I’ve identified the perfect example to illustrate the highly competitive nature of the card networks when it comes to setting interchange prices: interchange rates for consumer debit card purchases.
By now everyone has read many articles decrying the anticompetitive behavior of card networks and major card-issuing banks. Wrong! These articles were, of course, spawned by the inclusion of the Durbin amendment in the Dodd-Frank Act, which led to the Federal Reserve’s Regulation II. Reg. II imposes several new rules related to debit card interchange practices, but the headline is the dollar cap placed on debit interchange–as of Oct. 1, this cap will be about 22 cents per purchase.
Over the past couple of weeks, Visa Inc. and then MasterCard Worldwide released their new interchange rates to merchants via the merchant-acquiring banks. The card networks retained their general pricing structure, with many rate categories reflecting the diversity of merchants and the industries in which they compete—but only for banks not subject to Reg. II. Regulated banks have one rate—set right at the Fed-mandated rate cap. These changes effectively implement the so-called “two-tier” interchange rate structure.
As part of the new Visa pricing, rates for “small-ticket interchange” (purchases no higher than $15) were set at a slightly higher rate than in the past–the fee on a $10 purchase would increase by 1.5 cents. When MasterCard announced its new rates, the fee was set at the maximum allowed under Reg. II. On a $10 purchase, the increase is 2.5 cents (more than 12%), or on a $5 purchase the increase is more than10 cents, or by more than 85%.
Was MasterCard worried about its decision to severely increase the small-ticket price, given how hard the networks compete against each other? With such a pricing differential, you would expect Visa to eagerly anticipate merchants steering small-ticket transactions toward the Visa brand. Turns out MasterCard had little to worry about because Visa increased its pricing to match MasterCard.
Why? The only explanation is Visa was responding to MasterCard’s higher pricing to avoid losing card-issuer business–not gaining merchant business. This runs counter to the explanations in the card-network brochures that state “Interchange is consistently monitored and adjusted–sometimes increased and sometimes decreased–in order to assure the economics and value of the transaction are balanced for all parties.”
Nothing else I’ve ever seen (publicly) illustrates the pernicious nature of interchange any better–competition forcing prices up instead of down for the customer paying the fee. The large card-issuing banks have so much market power that Visa and MasterCard must aggressively compete on (higher) pricing to maximize their network volumes and value.
The banks are not doing anything wrong by demanding the best deals they can get from the card networks.
So what is wrong?
The merchant-acquiring business is working, as pricing spreads are kept in check because merchants can move their business among competitors. That leaves an obvious answer, which s that the interchange system has a fatal flaw–for debit as well as credit cards.
Interchange rates move higher, reflecting intense competition for card issuers instead of the networks objectively balancing the economic interests of all participants. Given this reality, government-imposed price caps might be an inefficient, unsatisfactory, yet perversely necessary partial fix that falls woefully short of effectively compensating for the market power exerted by issuers over the card networks.
And what about merchants that have a high percentage of their sales as small-ticket purchases? Well, I have seen plenty of examples of government regulation causing unintended adverse consequences. This price hike for small-ticket interchange is just one more cautionary tale.
Until a real fix for interchange is found that follows a process that truly balances the interests of all parties, the elemental market forces of competition will continue driving prices higher for merchants and ultimately consumers.
And what about merchants that have a high percentage of their sales as small-ticket purchases? I have seen plenty of examples of government regulation causing unintended adverse consequences. This price hike for small-ticket interchange is just one more cautionary tale. Until a real fix for interchange is found that follows a process that truly balances the interests of all parties, the elemental market forces of competition will continue driving prices higher for merchants and ultimately consumers.
You also may wonder about the other apparent consequence of Reg. II on bank pricing, which is new fees on consumer debit cards. A drop in interchange fees certainly factors into these price increases by Bank of America Corp. and other big banks. However, the loss of overdraft fees and the low interest rate environment makes checking accounts much less profitable as well. And let’s face it, with widespread use of debit cards, checks are becoming one of the least valuable services associated with a consumer demand-deposit account.
Until the economy recovers and deposit balances become more valuable, banks have some chance of making these new fees stick. However, Citi is not playing along, and smaller banks certainly see this increase as a golden opportunity to steal substantial numbers of accounts (and the larger financial relationship) from the big banks.
BofA and the others may be giving consumers just enough incentive to overcome their usual inertia. If consumers move in large numbers, the big banks will have to reign in their new fees, meaning the recent regulatory activism will have produced a competitive imperative–an imperative that merchants continue to wish worked for them instead of against them on interchange.
David Bellinger is director of payments at the
