Felix Salmon recently inquired why credit unions were fighting interchange reform, and like me when I’ve investigated this, he gets no hard numbers from anyone. The credit card companies, and banks too, are some of the most quantitatively sophisticated groups out there. I always find it dubious how quick they are to hide the obvious numbers that would make their case – that interchange is rising because costs are rising.
About a few weeks ago I reread pretty much everything Adam Levitin has written, so there’s going to be some posts about his work in the next week (Levitinbomb!). First up, though, he has studied interchange closely and can point out the specifics of the debate that are confusing.
The current system that prevents discounting debit over credit isn’t an accident. These merchant rules of not allowing discounting, minimums or maximums are designed to guide the payment system to certain people’s benefits. Here’s Adam Levitin’s Priceless? The Competitive Costs of Credit Card Merchant Restraints, which is the best one-stop paper for the topic I’ve found:
There is no marginal benefit to the merchant from accepting premium cards. He has merely funded the affluent Visa Signature card consumer’s first class upgrade or cash rebate. The consumer who purchases on the Signature card has functionally received a discount not available to other consumers…
The net effects of the card associations’ rules are: (1) to force merchants to charge the same price for goods or services, regardless of a consumer’s payment method; (2) to prevent merchants from steering consumers to cheaper payment options; and (3) to increase the number of credit card transactions and thus interchange and ultimately interest income for issuers.
Merchant restraints prevent consumers from accounting for the cost of payment systems when deciding which one to use. Instead, consumers decide based solely on factors such as convenience, bundled rewards, image, and float. These factors tend to favor credit card transactions over other payment systems. Higher purchase volume increases the issuer’s income on the front-end in terms of interchange fees and on the back-end in terms of more interest, late fees, and penalties.
If you are worried about the pernicious and predatory nature of our late fee credit system, remember it isn’t an accident that we’ve ended up here. The credit card companies knew about “nudging” decades before Richard Thaler and Cass Sunstein. Giving merchants the legal options to negotiate among card types will take this off the table.
During the conference, someone asked about the minimums and maximums part of interchange reform. The minimums are all about the fixed costs, but people on the panel thought that the maximums were some part of merchant plot. I didn’t have a great story for it other than knowing high-end purchases that are returned involve a lot of fees that really sting merchants. But here’s a better story behind maximums from Levitin’s paper:
For large transactions, the flat fee portion of the interchange fee is not important, but merchants are less keen on surrendering a percentage cut to the banks on large transactions than on small ones because of the total amount involved. The merchant receives the same essential service of fund transmission from its acquirer on a $50 payment as on a $5,000 payment, but the merchant will pay 100 times as much for the $5,000 transaction. In contrast, cash, checks, automated clearing house (NYSE:ACH) transactions, and most PIN debit transactions, cost a flat amount to accept. Thus, a merchant will pay approximately 5¢ to accept either a $50 ACH transaction or a $5,000 ACH transaction. For payment systems other than credit cards (and off-line debit cards that use credit card ACS networks), the marginal cost increase based on the number or size of transactions is minimal.
And a response to Zywicki
And two points from Levitin’s blog Creditslips on Zywicki’s paper specifically. One:
But there is another possible regulatory outcome that Zywicki never considers: banks might simply have to endure lower profit margins. If the consumer side of credit card pricing markets is competitive as Zywicki believes (I’ve got my doubts, which is the point of the whak-a-mole thesis), then the result should be smaller profit margins, instead of shifted fees. Zywicki seems to take it as a given that banks must maintain profitability levels. But they don’t. That’s the nature of capitalism: bank have a right to make a profit, but only through fair and legal competition. If a bank can’t operate profitably under those conditions, should it really be in business?
Zywicki provides several examples of cross-subsidies in the consumer economy: Starbucks charges the same price regardless of whether a consumer takes sugar and cream, so those who take their coffee black subsidize the sugar and cream of the others. Supermarkets offer free parking, so the walkers subsidize the drivers.
Zywicki’s examples, however, are false analogies to the credit card interchange cross-subsidy from users of low cost payment methods (cash, debit, nonrewards credit) to users of high cost payment methods (rewards credit). The Starbucks’ cross-subsidy is Starbucks’ business decision. The free parking cross-subsidy is the grocery store’s business decision. But the interchange cross-subsidy is not the merchant’s business decision. It is the card network’s business decision. Card networks force merchants to impose a cross-subsidy. It’s an affront to the nose-picking rule of commerce: you can pick your friends, you can pick your prices, but you can’t pick your friends’ prices….
Let’s see what happens to the Durbin amendment in conference committee.