When we left off last time, I said that there there was a major decision by the Reserve Bank of Australia in 2002 that had a dramatic effect on the future of the credit card industry. In order to fully understand the importance of these cases, however, I need to go back to the Five Actor Model and update it for credit cards. The good news is, the same terminology applies to debit cards and prepaid cards as well.
As we will do with all the payment methods, we are going to get into some terminology and definitions. In the payment card industry, we call the buyer’s bank an Issuer. We refer to the seller’s bank as an Acquirer. The word “acquirer” dates back to early days, when banks had to acquire merchants for the growing network.
We are also elaborating the model with three new roles: the Issuer Processor, the Acquiring Processor, and the Fraud Management processor (not shown, because it is a part of all the other roles). While in recent years there has been a move to bring these functions in-house (reflecting the increased strategic importance of payments), most banks still rely on outside firms to actually process their payments, bill their customers, and manage fraud.
Particularly in e-commerce, where there is no physical point of sale, fraud is a serious issue, and specialized companies have risen to meet it. I don’t have time to get into the topic in any great depth here, but it will be a subject of a future article.
Interchange Comes Under Attack: Australia, the UK and the EU
The Reserve Bank of Australia decided on August 27, 2002 in a landmark decision to regulate interchange using a “cost-based benchmark”. In the same decision, the RBA:
- removed prohibitions on merchants surcharging consumers to cover the costs of card acceptance,
- required the networks to allow issuers to offer cards from competitors like American Express.
A 2016 revision kept the credit card interchange cap at 50 cents (Australian). It capped debit card interchange at 8 cents (Australian). The European Commission followed suit. The United Kingdom created two new regulatory bodies with the power to cap prices and dictate the terms of competition. The United States has not undertaken similar action, because the Federal Reserve lacks the power to do it.
Antitrust Laws Are Not a Good Fit
The fundamental problem is the idea of multiple competitors working together to create a payments platform. On its face, this would seem to be anticompetitive behavior. Considering the network effect described in Part 2, however, it could not be otherwise. Forcing every bank to run its own private credit card program would never work, because each bank would have to negotiate separately with each merchant. Courts have ruled over time in favor of Visa and Mastercard on what is called the “rule of reason,” which focuses on whether the cooperation at issue harms consumers.
When merchants file suit against interchange fees as a form of price-fixing, they must therefore frame the arguments in terms of consumer harm. The arguments go like this: “When the issuing banks charge me a higher interchange fee, I have to pass that cost onto consumers, who pay higher prices as a result. Furthermore, because I cannot surcharge, cash consumers are subsidizing card users with higher prices.”
Consumer Harm is Hard to Show
The problem is, it has been hard to prove that prices have gone up in response to higher interchange fees. Retail is extremely competitive, so in fact merchants usually absorb higher costs rather than pass them on. When surcharging has been allowed, most merchants have been reluctant to use it, for fear of driving customers to competitors. Tellingly, the RBA made no finding that consumers paid higher prices as a result of higher interchange in Australia; in fact, it found that cardholders benefited from an average of 1.04% in rewards (cash back) on every purchase. The argument was based solely on the harm to merchants, who had no effective way to negotiate different pricing.
In the United States, merchants focused their attention on debit cards, which we will go into in Part 4. However, the same fundamental argument applies.
Are Payments a Utility?
All this regulation sounds like the sort of thing that power companies and telecommunications operators have to deal with. It reflects a growing understanding by governments around the world that the ubiquity of payment cards makes them an indispensable public resource. This is a very different situation from the early days of cards, when they were a scrappy insurgent against checks and cash. Now cards are the dominant method of non-cash consumer purchases. Governments see interchange fees set based on what the market will bear as a drag on economic growth, and an issue of international competitiveness.
Threats to Interchange
In private, many credit card executives admit that interchange will come down in the United States. However, the timing is uncertain. Congress would have to pass a law giving the Federal Reserve the power to regulate interchange. A more immediate threat is the advent of new “faster payment” systems. These networks transfer money directly between two accounts within minutes. In contrast to cards, faster payments systems lack integrated rewards and credit, acting much more like a very fast check. Transactions settle at “par,” which is a payment industry term meaning that there is no discount fee.
The Federal Reserve is working on a new faster payments system called FedNow, which I expect to launch in 2024. Two faster payments networks already exist in the U.S.; Zelle, which focuses on consumer payments and deposits, and The Clearing House Payment Company’s RTP network. Both are joint ventures of the biggest banks in the U.S. They are nervous about the Fed entering the market, since it does not have to turn a profit. The banks have so far prevented merchants from taking payment through their faster payment networks. The Fed is unlikely to support such restrictions, cutting into the market share of debit cards and depriving banks of a large amount of interchange.
In response, the large banks and payment networks are diversifying their revenue sources. Both Visa and Mastercard are expanding into non-card payments. Mastercard bought Vocalink in May 2017 explicitly to “allow Mastercard to expand beyond card-based payments to drive the major types of electronic payment transactions.” I will get into faster payments in a future article, but the model that is emerging is what I call an “unbundling” of the credit card, where services like a payment guarantee, credit, and rewards are separately, rather than bundled in. For a further explanation, see this article.
I will wrap things up here for now, but there is much more to say about credit cards. I will cover much of this in separate, focused articles. Next time, we will move to debit cards, where most of the legal conflict has taken place in the U.S.