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If you don't like cards, don't take them

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The cases of debit interchange in the US and cross-border interchange in Europe will, in the longer-term, serve to illustrate a general point: price controls don’t work, a fact well-known since the days of Diocletian:

Despite the fact that the death penalty applied to violations of the price controls, they were a total failure. Lactantius, a contemporary of Diocletian’s, tells us that much blood was shed over “small and cheap items” and that goods disappeared from sale. Yet, “the rise in price got much worse.” Finally, “after many had met their deaths, sheer necessity led to the repeal of the law.”

[From How Excessive Government Killed Ancient Rome]

OK, so the Durbin amendment probably wont lead to rioting in the streets, but it’s still price control, and it will have unfortunate consequences (not for me, since I never use a debit in the US anyway). There’s a good article in the January issue of Digital Transactions by Lauri Giesen examining the US card market. She’s specifically looking at the strategy of retailers with respect to cards. Having won lower debit card fees, retailers are going to go after the credit card business. Trixi Wexler, a spokeperson for the Washington DC-based Electronic Payments Coalition, says that retailers didn’t spend $10 million in lobbying “just to walk away with lower debit card fees”. I’m sure that’s true, but even if it isn’t, that $10 million represents pretty good value for money, since it will result in considerable savings for retailers.

The big retailers and other merchants — who are the real winners — claim they are going to help consumers from their end by passing their savings on in the form of lower prices… But those claims are spurious at best. In countries where these types of interchange rules have been adopted, like Australia, consumers have seen no benefit.

[From Bill Cheney: New Interchange Rules for Debit Cards: A Perceived ‘Win’ Is Really a Loss]

Retailers in the UK make the same claim.

The BRC claim that if charges for every payment method were as low as they are for cash, its members could pass on £480 million in cost savings to their customers.

[From Retailers concerned over ‘unjustified’ fees]

Yes, I’m sure they *could*, but they won’t. The evidence from Australia shows that the retailers managed to persuade the regulator to cap bank fees (for no real economic reason) and then simply kept the loot. That’s exactly what I’d do if I was them: it’s called “regulatory capture” by economists, because market participants are using regulation rather than competition to obtain a larger share of market rent. This all left me wondering, once again, what exactly the lobbyees (is that a word?) think that they are achieving by transferring this share of market rent from banks to retailers. Why, for example, are retailers more deserving of 0.1% of my supermarket purchase than banks? It’s not even as if it’s all retailers anyway.

Cooper said 80% of the projected debit card interchange revenues banks stand to lose will go to 1% of merchants.

[From Untitled]

This, to me, looks less and less like Durbin striking a blow for the little guy and more and more like regulatory capture by some of America’s biggest businesses, the culmination of a well-managed campaign.

Retailers have begged Congress for years, in vain, to limit the fees they must pay to banks when customers swipe credit or debit cards.

[From Debit Fee Cut Is Rare Loss for Largest U.S. Banks – NYTimes.com]

I imagine consumers have begged Congress for years, in vain, to limit the fees they must pay to retailers for food or to gas stations for fuel, so what’s the difference? Why has Congress intervened in order to transfer wealth from one group within society (consumers) to another group (retailers)? The answer, of course, is lobbying.

But retailers mounted an unusually effective yearlong campaign to frame the issue as a chance for Congress to help small business. A leading trade group for chain retailers worked with small-business groups to make sure that every time a senator held a town hall meeting back home, a local business owner showed up to ask about card fees.

[From Debit Fee Cut Is Rare Loss for Largest U.S. Banks – NYTimes.com]

Lobbying on behalf of banks is a bit of a lost cause at the moment, so you can’t blame the retailers for striking while the iron is hot, but if Congress wants to reduce the fees paid by retailers for payments, then it should create a regulatory environment that allows new entrants to come in and provide (non-bank, if necessary) solutions to the marketplace. Are they going to do this? (It’s not a rhetorical question – I genuinely don’t know, and look forward to hearing from some of our US readers to tell me.)

In short, then, if banks had gone up the hill asking regulators to cap the price of food, on the perfectly reasonable grounds that employee salaries are a big part of their costs and that employees spend a lot of their money on food, they would have got short shrift. But given the general hatred of banks, retailers spotted a good opportunity to transfer some of their costs away.

MasterCard said… This provision stands to benefit some of the largest retailers in the world and will harm not only consumers, but also community banks, credit unions, and government benefits administrators. Currently, merchants pay their fair share of debit acceptance; in the future, consumers will be responsible for bearing this cost.

[From Consumers to Pay More for Merchants’ Debit Card Benefits | MasterCard®]

I don’t want to be accused of being MasterCard shill [full disclosure: my employer Consult Hyperion has provided paid professional services to MasterCard within the last year] but there is a valid point here: what’s best for society is to have payment systems that have the lowest total social cost. Speaking in very general terms, this means debit cards (and in particular, PIN debit). So if that’s best for society, how should society apportion the costs? Unless we think we can do better than the market, then we should leave the market alone. Since neither I, nor retailers, nor banks, nor regulators know what the interchange fee should be, they should focus on competition to set them at the right level.

There’s another point that the Digital Transactions article makes that I found interesting. Trixi says that the money from card fees goes to pay for innovation and that without the income, issuers will stop innovating. This may be correct, although innovation is more about non-banks than banks and it is not only Durbin that is hampering payment innovation.

Rich started his address with the assertion that the “Payments system is under attack,” from a regulatory barrage – the CARD ACT, NSF/OD regulation, forthcoming rulings under the Durbin Amendment and the newly formed Consumer Financial Protection Bureau (CFPB) all are paralyzing innovation in the financial services sector. At the same time, innovations from outside the financial services industry are happening at an incredible pace.

[From Payment System Under Attack? Solutions Found in Georgia! – pymnts.com]

I think that in the US case it also means that the retail payments business will slide down the priority list. The lost income from debit interchange, which should have been reduced by competition (ie, the regulators should have told the big retailers “if you don’t like cards, don’t take them” or “if you think you can do it cheaper, go right ahead”) rather than by regulation, will be replaced by fee income from consumers and the marketing, management and retention of checking accounts will surely become more of a priority than debit card activation.

If retailers think that payment systems are too expensive, then why don’t they start one? Or why don’t they invest in payment startups? Starbucks seems to have done quite well by running its own prepaid card scheme and its own mobile payment service, and has been exploiting the benefits of integrated mobile so successfully that it has now decided to go for an immediate national roll-out with barcodes, switching to NFC when the handsets are out there.

However, Starbucks Corp., one of the few stores with a mobile payments program in place, says these transactions are little different from other card purchases, and the real benefit to the merchant comes when people use its app to reload their accounts while waiting in line instead of at the register.

[From Upside For Mobile Payments Comes Before The Payment – PaymentsSource Article]

Perhaps it will be the innovative retailers, working in partnership with technology companies, who will make the breakthroughs while the biggest retailers still find it more cost-effective to spend the money on lobbying.

These opinions are my own (I think) and presented solely in my capacity as an interested member of the general public [posted with ecto]

7 thoughts on “If you don't like cards, don't take them”

  1. jestep@gmail.com' Jestep says:

    “This, to me, looks less and less like Durbin striking a blow for the little guy and more and more like regulatory capture by some of America’s biggest businesses, the culmination of a well-managed campaign.”
    This is spot on. Walmart and other super-retailers have the NRF in their pocket. This whole fight is once again Walmart vs. Card Issuers.
    Let’s look at what happened last time they got in a fight. Walmart’s fees went down and every other retailer in the US pays more. Subsequently, a huge increase in the interchange system’s complexity can be directly attributed to this event. This regulation as presented is a recipe for disaster.
    Let’s see, debit card fees are capped, banks cut debit card benefits or cut cards altogether. Sales go down across the board. Saving money as a result of lost sales doesn’t seem much like a plan.

  2. davidsteed@paypoint.co.uk' David Steed says:

    There is a problem with letting market forces govern debit card interchange which is that is that competition is not working. Debit cards are not standalone products they link to current accounts and getting people to move current account is the issue (apparently you are more likely to divorce than move current account). Part of the reason for this is that banks make the move difficult (it is easy to change mobile phone provider as I can take my number with me – The same is not true in banking).
    It would be very hard for a new entrant to gain significant market share (ie. real competition) because of this barrier.
    Blended debit card interchange in the UK has gone up significantly with the demise of Maestro as the VISA debit interchange fee is more. With the continued large increase in the number of debit card transactions at the point of sale, processing costs per transaction should be going down rather than up – so it would be hard to argue that the increase in interchange is cost based. Competition is not working to keep the price down.

  3. mail@dgwbirch.com' Dave Birch says:

    The retailers could promote low interchange alternatives (like Revolution Money in USA), decoupled debit, their own prepaid no-interchange cards, and who knows what else. Competition was, i agree, limited (to banks) but the Payment Services Directive will surely have an impact here.

  4. dpvrai@yahoo.com' David True says:

    Yes, the regulation, resulting from lobby power, is a transfer to larger retailers. And we don’t have a good market here: there are barriers to competition and information is imperfect.
    The other key point is that we’ve all lived our business lives in the post Reagan period when regulation was out of favor. If you look over US economic history, there have been periods of more and periods of less regulation, and the pendulum, which never stops as the center, may be swinging back.
    Good business people spend their time working with the changes presented them, whether in consumer behavior or regulation, rather than complaining about what has changed.

  5. aalenr@gmail.com' al says:

    Loved that story i also have been in that situation and your blog was very useful.
    http://simplefastmoney.com/

  6. sdjohns@hotmail.com' Pragmatist says:

    We shouldn’t glorify interchange fees with classical allusions ;-). Roman price controls were a futile attempt to curb rampant general inflation, which finally finished off the Empire (http://mises.org/daily/3663). That doesn’t have any bearing on the choice of specific remedies in anti-trust cases.
    The point is that retailers have no choice but to accept Visa/MasterCard payment cards, and a large share of interchange goes toward loyalty programmes to keep cardholders using them. Regulators have reacted because card schemes seem able to raise interchange fees with impunity.
    The card schemes’ observation that retailers will not pass on the benefits of lower interchange fees in the form of lower prices is disingenuous. Firstly, it rests on the assumption that the only way retailers should reasonably differentiate themselves from each other is in terms of price. So the card schemes would have it that if retailers cut any of their costs, including interchange fees, they should take the ultimately suicidal step of always reducing their price to the consumer, rather than, say, investing in increased selection, improved customer experience or expansion to achieve economies of scale. That is an absurd position in itself, let alone one that would support the assertion that if retailers do not cut prices to consumers on the back of lower interchange fees, they are somehow behaving just as anti-competitively as the card schemes are alleged to be. The retail markets are distinct from the market for payment services. Lack of competition in retail markets can be – and is frequently – addressed on its own merits.
    However, I agree that the best long term solution is to introduce competing, lower cost payment methods – particularly those that result in a better consumer experience.

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