Why credit card interchange fees should come down

By Felix Salmon
June 25, 2009

Juan Lagorio is right. The various proposed bills regulating interchange fees — the fees that merchants pay whenever a customer uses a credit card to pay for something — could definitely hurt Visa and Mastercard, despite the fact that Visa and Mastercard don’t actually charge those fees and claim that they would not be impacted by the legislation.

How do we know that Visa and Mastercard are worried? Well, for one thing, Shawn Miles, the head of global public policy at Mastercard, has written an essay arguing against them:

No matter how loudly the big box merchants claim the mantle of “Protector of Consumer Interests,” granting big box merchants a collusionary antitrust exemption will have the opposite effect: less credit availability, higher prices, and reduced choice for consumers.

Miles points to the precedent of Australia, which saw credit-card fees rise after the government mandated lower interchange fees. But the post hoc ergo propter hoc argument is weak: for-profit card companies will naturally raise fees as much as they can no matter how much or how little money they make on interchange. It’s the same mechanism driving penalty rates of interest. And indeed the base case in the US is for a slow yet inexorable rise in interchange fees: one purpose of this legislation is to try and put an end to interchange-fee inflation (up 14% last year to about $48 billion, averaging an eye-popping 1.75% of total purchases).

In Australia, by contrast, interchange fees are now about 0.5%, which means there’s a lot of room for current fees to fall. What’s more, as Adam Levitin points out, the bills currently being considered by Congress don’t go nearly as far as the Australians did: they don’t mandate a fall in interchange fees, but just allow merchants to get together on one side of the negotiating table, against the small and powerful card issuers on the other side. Mastercard’s Miles characterizes the bills as “interfering with competitive pricing”, but that’s not really the case at all: pricing right now is pretty much unilaterally set by the card issuers, and the bills would introduce a much-needed bit of pushback from merchants.

Would lower interchange fees mean lower prices for consumers? Probably not — I suspect that Miles is right when he says that the profits would largely go straight to retailers’ bottom lines. But there’s really no reason why card companies should take $48 billion a year out of retailers’ profits — especially not when small merchants are disproportionately hit, sometimes paying 4% or more of their credit-card revenue to the bank. (You think those reward cards are great for you? You’re right, but the merchant will probably pay a higher fee when a reward card is used than when a regular card is used. If you want your merchants to do well, maybe think twice about using those rewards cards.)

On the other hand, there’s no reason whatsoever to believe Miles when he says that credit availability will go down, that prices will rise, or that “choice for consumers”, whatever that’s supposed to mean, will be reduced. The main thing that will fall is the card issuers’ profits — and that’s by design.

16 comments

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Thought for the day – If you don’t have the money to buy something, don’t buy it. Get a prepaid VISA and use it for making reservations, but pay in cash. Simple and it works every time and you’ll never rack up credit card fees – ever. This will stop the flimsy credit world from continuing to ruin our country.

Posted by Frank | Report as abusive

“…especially not when small merchants are disproportionately hit, sometimes paying 4% or more of their credit-card revenue to the bank.”

Except that accepting the cards in the first place is the merchant’s choice – nobody’s forcing them to do this. I bought a coffee today at a fancy (and expensive) place in Midtown, and I’m sure that 4% charge was the reason I had to pay cash.

Posted by ab | Report as abusive

This is ridiculous. Why does the government need to decide how much profit accrues to merchants and how much to credit card companies? As the previous commenter said, merchants are free not to accept credit cards if they find the economics unreasonable.

Posted by right | Report as abusive

or we could heed one of the core beliefs of most religions, that usury is a sin, and put a reasonable cap on interest rates, and let the magical invisible hand of the free market of banks decide how to allocate that interest revenue.

Posted by KenG | Report as abusive

I do not think merchants face anything but flat charge per card type. What seems to be true is that certain cards (I’m looking at you, American Express) charge even yet more than others. The fees really are usurious.

Frank, in a world where Fair Isaac dominates credit scoring, and in which you need a good credit score to get good rates on your home or car or small business loans, you need to have an use revolving credit in case you might ever take out a real loan.

ab, right, yes, those fees are a major reason for cash-only restaurants and cafes. That doesn’t mean the problem is solved. Where competition fails, government steps in. Me, I’d regulate these as a utility and shoot for pricing in ACH ranges. More profit for retailers strikes me as a useful, positive externality.

The total costs imposed by the card companies are much greater than the public understands. What’s publicized is the flat fee for a transaction.

The numbers are super important to small business owners.

Posted by jonathan | Report as abusive

If I could wave my magic wand and put ONE change into effect, it would be this:

Revoke the prohibition that Card cartels impose on merchants that prevent the discounting of Cash and Debit Card purchases vs. Credit Cards. The “level playing field” that the cartels force merchants to show consumers while they pay the 2-3% of every Credit Card transaction to them. Consumers do not realize that those who do not use Credit Cards pay a tax for all those that use them as Cash.

If I had a choice to pay $1,000 via Debit or $1,030 via Credit, I would use a Debit route. But my Merchant cannot do that as they would be in breach of contract that allows them to accept Credit Cards.

Does anyone know why this issue was not taken up in the reform bill recently?

Posted by ArtE | Report as abusive

My news may be old, but I always thought the (very clever) rule was that cash discounts are allowed, but credit surcharges are not. Yep, Google confirms: the Cash Discount Act. Funny thing, consumer psychology. Even today, a merchant can offer you a 3% discount for paying cash. And yet that has a far less powerful effect than charging for credit-card use.

For a quick laugh, here is Visa’s propaganda on the subject: http://usa.visa.com/personal/using_visa/ no-surcharge.html

I really hate Fair Isaac when I read things like that. If not for the tyranny of the FICO score, I could have spent the last two decades paying cash for purchases. Instead I subsidize ads like that one.

Regulating interchange is a form of price cap and in this economy price caps are not particularly effective and often have significant unintended consequences.

Actually, if interchange was capped, the credit card companies would massively reduce reward programs (the majority of interchange fees go directly back to cardholders in the form of rewards) and increase other fees and reduce credit lines further. In addition, due to lower rewards programs it is possible that people will use the credit cards less and debit cards more.

I would say that retailers complain about interchange fees but it allows them to generate revenue they otherwise would not have and not have to take credit risk, and fraud risk. Before the payment networks were established, individual retailers had to make decisions on whether to extend credit to their customers which is something (usually) beyond the core competency.

“I do not think merchants face anything but flat charge per card type.”

Wrong. Interchange is based on the type of transaction. PIN based transactions usually have a flat fee ($.30-.50), while signature-based are a percentage rate of the ticket sale.

According to DTPI, only 13% of interchange goes to actual card processing. 44% goes to a bank/issuer’s rewards program. 35% goes to profit margins.

Posted by J | Report as abusive

“What seems to be true is that certain cards (I’m looking at you, American Express) charge even yet more than others. The fees really are usurious.”

Oh yeah, but I am absolutely happy that Amex is doing that, however. I have an Amex card, and it’s proven to be much better when it comes to looking after my interests, than Mastercard or Visa. Your retailer won’t accept a return? Visa can’t do anything about it, but Amex will just tell the retailer to take a hike and not get paid. Your gadget out of warranty? Amex pays for it. I heard that it even compensates stuff being broken in the first few months, but I haven’t tried it myself so I am not totally solid on that point.

The moral of the story is, the profits (somewhat extortionate in Amex’s case) come out of somewhere, and they go somewhere. It’s not a free lunch. And it protects you from slimeball retailers (say hello to BestBuy) in a way that it would have no incentive to if the interchange fees are lower.

This is probably one of the reasons why a place like Neiman Marcus only takes Amex. Amex shoulders the risk that Neiman, being the premium retailer it is, would have shouldered out of “customer satisfaction” costs.

Posted by Myles SG | Report as abusive

As you point out, the for-profit banks would recoup losses. However, as with most reporters you fail to access the impact on NOT-FOR-PROFIT financial institutions or better know as credit unions.

Credit unions are small, local, financial co-ops where the members are the owners. Credit unions do not sell stock and can not raise private capital. Most credit unions barely break even on their Visa and MasterCard debit/credit products. Interchange fees allow credit unions to offer these products and services to their members.

Capping interchange is business on business crime that greedy retailers like WalMart and the oil companies are in favor of in order to line their pockets. Haven’t they gouged the American public enough?

I challenge the author to pick up the phone and call a local credit union to find out about the not-for-profit side.

Posted by Credit Union Supporter | Report as abusive

I agree, I don’t think that the government should have any say as to what the interchange fees should be. Listen, some companies don’t transact American Express because of their fee, but accept Visa because there’s no fee. The system has been working like that for years. Leave it up to the company to decide whether to accept certain cards. It’s the people of American and other countries that possess the credit card that are misusing how a credit card is intended to be used. It’s the irresponsible “PEOPLE” that are screwing up the system!

Some comments said merchants had the choice to accept or not to accept credit cards. True, but if a merchant does not accept cards then the number of customers will go down considerably. Merchants are really stuck between banks and consumers’ habit.

Posted by jup | Report as abusive

If the consumer chooses to use Credit / Debit or Pre-paid cards and the merchants want there business. Then they ought to accept these kind of cards. If the merchant doesn’t accept the cards then they may sell less. So Merchants, make up your minds. Do you want more sales and with that potential to higher profits or do you want less sales go back to checks and cash with little to no leverage for the cardholder to get their money back for bad products or bad service?

Posted by Chris R. | Report as abusive

“Would lower interchange fees mean lower prices for consumers? Probably not — I suspect that Miles is right when he says that the profits would largely go straight to retailers’ bottom lines.”

Actually, much of the benefits probably would be passed onto consumers. Many businesses that rely on credit cards are in fairly competitive industries – retailers, restaurants, gas stations, etc. Competition means these businesses are highly likely to pass savings onto consumers. Consider gas stations, falliing oil prices translate almost immediately to fall gas prices at the pump, not higher gas station profits. There are some exceptions – monthly billers like cell phones, cable, and utilities for instance, but even in these cases competition creates some incentive to pass savings onto consumers in the long run (actually some of the “monthly billers” already charge to accept credit cards vs. automated debit payments precisely because of credit card fees).

Posted by Benthamite | Report as abusive