Should the US Reform Interchange Fees on Credit Cards?

Last week, the Government Accounting Office issued a report on interchange fees, with the summary right there in the title: "Rising Interchange Fees Have Increased Costs for Merchants, but Options for Reducing Fees Pose Challenges." (links: full document, 1 page summary) Before we get to the big findings, what is an interchange fee, anyway? From the report:

When a consumer uses a credit card to make a purchase, the merchant does not receive the full purchase amount because a certain portion of the sale is deducted and distributed among the merchant's financial institution, the financial institution that issued the card, and the card network that processes the transaction. The majority of this amount generally is called the interchange fee and goes to the financial institution that issued the card. As card use has become more popular, the costs for merchants of accepting them have been rising, and considerable debate has been occurring over these costs, and particularly the level of interchange fee rates.

So what does this look like? Let's look at a diagram of this process broken down (click to enlarge):

You charge $100 with a credit card. The store has a hypothetical contract with his bank that has a 2.20% merchant discount rate and the bank affiliated with your credit card has a 1.7% interchange fee. So your bank collects 1.7% of your charge, while the store's bank collects 2.2 - 1.7 = 0.5%.

Now according to Federal Reserve analysis used by the GAO report, these fees have been going up. Looking at a chart from the GAO report, we can see the change in interchange fees over the past ten and twenty years (click to increase):


These numbers are reflective of domestic credit cards. The number of different categories a business could use have increased greatly since 1991. Visa went from 4 to 60, and Mastercard from 4 to 243. Critics argue that some of these increases in categories are to confuse and overwhelm merchants. But it makes sense that the credit card companies would need more specific and targeted categories over this time period since people are using credit cards for many more different types of purchases, including government, utilities, groceries, and online purchases, that they weren't using in 1991. As such, the credit card companies want a variety of options to be able to target the needs of a variety of businesses.

Since so much more activity is online, and online purchases can be more risky, we don't necessarily want to be watching the average to see if it is increasing or decreasing. We want to watch the change within categories. We normally associate innovation with decreasing fees, costs and profits as an industry matures. From this chart, we can see within categories, around 44% of rates increased over time, with only 12% decreasing.

What are the arguments for why this would increase? Sources from the credit card industry explained to me that the important thing to watch is the "effective rate" of all cards, which is the average in all cards, and that this hasn't changed over time. What's important to realize is that debit cards have less of a rate associated with them, and more people are switching to debit cards. However, as Felix Salmon noted, you can have the "effective rate" stay the same, or even fall, during a time period where all or some of the rates are increasing by having people switch to the lower rate.

This is, in Steve Waldman's phrasing, a move from transactional and revolving credit, and that is a move that could benefit consumers who have trouble managing revolving debt. It is worthwhile to know that the credit card bill passed earlier this year doesn't cover debit cards, and it is possible that fees and traps there could increase faster to compensate for the changes to the credit card industry.

Presented by

Mike Konczal is a fellow at the Roosevelt Institute.

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