Tag: interchange

  • Interchange is No Laughing Matter

    Posted by

    Adam Levitin
    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.

    SHARK strip

    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.  

  • Interchange and the Price of Gas

    Posted by

    Adam Levitin

    With all the attention being paid to the soaring cost of gasoline, there’s one price component that could easily be lowered that hasn’t gotten a lot of attention: interchange. Americans pay about 10 cents/gallon or $2/tank (20 gallon) in interchange fees. Compare this with the estimated benefit of drilling in ANWAR–3.5 cents per gallon by 2027. Tremendous political energy that has been spent over drilling in ANWAR. If we’re really interested in reducing gasoline prices, then reforming the interchange fee system presents an option of immediate savings that would far outstrip ANWAR. Of course, the maximum savings would be less than from a federal gas tax (18.4 cents/gallon), but a gas tax holiday isn’t permanent. (I’m putting aside the question of whether we should want pricing that encourages fossil fuel consumption.)

    Fortunately, the good folks at Visa are looking out for the American consumer. And out of concern for American drivers, Visa has adjusted its interchange rate schedule. Unfortunately, there’s more than meets the eye to Visa’s apparent benevolence and desire to “Help Ease Pain at the Pump.” The devil, of course, like so many things in the card industry, is in the details.

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  • Interchange Week on the Slips

    Posted by

    Adam Levitin

    Let’s call this interchange week. With efforts to bring the Credit Card Fair Fee Act to vote in Congress picking up steam, I’m going to do a few postings on different aspects of the interchange debate this week. Coinciding with this, the printer proof of my recent article on the economics and origins of interchange is available on SSRN (spoiler: interchange and merchant restraints are less about network effects than about evading TILA, usury laws, and branch banking restrictions).

    So as a primer for the rest of my posts, who’s up for some good ol’ fashion credit card network economics?

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  • Credit Card Fair Fee Act

    Posted by

    Adam Levitin

    This weekend, the lead editorial in the Wall Street Journal was about the Credit Card Fair Fee Act, legislation sponsored by John Conyers (D-MI) and Chris Cannon (R-UT) that would create a special administrative law judge panel to set credit card network interchange fees.

    The Journal came out against the legislation, as a simple fee setting regime. Whether an ALJ panel is the best way to fix the interchange problem is certainly a fair issue for debate…once we all acknowledge that there is a serious problem and that a legislative fix might be in order.

    I was pleased to see that the Journal recognized that there might be some problems in the card market, even if I am less sanguine that a fix will emerge from the market itself. Still, I want to address a few points in the WSJ editorial, though, that should not go unchallenged.

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  • The Visa IPO

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    Adam Levitin

    Visa is scheduled to have its IPO later this week. The IPO could potentially be the largest in history. This market seems like terrible timing for an IPO, although for liquidity-strapped
    banks, the IPO could be a much-needed source of cash. The Visa IPO, along with the 2006 MasterCard IPO and the end to MasterCard and Visa’s dual-exclusivity rules, which prohibited banks that issued MC/Visa cards from issuing Amex or Discover cards, is setting the stage for a major reconfiguration of the payments world in the next decade. These changes could have far-reaching effects for consumers, merchants, and banks because of potential shifts in the way payment networks will compete with each other

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  • Is Spending the Way2Save?

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    Adam Levitin

    Financial institutions have begun to offer programs that appeal to consumers’ desire for assistance with disciplining their saving and spending decisions. These programs draw on the insight of behavioral economics and cognitive psychology that default rules have a powerful effect in shaping consumer behavior. For example, Richard Thaler and Shlomo Benartzi have proposed requiring people to opt-out, rather than opt-in to employer-sponsored savings plans in order to overcome bounded rationality and encourage higher savings rates.

    The first financial institution I know of that offered a savings assistance program was Bank of America’s Keep the Change program, which has been well-critiqued around the web. Now Wachovia has a new program called Way2Save. On the surface the program looks great. But when probed, it isn’t clear whether consumers end up with meaningful savings—increased purchasing power. With all of these programs the question that we need to ask is how much does it cost you to save?

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  • European Commission Rules MasterCard’s Interchange Fees Are Illegal

    Posted by

    Adam Levitin

    In December, the European Commission antitrust authority, the Directorate General Competition, ruled that MasterCard’s interchange fees are illegal. (I realize it is now mid-January, but I wasn’t blogging when it the ruling came out.)  MasterCard is, of course, appealing. 

    Although ruling this made page 4 of the Wall Street Journal, it has gotten very little attention otherwise in the business or general press.  ( The ruling has huge ramifications for consumers and merchants.  The underlying issue is technical, however, but well worth understanding.   

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  • Who’s Paying for Your Rewards Points?

    Posted by

    Adam Levitin

    The relationship between consumers and credit cards gets a lot of attention. But merchants also have relationships with credit cards, and the dynamics of this relationship have significant effects on consumers’ use of credit cards as well as on the competitive landscape in the credit card industry. A lot of my academic work has related to this (I apologize for the self-promoting links), and this post is meant to provide a short summary of some of the issues that arise in this relationship. There are a lot of twists that I cannot convey in this blog posting, but I am happy to carry on a conversation in the comments and refer readers to my articles on the topic for more detail (the most recent papers are at the bottom of the linked webpage).

    Merchants pay banks a fee on every credit card transaction. The fee is referred to varying as the “merchant discount fee” or the “interchange fee.” Because of these fees, credit card transactions are much more expensive for merchants than transactions on most other consumer payment systems: cash, checks, ACH, PIN debit (but not signature debit). There is also significant cost variation among credit cards. Some cards, such as rewards and corporate cards can cost merchants twice as much as others. These fees (tens of billions of dollars) are vital to credit card networks’ profitability and have led merchants to attempt all sorts of strategies to minimize their payment costs.

    The largest component of the fee merchants pay goes to finance credit card rewards programs, which in turn generate more credit card transactions. Although merchants finance the rewards programs, they derive little or no benefit from them. Rather than generating additional sales, rewards programs merely induce consumers to shift transactions from less expensive payment systems to more expensive rewards credit cards. So why, then, do all consumers pay the same price for purchases, regardless of the means of payment?

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