There’s a way of thinking about the job that interchange fees actually are. The bulk of interchange fees flow back to cardholders in the form of rewards (particularly points or cashback on purchases) as well as general card features and benefits. In practical terms, cards function as a way for consumers to collectivize and demand certain discounts from sellers, proportionate to the spending power they represent.
On the merchant side, accepting cards has always helped to benefit top-line due to consumers higher propensity to spend on card as well as other benefits of convenience, operational efficiency and trust etc. But of course there’s a limit to how much those acceptance benefits weigh against the cost of swipe fees. All else being equal, any rational business would prefer to take less of a merchant discount rate if they could. This merchant calculus varies significantly across segments. But universally, acceptance volume is sensitive to payment costs.
For their part, the networks have long been stuck in sort of prisoner’s dilemma. Networks depend on not letting average interchange drift too high. But when effective rates get too high, card acceptance wanes, merchants push back, competing rails or close-loop schemes emerge, or regulators step in. And so the card networks struggle with trying to keep their merchant constituents happy enough while also keeping their share of issuance. Issuers are constantly playing Visa and MasterCard off each other for higher rates, or looser rules on qualifying various portfolios for premium rates. The issuers have to constantly push on interchange fees to compete against each other on rewards offers – even to the existential risk of the industry’s whole golden goose.
And that’s why this week’s settlement news (btwn MC, Visa and US merchants) is a potentially big win for the US card industry. If you haven’t already, read the whole details below. The merchants get a win, it’s not huge, but a 4-7bps savings in fees, locked in over several years is something. At the same time, those cuts should not materially impact rewards programs so consumers still win. For the networks and the banks though, a negotiated cap on rates helps break the prisoners dilemma of upward pressure on interchange. They can’t say it out loud, but many a network exec are probably breathing a sigh of relief that rates are correcting (slightly) downwards.
Lastly, the settlement potentially takes some of the heat off of Durbin2.0 and the likely industry carnage if the CCA act passed. In the meantime though, networks and issuers are just going to have to rely on actual innovation and delivering new value to compete instead of just on rates.