New Study Decries Interchange Caps, Favors Merchant Networks

With card interchange rates becoming a subject that even central bankers are beginning to ponder, a long-time analyst of the electronic-transaction market has released a report arguing that overall acceptance costs are often more favorable to merchants in the U.S. than overseas and that merchants would be better off developing competitive payment networks rather than agitating for regulation. The study, “Five Misconceptions about Interchange in America,” comes just as central bankers and electronic payments experts from around the world are wrapping up a conference on interchange in Santa Fe, N.M., sponsored by the Kansas City Federal Reserve Board. Also, a recently formed merchant group has set up shop in Washington, D.C., to lobby for regulation of interchange (Digital Transactions News, May 2). In the report, Gwenn Bezard, an analyst at the Aite Group, Boston, argues that, while interchange costs are higher in the U.S. than elsewhere, other acquiring costs account for a larger percentage of total acceptance expense for merchants overseas. In France, for example, an off-line debit transaction carries an interchange rate of 0.40%, compared to a signature-debit rate of 0.92% plus 15 cents in the U.S. But the French rate is only 40% of total acceptance costs, while the U.S. rate accounts for 90% of the cost of the transaction. As a result, Bezard says, the overall debit acceptance cost is roughly the same for the French and American merchant. In many overseas markets, he says, issuers have a tighter grip on acquiring than in the U.S., where merchant acquiring is more fragmented. As a result, the interchange component of total acceptance cost tends to be lower. Looked at in this way, Aite's research indicates that what U.S. merchants pay is sometimes favorable to what foreign merchants pony up for electronic payments. Total acceptance cost, or the merchant-service charge, for credit cards is lower in the U.S. on average than in all but three countries surveyed. The U.S. MSC of 1.55% is the same as in the U.K., and higher than only France (0.90%) and Denmark (0.75%). Debit cards, however, are another story. Average MSCs for signature (0.85%) and PIN debit (0.55%) in the U.S. are high by comparison to other countries, with only France, Spain, Portugal, and Japan featuring higher rates. In many countries with lower debit MSCs, however, telecommunications costs are higher and consumers pay debit card fees to their banks, largely because they already pay substantial fees to use checks. In the U.S., the proportion of banks charging consumer debit card fees has declined to 14% from 43% in 1993, according to numbers cited by the Aite report. “Arguing that the U.S. has very high interchange rates compared to other countries is a misrepresentation of reality,” Bezard says in the report. Bezard also attacks the idea that interchange in the U.S. has risen because of a lack of competition, pointing out that it is precisely heightened competition among many payment networks that has propped up interchange, as issuers have shown a willingness to move from one network to another to obtain better rates. Most overseas markets, he says, are controlled by single card networks. Bezard contends that by arguing for regulation, merchants are in reality arguing for less competition. “Merchants' complaints against the constant increases in interchange are legitimate,” he says in the study. “By pointing their finger at the supposedly monopolistic organization of the bank card industry, they bark up the wrong tree, however. Merchants need to recognize that the real culprit is competition between the networks. If merchants want regulators to intervene and cap the interchange as other countries have done (e.g., Denmark, France, European Union for cross-border transactions, Australia), they will…be pitching for less competition among networks and issuers.” Bezard doesn't spare issuers, however, on the interchange subject. He argues that issuers' contention that interchange is necessary to develop networks and new products is simply wrong, and contends issuers could live without interchange. Most issuers make most of their money on finance charges on credit cards, he says, and points out that on the debit card side many foreign countries have developed thriving networks with much smaller interchange flows. As for the notion that interchange income is necessary to fund innovation, Bezard points to the example of the exploding market for prepaid cards, where, he says, interchange is a negligible factor. “Banks and their card associations cannot seriously argue that the interchange is vital to the system,” he says in the report. Regulation, including action to cap interchange rates, may have a superficial appeal, Bezard says. He points to the example of Australia, where regulation has forced down average MSCs by 40 basis points. But such forced reduction, while benefiting merchants, would not benefit consumers, he argues, since merchants likely would not pass on the savings to customers. “In countries where the interchange has been capped, regulators have not been able to demonstrate the impact on consumer prices,” Bezard says in the study. “In Australia, although regulators remain convinced there will be an impact, it has yet to be seen.” Rather than push for regulatory relief, Bezard argues, merchants would be better off backing electronic networks they control. Examples he cites include Debitman, a startup network that settles PIN debit transactions through the automated clearing house, and a similar system in Germany that allows merchants to process debit card transactions without interchange. The system handles 53% of all debit traffic in the country, Bezard says.