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Why Is the Government Paying High Interchange Fees?

posted by Adam Levitin

The American Banker (subscription required) reports that Senator Dick Durbin has "added an amendment to an appropriations bill that would require credit card payments accepted at government agencies to be given the lowest available market interchange rates, which typically can only be negotiated by large supermarket chains."

The amount of money at stake is relatively small--perhaps $28 million/year. But it is rather astonishing that the US government doesn't already get rock-bottom interchange rates. If interchange is supposed to reflect the merchant's risk (an argument sometimes made), the US government should be getting the risk-free rate. It hasn't been. Frankly, I'm not sure why the government should settle for getting the best rates available to large supermarket chains-that's not a risk-free rate. If interchange is about risk-based pricing, surely supermarkets should pay a premium over the government?

But this just raises the question--is interchange about risk-based pricing or is it opportunistic pricing? It won't shock anyone that I think it is often the later: low rates are offered to induce industries to accept cards and once the industry has committed and has sunk costs, then the rates are raised to exploit the lock-in effect of consumers expecting to be able to pay with cards. Government interchange rates are pretty hard to explain from a risk-based perspective.

Final thought: will we see state copy-cat legislation? A number of states reserve the right to surcharge for credit card transactions. But if the state can get rock-bottom interchange rates, why bother surcharging? (Of course, some states--California and Illinois, e.g.--might be much worse credit risks than a lot of merchants...)

Comments

Not sure I follow your points. To the extent Interchange is a function of risk of chargebacks(and no one could, with a straight face argue that is wholly the case - rewards cards face no higher risk of chargebacks), it can't really be about the non-payment of chargebacks - the acquirer is always on the hook for that, not (in the end) the merchant or the issuer. Instead, it is likely about increased risk of such chargebacks and the attendant overhead and customer hassle and (perhaps ultimately, in this day and age) about reissuance costs of such cards, which costs really aren't reimbursable by the Merchant/Acquirer in the ordinary course.

As to your second point, most governments Merchants, including the US government as Merchant in all cases I've ever dealt with, surcharges the cardholder, which should make it interchange-neutral for the government Merchant. Why then, as a matter of economics, does the government Merchant care what the interchange rate (or for that matter, the entire discount rate) is? They are whole in any event. Even if interchange and discount rate are rock bottom, it's greater than 0%, and the government Merchant still wants to get the entire ticket amount. What am I missing?

Gross overstatement on my part re: federal government surcharging upon reflection - postal service, Amtrak, etc. are government Merchants that don't surcharge. I think the rest of the post stands, and to the extent government Merchants do surcharge (tax payments, etc.), the original point holds.

Technically the acquirer is on the hook for chargebacks, but the merchant is on the hook to the acquirer for it. Likewise, interchange is technically an interbank fee, but it's the only interbank fee I can think of that is set based on the characteristics of bank customers, not the bank.

I don't think chargeback expense can explain things. Chargebacks have their own set of fees and often the interchange on the original transaction is not returned. I don't think issuers mind the chargebacks so much, and reissuance costs are a drop in the bucket relative to interchange revenue.

To the extent the government surcharges, yes, it should be more-or-less interchange neutral. But surcharging pushes some transactions away from credit, and the government (I guess) likes credit transactions. It's fair for the government to pay something for those transactions, but that should be a competitive rate.

"Technically the acquirer is on the hook for chargebacks, but the merchant is on the hook to the acquirer for it. Likewise, interchange is technically an interbank fee, but it's the only interbank fee I can think of that is set based on the characteristics of bank customers, not the bank."

I agree with everything you said, but we may be missing each other somehow. 1) Interchange is solely a way to compensate issuers (V/MC charge assessments, which are sometimes lumped in with interchange, but are really a different thing, and not what we're talking about here, especially since they are flat). 2) Interchange appears to have some risk-based function (keyed charges have higher interchange than swipes). 3) Issuers take no risk if Merchants can't pay for chargebacks - the acquirers are on the hook for that.

So, where I end up with that is that merchant credit quality should have no effect on interchange. Issuers have nothing on the line. Now, I proposed a theory of "incidental" costs that could make issuer's care about risk of chargebacks, if not really the non-payment of chargebacks, but it's just a theory (one you don't buy). In the end, I think we can agree on 1-3, but I can't get to your original point that issuers should care how credit worthy the government is and offer the best interchange. Perhaps the discount rate ought to approach interchange, because there is no risk of uncompensated chargeback loss.

"I don't think chargeback expense can explain things. Chargebacks have their own set of fees and often the interchange on the original transaction is not returned. I don't think issuers mind the chargebacks so much, and reissuance costs are a drop in the bucket relative to interchange revenue."

Perhpas, but that hasn't kept issuers from passing laws (WA,MN), providing for reissuance reimbursement or from suing TJX and Heartland, etc., etc. for the reissuance cost. It's SOMETHING, but I agree that it may not be so materials as to drive interchange rates.

This is a complicated issue, if government gets away with surcharging which often homes at 2.5% along with utilities and other educational institutions, the private sector would want the same. This is why VISA is not allowed on certain campuses, because they feel rightly that there are benefits to accepting cards such as employee theft prevention, accounting costs, less need for armored car services, no float on checks, and people may spend more money. Chargebacks are probably less of an issue with governments since its more of an official transaction, say paying college tuition or taxes. The IRS is already charging fees of 2.5%, so I am not sure what interchange is being paid.

Perhaps the only people who would pay that fee or those who are extremely wealthy making in the millions (not 150k) or the low income folks who don't have the money.

In that case the government isn't paying interchange fees. The Durbin amendment has been stricken to study convenience fees which are already being charge. I am surprised master-card is allowing them. What happens is a third party processes transactions , however sometimes for a flat fee such as $10-20 regardless of tuition or payment amount is charged directly under the institution as opposed to third party transactions.

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