Tag: merchant discount fee

  • Interchange Fee Settlement

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    Adam Levitin

    MasterCard settled a lawsuit brought by the European Commission’s Directorate General for Competition, which alleged that MC (and Visa’s) “Multilateral Interchange Fee” (MIF) an interbank fee for cross-border transactions in Europe (basically good old US interchange) was anticompetitive. While the settlement allows MC to keep charging an MIF, MC agreed to drop the weighted average of the fee from between .8% and 1.9% to .3% for credit cards and .2% for debit cards. As the Commissioner for Competition Policy noted, “MasterCard could not justify their level with any solid methodology, or explain what, if any, efficiency gains were being passed on to merchants and consumers at the end of the day.” Visa has not settled in the litigation.

    MasterCard’s MIF was always much lower than US interchange, which is somewhere upwards of 2.0% (and that’s not the full merchant discount fee, just the interchange component). But now we see that MasterCard has decided that it can survive by charging just .3% interchange on credit cards in Europe. So why are American merchants going to pay seven times as much in interchange for credit card transactions? Are American banks or merchants seven times riskier? Or is US antitrust law just seven times weaker?

  • Interchange is No Laughing Matter

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    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.  

  • 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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