I was interviewed for an article by Matthew Bandyk that was published in US News & World Report. I was asked several questions on interchange.
Q: What about the argument that limiting interchange fees will lead to credit card companies offering fewer rewards and benefits? What about the business side? Are they only benefits for merchants if Congress were to limit interchange fees? Any potential drawbacks? I've read a little about the example of Australia. What kind of regulations did they enact there, and what were the effects? I've also read a little on your blog about how interchange fees affect different kinds of businesses differently--can you give an example?
A: Credit card companies finance their points, miles and other rewards primarily out of interchange fees. Everybody knows that gold and platinum credit cards give more rewards, but very few people know that these cards generate higher interchange fees for merchants to pay. The rewards are financed directly out of those interchange fees. Cutting interchange fees will cause banks to give less rewards, or to find other ways to finance those rewards.
In other countries, whenever interchange fees were cut, there was little evidence that merchants passed the savings on to their customers. The benefits of lower interchange benefit merchants directly, immediately, by lowering their cost of doing business. Theoretically, the lower costs will eventually find their way into the prices that shoppers pay, but that could take a long time. Look at how fast gas pump prices go up when oil is expensive, and how long it takes for prices to come back down after oil goes back down.
In Australia, there were essentially two decisions made to help limit interchange fees. First, the fees were forced to be cut by around half. Second, merchants were given the right to surcharge for the use of credit cards. The result was that credit card companies cut their rewards programs and many merchants began surcharging.
Interchange does not react to competitive forces in the same was as other types of fees. Interchange fees are set by Visa, MasterCard and other card schemes as a feature of each card product that the scheme offers to banks. When a bank is deciding between a Visa or MasterCard logo on their cards, and between one company's platinum card and the other's, it is very tempting to choose the one that provides the highest interchange fees. This competition is what has driven interchange fees higher over the years. Merchants are not part of that negotiation process of course, yet they are the ones that pay the fees. This is where the animosity comes from.
The question is whether merchants receive more benefits from higher interchange cards, like gold and platinum cards, than from standard credit cards. If they do receive more benefits, then they should pay the higher cost of accepting these cards. But today, merchants have no choice to say whether or not they get more benefit and whether or not they will pay more. They must simply accept all cards at the fees defined by the payment schemes, with no recourse other than to no longer accept cards at all.
The payment brands should be competing to provide the best services to merchants to justify their higher interchange fees. This is not happening. And capping or cutting interchange fees will not cause this to happen. However, the threat of surcharging will cause that innovation to finally happen.
Q: When you say surcharging, in the context of Australia, does that mean merchants paying a flat fee for the use of credit cards, as opposed to a fee based on the number of exchanges? What do you mean by "best services"? What's an example of how they could innovate if given the incentive? When you say threat of surcharge, do you mean threat of regulation requiring or allowing surcharges, or something else?
A: Surcharging is the practice of charging customers a fee when they choose to use a credit card. The fee is typically an additional 5% on the cost of the purchase. This is also very common here in Singapore and other parts of Asia, as well as some parts of Europe. In the UK for example, all travel agencies charge customers a 10% surcharge.
Payment brands create lots of new features for their cards, with a focus on customers. Things like guarantees and other features. If there is an incentive to focus on merchants, the payment brands will innovate and create new features and services that make cards more useful and attractive to merchants. This is happening already to a certain extent with marketing services, where merchants can have targeted messages delivered to customers based on their card usage profile, a service that American Express originally offered, and which is now also offered by other brands. Much more work should be happening in this area.
By threat of surcharges, I mean that if a major retailer threatens to begin charging customers a fee for using a specific brand or card type - for example Visa Platinum cards - then there would be strong pressure and incentive for the payment brand to negotiate with the merchant and perhaps promise additional added value in exchange for not surcharging.
Q: Aren't retailers typically prohibited via their agreements with credit card issuers from charging more for customers who use cards?
Yes, yes, that's the problem, that's why merchants are fighting. The credit card schemes prohibit merchants from surcharging. Merchants have challenged that prohibition in many countries, including the US. it's the ability for card issuers to prohibit surcharging that the Australian authorities abolished. They and other governments have found that the credit card issuers abuse their power through those types of prohibitions. It actually started a few years ago in the US when Walmart and other retailers won a major lawsuit that abolished another similar barrier, something called the "honor all cards rule" which required merchants to accept all Visa or MasterCard cards, and not just debit cards for example.