card’s member banks perform member management,

recruit merchant members, and manage delinquencies, with

each member bank using all recruited merchants without

paying fees, and BC Card does merchant management, and

payment settlement, and collects an agency fee from member

banks.

○ BC Card has adopted a type of 4-party scheme, but individual

issuers set merchant fees on their own, so there is a difference

from the 4-party scheme of Visa or MasterCard.

○ Currently, it has 11 members: IBK, Kookmin Bank (formerly

Housing & Commercial Bank), NACCP, Shinhan Bank (formerly

Chohung Bank), Woori Bank (formerly Hanbit Bank), SC

Cheil Bank, Daegu Bank, Busan Bank, Kyongnam Bank, Hana

Bank (formerly Chungchong Bank and Seoul Bank), Citibank

(formerly Koram Bank).

<Figure 6> BC Card’s Card Settlement System

Issuing MemberBank

Transact. approval notice,computation of payment

Request for approv,Notice of transact.

SettlementIssuance,Paymentcharged

Acquiring transaction,Merchant fee payment

Credit CardTransaction

Acquiring contract w/merchant,payment upon deduction of merchant fee

BC Card

Cardholder Merchant

023


■ Korea’s credit card industry is dominated by the 3-party scheme

centered on independent card companies, and BC Card’s 4-party

scheme grew its share after the 1997 currency crisis, it has since

gone back down.

○ In 2000, before credit card usage was stimulated, 3-party

schemes, which independent credit card companies such as

Samsung Card adopted, occupied 99% of the market. But as

credit card use expanded from 2001, banks’ sales expanded

and the share of BC Card with its 4 party scheme shot up to

32.8%, reflecting expanded card business of banks.

* BC Card’s share is the combined share of its member companies.

○ However, this share has gone down, excepting the 2003 credit

card crisis, when bank credit card companies were merged with

parent banks. With banks scheduled to spin off more credit

card business, this share is expected to be cut into further.

<Table 4> Share of Credit Sales by Credit Card Company(Unit: trillion won, %)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Total 48.7 155.1 255.4 240.7 158.1 258.2 279.2 312.3 356.5 372.8

Samsung 26.7 25.3 23.7 15.1 15.4 10.2 10.1 10.1 10.4 10.3

Hyundai 2.1 0.8 2.6 6.6 8.8 7.4 8.8 9.6 10.2 11.9

Lotte 2.2 0.6 0.5 0.7 4.2 3.7 4.7 5.3 5.6 6.2

Bank Cards 30.9 26.7 31.0 37.5 28.7 51.8 49.2 54.6 58.5 55.6

BC 0.4 32.8 27.2 29.4 45.8 31.4 29.4 24.3 22.5 24.8

Note: Bank cards are specialized or joint bank cards that except BC Card member companies.

024


3. Problems with the Transaction Scheme for Korean Credit Cards

1) Problems with the Credit Card Market

■ In Korea, a highly competitive market structure has formed to

attract credit card user members.

○ As of end March 2010, the 8 credit card networks and 21

issuers, and 4.5 cards per member of the economically active

population mean that the credit card market is saturated.

○ As a result, credit card companies including banks offer

customers points, mileage, discount services, no-interest

installment services and annual fee exemptions in order to

entice them to use their cards.

■ In the market structure that has formed, there is almost no need

to compete for merchant members.

○ Since government policy makes it effectively mandatory for

merchants to be card members join and accept card payments,

credit card companies have little need to compete for merchant

members.

■ Smaller merchant members have complained that, in such a market

structure, credit card companies pass on most of the expenses

for systems maintenance and marketing to the card user offering

added members on to them by maintaining high merchant fees.

○ While credit card companies should have to spread the related

costs evenly to the card user and merchant members in order

to expand their member and merchant network.

025


○ Credit card companies argue that the various benefits offered

to user members for card usage help expand merchant’s sales,

but with 4.5 cards for every member of the economically active

population, it appears to be of more help in expanding use of

their cards.

○ Credit card companies have imposed the costs of providing

such services to card user members on the merchant members,

but this ultimately gets passed along to consumers, particularly

non-card members, in the form of higher prices for goods and

services.

○ Card members receive points from card companies according

to their usage, but the points that could not be used because

the expiration date had passed reached 85.5 billion won in

2004, 125.3 billion won in 2005, 121.4 billion won in 2006,

150.0 billion won in 2007, and 120.0 billion won in 2008.

■ Credit card companies hold greater bargaining power over prices

with most smaller merchants, but low power with larger ones.

○ In 2006, large supermarkets made up 16.5% of card

companies’ transactions by number, and 13.6% by transaction

amount, so are important to card companies for expanding

their earnings.

○ Further, new user members can be recruited through kiosks

installed at such large marts, and credit card companies can

expand credit card usage through offering services such as

discounts for using credit cards.

■ Large marts’ merchant fees are from 0.5%-1.5%, much lower

than average fees (2.33% in 2006) because of competition

026


among card companies, and lowers the capacity for card

companies to bring down smaller merchants fees.

○ In a credit card transaction, approval and acquiring have fixed

unit costs, so if the merchant fees are set according to the

expenses that arise, larger merchants with larger transactions

may have lower fees.

○ However, lower fees for large marts has widened the fee gap

among merchants, and this has spurred resistance from smaller

merchants.

■ When setting fees to maintain their card networks, credit card

companies must consider balance between both members and

merchants, as well as smaller and larger merchants, but in a

market structure where it’s hard for merchants to opt out, this

latter balance may be overlooked.

○ Credit card companies must build a diverse merchant network

for the convenience of card user members, and to do so,

must reduce the fee gap for smaller merchants so that such

merchants don’t opt out.

○ When merchants are dissatisfied with fee levels, they may

cancel their contracts, but this is not a realistic option in Korea.

2) Pros and Cons of Korea’s 3-Party Scheme

■ Under the 3-party scheme, individual credit card companies

recruit members and issue cards, but having to separately recruit

merchants entails high expenses for merchant recruiting and

management.

027


○ Under the 3-party scheme, a single credit card company handles

both issuance and acquiring services, so each card issuing

financial company must separately recruit merchants and build

its network.

○ As of end 2009, each of 8 credit card network has agreed on

merchant contracts with around 2.9 million merchants, and while

500,000 merchants close their doors annually, 500,000 new

contracts are also agreed to.

○ Conversely, under the 4-party scheme, credit card companies

handle issuance and acquiring separately, so issuers can issue

joint brand credit cards, and acquirers are able to jointly use

recruited merchant members.

○ As a result, it is very hard for new credit card companies to enter

under the 3-party scheme, but easier under the 4-party scheme.

■ Merchants are only able to ask for acquiring transactions to the

relevant credit card company, so they have low bargaining power

in the determining of the merchant fees that can be called the

cost of processing credit card transactions.

○ Merchants present the billing statement from card members’

goods purchases to the relevant credit card company and

collect the sales price less the preset merchant fees.

○ It is in reality obligatory for merchants to join and accept credit

card payment, and since the relevant card companies can pay

for the goods in place of the customer, these companies hold

the power to determine the merchant fees.

○ Conversely, under a 4-party scheme, merchants can choose

the acquiring bank that acquires transaction, so it’s possible to

choose an acquirer that offers more advantageous terms.

028


■ In addition, merchants must enter into contracts with all credit

card companies to prevent customers using credit cards from

going elsewhere, which produces management-related costs and

complications.

○ There are currently 21 credit card companies (6 independent

card companies, 15 card issuing banks), but some card issuing

banks are allied with larger ones for which they issue cards, so

merchants must make contracts with 9 credit card companies

(networks).

○ Merchants receive payments from card user members into

different accounts according to each card company’s payment

cycle, which makes it hard to manage payment.

○ Conversely, under a 4-party scheme, the acquirer can acquire

all transaction using various credit cards, which is much more

convenient for the merchant members.

<Table 5> Credit Card Companies in Korea

Number Company Name

CreditCard

Company

Bank subsidiary 4 BC, Shinhan, KDB Capital, Hana SK

non-bank subsidiary 3 Samsung, Hyundai, Lotte

CardIssuingBank

KEB Card 1 KEB

KB Card and alliance 2 KB, NACCP (formerly KFLC)

Shinhan Card andalliance

4Shinhan, Cheju, Suhyup, Chonbuk, Kwangju

BC Card Members 11IBK, KB, NACCP, SC First Bank, Hana, Woori, Daegu, Busan, Kyongnam, Citi Korea, Shinhan

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■ Since card companies hold the power to determine merchant

fees, they compete by using this to offer excessive services for

card user members.

○ Since card companies can impose most of the transaction costs

on merchants, they compete by trying to entice customers

to use their cards through offering services such as points,

mileage, discounts, and no-interest installment plans based on

usage amount.

○ Under the 4-party scheme, network companies like Visa and

MasterCard set the interchange fees that determine merchant

fees, so they can control to some extent the marketing expense

of card issuers on behalf of customers.

030


1. Mandating a Merchant Member Pool System

1) Review Switching to a 4-Party Scheme ■ Introducing a 4-party scheme by consolidating the eight card

networks into one or two networks and switching existing card

companies to issuers would be expected to be able to ease

problems for merchant members.

○ Merchant members would be able to seek out and transact with

acquirers beneficial to them that apply low merchant fees.

○ Since a small number of networks such as Visa and MasterCard

would determine the interchange fees for card issuers, this

would rein in the offering of excessive beneficial services to card

user members.

○ Further, if card network providers are consolidated, this will

allow the costs of maintaining the card networks to be imposed

to some extent on larger merchants, which may ease the fee

gap between small and large merchants.

■ However, each card company possesses around 2 million merchant

members, so it won’t be easy to have them give up their merchant

members and switch to being issuers.

○ If card companies are turned into issuers, this may save costs

for recruiting and managing merchants, but part of the fees will

have to be paid to acquirers and the networks, and proprietary

marketing will be hard to conduct.

Ⅳ. Potential Measures for Improvement

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2) Mandate a Merchant Member Pool System

■ It will not be easy to switch to a 4-party scheme, but mandating

a merchant member pool system should alleviate the problems

under the 3-party scheme.

○ Allowing card companies to use other companies’ merchant

members will alleviate the problems of redundant contracts.

○ When using a credit card at non-affiliated merchant members,

the joint interchange fee can be calculated appropriately and

imposed on merchant members.

■ For the card companies, mandating a merchant member pool

system can help improve bargaining power over large merchants.

○ For large merchants, since they would have to accept all

credit cards regardless of whether they are merchant member

of them and the industry-specific interchange fee would be

applied, card companies would be able to decline requests by

large merchants for excessive lowering of merchant fees.

■ However, currently, virtually all merchant members fear being put

at a disadvantage and sign individual contracts with credit card

companies, so there is almost no use of a compulsive merchant

member pool system.

○ Under the current merchant member pool system, acquiring

transactions from affiliated merchant members would be

handled electronically, with payment taking 1-3 days, but

acquiring transactions from non-affiliated merchant members

would be handled manually and this will have the disadvantage

of taking 6 days or more to settle the payment.

032


■ Therefore, it is necessary to stimulate use of the merchant

member pool system by lowering inconveniences such as time

lags when disbursing payment for non-contracted credit card

receipts.

○ The merchant member pool system may allow for the good

points of the 4-party scheme under the current 3-party scheme.

2. Limits on Merchant Fees

■ A measure to place upper limits on merchant fees has been

discussed since early 2010 in the National Assembly. But card

companies have announced they will lower merchant fees

voluntarily. So this measure was not introduced.

○ With constant complaints about merchant fees, the National

Assembly established a Merchant Fee Investigative Committee,

which mulled introducing a bill calling for ceilings upon a cost

analysis.

○ In response, card companies announced plans early this year to

lower fees for small merchants (with sales under 96 million won)

from the current 2.3-3.6% to 2.0-2.4%, and for merchant at

traditional markets from 2.0-2.2% to 1.6-1.9%.

■ However, if there are changes in merchant fees resulting from

economic conditions such as rising interest rates or a jump in

credit card defaults, complaints over fees could appear again.

○ Even at present, smaller merchant members have complained

that the current measure to lower fees has not gone far enough.

033


■ With merchants obligated to join and accept credit card

payment, limits on fees would be the most effective and direct

means of tempering dissatisfaction among smaller merchant

members about fee levels.

○ If such limits are established, most fees would be determined

to match these limits, so establishing an average fee limit

instead of a fee cap should be considered.

* Australia limited average merchant fees in its 2005 credit card

system reform.

○ Card companies may differentiate fees by merchant type, and

be able to manage it so the average fees don’t exceed a set

level.

■ It’s been pointed out that, if merchant fees are capped, this sets a

precedent of the government interfering with the market pricing

mechanism, but given the mandatory merchant participation,

some government intervention is needed.

3. Promoting Debit Cards

■ In Korea, credit cards are used far more than debit cards, which has

brought about overconsumption and resulting credit delinquency,

so debit cards need to be promoted.

○ Credit cards offer convenience by allowing the customer to buy

goods and services without immediate payment within a preset

limit.

034


○ Conversely, debit cards deduct payment upon usage from the

purchaser’s bank account within 2-3 days, and thus do not

offer credit, and only offer convenience.

■ Debit cards offer several benefits for card user members, merchant

members and card companies, and have thus become used in

many countries as the primary small-sum payment system.

○ For customers, it prevents abuse by limiting usage to within

their deposits, and can effect rational consumption habits, and

may also be issued to minors or those with poor credit who

would not be able to obtain credit cards.

○ For card companies, there are no losses from unpaid card pay-

ments and there is no need to raise funds for paying merchants

for goods, so there is no interest rate risk.

○ For merchants, card companies impose lower fees on merchants

versus credit cards, which may cut the expense of accepting card

payments.

■ The Korean government expanded income deductions for such

cards from 2010 to support their usage, but more forceful measures

are needed.

○ Keeping the income deduction ratio for credit cards at 20% and

expanding it to 25% for debit cards would expand usage of the

latter.

○ However, considering that debit card use is markedly lower

than credit cards, the income deductions for both need to be

readjusted in addition to other measures to stimulate debit

card usage.

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