The ongoing debate in Congress over credit-card “swipe” fees can get technical very fast, but it really boils down to three questions that should be of interest to every consumer:
- Is it fair?
- Does it keep costs low?
- Is it progressive, allowing the embrace of new technology that would lower fraud and reduce costs even more?
Unfortunately, the current system fails on all three counts. And the problems are getting worse.
First, the system is unfair. All those rewards that credit-card companies dole out to their best customers have to be paid by someone. So the companies charge merchants “swipe” or interchange fees for every credit-card transaction. When those fees go up, then merchants raise prices for everyone – people who use rewards credit cards and those who don’t.
Thus, consumers who use cash or a plain-vanilla credit card without rewards end up paying extra without getting the advantage of credit-card rewards. Some believe this situation serves as a regressive transfer from wealthy to lower-income Americans. That’s subject to debate, but what’s very clear is that it’s an income transfer from users of basic and simple rewards credit cards (say, a Visa Classic card, with 1 percent or fewer rewards and no bonuses) to those with premium reward cards (a Visa Signature). After all, cardholders are receiving the same service, with the same fraud risk, but only some receive rewards..
A similar discrimination happens with merchants. Interchange fees are lowest for large merchants processing plain vanilla credit cards, while they are highest for small merchants processing premium rewards cards. According to NerdWallet’s calculations, a small supermarket pays $1.15 to process a $50 credit-card transaction from a Visa Signature” customer, while a large supermarket pays $0.63 to process the same transaction from a basic or simple rewards customer.
This is arguably anticompetitive. Big chains have the clout to negotiate lower fees from the credit-card companies. Small supermarkets and other small retailers don’t.
As the two biggest players in the industry by far, Visa and MasterCard indirectly set the interchange fees charged to merchants. Around 2007 (roughly the time they became publicly traded companies), Visa and MasterCard began raising interchange fees on premium rewards cards at a rate that far exceeds increases on standard credit cards. (Click on the interchange fees graphic above.)
Which brings us to the second issue: The current system is costly.
Consider an international comparison. In the United States, the level of “swipe” or interchange fees appears to be based on merchants’ ability to negotiate (Walmart pays substantially lower processing fees than smaller stores and restaurants). The regulated interchange fees in Europe seem to be based more on the costs of processing.
Take a similar $50 Visa transaction at supermarkets around the world. Of 35 developed nations, all but seven have a maximum interchange rate of 1 percent or lower, according to NerdWallet’s calculations. In the US, by contrast, the maximum is about 2.3 percent – well ahead of No. 2 Canada, whose rate is below 2 percent. (See international comparison chart above.)
There’s another key difference: The US rate varies a lot. The difference between its maximum rate and the minimum rate is the highest of the 35 nations (most charged the same rate to everybody). For example: While Visa’s US interchange sheet has four separate classes of consumer credit cards, and 26 different types of merchant classifications, Visa France’s interchange sheet lists only one class of credit card and six types of payment technologies, each with varying fraud risk.
Not only is Visa France’s system much simpler, it’s far cheaper. Interchange rates range from as low as 0.22 percent plus €0.10 (14 cents) to 0.45 percent plus €0.15. Presumably, this difference is driven by fraud risk, which is a cost borne by the credit card companies.
And here’s where it gets interesting: The cards that qualify for the lowest French rate are those with so-called “EMV” chips, computer chips that are far superior at minimizing fraud risk than normal magnetic-stripe encoding common in the US. In fact, only United Nations Federal Credit Union and State Employees Credit Union have started to issue such cards domestically, and this is only because their international member bases have started facing card rejections abroad.
Why is the US sticking with technology from the 1960s? The current payment system seems to have created resistance to improvements that would lower fraud and reduce costs. That’s point three: The system is not progressive.
Walmart has a pretty logical explanation as to why US issuers are dragging their feet on EMV. It says they want to continue collecting high interchange rates on signature based transactions, as opposed to switching to a technology with lower fraud risk, and which would presumably justify lower interchange rates. If Walmart’s allegations are true, this lends further support to the argument for regulation.
The amounts lost to fraud are substantial. American Express, alone, reported $120 million in provisions for unauthorized transactions over the first nine months of 2010. Presumably, the number would have been much lower with widespread use of EMV cards.
It is highly unusual to encounter an industry where raising prices benefits your customers, and the costs are borne by people who do not consume your product. This is exactly the case with credit-card processing. When Visa and MasterCard raise the interchange fees they charge a merchant, the resulting revenues mostly accrue to their customers: the banks that issue the cards. As a result, the merchant raises her prices, consumers take the hit whether they pay cash or use a credit card.
Which consumers are cushioned from that higher price? Only those with premium reward cards, who get cash or something else of value when they make transactions.
Lawmakers and the Federal Reserve are well aware of these issues, which means that real regulation seems likely at some point in the future. Until then, consumers who use cash and those “plain vanilla” credit-card holders will pay a price for a system seriously out of whack.