Following last week’s blog, where we discussed the basics of interchange fees – what they are and why they are controversial – we will now focus on possible ways in which they will evolve as all parties involved – regulators, merchants, issuing & acquiring banks, networks and consumers – seek to improve card payments systems.
All of the options being considered aim to solve one or more of the reasons why interchange fees are controversial (list included in previous blog). Below I list a number of these options:
1) Do nothing. It would only make sense to change the status quo if we can ensure that the resulting outcome will be more efficient. It is very difficult to develop this type of quantitative ‘proof’ given the complexity of the system, so how can we determine the best alternative if we cannot measure and compare the different outcomes?
2) Further enable differential pricing across payment methods (affecting the no-surcharge rule). When considering this alternative, it is important to remember that most merchants in countries (or states within the US) that are already allowed to apply differential pricing have chosen not to do so. The reason for this is probably the unknown effect it has on sales. If faced with higher prices at a store to use, for example, an AmEx card, will the consumer just use a different card (if he does indeed have another card)? Will he go to another store instead? How many impulse purchases will be lost? There may be too many unknowns for retailers to feel comfortable with experimentation, particularly within the current economic environment.
3) Allow bank / merchant determination of interchange fees. This option would (a) eliminate anti-competitive concerns (external third party setting up fees in a way that may encourage higher prices) and (b) allow large merchants to leverage their size in negotiations, potentially giving consumers a more efficient system.
The main draw-back would be complexity – Each issuer would, potentially, need to negotiate fees with each merchant, raising the number of contracts each issuer needs to manage into the thousands. The same would be true for each merchant.
4) Regulate fee level. Given that the general perception is that interchange fees are too high, this option would probably equate to lowering them. The problem the regulators would face is the same banks and merchants are struggling with today: How to set this level so as to ensure that it reflects benefits / costs borne by the parties? What level will make the credit card system most efficient and beneficial for the consumer (for example, in the way it would affect acceptance and rewards)?
5) Relax card acceptance requirements (affecting the honor-all-cards rule). The honor-all-cards rule has become very controversial in the last few years as the networks have introduced premium cards that have higher interchange fees attached. It could make sense to allow merchants to decide which cards, within each network, they wish to accept.
The main issue is that we could run into similar problems as those described in the second option above: What would a consumer do if his preferred card is not accepted at a store? How much would be lost in sales? Furthermore, how can a merchant describe the credit card programs it does and does not accept in a way easily understandable to consumers?
6) Allow multi-bugged cards. The idea in this case is to provide consumers with one card that connects to all networks. Then, at the point of sale, based on the specific purchase, the retailer will choose the best network (probably cheapest) to carry out this transaction. It would mean each issuer would need to enter contracts with multiple networks.
This option may be the one that will result in the most efficient outcome since it allows for direct competition among networks at the point of sale. At the same time, it would be difficult to implement. For example: What info would the merchant provide to the consumer regarding routing (or would it not be relevant)? What logos would the card carry? Would this result in less brand recognition for networks and therefore fewer incentives to innovate?
Whatever option is taken, except for the ‘Do nothing’ alternative, change will come slowly since:
1) The effects need to be detailed and quantified: Because of the number of players and the complex relations among them, any change will have numerous implications, some of which are difficult to anticipate.
Also, up to this point, regulators and industry players, have been able to describe some of the qualitative effects of these changes but have had difficulties in creating credible and comprehensive quantitative models.
2) Revenues – whether more or less – need to be re-distributed. As we have previously discussed, interchange fees are meant to reflect the benefits of the merchants and acquiring banks while covering the expenses of the issuing banks. Both things are extremely difficult to measure – some may even argue impossible to measure. How then should a new revenue and fee structure be built?
3) Three-party networks and debit-card transactions also need to be included in the conversation. So far, the conversation has focused on four-party credit card networks but the full spectrum of payment options should be included in the conversation to avoid networks migrating from more to less regulated service options.
Furthermore, with new payment systems constantly being developed, any new rules and regulations should be flexible enough to allow for new options and challenges.
Interchange fees are a controversial topic. Changes will be implemented slowly given the difficulty in determining the cost / benefit the credit card structure provides to issuers and merchants and in quantifying the effects of any change. Controversy is here to stay!
Sources:
1) 'Payments Systems in the U.S. - A Guide for the Payments Professional' by C. Coye Benson and Scott Loftesness. Glenbrook Payment Essentials.
2) 'Finance and Economics Discussion Series. Division of Research & Statistics and Monetary Affairs. Federal Reserve Board, Washington, D.C. - Interchange Fees and Payment Card Networks: Economics, Industry Developments, and Policy Issues' by Robin A. Prager, Mark D. Manuszak, Elizabeth K. Kiser and Ron Borzekowski.
3) 'Theory of Credit Card Networks: A Survey of the Literature' by Sujit Chakravorti from the Federal Reserve Bank of Chicago.
4) 'Working Paper 03-10. An Introduction to the Economics of Payment card Networks' by Robert M. Hunt from the Federal Reserve Bank of Philadelphia
All of the options being considered aim to solve one or more of the reasons why interchange fees are controversial (list included in previous blog). Below I list a number of these options:
1) Do nothing. It would only make sense to change the status quo if we can ensure that the resulting outcome will be more efficient. It is very difficult to develop this type of quantitative ‘proof’ given the complexity of the system, so how can we determine the best alternative if we cannot measure and compare the different outcomes?
2) Further enable differential pricing across payment methods (affecting the no-surcharge rule). When considering this alternative, it is important to remember that most merchants in countries (or states within the US) that are already allowed to apply differential pricing have chosen not to do so. The reason for this is probably the unknown effect it has on sales. If faced with higher prices at a store to use, for example, an AmEx card, will the consumer just use a different card (if he does indeed have another card)? Will he go to another store instead? How many impulse purchases will be lost? There may be too many unknowns for retailers to feel comfortable with experimentation, particularly within the current economic environment.
3) Allow bank / merchant determination of interchange fees. This option would (a) eliminate anti-competitive concerns (external third party setting up fees in a way that may encourage higher prices) and (b) allow large merchants to leverage their size in negotiations, potentially giving consumers a more efficient system.
The main draw-back would be complexity – Each issuer would, potentially, need to negotiate fees with each merchant, raising the number of contracts each issuer needs to manage into the thousands. The same would be true for each merchant.
4) Regulate fee level. Given that the general perception is that interchange fees are too high, this option would probably equate to lowering them. The problem the regulators would face is the same banks and merchants are struggling with today: How to set this level so as to ensure that it reflects benefits / costs borne by the parties? What level will make the credit card system most efficient and beneficial for the consumer (for example, in the way it would affect acceptance and rewards)?
5) Relax card acceptance requirements (affecting the honor-all-cards rule). The honor-all-cards rule has become very controversial in the last few years as the networks have introduced premium cards that have higher interchange fees attached. It could make sense to allow merchants to decide which cards, within each network, they wish to accept.
The main issue is that we could run into similar problems as those described in the second option above: What would a consumer do if his preferred card is not accepted at a store? How much would be lost in sales? Furthermore, how can a merchant describe the credit card programs it does and does not accept in a way easily understandable to consumers?
6) Allow multi-bugged cards. The idea in this case is to provide consumers with one card that connects to all networks. Then, at the point of sale, based on the specific purchase, the retailer will choose the best network (probably cheapest) to carry out this transaction. It would mean each issuer would need to enter contracts with multiple networks.
This option may be the one that will result in the most efficient outcome since it allows for direct competition among networks at the point of sale. At the same time, it would be difficult to implement. For example: What info would the merchant provide to the consumer regarding routing (or would it not be relevant)? What logos would the card carry? Would this result in less brand recognition for networks and therefore fewer incentives to innovate?
Whatever option is taken, except for the ‘Do nothing’ alternative, change will come slowly since:
1) The effects need to be detailed and quantified: Because of the number of players and the complex relations among them, any change will have numerous implications, some of which are difficult to anticipate.
Also, up to this point, regulators and industry players, have been able to describe some of the qualitative effects of these changes but have had difficulties in creating credible and comprehensive quantitative models.
2) Revenues – whether more or less – need to be re-distributed. As we have previously discussed, interchange fees are meant to reflect the benefits of the merchants and acquiring banks while covering the expenses of the issuing banks. Both things are extremely difficult to measure – some may even argue impossible to measure. How then should a new revenue and fee structure be built?
3) Three-party networks and debit-card transactions also need to be included in the conversation. So far, the conversation has focused on four-party credit card networks but the full spectrum of payment options should be included in the conversation to avoid networks migrating from more to less regulated service options.
Furthermore, with new payment systems constantly being developed, any new rules and regulations should be flexible enough to allow for new options and challenges.
Interchange fees are a controversial topic. Changes will be implemented slowly given the difficulty in determining the cost / benefit the credit card structure provides to issuers and merchants and in quantifying the effects of any change. Controversy is here to stay!
Sources:
1) 'Payments Systems in the U.S. - A Guide for the Payments Professional' by C. Coye Benson and Scott Loftesness. Glenbrook Payment Essentials.
2) 'Finance and Economics Discussion Series. Division of Research & Statistics and Monetary Affairs. Federal Reserve Board, Washington, D.C. - Interchange Fees and Payment Card Networks: Economics, Industry Developments, and Policy Issues' by Robin A. Prager, Mark D. Manuszak, Elizabeth K. Kiser and Ron Borzekowski.
3) 'Theory of Credit Card Networks: A Survey of the Literature' by Sujit Chakravorti from the Federal Reserve Bank of Chicago.
4) 'Working Paper 03-10. An Introduction to the Economics of Payment card Networks' by Robert M. Hunt from the Federal Reserve Bank of Philadelphia
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