Payment Card Interchange Fees: An Economic Assessment

Walter W. Eubanks
Specialist in Financial Economics

Interchange fees in the processing of credit and debit cards have become controversial. An interchange fee is paid by the merchant's bank to a cardholder's bank (that issued the card) after the cardholder purchases goods or services with a payment (credit or debit) card. Merchants and cardholders assert that they must accept excessive and increasing interchange fees set by the card associations such as Visa and MasterCard and member card-issuing banks. Interchange fees have been rising since the 1990s, despite diminishing fraud losses and technological advances in communications that lower the costs of accessing the electronic payment system. Merchants argue that the card associations have not negotiated these fees with them but instead present the fees as "take it or leave it" offers. 

Economists who have studied the payment card markets attribute the higher interchange fees to the nature and structure of the market. This is not the traditional market, they point out, but a twosided market where suppliers compete for two types of customers with different demand responses, like a newspaper that must attract both readers and advertisers. In the payment card market, banks must attract cardholders and merchants, and a transfer of revenues is usually necessary to provide card-issuing banks an incentive to issue more cards, which provide more payment card users to merchants. This is similar to newspapers, where the lower the subscription rates, the higher the readership and the higher the advertiser revenues. For a payment card system that needs more cardholders to achieve the optimal benefits to cardholders and merchants, more revenue transfers may be needed to offset the cost of issuing more cards to cardholders. There could be cases, however, where the revenue transfers are excessive, which would mean that the interchange fees are providing excess profits to issuer banks. 

Even though interchange fees were not considered a contributing cause of the 2007-2009 financial crisis, S. 3217 as amended by the full Senate and incorporated into the Senate-passed version of H.R. 4173, which addresses the regulatory causes of the crisis, also contains provisions on interchange fees. The Durbin Amendment (S.Amdt. 3989) on interchange fees was adopted. The amendment mandated specific regulations to applied debit cards to ensure that small businesses and other entities that accept debit cards pay a reasonable and proportional price for the use of the payment card network, and limit the payment card network from imposing anticompetitive restrictions on small businesses and other entities that accept payment cards. The amendment does not address what some believe to be a critical part of the interchange fee issue that relates to legal or regulatory caps on the fees. Specifically, presently there is not a mechanism that could be used to ensure that merchants lower their prices to pass the excess revenues back to the cardholders. In countries where interchange fees are capped, the governments have been relying on merchants to voluntarily lower prices. Yet, there is no evidence that merchants have done so. 

This report examines the Visa and MasterCard card associations' systems. The report begins with a discussion of the nontraditional structure of the payment card market. The next section is an analysis of the problem of the optimum level of payment cards to achieve the highest social welfare benefit for cardholders and merchants. The third section discusses the provisions in Senator Durbin's amendment and other legislation in the House that was not acted upon by the full House of Representatives that would grant the payment card stakeholders limited antitrust immunity for negotiating access fees and terms for using electronic payment card system. The last section is a discussion of some implications of the analysis.


Date of Report: June 9, 2010
Number of Pages: 14
Order Number: RL34647
Price: $29.95

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