A new report from the Federal Reserve Bank of Boston precisely defining how much certain consumers win or lose from rewards-based credit cards is stirring debate among some payments industry experts.
Economists from the Boston Fed’s Consumer Payments Research Center on July 26 released a report asserting that credit card interchange fees indirectly enable wealthier credit card rewards-using households to receive $756 on average annually while costing poorer households relying mainly on cash, checks or debit cards $23 per year.
Merchant acquirers pay interchange to card issuers when their cards are used to initiate purchases. Card networks set the interchange rates, which help offset issuers’ costs to provide reward programs. Acquirers pass their interchange expense along to merchants as part of the discount rate, and the retailers include the cost when setting the prices for the products or services they sell, the researchers contend.
That, in turn, generates an “implicit money transfer” to wealthier rewards credit card users (households earning $150,000 or more annually) from poorer consumers (those earning $20,000 or less annually) who primarily use cash, they argue.
Reducing merchant interchange rates and card-rewards programs “would likely increase consumer welfare,” the report concludes.
Some payments experts dispute many of the report’s assumptions, but the formula-laden, 57-page report could reignite discussions about legislation to regulate credit card interchange, some observers say.
“The timing of this report is very interesting,” Red Gillen, a senior analyst with Celent LLC, tells PaymentsSource, noting the success of recent legislation to regulate debit card interchange that will go into effect next year as part of the recently enacted financial-reform bill.
The discussion of noncard users’ subsidization of credit card users’ rewards has been going on for years, but the report introduces important new data, Gillen says. “This is the first time we’re seeing real numbers on how much interchange costs certain types of households,” he says. “The formulas may be debated, but this is certainly the starting point for a new conversation on interchange’s effects.”
The Boston Fed’s report “confirms what we’ve been saying, which is that credit card interchange fees drive up costs for everybody. But it also brings out the fact that middle- and lower-class consumers who use credit cards the least are essentially subsidizing others in the system,” Mallory Duncan, senior vice president and general counsel at the National Retail Federation, tells PaymentsSource.
The average credit card interchange rate is about 2% of the sale. Consumers pay about $50 billion annually in interchange, the federation contends.
“So everybody is paying 2% more for everything at the point of sale to cover the cost of interchange, but rewards cardholders are getting some of that back,” Duncan says. “It means that the wealthy end up paying an effective lower interchange rate than cash-paying customers.”
Some observers disagree.
“There are gaping holes in these economists’ argument,” says Megan Bramlette, a director with the New York-based credit card consultancy Auriemma Consulting Group. “Their underlying assumption is that if interchange were reduced or eliminated, merchants would lower their prices across the board, and there is no evidence that such a thing would happen,” Bramlette says, noting that when regulators in Australia cut interchange rates several years ago, the consumer price index did not budge.
The economists also ignore that merchants derive many benefits from accepting cards, including reducing their cash-handling costs and selling more goods because of the convenience of using plastic instead of cash, Bramlette says. Merchants dealing in cash and checks also are subject to higher losses, she says.
“Imagine the kind of security costs there would be if Walmart took only cash,” Bramlette says. “From a purely academic standpoint, this report makes a point. But it ignores so many other elements of the payment system that, in my view, it is not complete.”
Given the raft of new regulations credit card issuers are facing from the Credit CARD Act that went into effect this year, and new restrictions on debit card interchange, the economics of card-rewards programs are in flux as issuers scramble to retool card programs and fees, says Brian Riley, a research director with TowerGroup.
“Card rewards are under duress, so many points in this report may be moot,” he says.
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