The interchange fee panel

By Felix Salmon
June 9, 2010
panel on interchange fees was a little bit frustrating, for me: there were lots of arguments, but everybody seemed to be talking past each other to a large degree. I particularly wanted to get into the argument, which was made by Todd Zywicki in his paper and also by Geoffrey Manne on the panel, that interchange fees were an important way of banks passing on credit losses to merchants. Here's the comment that Zywicki left on my blog:

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This morning’s panel on interchange fees was a little bit frustrating, for me: there were lots of arguments, but everybody seemed to be talking past each other to a large degree. I particularly wanted to get into the argument, which was made by Todd Zywicki in his paper and also by Geoffrey Manne on the panel, that interchange fees were an important way of banks passing on credit losses to merchants. Here’s the comment that Zywicki left on my blog:

I am not arguing that credit risk is overall a money-losing proposition for card issuers for exactly the reason you state–purchases is what generates a customer base for issuers. What I am arguing is that merchants want to argue that the only costs that matter are the marginal costs of processing transactions. That ignores the costs of credit risk. Once that variable is considered, with respect to credit cards, it is not obvious at all that merchants are being overcharged on interchange fees. For reasons discussed in the paper, merchants likely would have issued much of this credit in-house (or foregone sales) and would have suffered similar, and probably larger, credit losses.

My take is exactly the opposite: that the provision of credit is a source of profits, not of losses, and that talk of “credit losses” makes no sense without looking also at credit profits, in the form of fees and interest payments. It’s undoubtedly true that merchants get higher revenues as a result of their customers being able to buy things on credit. But it’s silly to say that the merchants are dodging losses insofar as those customers default on that credit: after all, no one accuses them of dodging profits insofar as other customers end up paying much more, over time, for their purchases than the merchant received, after factoring in those fees and interest payments.

I was also interested to hear a number of people try to make the case that interchange fees are rising because of the rising amount of fraud and identity theft. I haven’t seen much in the way of hard numbers on this front, but it does seem obvious to me that if banks were seriously worried about fraud and identity theft, they would lobby for the same EMV (or chip-and-PIN) system that most of the rest of the world uses, rather than relying on cards with magnetic stripes. The UN’s credit union has just started offering these cards to its customers in the U.S., probably because they tend to travel abroad so much. Why are the banks happier to suffer fraud losses and raise interchange fees to make up for them than they are to implement EMV? Because EMV would involve a cost, for them, while interchange fees are a significant profit center.

After the panel was over, a representative of CUNA, the credit union association, introduced himself to me. I asked him why CUNA was opposed to the Durbin amendment which places limits on interchange fees, even though it explicitly excludes 99% of credit unions; he said that it was simple, really. If the Durbin amendment goes through, then interchange fees are likely to come down across the board, and credit unions make lots of money from interchange fees.

And if credit unions make lots of money from interchange fees, you can only imagine what the big banks make: 15 large banks have almost 95% of the credit card market, where interchange fees are the highest. The fact is that the banks love interchange fees because they’re an easy and invisible way of providing billions of dollars in effort-free profit. So let’s hope that the Durbin amendment goes through, and starts to tilt matters in the other direction, moving those billions of dollars out of the hands of the banks and into the hands of merchants and consumers.

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