The Latest Chapter on Interchange Fees
Published by David Evans on February 24th, 2008
Filed Under:
Payments, Regulation, Economics
The wagons continue to circle around the payment card systems over interchange fees. The European Commission has found MasterCard’s fees for cross-country transactions unlawful and Visa is next on their radar screen. Meanwhile merchants seem to be hedging their bets with their mega antitrust case in the United States with MasterCard and Visa by getting Congress to look into protecting their interests.
Government regulation of interchange fees, and making the fees lower, will eliminate one of the major tools that the card systems have for encouraging banks to join their systems and for encouraging banks to entice cardholders to take and use their cards. Antitrust liability in the U.S. could also lead to yet another drain on bank members if they have to fund settlements or damage verdicts.
One can debate who is right in this debate. Merchants bemoan the market power of the card systems, but that complaint is a bit ironic coming from companies like WalMart. The card systems sometimes talk about all the services that merchants get for the interchange fees paid, but at the end of the day this is a simple two-sided business model where the basic economics means earning the profits from the merchant side and not the consumer side (see free tv and shopping malls for other examples).
But whoever is right on this, it is just smart business to at least start planning for the day when there are caps on interchange fees. Systems need to make sure they have other tools available for competing with other systems—right now they use higher interchange fees to attract bank members. And banks—especially ones issuing credit cards—need to pay attention to Australia where the banks have already adjusted to lower interchange fees.
My own view is that we should let the markets sort out the right business arrangement between merchants and card systems and neither the governments nor the courts should stick their noses into a highly efficient payment system. Unfortunately, that view may not prevail and banks and systems should have their contingency plans sewn up.
For more on how the payment industry works, take a look at Paying with Plastic.
David,
It is very easy to say “let the market sort it out,” but that ignores the serious restraints placed on the market by the card networks’ operating rules like no-surcharge and honor-all-card rules. If we really want a market solution to interchange issues, let’s start by actually having a free, unfettered market. If we do that, interchange fees will be subject to full market discipline.
Interchange is a historical relic from a different era of banking regulation. The original reason interchange started in the 1970s was to evade Truth-in-Lending disclosures and then-potent usury laws. Later, interchange morphed into a tool for recruiting banks to multi-bank networks. But the need for multi-bank payment card networks was because of US banking regulations in the 1970s that prevented banks from having multi-state branch banking operation. If a bank wanted to do branch banking and have a payment card network, it had to be part of a multi-bank system. Amex didn’t do branch banking, so it was able to be a national single-bank network. Other banks had to form associations to work around the branch-banking regs.
Since 1994, however, the branch banking regulations have ceased to be an issue. So what is the social value of continuing with the multi-bank network with its problematic interchange fees? Wouldn’t we be better off with single-bank networks without interchange fees, like Bank of America toyed with doing a couple years ago?
David - I do agree with your assertion that governments/regulatory bodies should ‘let the markets sort it out’, but at the same time have to give in to some of Adam’s points above.
V/MS have extremely restrictive rules/policies and closed system architectures, which need to go away to enable people to choose for themselves. E.g. The Amex/Discover lawsuit and the Walmart/Retailer lawsuit that V/MC lost
But I would like to counter with this question - If interchange goes away, what would replace it? How would the pricing work as this is inherently an oligopolistic market and we have five stakeholders - network, card issuing banks, merchant’s banks/processors, retailers and consumers?
Regulation of interchange in other countries has not resulted in any price decrease to consumers, in fact it has resulted in reduction in options for consumers and increase in cost of accessible financial services to them.
It is pretty much a given that acceptance of electronic (incl. card-based) payments will continue to increase and we need to come up with a pricing mechanism which provides sufficient incentive for players to operate and innovate.
P.S. Interesting site… Need to get hold of a copy of the book!
Thanks Anon. Hardly anyone serious is talking about actually eliminating the interchange fee. There has to be some agreement between banks that acquire merchants and banks that issue cards on who gets what as a result of that transaction, how risks are going to be borne, and so forth. And hardly anyone, including regulators, who have looked at this business seriously believe that in most countries there could be bilateral deals between acquiring and issuing banks–too many possibilities, way too complicated. So the question is what the interchange fee is going to be and who sets it. So as a practical met it either gets set by regulators (who may give the bank systems a formula for calculating it) or it is set by the systems. Most regulators have advocated setting it at a level that allows issuing banks to recover some costs they incur on behalf of the acquirer; a few have suggested that it should be set at $0 (which is a price, but not a zero one).
If interchange fees are regulated so they are at 0 or at cost then the bank systems won’t have this fee available to them to adjust the relative cost of the system borne by merchants vs cardholders and won’t have it available to them in the competition for banks with the closed systems (Amex, Discover)that aren’t covered by regulators.
Generally, when prices are regulated in markets businesses figure out ways to achieve business objectives in different ways. In Australia so far this has resulted in banks simply adjusted prices to that cardholders don’t get as good deals. But the big change wrought by the interchange fee regulation is the change in the organization of the systems.
MasterCard and Visa have both moved away from being cooperatives of banks (MasterCard did this in 2006 and Visa will do this later this year)–which subjects them to antitrust complaints that the interchange fee is is price fixing among banks–and are becoming closer to being systems like American Express with public shareholders. American Express can charge merchants out the wazoo without facing much of any antitrust risk. These new publicly owned companies will no doubt move in other directions that allow them to compete with no, or low, interchange fees.
Sorry for this long response. David.
Hi David,
I am Yonghui Chen. Your book Paying with Plastic (2nd edition）was translated into Chinese by us. I had a good cooperation with Terry X. Xie. Your book is welcomed in Chinese payment industry.
Now I am in internationl division of China Unionpay, looking after Australia and New ZeaLand market.In Australia, China Unionpay cooperate with NAB( National Australia Bank）and FDI(Cashcard). In New Zealand we cooperate with BNZ( Bank of New Zealand).I spend most of my time in Sydney.
I leave this message just want to say hello to you. My email address is yhchen1@chinaunionpay.com.