State the Issues - August 2005

State the Issues

by Noah J. Hanft , Teri Richman

Question: Should interchange fees charged by credit card companies be regulated by the government?

by Noah J. Hanft

MasterCard cards provide cardholders and merchants with a valuable proposition. Cardholders can purchase almost anything just about anywhere in the world with a single piece of plastic. Merchants increase sales and receive guaranteed payment, as well as management of lending losses, fraud and the skyrocketing cost of meeting regulations. Merchants pay an extremely small price for the value they get from accepting MasterCard.

Interchange is a small fee paid by the merchant’s bank to the cardholder’s bank to balance costs in the system. It is set by payment systems to accomplish one goal: to maximize output, meaning more cards in circulation, more use of cards by consumers, more merchants accepting cards and more sales for those merchants. It enables payment systems, like MasterCard, to provide the services that allow thousands of financial institutions to offer a huge range of payment options to millions of merchants and cardholders around the world.

The U.S. economy continues to thrive while many other economies in the world are stagnant because of our belief in the wisdom of the free market. Those who advocate regulation or want to litigate over interchange seek to replace the wisdom of the free market with their "guess" of what is best. Time and again, history has shown that where free markets are destroyed, costs ultimately go up and quality ultimately goes down. If the advocates against interchange get their way, they will ultimately drive up the costs of using credit and debit cards by undermining the system that has been a home run for the global economy, cardholders and merchants.

They claim interchange is a "hidden tax" because the fees aren’t disclosed to consumers. Under that line of reasoning, every cost a merchant has should be defined as a "hidden tax," because it is not disclosed to consumers. When was the last time you walked into a store and had the merchant say a sweater costs $50 because he pays $3 for yarn, $10 for labor, $3 for shipping, $4 for employee time, $5 for utilities, $2 to keep track of cash, $3 to deal with bad checks, and he makes a profit of $20?

Simply put, it is the job of markets to set prices. Ironically, retailers understand this better than anyone. They certainly do not want the government setting prices for goods and services they sell. So why do some call for government intervention here? Is it really because they believe in the unfairness of bankcard system? Or might it reflect a far more fundamental wish: to pay less.

by Teri Richman

In most countries, the United States being the notable exception, interchange rates have declined or are declining. In some cases, it has been as a result of recent regulation. However, even before these reductions, the U.S. interchange rate was considerably higher than that of other countries, including the UK, Australia and the European Union. In Europe, fees average about 0.70 percent, and in Australia, they average 0.55 percent. In the United States, however, interchange fees average 1.75 percent on every MasterCard or Visa transaction.

In the United States, Visa and MasterCard are such strong unregulated monopolies they are free to collectively arrive at interchange pricing with no oversight and no transparency. Their sheer market power and monopoly status make them different from other cards in use today.

As a result, this is a "hidden tax" on every American family, estimated at $232 per household per year. Moreover, the new rewards cards being promoted are not yet providing any discernible benefit to merchants. For the convenience store industry, an analysis of four recent months of data shows the typical transaction on cards of all types is $24.36, whereas the typical reward card transaction is $19.69. No sales lift there.

In fact, it defies logic that the notion of rewards will be enough to encourage the vast majority of consumers to spend six times more, as MasterCard contends. The fact is, rewards are available to an elite few. Cash customers are hit hardest as they pay the same for goods and services as everyone else. In the current environment, surcharging for credit is prohibited and the discounting-for-cash laws in the states are complex and ambiguous.

So, is regulation the answer? That’s hard to say. The question, however, is on point. We are delighted that the Kansas City Federal Reserve Bank held a forum on this issue earlier this year and that New York will host one in September. They, after all, are the ones who must ensure a healthy banking system for our nation. We applaud their efforts to take a look at what other countries, where interchange is regulated, have done and what the effects have been. Finally, it is also more likely than not that Congress will also take a look.

Interchange is a system out of control. Regulation may be the answer, but one thing is certain and that is that merchants are finally being heard on this matter and change may well be in the offing.

Noah J. Hanft , Teri Richman
Noah J. Hanft is general counsel for MasterCard International Teri Richman is the secretary for Merchants Payments Coalition, Inc.