The Merchants Payments Coalition, a merchant alliance that is pushing for reform of the credit card interchange fee system, has a nifty little cartoon out in Roll Call and the Washington Times.
So a few words of explanation. Interchange is no small change. I've written about it on the blog here, here, here, here, here, here,here, here and here. Interchange is technically a fee paid on every credit card transaction by the merchant's bank to the bank that issues the credit card to the consumer. The fee is set by the card network (MasterCard, Visa, etc.). While interchange fees are generally in the range of a couple of percent of credit card transaction value (say 2%) it adds up to big bucks. $48 billion last year!
The fees depend on the type of business the merchant is in, the way the transaction is processed (card present or not, e.g.), the size of the merchant's business, and crucially, the type of card used. Each card network has a couple of flavors of cards depending on the rewards and customer service that go with the card. The more rewards, etc., the higher the interchange fee, as nearly half of interchange is used to fund rewards programs (and card issuers' financials illustrate this–rewards are listed a reduction in interchange revenue).
More broadly, though, interchange is used to refer to the "merchant discount fee," the fee that the merchant's bank charges the merchant for every card transaction. The merchant discount fee, of course, includes interchange as its major component. Interchange sets the floor for the merchant discount fee. If interchange is 2%, the merchant discount fee might be 2.5% or 3% or even 15% for high risk merchants (GOB sales, adult Internet sites, etc.).
Merchants are likely to pass some or all of that merchant discount fee back to consumers in the form of higher prices. Merchants can't pass it back just to card users because credit card network rules prohibit them from surcharging for credit or from discriminating among cardholders. Federal law allows merchants to offer discount for cash, but that's not the same economically as a credit surcharge, even if it is the same mathematically.
What's more, the problem for merchants isn't that they don't want to take credit cards. Instead, merchants want to avoid the higher cost rewards cards for which they receive no clear benefit. The federal right to offer cash discounts doesn't help merchants avoid high cost rewards cards.
Interchange is not just a merchant vs. bank issue. It's an issue that affects the entire consumer credit system. As I've written elsewhere, interchange supports and encourages reckless credit card lending and is used to fund rewards programs that encourage overuse of credit cards for payments, which inevitably results in unintentionally and expensively revolved balances and late/overlimit fees.
Interchange is transaction-based revenue; the issuer doesn't incur the consumer's credit risk. That means that issuers can risk greater credit losses because they've already made a nice bit of money via interchange with virtually no risk. Not surprisingly, interchange has increased over the last decade from being about 13% of card issuer revenue to being 20%. Just as with mortgages, the shift from a lending to a fee-based business model encourages more reckless lending. Securitization only further encourages this, although it works differently for credit cards than for mortgages, an issue about which I'll post another time.
To be sure, issuers can argue that interchange covers the cost of the typically 20 days of float on gets on a credit card. But if that's the case, then it's really a finance charge for a 20 day extension of credit, which would be annualized at 36.5% APR (based on 2% interchange rate). And if we include a merchant discount fee (including interchange) of 3%, then we're talking about a 55% APR. And that's not including the cost of then revolving a balance. In short, credit cards are a lot more expensive then they appear.
To be fair, there are costs associated with other payment media. It's expensive to print and distribute cash, and the inefficiencies of the paper check system of legendary. But these are both systems in which the government is heavily involved. And that means that the costs are, in theory, subject to political control. MasterCard, Visa, American Express, and Discover are, at best, subject only to shareholder control. Payments are a lot like a public utility. They are as essential a part of the economic infrastructure as the electric grid or the water pipes. And maybe we should think about regulating them as such.
Comments
2 responses to “Interchange is No Laughing Matter”
Even if interchange supposedly covers the ‘grace period’ (during which borrowers can essentially get a free loan), why should merchants (and by extension, of course, their consumers, including those who don’t use credit cards — and get rewards) pay for a contractual term set by an issuer and charged to its (credit-card carrying) customers???
I think about this every time I see someone using a credit card to buy a donut & coffee. The card companies have done a great job of convincing people that paying cash is passe and plastic is faster and more convenient (though it doesn’t really feel like it when you’re waiting in line–has anyone actually measured this?). Why do they deserve a cut of every transaction we make? They don’t. We should burn our credit cards the way draft cards were burned in the 60s. But I don’t see this becoming a consumer issue, even though the game is rigged against them.