As payment cards have become an increasingly important electronic retail payment type in many countries, payment card fees, especially interchange fees, have become the source of a good deal of controversy. The interchange fee is used by card networks, such as MasterCard and Visa, to achieve a desired balance between merchants accepting and consumers holding and using their cards. Typically, merchants pay the interchange fee, which ultimately flows to the bank that issues the card the consumer uses. Recently, public authorities in many countries have intervened in or have initiated investigations in the payment card markets. The United States is no exception. Congress is now considering bills regarding interchange fees and card networks’ rules, such as no-surcharge rules and honor-all-cards rules, which impose contractual restrictions on merchants.
U.S. merchants are generally dissatisfied with the level at which the fee has been set. They argue that it does not make sense that the U.S. interchange fee is among the highest in the world despite the fact that the United States has the largest number of payment card transactions and the payment card industry exhibits economies of scale. They are also dissatisfied with the idea that the interchange fees fund payment card rewards received by some cardholders. Card networks respond to the argument by saying that although the U.S. interchange fee is among the highest, the total fee level on each transaction paid by merchants (i.e., the merchant service charge, hereafter MSC) is not necessarily higher. Overseas, merchants pay higher fees to acquirers and processors because acquirers assume more risk responsibility. Card networks also claim that the interchange fees are a necessary tool to balance the merchants’ card acceptance and the consumers’ card adoption and usage.
This article provides some empirical evidence in considering the arguments above. First, it compares interchange fees and MSCs for credit and debit cards in the United States and 12 other countries (Australia, Belgium, Canada, Denmark, France, Germany, Italy, the Netherlands, Spain, Sweden, Switzerland, and the United Kingdom) where the payment card industry is well established. Second, it discusses other factors that are important for interchange fee debate, including the total number of card transactions, cardholder fees, and card frauds.
Interchange Fee and MSC Comparison
Figure 1 compares credit card interchange fee rates (%) among 13 countries. The top panel shows interchange fee rates for face-to-face retail transactions, and the bottom panel shows those for e-merchant (i.e., online) transactions. In all countries where MasterCard interchange fee rates are reported in the figure, MasterCard interchange fee rates vary by reward features of the card. No-premium is the rate for the no- or the least-rewards cards and premium rate is for the highest-end rewards cards (World Signia in Europe, Premium in Australia, and World Elite in the U.S.). In contrast, according to the interchange fee schedules posted by Visa Europe, Visa does not have premium card interchange fees in all European countries where Visa interchange fee rates are reported in the figure. Visa sets different interchange fees for premium cards in Australia, Canada, and the United States.
Figure 1. Credit Card Interchange Fee Rates
Note: Spain, Canada, and the U.S. have multiple rates per category. The mid rate (=(lowest rate + highest rate)/2) is shown.
Sources: MasterCard and Visa
It is clear that the United States has the highest interchange fee rates among the 13 countries. The non-premium interchange fee rates in the U.S. are almost comparable to the premium interchange fee rates in Europe. Canada has the second highest interchange fee rates. The no-premium interchange fee rates in Canada are similar to those in the U.S., while the premium interchange fee rates in Canada are much lower than those in the U.S.
Another interesting finding from the figure is that e-merchants are not necessarily charged much higher interchange fees than face-to-face retailers. The interchange fee rate difference between e-merchants and face-to-face retailers is about 0.1% to 0.3%. It is considered that online transactions are much riskier than face-to-face (card present) transactions. Whether interchange fee rate differences reflect the risk differences between e-merchants and face-to-face retailers or differences among the 13 countries will be discussed later in this article.
Unlike credit card interchange fees, debit card interchange fees are difficult to compare across the 13 countries. As Table 1 presents, some schemes use fixed fees, and other schemes use proportional fees with or without a cap. Thus, ranking of the countries based on the debit card interchange fee levels varies depending on transaction value. In addition, in some countries, the domestic scheme is mainly used and the international schemes (MasterCard and Visa) are only used by foreigners. Thus, even if the international schemes set relatively high debit card interchange fee rates, the average debit card interchange fees the merchants actually pay may not be as high. Five countries (Belgium, Denmark, Germany, the Netherlands, and Canada) have a national debit card scheme with zero interchange fees. In Australia, interchange fees of EFTPOS, a national debit card scheme, are paid by card issuers to merchant acquirers. In Sweden, Switzerland, and the UK, MasterCard and Visa have replaced the domestic card scheme(s).
Table 1. Debit Card Interchange Fee Schedules (Face-to-Face Retail)
* α = risk associated for payment guarantee. Information on French domestic scheme interchange fee is from Judgment (Case A 318/02 Servired Interchange Fees) by the Spanish Competition Court. The document (in Spanish) is available at http://www.cncompetencia.es/Administracion/GestionDocumental/tabid/76/Default.aspx?EntryId=31216&Command=Core_Download&Method=attachment.
** In Sweden, Switzerland, and the UK, MasterCard and Visa have replaced the domestic scheme(s).
*** In the United States, MasterCard and Visa’s rates are signature debit rates. Their PIN debit rates are considered as domestic schemes.
Sources: MasterCard, Visa, Reserve Bank of Australia, and European Payment Cards Yearbook.
The average debit card transaction value significantly varies by country (Table 2). The United States has the lowest value ($39.11) among the 12 countries, followed by Canada. Switzerland has the highest value ($134.91), which is more than three times higher than the United States.
Table 2. Average Debit Card Transaction Value (2007)
Sources: Bank for International Settlements, European Central Bank, and Reserve Bank of Australia.
Figure 2. Debit Card Interchange Fees for a US$40-equivalent Transaction
*The domestic debit scheme has zero interchange fees.
** In Switzerland, recently (March 25, 2009) the Competition Commission opened a preliminary investigation into Maestro’s introduction of an interchange fee. Maestro’s interchange fees in Switzerland are not available.
Figure 2 shows debit card interchange fees for a US$40-equivalent transaction. In general, the United States has the highest debit card interchange fees. Two exceptions are Visa’s highest interchange fee rates in Germany and in Spain. In Germany, the interchange fee rate for V-Pay, Visa’s new European debit product based on EMV chip technology, is much lower (0.3%) compared with the interchange fee rate for a traditional immediate debit product (1.58%). In Spain, Visa’s interchange fee difference is based on merchant size. Merchants who generate the smallest transaction value (0-100 million euros) are charged the highest interchange fee (0.43 euros), while merchants who generate the highest transaction value (500 million euros or over) are charged the lowest interchange fee (0.24 euros).
In the United Sates, interchange fees for PIN debit transactions are generally lower than those for MasterCard and Visa’s signature debit card transactions. But, compared with PIN debit interchange fees in the other countries, the U.S. PIN debit interchange fees are higher.
Figures 1 and 2 provide evidence that the United States has the highest interchange fees for both credit and debit cards among the 13 countries, where adoption and usage of payment cards are well advanced. Does the United States have the highest MSCs among these 13 countries? Figure 3 compares MSC rates across 12 countries (Sweden’s data is not available). The MSC includes fees paid to the acquirer, to the network, and to the issuer. Switzerland’s credit card MSC rate is the highest (2.8%), but the rate does not fully reflect the interchange fee regulation that was implemented in Switzerland in 2005. Following Switzerland, Canada and the U.S. have the second highest MSC rate for credit cards (2%). For debit cards, the MSC rate for the U.S. signature debits is the highest, followed by Spain. The third place is shared among the U.S. PIN debit, France, and Italy. Thus, U.S. merchants may not pay the highest MSC rates but they likely pay the second highest MSC rates for both credit and debit cards among the 12 countries.
Figure 3. Merchant Service Charge Rates
Notes: All figures are 2006, except for Denmark (2004), Australia (2009), and the U.S. (2008). Australia’s debit card rate may potentially be negative, because EFTPOS interchange fees received by acquirers are shared with major merchants. The U.S credit card rate is MasterCard and Visa only.
Sources: Peter Jones and Chris Jones, “Explaining Differing European MCS Levels,” Papeles de Economia Espanola, (2006); Reserve Bank of Australia; Carlos Arango and Varya Taylor, “Merchants’ Costs of Accepting Means of Payment: Is Cash the Least Costly?” Bank of Canada Review (Winter 2008-2009); The Nilson Report, “Merchant Processing Fees,” 936 (October 2009). For this figure, the author estimated the signature debit MSC rate, based on Visa and MasterCard’s PIN and signature debit shares; Jeremy Dixon, “Credit Crunch: Dispute Over Interchange Fees Rages On,” YCM (March/April 2009), available at http://www.conveniencecentral.ca/200903/pdf/Credit_Crunch.pdf.
Factors that Affect Interchange Fees and MSCs
Economies of Scale and Card Network Competition
U.S. merchants question why U.S. interchange fees are among the highest in the world despite the fact that the U.S. has the largest number of card transactions. As the top panel of Figure 4 shows, the United States has the largest number of transactions for both credit and debit cards. The number of U.S. card transactions is about 7.5 times greater than that of the second largest country, the UK. Switzerland has the smallest number of transactions – less than 1% of the U.S. card transactions. The second panel shows the number of credit and debit card transactions per capita. Again, the U.S. has the largest number of credit card transactions per capita. In contrast, in terms of the number of debit card transactions per capita, the U.S. is fourth among the 13 countries.
Although the numbers of card networks, processors, acquirers, and card issuers in the U.S. are larger than those in any other countries, each U.S. player, especially a larger one, is likely processing enough transaction volume to take advantage of economies of scale. Thus, if the fundamentals of card transactions, such as transaction processing and clearing technologies and risks are the same across these 13 countries, each card transaction in the U.S. should not require more resources than a transaction in any other country.
Figure 4. The Number of Payment Card Transactions (2007)
Sources: Bank for International Settlements, European Central Bank, and Reserve Bank of Australia.
However, this does not necessarily imply that interchange fees or MSCs in the U.S. should be as low as those in other countries. Literature on two-sided markets suggests that if card service providers (i.e., card networks, acquirers, and card issuers) do not have market power, then the sum of the two fees – one is paid by merchants and one is paid by cardholders – should be close to the cost. Thus, the higher interchange fees or merchant service charges do not necessarily result from the market power of card service providers; rather they might imply lower cardholder fees.
Despite the importance of cardholder fees for efficiency of the payment card markets, information on cardholder fees is not well documented. This is partly because the cardholder fee structure is more complex than the merchant fee structure. For credit cards, an annual fee is typically charged by card issuers (Canada and the U.S. are exceptions); per transaction fee is very rare, but a negative per-transaction fee, i.e., rewards, is given for some transactions. For debit cards, in some cases, a
Table 3. Credit Card Cardholder Fees
**Only for Discover, MasterCard, and Visa. The author visited top 10 U.S. credit card issuers’ websites to check the annual fees charged by those issuers in October, 2009.
Sources: European Commission Directorate-General for Competition, “Report on the Retail Banking Sector Inquiry,” Commission Staff Working Document, January 31, 2007; Reserve Bank of Australia, Payment System Board, Annual Report 2009; Visa Research Services, “2005 Payment Method Factbook: Visa Payment Panel Study.”
Table 4. Debit Card Cardholder Fees
Sources: European Commission Directorate-General for Competition, “Report on the Retail Banking Sector Inquiry,” Commission Staff Working Document, January 31, 2007; Reserve Bank of Australia, Payment System Board, Annual Report 2009; Dove Consulting, “Debit in Canada: An Overview of the Canadian Debit System and Comparison with the U.S. Model,” (February 2004) (This white paper was prepared by Dove Consulting and commissioned by Pulse EFT Association.); Laura Bruce, “2008 Checking Study: Banking Fees Continue to Soar,” Bankrate.com, October 27, 2008, available at http://www.bankrate.com/brm/news/chk/chkstudy/20081027-checking-study-a1.asp; Oliver Wyman, Pulse EFT Network, “2008 Debit Issuer Study,” April, 2008 (detailed summary available at http://findarticles.com/p/articles/mi_m0EIN/is_2008_April_29/ai_n25361372/?tag=content;col1) and “2009 Debit Issuer Study,” June, 2009 (news release available at https://www.pulsenetwork.com/public/upload/storage/file250/file/2009-Debit_Issuer_Study_Release.pdf).
U.S. cardholders likely pay lower cardholder fees or receive higher levels of rewards than cardholders in the other countries. In the United States, fixed fees (i.e., annual credit card fees and monthly checking account fees) are not very common for both credit and debit cards. Although some banks charge a per-transaction fee for PIN-based debit card transactions, only a small percentage (0.6%) of cardholders are affected by such a fee. U.S. cardholders receive rewards for their use of credit cards and (signature-based) debit cards. In contrast, fixed fees are common outside the United States (except Canada for credit cards). Generally, per transaction fees are not used in Europe and Australia. In Canada, cardholders pay a per-transaction fee for some debit card transactions. Credit card rewards are provided in Europe, Australia, and Canada, but details, such as the average levels of rewards and what percentage of transaction value/volume are made by reward cards, are not well documented. In general, debit card rewards are not provided outside the United States.
Do the lower cardholder fees in the U.S. offset the higher merchant fees? In other words, is the sum of the cardholder fee and merchant fee lower in the U.S.? For debit cards, the sum of the two fees is likely the highest in the United States; while for credit cards, the sum of the two fees in the U.S. might be lower than that in some European countries. Interestingly, the sum of the two fees for credit cards is still higher than that for PIN debit cards in the United States.
Unless significant technological inefficiencies or fraud risks exist in the U.S. debit card markets, or debit cards are profit-losing businesses in some other countries, the higher sum of the two fees for the U.S. debit cards may suggest some market power of the U.S. debit card service providers.
In contrast to debit cards, it is difficult to interpret the sum of the two fees for the U.S. credit cards. It is possible that the U.S. credit card service providers have some market power. The lower sum of the two fees for the U.S. credit cards than that of some European countries’ credit cards may imply that the U.S. credit card service providers take advantage of significant economies of scale but they may still earn a profit margin. It is also possible that the U.S. credit card service providers have less market power. The higher sum of the two fees for the U.S. credit cards than for the U.S. (PIN) debit cards may simply imply credit cards require many more resources than (PIN) debit cards.
Even if the sum of the two fees for the U.S. credit cards is close to the resource costs, this does not necessarily imply that the U.S. credit card market is efficient. As two-sided markets literature suggests, efficiency also depends on the fee structure – how to split the total fees between merchants and cardholders. Thus, too much transfer to credit card cardholders through rewards programs might cause inefficiency, especially when a credit card transaction requires more resources than a transaction using other payment methods, such as PIN debit cards. Also, if the transfer is made to very limited group of consumers – for instance, if the majority of rewards are received by high income earners – then the fee structure may potentially create a redistributional issue.
Fraud risk is another factor that likely affects interchange fees and MSCs. It is more likely that not just fraud losses but also costs for fraud prevention and detection affect interchange fees and MSCs. It is difficult to pin down the exact costs associated with payment card fraud, especially the fraud prevention and detection costs. Statistics on payment card fraud losses are becoming available in many countries, while only fraud losses for card issuers are available in the United States (Table 5).
The fraud loss rate varies by country. Italy has the highest loss rate (22 basis points), followed by the UK (10.1 basis points). Five countries listed in the table (Belgium, Netherlands, Spain, Sweden, and Australia) have total loss rates that are lower than card issuers’ loss rate in the United States (5.0 basis points). In some countries, more detailed statistics are available. For example, fraud loss rates for credit versus debit are available in Australia, Netherlands and the UK; in these countries, the loss rate for debit is much smaller – debit loss rates are about one-fifth (Australia), one-eighth (Netherlands) and one-third (UK) of credit loss rates. Types of transactions, such as card-present versus card-not-present and domestic versus international, also affect fraud loss rates. In France, the domestic loss rate on face-to-face and unattended payment terminal automatic payments was 1.5 basis points, while the domestic loss rate on payments at a distance (online, mail, and telephone order) was 25.2 basis points, and international loss rates were much higher across all types of card transactions in 2008.
Table 5. Fraud Loss Rates
Sources: Phillip Myers, “Getting a Fair Deal on Card Payments in the Chip and PIN Era,” European Retail Round Table (presentation at FMI Market Techniques, Washington D.C., February 15, 2005), available at http://www.fmi.org/facts_figs/conference_pdfs/Retail_Payments_Trends_1.pdf.; Welch (2009); ACI Worldwide, “Stopping Card Fraud in its Tracks” (2009), available at http://www.aciworldwide.com/downloads/CardFraudGuide.pdf; Visa Europe, “Payment Security Report Sweden” (2009), available at http://www.visa.se/press/payment_security_report_sweden.pdf; Australian Payments Clearing Association, “Fraud Perpetrated on Australian Issued Payment Instruments,” available at http://www.apca.com.au/Public/apca01_live.nsf/WebPageDisplay/FraudStats_2009A_Summary?openDocument; Interac, “2008 Statistics,” available at http://www.interac.ca/media/stats.php; The Nilson Report, “Credit Card Fraud – U.S.,” 876 (March, 2007); Pulse EFT Network (2008).
Generally, information on how the fraud losses are shared among payment card industry participants – consumers, merchants, and card service providers (card issuers, card networks and acquirers) – is not available. An exception is France. In France, the fraud losses are distributed across cardholders (2.6%), merchants (53.5%), and issuers and acquirers (43.9%).
Although the fraud loss rates vary by country, by card type (credit vs. debit), and by transaction type, fraud losses may only explain a very small portion of interchange fees or MSCs. It is quite possible that card issuers, networks, and acquirers spend tremendous amounts on preventing and detecting payment card frauds. However, due to a lack of data, whether these costs explain a large portion of interchange fees or MSCs is not known. According to Sullivan (2008), U.S. banks spent an estimated $3.1 billion to prevent payments fraud in 2006. The amount is equivalent to 0.1% (or 10 basis points) of payment card transaction value in the U.S. in 2006.
This article first made international comparisons of interchange fees and MSCs and then discussed the factors that likely affect interchange fees and MSCs. Overall, the U.S. merchants pay higher interchange fees and MSCs for credit and debit card transactions than their counterparts in the other 12 countries considered in this article. However, U.S. cardholders likely pay lower cardholder fees or receive higher levels of rewards than their counterparts. The sum of the two fees – the merchant fee and cardholder fee (which can be negative to reflect rewards) – is likely the highest in the U.S. for debit cards, while for credit cards, the sum of the two fees in the U.S. might be lower than that in some European countries. Nevertheless, the sum of the two fees in the U.S. for credit cards is still higher than that for PIN-debit cards. Given the volume of card transactions in the U.S., this higher sum of the two fees for debit cards may imply higher markups for the U.S. debit card issuers, card networks, or acquirers, unless technological inefficiencies or higher fraud risks exist in the U.S. A potentially lower sum of the two fees for the U.S. credit cards than that for some European countries’ credit cards may not necessarily imply efficiency of the U.S. credit cards; the U.S. credit card fee structure – higher merchant fees and negative cardholder fees – may potentially create inefficiency in the U.S. payments system. Due to the lack of data on costs for fraud prevention and detection incurred by card service providers, whether fraud risks explain interchange fees and MSCs is still unanswered, but fraud losses may explain only a small portion of interchange fees and MSCs.