Opinion

Felix Salmon

Will US courts take aim at credit-card interchange?

By Felix Salmon
January 12, 2012

Dan Freed has an amazing story today about credit-card interchange fees — the ones that weren’t touched at all by the Durbin amendment in the Dodd-Frank bill. But it turns out that the courts might yet prove even tougher than Congress: various suits working their way through the legal system could end up costing the banks hundreds of billions of dollars in settlement costs — plus a reduction of interchange fees to something approaching international norms.

The threat here is very real: Visa has already put more than $4 billion in a litigation escrow account, and the card companies’ potential liabilities are much smaller than those of the big banks. Deutsche Bank analyst Bryan Keane says that total damages “could total a couple of hundred billion dollars”, and that’s backed up by some back-of-the-envelope math:

JPMorgan’s 10-K gives no specific numbers regarding its exposure, but notes that, “based on publicly available estimates, Visa and MasterCard branded payment cards generated approximately $40 billion of interchange fees industry-wide in 2009.”

Those numbers cited by JPMorgan would appear to point the way to a very large settlement, since the case covers eight years and counting — from 2004 through the present. Eight times $40 billion is $320 billion, and an influential 2005 report on price-fixing by Purdue University economics professor John Connor that looked at 700 cartels going back to the 1600s found a median overcharge rate of 25.5%. But even if one assumes an overcharge of just 10% — the figure used by the Justice Department in its antitrust cases — that would suggest $32 billion of overcharges over eight years. That number, however, would be trebled, as is the rule in antitrust cases, meaning damages could conservatively be estimated at $96 billion. If Bank of America had to pay roughly 10% of that, as per its 10-K, the bank would have to cough up $9.6 billion.

Freed includes this helpful chart, showing just how high US credit-card interchange fees are when compared to the rest of the world.

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Note that the smallest bar, over to the right, is for the EU as a whole. If Germany is at 1.5, Spain is at 1.1%, and the UK is at 0.8%, then there have to be a lot of countries at or very close to zero in order to bring the overall average down to 0.3%.

Now that Congress has decided quite clearly that it’s not going to regulate credit-card interchange fees, it stands to reason that merchants are going to take their case to the courts. This one will run and run, I’m sure: there won’t be any checks written for a very long time yet. But it’s a huge contingent liability for the banking sector, just as negotiations over a mortgage settlement come to a head. If I were a bank shareholder, I certainly wouldn’t count on credit-card interchange fee remaining at its current inflated levels indefinitely.

Comments
27 comments so far | RSS Comments RSS

When I glanced at that chart’s source note I first saw “Source: Ben Stein Research” and thought “WHOAAA!”. Perhaps an optician’s appointment is due.

Posted by ottorock | Report as abusive
 

Actually, if Germany, Spain and the UK (which together represent about 2/5ths of the EU population) have the rates shown, the only way the total EU rate can be 0.30% is if the remaining EU population enjoys a rate of neagtive 0.23%. That seems highly unlikely, which makes me doubt the reliability of this data as a whole.

Posted by DCWright | Report as abusive
 

Not entirely sure what EU number refers to, although it could refer to the commitment from MasterCard to limit its intra-EU fees on credit cards to 0.3% (Visa Europe has made a similar commitment of 0.2% for debit cards).

See here for an interesting discussion paper on interchange fees in the EU from ECB: http://www.ecb.int/pub/pdf/scpops/ecbocp 131.pdf

Posted by J_F | Report as abusive
 

Cartels and oligopolies do not equal free markets.

free market theory requires a large number of providers as well as buyers so that there is real competition.

Cartels need regulation or they just rip people off through price fixing.

Posted by ErnieD | Report as abusive
 

DCWright – I probably shouldn’t pontificate without looking at the source data, but I’d assume the EU rate is based on an average across countries, not an average across population. Which makes it somewhat less unedifying, but not untrue.

Posted by strawman | Report as abusive
 

I’d be curious if anyone has a good estimate to what degree the additional U.S. interchange fees are split between the issuing banks and better rewards/lower costs for cardholders. Credit cards are a two-sided market, which makes analysis complicated. What I can say is that I feel certain that my card and usage pattern (no annual fee card that does provide point-based rewards on which I don’t carry an interest-bearing balance) would be a money-loser for my bank at 0.30% interchange.

I’d always be interested to know which (if any) of the foreign interchange fees are at that level because it’s been set by regulation.

Posted by realist50 | Report as abusive
 

free market theory requires a large number of providers as well as buyers so that there is real competition.

Posted by seancredit | Report as abusive
 

These are Interchange fees charged to MERCHANTS. That’s why the numbers don’t seem to add up. However, I’d like to see the source data in order to make more assumptions…

Posted by JAGutierrez | Report as abusive
 

There’s a competitor to interchange fees, it’s ubiquitous and costs absolutely nothing: cash. Costco demands it, independent cash stations also, so do plenty of other retailers. Give competition a chance.

Posted by billyjoerob | Report as abusive
 

The interchange fee is only part of the charge Merchants pay. It is the amount that goes to the bank which issued the card. On top of that are “assessments” which fund Visa or Mastercard, and the fees charged by the “acquirer” and its sales agents (the people the Merchants deal with).

Interchange is largely profit for the bank – they get $2 on a $100 transaction and their costs are well under 20 cents.

Perversely because of their duopoly Visa and Mastercard compete by raising interchange charges instead of decreasing them. The higher interchange enable banks to boost their profit at the expense of merchants, who have no alternative to choose.

I suspect the reason rates are much lower in Europe is mainly that Visa and Mastercard competed! It was common for merchants in many countries to only sign up with one or the other. Naturally they would choose the one who gave them lower fees.

Posted by Paul78704 | Report as abusive
 

To explain the EU rate: this is the EU regulated rate that applies to cross-border transactions in Europe (e.g. when a German purchases something in France).
Up to now transactions within one country have been regulated only by that country. However EU are moving towards community wide regulation – probably at that 0.3% interchange rate.

Note again Interchange, though widely misused, only refers to the subsidy which the merchant is forced to pay to the issuing bank. Some European countries have set it at ZERO: in other words merchants pay the acquirer’s costs plus the MC/Visa costs, and the issuing banks have to pay the (minuscule) costs of their own credit card transaction recording.

Any subsidy is evidence of monopolistic pricing. Merchants when they accept a check don’t subsidize the banks check processing costs.

Posted by Paul78704 | Report as abusive
 

We now know what happens, although many of us predicted it before the debit interchange saga took place, when there is a fall in the issuers’ interchange revenues. That shortfall will be offset in one way or another, so that when it’s all said and done, the banks will have managed to get their overall revenues to pre-reform levels and it will be the consumer who will end up paying the bill. Only this time that bill would be much bigger, as banks’ losses from a potential credit interchange cut would be several times as large. http://blog.unibulmerchantservices.com/s ettlement-may-cut-credit-card-interchang e-fees-consumers-beware

Posted by D.D.D. | Report as abusive
 

If costs shift to consumers, and cards reflect more of their real cost, we may start to have something closer to a real free market, where the recipient of the benefits can decide if they are worth the cost.

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Posted by carlasmith1887 | Report as abusive
 

I’m sure the bank will defend their rates by claiming that Americans are slow to get on the technological band wagon and start requiring their cards and POS terminals all have the Pin and chip fraud prevention technologies. The cost of frauds make up the lion share of the transactions cost found in the interchange rates. The EU have widely adopted this technology and we as Americans are lagging behind are we becoming a second rate country?

The interchange fee is explained here http://blog.sekurecardservices.com/credi t-card-processing/interchange-fee/

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