Capping the Cards

20150905-Card imageThis post was published on Huffington Post at this link.

Does Canada hold the key to regulating the global payments industry?

The subject of payment regulation, pitting retailers and restaurants against the credit card companies and banks, is a hardy perennial for discussion in legislative bodies the world over. The British government, for example, is currently grappling with how to supervise compliance with the European Union’s Interchange Fee Regulation.

Dry as the subject may seem, for the people of the UK, their government’s decisions on this subject could have far-reaching consequences: when similar provisions were enacted in the United States, the law of unintended consequences meant that, by one calculation, between $1 billion and $3 billion has been transferred annually from households to big retailers and their shareholders. In the UK and in other legislatures across the globe the question is, could the same happen here?

A quick revision. When a purchase is made by debit or credit card there is a risk the buyer does not have sufficient funds to balance his account, or that it is a stolen card and the transaction is, simply, fraudulent. So that the merchant is not left out of pocket, the card-issuing bank guarantees payment.  But in return for carrying the risk of a dodgy sale the merchant’s bank pays the card-issuing bank a small fee, known as the interchange fee or popularly, if misleadingly, the ‘swipe’ fee.  It is usually recouped from the merchant through business banking charges and passed on, in turn, to the consumer through higher prices.  So, on the face of it, any lowering of the interchange fee would be passed through to consumers.  That may be the theory, but it didn’t happen in the United States where the ‘savings’ were soaked up on the way through the system to the price tag.

Britain’s Chancellor of the Exchequer, George Osborne, said he expects businesses to pass on any savings to consumers in the form of lower prices. There were almost 10.7 billion credit and debit transactions in Britain in 2013 and the British Retail Consortium estimates the agreement could save British businesses up to £480m a year. The government proposes implementing a 0.30% cap on domestic credit card fees and an average 0.20% cap on domestic debit card transactions from December 9th this year.

As merchants cannot charge different prices for cash, credit or debit payments and obviously price-in the interchange fee, those consumers using cash (e.g. those on fixed incomes such as the retired) are, in effect, paying a hidden fee. So reducing interchange fees as far as possible make sense. Or does it?

Regulation can be a blunt tool and banks don’t like being bashed; losses are normally recouped elsewhere. For example, in 2009 banks provided 76% of America’s current accounts free of charge.  After capping interchange fees that figure halved by 2013. And a lower interchange fee could see banks recovering costs elsewhere, such as higher annual fees to use cards or fewer benefits.

So perhaps an interchange fee at a slightly higher rate could encourage the banks to play fair, whilst not squeezing consumers too much. The Payment Systems Board of the Reserve Bank of Australia is considering a reduction in the current weighted average of 0.5% to either a hard cap, or a lower weighted average, for implementation in 2016.

A rather elegant solution has recently been adopted in Canada. MasterCard and Visa have enacted a voluntary deal to cut the average interchange fee to 1.5% (an effective drop of 10%). This was enough to encourage the card networks to step up, but not so much that the banks felt the need to claw back revenue from other areas such as ending free banking or increasing overdraft fees.

The Canadian government was not keen to enforce regulation as a “gutting of interchange would lead to a gutting of the rewards programmes and no government want to hear ‘hey kids, the government have cancelled our trip to Paris,’” says Dan Kelly, President and CEO of the Canadian Federation of Independent Business.

Former Minister of Finance in Canada, Joe Oliver, said that the industry-led solution balances the need for rate reductions and rate predictability for merchants, while allowing the sector to continue to provide the rewards and benefits associated with credit card products that consumers have come to enjoy. (Not every Canadian is happy though.  The New Democratic Party says the fees are “excessively high and anti-competitive” and planned to regulate had they won power in the general election on October 19th this year.)

The European Commission estimates that interchange fees amount to £1 billion per annum in the UK; the Chancellor should tinker with such a revenue stream guardedly. He says he will set up a Payment Systems Regulator to supervise the interchange fee regulation.  Whether this body will have sufficient visibility and power to ensure the consumer enjoys the rewards of a lower fee, without paying for it through other means is not yet clear. The contrasting examples of America and Canada offer valuable lessons.


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