How Justice Department’s Ruling Affects Credit Card Customers
The Justice Department sued Visa, MasterCard, and American Express for anticompetitive practices. At the same time, it reached a proposed settlement with Visa and MasterCard. The ruling aims to end anticompetitive practices and allow customers to save money, but it is likely to also have unintended consequences for consumers.
Interchange Fee is Confusing
Interchange fees, or swipe fees, are difficult to understand, and credit card processors like Visa, MasterCard and American Express have provided very little information about these fees, protecting their control and this significant revenue source.
Interchange fees began in the 1960s to help banks to cover the cost of processing credit card transactions. The fee is divided between the merchant’s bank, the consumer’s bank and the credit card company. The fee covers processing fees, billing statements, fraud protection, innovations, and other expenses.
Interchange fees typically range between 1.0% and 3.5% of every purchase made with a credit card. Few consumers realize how much the merchant pays for the convenience of credit cards. There is no mention about the fee in the credit card terms and conditions, and merchants have been prohibited from mentioning swipe fees to customers. Merchants argue that these fees have inflated the cost of goods, especially for the consumer that pays with cash instead of a credit card.
Interchange fees are not a flat rate for every merchant. They can vary by industry, the method of card acceptance, the merchant’s volume, the type of card, transaction size and special deals. For example, many grocery stores and utilities have lower interchange fees as a special incentive from the networks, but interchange fees may be higher for merchants in industries such as travel and entertainment because customers spend more with their credit cards.
Visa, MasterCard, American Express and other processors have enforced this system as long as possible because it is a large source of revenue. Last year, Visa, MasterCard, American Express, and their affiliated banks collected $35 billion in swipe fees.
Currently, retailers and merchants must accept all cards in the payments network but they can not provide discounts or guide customers to individual cards or alternative payments, even if these cost less to process. The Justice Department ruled that this is anticompetitive.
In the settlement, Visa and MasterCard will no longer prevent merchants from offering immediate discounts or rebates for using a particular card or other form of payment. Merchants can also give preferential treatment to a card or card network, and they can promote particular cards in communication with customers. Merchants can also inform consumers about their costs incurred from the use of a specific card.
The settlement allows any merchant that only accepts Visa and MasterCard to start immediately. Since American Express is not participating in the settlement, many merchants that accept American Express along with Visa and MasterCard will not be able to take full advantage of their new options under the proposed settlement.
Effect on Consumers
This verdict will create change for the credit card issuers, merchants, and consumers. For the first time, merchants will be able to direct customers to the cheapest payment. However, the payment choice is still up to the customer. Will they embrace the discounts or continue to use the same cards to accumulate their rewards?
It is unclear how this will trickle down to consumers. Notices and additional choices can add confusion to checking-out, making lines and waiting even worse at the cash register. Shoppers using cash to take advantage of discounts will also take more time as they count out their payment. Shoppers also spend less when they pay with cash.
Possible Response from Credit Card Issuers
Even though the verdict is against Visa, MasterCard, and American Express, it will spillover onto all other credit card issuers. If consumers switch to cheaper cards or alternative payments, it will not only decrease the amount of interchange fees revenue for banks, but also their interest revenue.
On a number of occasions these rulings against banks and credit card companies have had unintended consequences on consumers. This verdict is another blow to credit card revenue during a time when issuers have been slammed with new rules and restrictions following the financial crisis. Issuers will likely respond with higher rates and fees on credit cards and other bank services in order to make up for this loss in revenue.
Credit card analysts are split on how issuers will react to this development. Some feel credit card issuers may increase incentives for using reward cards. Perhaps issuers will tie cash and point bonuses to certain spending levels, providing a reason to continue using the credit card. Some issuers are already doing this: the Discover More card offers a $100 cashback bonus after one makes $500 in purchases within the first three months; the Chase Freedom Visa gives a $100 bonus if one spends $799 in the first three months.
On the other hand, some analysts believe this will decrease credit card rewards. For years, some believed that the rewards system was financed by the interchange fee. If the revenue from the interchange fee decreases, rewards may also decline. 71% of credit cardholders held a rewards card in 2008.
American Express Refuses to Settle
American Express was also sued by the Justice Department but refuses to settle. The company says its business model is different from Visa and MasterCard because it issues its own credit cards and negotiates directly with retailers to set the swipe fees. American Express swipe fees are higher, and it justifies these because they help pay for the services and rewards that are popular with higher income clients who retailers are anxious to attract.
American Express says the settlement is unfair because it would permit merchants to guide customers away from American Express to Visa and MasterCard and, giving the competitors more market power. This would squeeze market share and revenue. In the second quarter, merchant fees were 65% of AmEx’s noninterest revenue and 55% of all revenue net of interest expense (Wall Street Journal).
Ironically, this decision by American Express delays indefinitely the implementation for any merchant that also accepts American Express. If this drags out in court, it may be years before they can offer the discounts.
Other Interchange Rulings and Legislation
Under the new financial reform bill signed in July, merchants will be allowed to require a $10 minimum purchase for credit card purchases. Merchants can also offer discounts to people who pay with cash, checks or debit cards. The Federal Reserve is currently surveying issuers and merchants about interchange fees and will issue the new rules in the spring.
The interchange fee has been a legal battle almost 30 years. The first antitrust challenge to interchange fees was National Bancard Corp. (NaBanco) v. Visa U.S.A. The U.S. District court rejected NaBanco’s challenge that interchange fees were illegal price fixing.