Guillaume’s blog

One of the best papers I've seen on this this topic is "Interchange Fees and Payment Card Networks: Economics, Industry Developments, and Policy Issues" [1]. I'm still trying to get a grasp on the economics of interchange fees, and have found it to be a great help.

I think the key assumption here is that bilateral interchange agreements between small issuing institutions and the networks aren't going to happen: there are too many small institutions for this to work. (see pp46, ibid). I think it's safe to assume that Star/Plus/Visa/Mastercard are all going to go cheap and not do bilateral negotiations with smaller institutions. Besides, there's no way that Visa/Mastercard are going to destruct their brand identity by dismantling the honor-all-cards rule, and you' d pretty much need to do that to stratify the interchange fees.

Therefore, an institution is going to need to differentiate their fees through their choice of networks. However, if the network is too expensive, it risks rejection by merchants. This strategy leaves a network open to a Metcalfe's-law dealth-spiral: I used to work retail, I remember a big pissing match between a regional network and the retailer, they simply rejected the cards of fell back onto another logo. ("Run it as credit.")

As long as there is a Visa/Mastercard/Plus/Star logo on the card, there will be downward price pressure, and the CUs will lose interchange fees -- even if they're exempt from the regulations. And if you drop those networks, how usable is your card, anyways? (Remember, a big catalyst for interchange fees rising was network consolidation...)

Getting back to your question: CUs are acting this way out of self-interest. The system is messed up, and I'm disappointed by CUNA and the regional CU organizations, I think they could have given this some additional thought instead of being so reactive. There are merchants involved, as well as consumers. Both are members of our communities, something I'm surprised that CUs seem to forget, with so many moving into small business loans aggressively.

We have a strong "buy local, be local!" campaign up here, and it pains me that so many local businesses don't accept cards because of the fees involved.

... not to mention the argument that interchange fees are regressive because they shift costs onto cash-only users, and give high rewards (1% cashback!) to the affluent. Rewards cards really show how convoluted this system has become.

Maybe I'm wrong: but I fail to see how cheap efficient payments can be bad for anybody.

[1] http://www.federalreserve.gov/pubs/feds/2009/200923/200923pap.pdf

I also tend to support cheaper payments. To replace the cash back programs, I think FIs need to work with merchants to design attractive programs that benefit both merchants in term of $ costs of processing and in term of value given as reward to the cardholder.

Do we really need a replacement for cash back programs? As long as the incentives cycle needlessly in the system, I think the results will be counterproductive.

Can't debit cards be magical in the same way as the internet: Fast, convenient, and practically free? The argument which Visa/MC make that debit cards SHOULD be more expensive because they're better than checks (this old canard is mentioned in the Mercator report [1]) seems ridiculous to me. By the same argument, the bill for a mobile phone with nationwide calling should cost hundreds of dollars a month, because long distance used to be so expensive, and they're so much more convenient...

[1] http://bit.ly/bLXc0F