Why the Credit Card Competition Act Won’t Lower Merchant Interchange Fees

In 1955, the island nation of Borneo was in the throes of a serious malaria virus outbreak. It turned to The World Health Organization for help. WHO recommended spraying massive amounts of DDT across the island to kill the mosquitos that carried the disease. Borneo sprayed. Mosquitos died. Malaria cases fell dramatically.

Soon thereafter, so did the thatched roofs of the houses people lived in. It turns out, DDT also killed the insects that ate the caterpillars that spent most of their day munching on roof thatching.

Then there were the rats.

DDT’s collateral damage spread to the food supply that poisoned most of Borneo’s cat population. Since the cats ate the rats that seemed impervious to the chemical, the island soon became overrun with them. That drove island-wide outbreaks of typhus and the plague and made island residents deathly ill.

Five years later in 1960, Borneo again asked for help to control the rat infestation. This time it was the U.K.’s Royal Air Force to the rescue. They parachuted 14,000 cats, packaged into little crates, onto the island to eat the rats in the hopes of restoring the island to its rightful ecological equilibrium.

This is a true story.

Operation Cat Drop, as the operation was dubbed, had its many critics. The images, like this one courtesy of Anifex, made light of the seriousness of the situation – and the seemingly Rube Goldberg-like solution that apparently only 14,000 flying cats could fix.

It is also one of the more extreme examples of what can happen when actions taken by those in positions of authority “for the good of the people” backfire when they fail to contemplate the downstream effects — the unintended consequences — of their recommendations.

Operation Credit Card Interchange Backfire

I am certain I’d have no trouble finding people from across the payments ecosystem to fund the purchase and transport of 14,000 cats — if airdropping them on Capitol Hill would derail Senator Durbin’s Credit Card Competition Act, aka CCCA.

For those in and around payments, the CCCA is the pending bipartisan piece of legislation that purports to create a more competitive credit card playing field. The bill’s intention is to drive interchange fees down by letting merchants choose  which network rails they use to route credit card transactions — under the assumption that they will pick the lowest-cost option. Merchants and merchant associations like the NRF and The National Association of Convenience Stores have heavily lobbied Sen. Durbin to write the bill and encourage bipartisan support to pass it.

The bill itself is short. It has essentially no details about how this would work in practice. If you have three minutes, you can read the legislation here. If you have five minutes, it’s worth glancing at Sen. Durbin’s Cliff’s Notes version here.

I believe the CCCA is based on a flawed argument rooted in a lack of understanding of how the credit card system functions in the U.S. today.

Like me and everyone else who reads the CCCA bill, you probably have a lot of questions about how it will work. Don’t sweat the small stuff, though — if passed, the payments ecosystem will have one whole year to figure out how it will work and implement new rules, processes and procedures to support it.

Unsurprisingly, payments lobbyists have been out in full force, all guns blazing, taking a whack at the legislation and its impact on credit card rewards if passed. That seems to have met with a collective lawmaker yawn, seen as the predictable response by big banks and card networks whose only interest is to “stick it to the merchants,” they believe.

I’ve been thinking about this a lot recently since it has become such a hot topic of conversation. Like many, I believe the CCCA is based on a flawed argument rooted in a lack of understanding of how the credit card system functions in the U.S. today — and a belief that merchants, not consumers, know best.

Unlike many, I don’t think the CCCA will reduce interchange at all — or if it does, by maybe an unnoticeable smidge.

In fact, it may even increase it.

On second thought, we might not need the cats.

Amex to the Rescue?

The bill, as written, is almost sanctimonious in its claim that the current card networks, Visa and Mastercard, have too much power. The intent of the bill is to force big banks to issue cards that have an alternative credit card network on the front or back of the card so that merchants can decide over whose credit card rails they route the shopper’s payment. The hitch is that issuers can’t put Mastercard on their Visa cards — or vice versa. But they can opt for one of the current three-party alternatives. There’s Discover and Amex.

The intention, as I mentioned, is to force Visa and Mastercard to lower interchange and network fees because they will have to compete for volume with an alternative network. But that assumes that issuers would default to putting Discover on their cards, which has lower merchant discounts (the equivalent of the interchange fee and network fee for the four-party systems.)

But why would big banks do that?

Any issuer that chooses to put Discover on their cards  is making a conscious decision to cut into the credit card rewards that consumers know and love, and drive top-of-wallet status for them.

So, if I am an issuer thinking strategically, I’m on Zoom calls with Amex to negotiate a higher interchange fee that will allow me to support consumer rewards at the levels they are now. Otherwise, they could threaten to put Discover on the card.

Then guess what would happen?

For Discover to be a competitive option for banks, they, too, would have to bid up interchange fees for issuers.

Who knows, maybe the reason that Capital One is trying to buy Discover is to capture more interchange fee revenue for the cards going over the Discover network by raising merchant fees.

Here’s another thought: The CCCA bill, which is an ode to three-party networks (but really Discover, since Amex is even more expensive for merchants than Mastercard and Visa), could give rise to even more of them in the U.S.

There is a short list of providers who have both issuing and acquiring, and those include the big banks. Who’s to say that one of them couldn’t emerge as a contender with their own network to be considered that competitive alternative? And  they would bid to have banks issue their third-party card in addition to Mastercard or Visa.

The effect on the merchant community may be the direct opposite of what Sen. Durbin and his CCCA legislation intended.

Notwithstanding a lack of understanding of how dual routing would work for credit card transactions, the flaw in Sen. Durbin’s bill is a lack of understanding of how the current credit card ecosystem works. And, more fundamentally, how platform ecosystems ignite and scale — and are monetized.

Starting with the small detail that Amex and Discover aren’t really three-party networks.

Both allow banks to issue their card products — there just hasn’t been much of an appetite for banks to do that. But Katie, bar the door now.

If passed as currently proposed, the effect on the merchant community may be the direct opposite of what Sen. Durbin and his CCCA legislation intended.

What Happened to Consumer Choice?

Although the Administration, Congress and CFPB are all very concerned with consumer choice, their voices have been surprisingly muted on this bill.

Let’s say that issuers  choose to cut into their own fee income and put a low interchange alternative on the back of their cards — basically issuing all of their cardholders a Discover card. There will be a material hit to card rewards — and that will have a noticeable effect on consumer spending and wellbeing.

It is also flawed thinking that merchants will re-allocate their interchange fee savings to consumer promotions and rewards, if past is prologue.

Research in the aftermath of the first Durbin reduction to debit interchange finds that merchants didn’t — and if they did, the savings were so insignificant as to be imperceptible to consumers. Home Depot even admitted in a 2011 earnings call that they realized a $35 million net margin increase from interchange fee savings after pledging to reallocate those savings to consumers.

It is flawed thinking that merchants will re-allocate their interchange fee savings to consumer promotions and rewards.

However, consumers did pay more to keep their checking accounts at the banks that issued their debit cards, and to support other value-added services related to those accounts.

But these arguments are familiar and well-trodden.

One that isn’t: the CCCA, if successfully passed, would create potentially enormous confusion for the consumer at the point of sale.

It is crazier than it seems at first glance.

Wait, I Thought I Had a Mastercard from Citi?

Dual network routing for credit card transactions is a very different animal than dual network routing for debit. Debit transactions pull money out of a checking account. Processing a credit card transaction is about managing risk, extending credit and managing issuer balance sheets using a network that supports the issuer who underwrites the risk and establishes a credit line for that consumer.

That means that a consumer with a Visa or Mastercard — issued by a bank they know and trust — signed up for a card with a rewards program that suits their needs, a line of credit they know, and an interest rate on balances that they understand. When they present their card at the virtual or physical point of sale, their expectation is for those card program attributes to be honored as agreed. If there is fraud, they know who to call. If there is a dispute, they know who to call. When they get their statement, those transactions are easy to see and understand; their bills are easy to pay.

The CCCA would create potentially enormous confusion for the consumer at the point of sale.

When merchants get to decide the network rail that processes the transaction, it is unclear how any of this will work.

Will the consumer have to be underwritten for credit by the alternative network? If so, will they have a different credit line and interest rate? Does the consumer have to agree to those terms for the bank to issue a card with an alternative logo on that card? What if they don’t?

Will all issuers and networks be forced to accept all consumers from the alternative network? If a consumer has a Mastercard from one issuer that chooses to add Amex as the second network, does Amex have to match interest rates and credit lines for that consumer? Can they say no?

And since this is all on a single card, when a consumer presents that credential at the virtual or physical point of sale, when will the consumer know what the implications of that transaction routing are? Did the merchant choose the card with the higher interest rate or one where the consumer was close to their credit limit and could be declined? Who is responsible if there is fraud or a false decline?

Oh, I forgot. The industry has 12 months to figure that out.

As written, the bill takes all these decisions out of the consumer’s hands to let the merchant decide what’s best for the consumer, based on what’s best for their bottom line.

It’s no different than ordering Skippy peanut butter from a grocery store online and being given a store brand for the same price because it buffs the merchant’s balance sheet.

Well, at least GenAI can help make bank call centers more efficient, since they will be flooded with calls from confused consumers if CCCA becomes the law.

Bring in the Surcharges and Friction

The CCCA is coming while merchants are using a variety of tactics to shift more of their costs of doing business onto consumers, often in sketchy ways.

Merchants can add fees to cover the cost of payments processing in all but two U.S. states now, even as many states have implemented caps on the amount charged. It is speculated that merchants will increase their use of surcharging regardless of the CCCA’s outcome.

According to PYMNTS Intelligence data, half of consumers surveyed in March of 2022 said they recall paying a surcharge to cover credit card fees. In that same survey, half of consumers who paid a fee said they would switch to a merchant that didn’t charge one — so consumers may have paid it once but were unwilling to pay it twice.

Only one in ten consumers who never paid a surcharge — or remembered doing so — said they would be willing to pay a surcharge at a merchant, which means nearly all say they would not.

At the same time, there has been a noticeable increase in tip options at the point of sale in places where the service element of the customer experience is questionable. Fast food, grocery and convenience stores have become notorious over the last several years for forcing tips on transactions for which the only “service” is ringing up the items and putting them in a bag. Processors make it easy to add a tip option on the checkout screen, so why not?

Consumers don’t like it.

It seems odd that merchants seem so willing to introduce friction at the point of sale for their own benefit, particularly when consumers are more interested in their own balance sheets than those of the merchants they shop.

More than third of consumers surveyed by PYMNTS Intelligence in October of 2023 say that the pressure to tip in these situations has gotten out of hand. Thirty percent of consumers recalled being asked to tip at retail and convenience stores, twenty percent at self-checkout. Nearly all consumers say that being asked to tip where there is no tip precedent is never acceptable, with 65% saying they will find alternatives rather than be pressured to add another 10 to 15% tax to their transaction.

Surcharging can only work if all merchants do it. The consumer’s willingness to pay weighs heavily on those decisions, which is why most merchants don’t. It seems only a matter of time before forced tipping in the absence of service will be marginalized if merchants want the pitter patter of consumer feet in their stores.

Operation Interchange Fail

It seems odd that a CFPB so focused on junk fees hasn’t expanded their definition to include one or both of these merchant-directed items.

It also seems odd that merchants seem so willing to introduce friction at the point of sale for their own benefit, particularly when consumers are more interested in their own balance sheets right now than those of the merchants they shop.

I predict that the CCCA will collapse under its own weight for some of the reasons I pointed out, and the many more that a deeper look under the hood will uncover. People in payments who know the industry, know networks and know credit know that this is an unworkable idea.

Just as Borneo discovered around the same time that the four-party model was introduced in the U.S., what may look good at the time creates years of chaos that can be hard to recover from. As I write this, the CCCA legislation has not been reintroduced. With any luck, it stays that way.