Point of sale (POS) interchange fees (for payment card purchase transactions) account for an enormous flow of funds between acquirers and issuers, and indirectly between merchants and acquirers. In 2000, these fees totalled over US$26.5bn worldwide, and this figure grew 140% to US$63.8bn (€48.4bn) in 2006, including US$38.8bn in Canada and the US and US$10.1bn in western Europe.
Source: RBR analysis
The massive growth in POS interchange fees has mainly been fuelled by a phenomenal increase in payment card purchase expenditure worldwide and increased interchange rates in the US, the world’s largest payment card market. It occurred despite reduced interchange rates in Australia, Europe and elsewhere, resulting from the activities of public authorities, competitive pressure, litigation by merchants and retailer associations, and the impact of reduced processing, fraud and other costs.
Controversial Fees Increasingly Under Attack from Authorities
POS interchange fees have been the subject of analysis, controversy, legal actions and scrutiny since the Nabanco case in the US in the mid-1980s. During the last decade, however, public authorities – central banks, regulatory and supervisory bodies, and consumer protection agencies – have become increasingly knowledgeable about interchange fees. Either on their own initiative or as a result of complaints from merchants and/or retailer associations, they have undertaken numerous investigations and actions into these fees and related matters, such as MasterCard and Visa’s honour-all-cards and (no) price discrimination rules.
The list of countries where there have been recent legal, competition or regulatory actions is getting longer rapidly and includes: Austria, Australia, Brazil, Colombia, the European Union, Germany, Hungary, Israel, Italy, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, Romania, Singapore, South Africa, Spain, Sweden, Switzerland, the UK and the US.
Although this list includes some with relatively immature markets, activities by authorities in developed and mature payment card markets have had the largest impact.
Some of the most prominent actions have been those of the European Commission, primarily the Directorate General for Competition, and the Reserve Bank of Australia (RBA), which has undertaken a sustained campaign since the late 1990s to reform the country’s payment card market and, in particular, its ATM and POS interchange fees. The decisions of these two organisations increasingly influence authorities in their own and other regions, part of a worldwide trend for one authority to refer to and/or incorporate the analyses and rulings of another authority in its investigations, in a mutually enforcing virtuous circle. A recent example of this is the report of the South Africa Banking Enquiry, published in June, which makes frequent references to the situations and investigations in Australia, Europe and the UK.
In the US, the status and legality of POS interchange fees has historically been established by lengthy individual legal cases under anti-trust legislation. The most well-known litigation is the ‘Wal-Mart case’, which was resolved in April 2003 when MasterCard International and Visa USA agreed to pay merchants a total of US$3.05bn over a 10-year period and unbundle their acceptance services to allow merchants to accept signature-based debit cards and/or credit cards.
At the beginning of March 2008, however, the Credit Card Fair Fee Act was introduced into the US House of Representatives, to be followed in June by a US Senate bill with the same name and the introduction into Congress of the Credit Card Interchange Fees Act of 2008. If these bills are enacted, and the Credit Card Fair Fee Act appears to have significant deficiencies, they would dramatically change the rates and terms of access of payment card acceptance in the US and the country’s POS interchange rate structure and fees.
Fee Levels and Structures Vary Significantly
There are significant variations in the levels of domestic POS interchange rates throughout the world, even between countries whose payment card markets are at a similar level of maturity such as the major economies in western Europe. In Europe, domestic interchange fees for debit card transactions range from zero (in countries such as the Netherlands and Norway) to an average of €0.45; while country averages for purchases using consumer credit and charge cards are between 0.4% and 1.9%.
There is also no consistent approach to interchange rate structures. Some countries have relatively simple structures with a small number of interchange rate categories per payment card scheme and card type, whereas others have extremely complex structures with a multitude of categories. In the US, for example, the structure is bewilderingly complex: MasterCard has 167 interchange rate categories for purchases and 29 for refunds; while Visa has 124 and 8 categories respectively. This complexity is made worse by the fact that both payment card schemes set interchange rates for consumer and commercial credit/charge cards that are not just dependent upon the merchant sector and transaction type but also upon the ‘product group’ of the card used in a transaction. This is not known by a merchant as it reflects different levels of cardholder/company rewards, benefits and services.
Despite this variability, some trends are evident:
- Weighted average interchange fees in western Europe are falling. They fell by an estimated 10% overall between 2004 and 2007 despite off-setting increases in some countries. In the UK, for example, the average interchange fee for a domestic debit card POS transaction increased by a third between 2002 and 2006 as a result of the migration of Switch debit cards to Maestro and corresponding increases in the multilateral interchange fees (MIFs) for Visa debit cards.
- The weighted average POS interchange rate for domestic transactions in the US increased continually from the late 1990s until 2007, but with lower rates of increase since 2005. In 2008, the average is around 1.77%, the same as in 2007.
- In Australia, the RBA’s reforms have led to a halving of the weighted average POS interchange fee for credit card transactions, from 0.95% to 0.50%, and reductions of up to 80% in the average interchange fee for debit card transactions. As a consequence, Australian issuers lost an estimated AUS$2bn (€1.2 billion) in interchange fee revenues from November 2003 to December 2006.
Uncertain Future for POS Interchange Fees
RBR’s report states that there are four main reasons why the future of POS interchange fees is uncertain.
First, the authorities’ interest in POS interchange fees and related matters will undoubtedly expand in the future. Recent authority investigations have typically established that MIFs restrict competition, violate anti-trust or anti-competition legislation, distort competition between payment instruments, and do not have adequate mitigating benefits in terms of their contribution to technical and economic progress.
Second, authorities have not found the arguments put forward by payment card organisations, banks and others in support of current interchange fee arrangements – and MIFs specifically – compelling or convincing. This has meant they have taken increasingly tough stances on payment card schemes’ MIFs. Their rulings have covered the processes by which MIFs are set, actual interchange rate levels, and the cost elements that can be included when a MIF is calculated, based upon an underlying issuer cost-reimbursement methodology in the absence of a cogent alternative.
Third, the European Commission’s actions in relation to POS interchange fees and related issues will increasingly influence those of other European National Competition Authorities (NCAs). In part this is because of EU Regulations, but also because of the European Competition Network where EU NCAs and the Commission’s Competition Directorate meet to ensure coherence in competition decisions and policies.
Lastly, because pressure from merchants and retailer associations towards reduced interchange fees (or even their removal) will intensify. In Europe, this pressure will be amplified by political and regulatory pressures to converge and standardise interchange fees in the SEPA area, and by the overall ‘war on cash’ to replace cash transactions by what their advocates promote as more-efficient card payments.
Wholesale and Dramatic Changes are Forecast
RBR’s report forecasts a general decline in the levels of POS interchange fees around the world, accompanied by changes to interchange rate structures and enforced amendments to the international payment card schemes’ honour-all-cards and price discrimination rules.
These movements are likely to occur more rapidly in Europe than in the US, with those in Australasia proceeding at a medium pace. Within Europe, the rapidity of change will depend upon numerous factors. In general, those countries with relatively immature payment card markets may be afforded a degree of protection and their levels of domestic interchange rates may be sustained longer than countries with developed and mature payment card markets.
Conclusions will be reached eventually in the European Commission’s formal investigation into Visa Europe’s MIFs and honour-all-cards rules, which began in March, and the MasterCard case, where the payment card organisation has suspended its intra-EEA interchange fees pending the result of its appeal to the European Court of First Instance against the Commission’s ruling of December 2007. The outcomes are likely to consist of agreements that maintain MIFs but encompass a degree of compromise by both sides from their ideal positions. Such agreements will probably encompass significant reductions in the schemes’ MIFs, changes to their honour-all-cards rules, and the removal of Visa Europe’s rule that bans price discrimination, to make Visa’s rules compliant with the Payment Services Directive (PSD).
RBR also anticipates that interchange rates will fall in the US in the next three to four years as a result of the cumulative impact of legislation, litigation by merchants and retailer associations and merchant actions to accept and promote alternative payment methods, such as those where debit card transactions are settled via automated clearing houses (ACHs).
Finally, there will be considerable changes in the short term to the interchange rate structures in developed and mature payment card markets. The direction and pace of change will vary by region, country and regulatory jurisdiction, but recurrent themes are likely to include the requirement to unbundle the various components of multilateral interchange rates into three main cost categories: transaction processing; the payment guarantee; and the costs of fraud prevention, detection and monitoring and fraud-related technological developments.
Major Implications for Industry Participants
The decline in the levels of POS interchange fees and the associated changes to interchange rate structures and payment scheme rules will have major strategic implications for payment card organisations, issuers, acquirers, merchants and consumers.
For payment card organisations, for example, one key strategic decision is their reaction to the new interchange fee environment. A payment card scheme with MIFs must take strategic decisions on its overall approach to authority investigations It has to decide if it is to continue to attempt to prove that its MIFs produce economic and technical benefits that outweigh their anti-competition, anti-trust and other negative effects, coupled with the continuance of damage limitation activities to decelerate interchange rate reductions; or to concede that the attempt is unlikely to succeed and therefore to adopt a policy of active and positive co-operation. Although payment card schemes may not move away from the first option in the short-term, this is unlikely to be a viable long-term strategy.