Integrating European retail payment systems: some economics of SEPA

Using a spatial competition model of retail payment networks, this paper discusses the likely economic consequences associated with the formation of the Single Euro Payments Area (SEPA). The model considers an expansion of positive network externalities on the demand side and adjustment cost on the supply side and reveals that the introduction of SEPA may not lead to a fully competitive and integrated retail payment markets. This is especially the case when the markets are segments before the introduction of SEPA. In such a scenario, the post-integrated markets are likely to remain segmented or will be characterised by a kinked equilibrium where no significant price competition takes place. In both outcomes, SEPA leads to increased prices, larger network sizes (ie increased number of customers) and a higher consumer surplus. Additionally, if the SEPA-induced adjustment costs for payment networks are not prohibitively high, SEPA may also lead to an increase in both profits and social welfare.

Introduction: The Single Euro Payments Area, SEPA, aims at creating one pan-European market for cashless retail payments in euro.Current national retail payment systems will gradually migrate to SEPA from 2008 onwards. When completed,SEPA will have a huge influence on the European retail payments landscape: philosophically, it should do the same to non-cash retail payments what did the introduction of euro notes and coins to paying in cash. In this respect, SEPA can be seen as a natural progression to the introduction of euro and a further step in realising the full potential of the Single Market for Europe.Given the topicality of the SEPA-initiative and its potentially far-reaching implications for the retail payment industry in Europe, it is somewhat surprising that analytical studies on its implicationsare almost non-existent. In the present paper, we aim to make a contribution to this rather unexplored area by providing a simple industrial organisation analysis on the implications of SEPA. Our research question is straightforward: What are the economic effects of SEPA? We study this question in a spatial competition model of retail payment networks.

Author: Kari Kemppainen

Source: Research Discussion Papers, Bank of Finland

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