Interchange Fees - The Economics and Regulation of What Merchants Pay for Cards- 2011 (Free)
Interchange fees have become increasingly controversial. These fees constitute the bulk of the cost that merchants incur for taking cards because most consumers pay with a card from a four-party system that assesses these fees. The total interchange fees paid by merchants have increased dramatically as consumers have switched to electronic payments. Merchants have complained, have filed lawsuits, and have lobbied governments to do something about this. Meanwhile governments around the world have intensified their examination of these fees. For example, the US Congress passed legislation in 2010 that required the Federal Reserve Board to regulate debit card interchange fees; the Reserve Bank of Australia decided to regulate credit card interchange fees in 2002 after concluding that a market failure had resulted in merchants paying fees that were too high; and in 2007 the European Commission ruled that MasterCard’s interchange fees violated the EU’s antitrust laws.
The controversy raises two broad issues. The first relates to how payment card systems decide how much merchants should pay for taking cards either through the interchange fee for four-party systems or the merchant discount for three party systems. The second concerns whether the setting of interchange fees by private businesses results in a market failure and if so what if any regulation should be adopted to correct this market failure.
This interchange fee debate helped stimulate a new literature on multi-sided platforms or what are sometimes called two-sided markets. Payment card systems serve as intermediaries between merchants and consumers and operate a platform that enables these two different kinds of customers to interact. It turns out that there are many other businesses that have similar features including software platforms like the iPhone OS, shopping malls, search engines, and exchanges. Economists have developed general models of multi-sided businesses and applied them to payment cards.
This volume consists of seven articles on the economics and regulation of interchange fees. All rely on the multi-sided platform framework. The first two chapters examine whether there is a market failure in setting interchange fees and present principles for considering correction to a market failure. One of the themes of these articles is that regulating one side of a two-sided market necessarily has effects on the other side of the market: lower prices for merchants means higher prices for consumers. Chapters 3-5 address that tradeoff which is sometimes called a “waterbed effect”. Chapter 3 presents an empirical study of what happened following the imposition of price controls on interchange fees in Australia in the mid 2000s. Chapters 4 and 5 estimate the prospective impact on consumers in the US and EU of interchange fee caps. These chapters rely heavily on the economic concept of pass-through, which concerns the extent to which business change their prices in response to changes in costs. The net impact of reductions in interchange fees on consumers depends on the extent to which issuing banks raise fees and merchants lower prices in response to a reduction in interchange fees which are revenues to banks and ultimately costs to merchants. Chapter 6 examines a related question: how do interchange fee price caps affect investment and innovation for payment systems. Chapter 7 examines arguments that merchant representatives have made concerning debit card interchange fee regulation. That is followed by a short chapter with a few concluding thoughts.
About the Author
David S. Evans, is the Chairman of the Global Economics Group in the firm’s Boston office, and has broad experience in the economics of antitrust, intellectual property, and financial regulation. Dr. Evans has an international practice and has worked on matters in the United States, the European Union, China, Brazil, Australia, and other jurisdictions. He has provided economic advice on a wide range of industries but has special expertise in financial services, internet-based, media, and information-technology based businesses. He is one of the world’s leading authorities on platform-based (“two-sided market”) businesses.
Dr. Evans currently teaches economics and antitrust at the University of Chicago Law School where he is a Lecturer and at the University College London where he is a Visiting Professor. He is the Editor-in-Chief of Competition Policy International and the CPI Antitrust Chronicles and is on the editorial boards of Concurrences and The Review of Network Economics. He has authored or edited 8 books and more than 100 articles and book chapters.
Dr. Evans was a Managing Director of LECG (2004-2011) where he was the head of its global antitrust practice and Vice Chairman of LECG Europe. Previously he was Senior Vice President at NERA (1989-2004) where he was also a member of the management committee and board of directors.Prior to his responsibilities at NERA he taught at the Department of Economics and the Law School at Fordham University in New York.
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