Interchange fees are the largest component of merchant card-acceptance fees, and the merchant lobby has been waging an aggressive political campaign to get government to curb them.
Last June, during an earnings presentation, Visa Inc. CEO Joe Saunders said, "We are confident that the legislators and the regulators understand that interchange is a pro-competitive structure. … And our discussions in Washington, D.C., suggest that the legislators now appreciate that there would probably be a significant negative unintended consequence from any congressional action on interchange."
On May 13, 64 senators, including 17 Republicans, apparently did not understand or care about the pro-competitive structure and voted to attach Senate Majority Whip Dick Durbin's amendment capping debit interchange fees to the Restoring American Financial Stability Act.
Two-sided retail payment networks such as American Express, Discover, MasterCard, Star and Visa use interchange fees to balance participation of issuance and spend, and of acceptance, to maximize transactions and network value and fuel a powerful network effect. Spend begets acceptance and acceptance begets spend, bringing more value to all.
Many two-sided markets use asymmetric pricing to maximize value. Google, Microsoft and Yahoo charge sellers but not searchers. Adobe provides readers for free. Bars sometimes offer women, but not men, free drinks.
For card purchases, interchange fees flow from merchants to card issuers and cardholders, while for ATM transactions they are paid by issuers and cardholders to bank, merchant and processor ATM owners.
In the past, interchange bills had difficulty moving on their own. Financial system regulatory overhaul in 2010 provides a vehicle to piggyback. Senate Banking Committee Chairman Chris Dodd's 1,566-page Restoring American Financial Stability Act is now being debated. Democrats have positioned it as Wall Street reform, which no senator this election year wants to be perceived as being against.
Durbin's amendment would permit merchants to differentially discount different payment networks, but not different users, and to refuse cards for purchases above and below certain dollar thresholds. It would also set debit interchange fees for large card issuers. Interchange fees would be based on recovering direct, incremental processing costs determined by the Fed.
That's a public utility model. By regulatory diktat interchange would become a nominal fixed transaction fee, 90% or more lower than current levels.
Interchange fees are the primary source of revenue for debit cards and the No. 2 source of revenue for credit cards. Eighty percent of Americans have debit cards, a majority of which are from Goliath banks.
Forced interchange fee reduction will spur new and higher cardholder fees, eliminate rewards and reduce debit card availability for tens of millions of unbanked and underbanked Americans. That's hardly pro-consumer. If the amendment passes, Durbin will pursue a similar price-control regime for credit card interchange fees, with even greater negative impact on cardholders.
However, issuers with assets below $10 billion would be exempt, not because the interchange they reap is any fairer, but rather because they are politically popular on both sides of the aisle, whereas behemoth banks are politically toxic, and the networks not sympathetic. It's politics rather than markets determining winners.
Community bank debit cards could cost 10 times more to accept than those from colossus banks. But small issuers could offer consumers free debit cards with rewards, while giants such as Bank of America, JPMorgan Chase and Wells Fargo would have to boost cardholder fees and slash benefits.
A handful of bantam banks would seek to compete nationally. It's possible they would issue decoupled, no-fee rewards debit cards to consumers with demand deposit accounts at large banks poaching attendant interchange. Consequently small banks would gain debit share.
Their gains would benefit the networks, which bring more value to and have better pricing power with small issuers.
Di minimus interchange would accelerate the already marked trend of MasterCard and Visa migrating a greater share of their fees to the acceptance side of the network.
The interchange debate turns on whether one favors consumer choice and markets or Washington mandarins determining payment pricing.Because consumer payment preferences generally reign at the point of sale, competition drives interchange flows to card issuers and cardholders in the form of no fees, grace periods and a rich trove of rewards. If consumers were indifferent among payment products, merchant preferences would rule and interchange would instead flow to merchants.
Instances where consumer payment preferences count for little underscore the point. Networks reduce interchange for and often subsidize utilities' card acceptance — synthetic reverse interchange. The Internal Revenue Service surcharges.
Price controls on interchange will suppress issuer innovation. Interchange funds a fount of innovation.
An energized merchant lobby recognized from the get-go that this war would be won or lost in the political arena, that politics is a contact sport.
In contrast, while the payments industry trotted out lobbyists and arguments and circled the community-bank wagons, it never made an effort to engage and make an affirmative case to one hundred million-plus cardholders who will be harmed.
Saunders was right, however, interchange price controls will have painful "negative unintended consequences;" higher cardholder fees, less attractive debit products, reduced payments innovation and less debit availability. American consumers will pay the price.
Eric Grover is a partner in Intrepid Ventures in Menlo Park, Calif.