Beware the bounce

rosie-mclennanThis article was published on Huffington Post Canada

Payment card reward schemes could be the unwitting victims of government regulation 

When Rosie McLennan bounced her way to gold for Canada in the Rio Olympics, regulation of the payment card industry was probably not uppermost in her mind. Which is surprising, given the trampoline routine of the 27-year-old resident of Toronto typifies that of the modern consumer when it comes to banking fees: just when they go down in one area, they tend to pop back up somewhere else.

The recent spat between Walmart Canada and Visa has reignited the debate about interchange; the fee paid by a merchant to customers’ banks when a payment card has been used for the purchase. It is, effectively, a price to be paid for the convenience, efficiency and relative safety of card payment systems.

Some observers contend that price (and by extension the interchange fee) is the sole determinant of consumer behaviour. It is undoubtedly a major driver, but it is by no means the only one. A recent survey reported a card’s rewards programme was considered more important than the interest rate. Well-intentioned action to lower prices at the tills could actually harm an aspect of personal financing – the reward programmes – of more concern to consumers.

Diane Brisebois, President and CEO of the Retail Council of Canada insisted the reward programmes in Europe survived interchange fee regulation: “they did not disappear and they are as generous as they were” she says. But the evidence suggests otherwise. Capital One, a credit card provider, said such reward deals were “no longer sustainable” after the fee caps, which the UK Cards Association reckons has cost banks £750m a year from card transactions.

Private Member’s Bill tabled by Liberal MP Linda Lapointe (Rivière-des-Mille-Îles), backed by the Canadian Convenience Stores Association and the Small Business Council, retail bodies, seeks to grant the federal government the power to cap credit and debit card fees. Such caps exist in many countries around the world but Canada, so far, has declined to take this route. Instead, a five-year voluntary agreement between Visa and MasterCard has been operating for a year, obviating the need for government-imposed regulation.

Walmart has stated that it will stop accepting Visa throughout its 370 Canadian stores, citing the cost to their business of processing credit cards, which they put at $120m (albeit without breaking that figure down by specific companies). Other Canadian retailers likewise bemoan interchange fees as a significant cost of business. As most, if not all, the costs are passed on to the consumer, the issue impacts us all, whether we know it or not.

(Some critics suggest Walmart’s action is aimed more at driving consumers to their own card scheme or soon-to-be-implemented electronic payment system – Walmart Pay – or simply as a bargaining tactic in their negotiations with Visa.)

Diane Brisebois, says fees are “too high for both retailers and consumers” and compares the 1.5% voluntary rate for credit cards in Canada with 0.3% in much of Europe. Any savings from a lower interchange fee will, she predicts, flow back to benefit the consumer through cheaper prices at the tills.

It all sounds good in theory. Possibly too good. The experiences of Europe, Australia and the United States suggest the expectation of immediate and lasting benefit to the consumer through government-imposed regulation is, unfortunately, flawed.

Primarily this is because such thinking fails to acknowledge that interchange is but one small part of the financial ecosystem that links banks, card networks, merchants and consumers. History has shown that fiddling with such a delicate and inter-connected system rarely ends well for the consumer.

The loss of revenue from lower interchange fees is usually paid for by the consumer through higher bank fees elsewhere (and there is evidence this is already starting to happen in Canada) or swallowed up by merchants before it even reaches consumers’ pockets.

A research paper written by PERC, an economic think-tank, says that in the five years after Spain brought in regulations in 2005, consumer organisations there found merchant savings had not been passed on to the public and two billion Euros in additional credit card fees were levied on consumers. There was no evidence from Spain or Australia that pointed to a reduction in price level to reflect the lower merchant fees. Additionally, in a business survey conducted in the United States, 57% of merchants claimed they would not pass on all savings from a lower interchange fee to consumers.

There is further bad news from Down Under. The Reserve Bank of Australia (RBA) implemented interchange fee regulation in 2003. In a paper submitted to the RBA, CRA International, a commercial services firm, said annual fees for standard cards rose by 22% and similar fees for rewards cards increased by between 47% and 77% from 2001 to 2004. The study found no evidence that the payment system in Australia operated any more efficiently or that consumers derived any net benefit from the regulation imposed by the RBA.

Reducing the financial burden on consumers and business is a laudable aim. But the payment system structure is too complex for the blunt tool of interchange fee regulation to have beneficial effect only. Expensive unintended consequences are usually paid for by the consumer. And as the PERC paper concludes: “it may not be sound public policymaking to simply take on faith…that the results of policy will be beneficial”. And up goes Rosie MacLennan again.

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.