Click here to download eBook
Introduction
Interchange fees have become increasingly controversial. These fees constitute the bulk of the cost that merchants incur for taking cards because most consumers pay with a card from a four-party system that assesses these fees. The total interchange fees paid by merchants have increased dramatically as consumers have switched to electronic payments. Merchants have complained, have filed lawsuits, and have lobbied governments to do something about this. Meanwhile governments around the world have intensified their examination of these fees. For example, the US Congress passed legislation in 2010 that required the Federal Reserve Board to regulate debit card interchange fees; the Reserve Bank of Australia decided to regulate credit card interchange fees in 2002 after concluding that a market failure had resulted in merchants paying fees that were too high; and in 2007 the European Commission ruled that MasterCard’s interchange fees violated the EU’s antitrust laws.
The controversy raises two broad issues. The first relates to how payment card systems decide how much merchants should pay for taking cards either through the interchange fee for four-party systems or the merchant discount for three party systems. The second concerns whether the setting of interchange fees by private businesses results in a market failure and if so what if any regulation should be adopted to correct this market failure.
This interchange fee debate helped stimulate a new literature on multi-sided platforms or what are sometimes called two-sided markets. Payment card systems serve as intermediaries between merchants and consumers and operate a platform that enables these two different kinds of customers to interact. It turns out that there are many other businesses that have similar features including software platforms like the iPhone OS, shopping malls, search engines, and exchanges. Economists have developed general models of multi-sided businesses and applied them to payment cards.
This volume consists of seven articles on the economics and regulation of interchange fees. All rely on the multi-sided platform framework. The first two chapters examine whether there is a market failure in setting interchange fees and present principles for considering correction to a market failure. One of the themes of these articles is that regulating one side of a two-sided market necessarily has effects on the other side of the market: lower prices for merchants means higher prices for consumers. Chapters 3-5 address that tradeoff which is sometimes called a “waterbed effect”. Chapter 3 presents an empirical study of what happened following the imposition of price controls on interchange fees in Australia in the mid 2000s. Chapters 4 and 5 estimate the prospective impact on consumers in the US and EU of interchange fee caps. These chapters rely heavily on the economic concept of pass-through, which concerns the extent to which business change their prices in response to changes in costs. The net impact of reductions in interchange fees on consumers depends on the extent to which issuing banks raise fees and merchants lower prices in response to a reduction in interchange fees which are revenues to banks and ultimately costs to merchants. Chapter 6 examines a related question: how do interchange fee price caps affect investment and innovation for payment systems. Chapter 7 examines arguments that merchant representatives have made concerning debit card interchange fee regulation. That is followed by a short chapter with a few concluding thoughts.
The Fed’s Final Debit Rules: Did Anyone Win?
We’re always on the lookout for opportunities to partner with innovators and disruptors.
Learn More