The economics of card payments

Alberto Heimler

Professor of economics

SSPA Roma

The Role and Regulation of Interchange Fees in European Payment Cards

Bruxelles, June 15 2011

Payment cards: some market features

• Two sided market: card holders and retailers.• BUT now cards are an integral part of the banking relationship

and all retailers have a POS connection. Network externality is no longer an issue, at least for established cards. Usage externality is not a justification either.

Rules • No price discrimination• No steering rule

The market for payment instrument: what is the price and the cost of alternatives

• Cash NO COMPETITION zero price (but its is a costly service)The supply of money is free for all users (seignorage costs paid by tax payer;

banking costs paid by bank service users). Transaction costs paid by consumers and merchants.

• Checks NO COMPETITION zero price (but it is a costly service)Issuers pay a fixed price per transaction. Beneficiary pays by a delay in

accreditation • Bank transfers LITTLE COMPETITION (between deposit holding banks)Debtor pays a price set by its bank, Beneficiary pays by a delay in accreditation• Direct debit COMPETITION ON ACQUIRINGDebtor pays a fixed price per transaction, creditor pays acquirer fees,

Interchange fee is zero (SEPA)• Debit card COMPETITION ON ACQUIRINGHolder pays at most a fixed yearly fee, merchants pay merchant fees, issuer bank

gets interchange fee• Credit card COMPETITION AMONG ISSUERS AND ACQUIRERSHolder pays at most a fixed yearly fee, merchants pay merchant fee, issuer bank

gets interchange fee. Expenses cleared once a month

Usage externality and the interchange fee

Acquirer benefits 0.0 0.0

Less acquirer costs 0.5 0.5

Plus transfer 0.0 0.5

Acquirer surplus -0.5 0.0

Issuer benefits 0.0 0.0

Less issuer costs 0.5 0.5

Plus transfer 0.0 0.5

Issuer surplus -0.5 0.0

Consumer benefits 0.5 0.5

Less consumer costs 0.75 0.75

Plus transfer 0.0 0.5

Consumer surplus .0.25 0.25

Merchant benefits 2.25 2.25

Merchant costs 0.25 0.25

Less transfer 0.0 1.50

Merchant surplus 2.0 0.50

Elimination of the non discrimination rule and of the interchange fee

• Merchants would decide the discount or the overcharge associated with the different payment instruments

• Competition between credit cards would increase and not for interest payments but also for the cost of using the card

• Banks would charge for the supply of the different payment systems.

• Consumers would choose among the different payment systems according to their costs

Usage externality and each party pays its own dues

Acquirer benefits 0.0 0.0

Less acquirer costs 0.5 0.5

Plus transfer 0.0 0.5

Acquirer surplus -0.5 0.0

Issuer benefits 0.0 0.0

Less issuer costs 0.5 0.5

Plus transfer 0.0 0.5

Issuer surplus -0.5 0.0

Consumer benefits 0.5 0.5

Less consumer costs 0.75 1.25 (includes the 0.5 to issuers)

Plus transfer 0.0 1.0

Consumer surplus .0.25 0.25

Merchant benefits 2.25 2.25

Merchant costs 0.25 0.25

Less transfer 0.0 1.50

Merchant surplus 2.0 0.50

The interchange fee and payment cards

• The interchange fee rebalances the turnover between the two sides of the market.

• Consumers have only one debit card. No multihoming in debit. So there is no elimination of extraprofits by issuers

• In credit multi-homing but which card to use depends on the rewards consumers get or on the interest cards issuers charge. The cost to merchants does not enter consumer decision making

• In any case the cost of the card transaction does not depend on its size. So issuers (and acquirers) should be paid on a per transaction basis.

• If interchange fee is at par, consumers would be charged and in case merchants would discount.

• The tourist test is not a competition price (nothing guarantees the zero profit condition). It is a monopoly price.

Conclusions

• By eliminating the no discrimination rule and the interchange fee opportunistic behaviours (on the part of card holders) would be eliminated

• Issuing banks and acquiring banks would compete on prices without the constraint of the interchange fee (both on the price level and on the way to charge).

• Retailers and consumers would choose on the basis of costs and benefits

• Innovation in payment system would be promoted without constraints on pricing

• Is the elimination of the interchange fee an objective to be achieved by antitrust enforcement?

• I changed my mind on this and now my position is …

YES