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The Politics of Swipe Fees

posted by Adam Levitin

The HuffPo has a major piece on the debit card swipe fee legislative fight, which seems to be a stand-alone K-Street Full Employment Act. It's well worth the read. I'm proud to say that Credit Slips has probably had longer, more continuous, and more in-depth coverage of swipe fees than, well, anyone. Back to Sept. 21, 2007, to be precise. 

I'd add a few points to the HuffPo piece, however: the Booger Rule of Antitrust, the Small Banks and Small Businesses (with help from Wrestlemania III), and Consumer Advocates. 

What's the Problem with Swipe Fees?  The Booger Rule of Antitrust

First, it never really explains what's the problem with swipe fees other than that merchants think they're too high.  Merchants think lots of costs (fuel, electricity, etc.) are too high. But what galls merchants about swipe fees is that they have no ability to negotiate over them as they do with other costs of business. For example, Home Depot can't get lower MasterCard swipe fees by making it the "top shelf," preferred payment method. And merchants can't pass along swipe fees to card-using consumers. Payment card network rules say that they have to pass it along to all consumers. These rules are the problem. 

It's as if Visa and MasterCard both operated parking lots that surrounded a WalMart.  WalMart can't really operate unless there's parking for customers, and it won't be unreasonable for those customers who park to have to pay for it.  Similarly, it wouldn't be unreasonble if WalMart wanted to offer free parking and to spread the costs to all of its customers.

But that's not how the MasterCard-Visa parking lot works.  Instead of charging those people who choose to park in the lot for doing so or just charging WalMart and letting it do whatever it wants in terms of passing on costs, MasterCard and Visa instead tell WalMart that it is forbidden to charge consumers who use the parking lot more than those who don't.  So WalMart has to charge all of its customers for using the parking lot, even if those customers who walked, took public transit, helicopter or parachute. That's the antitrust problem--you can pick your friend, you can pick your nose, but you can't pick your friend's nose.  Same goes for prices.  You can pick your prices, you can pick your business counterparties, but you can't pick their prices.  Call this the booger rule of antitrust. 

Not surprisingly, US merchants pay substantially higher swipe fees than anywhere else in the developed world.  Think that ain't a tax on the economy Grover Norquist? Or is it OK because that tax is exercised by banks, rather than the government (maybe Norquist recognizes where sovereignty really resides...)? 

Small Banks and Credit Unions:  Missing an Opportunity

Second, as I've blogged previously, I think the small banks and credit unions are really misplaying their hand on swipe fee reform.  Swipe fee reform offers them a chance to offset the tremendous economies of scale that the big banks enjoy for payment cards. The exemption for institutions with less than $10B in consolidated net assets is likely to be real--if Visa doesn't treat the small banks well, it lets MC grab market share, so V will treat them well and keep interchange fees for small banks where they are. 

The Small Businesses

The HuffPo piece is at times dismissive of the swipe fee battle as one of big banks vs. big merchants, and says a pox on both your houses, you bad corporations. But this isn't just a battle of the giants. Just as there are small banks and credit unions involved, so too are small merchants lined up. Wal-Mart can handle debit swipe fees far more easily than the ma and pa store (which might be incorporated or might be a sole prorietorship).

A better way to view this battle is as analogous to the match between HillBilly Jim and King Kong Bundy, each accompanied by two midgets, in Wrestlemania III (one of the greatest events in American cultural history, if totally not PC).  


Where Consumer Advocates Stand

Finally, it's worth understanding better where consumer advocates stand.  They are either in favor of the Durbin Amendment (Katie Porter and I are all on record about this, as is US PIRG) or on the sidelines (Consumers Union, Consumer Action, Consumer Federation of America) about this particular legislation, even though they have expressed concern over swipe fee antitrust issues previously, and clearly stated that swipe fees cause consumers to pay higher prices.  There is no genuine (non-astroturf) consumer group opposing the Durbin Amendment or even advocating for a delay in implementation. (To understand Consumer Federation of America's particularly awkward position, it's helpful to remember that CFA has not only consumer members, but also credit union members.)  

Some consumer groups are concerned that the Durbin Amendment will just result in a redistribution from banks to merchants, and there will be some of that in uncompetitive retail sectors, but that's the exception, not the rule, and the solution there is to work to improve competition in those areas. Merchants as a whole are much more competitive than banks, so it's hard to imagine that the Durbin Amendment won't result in a tangible consumer surplus.  

Bottom line:  Swiper No Swiping!


Why is it that so many other countries have been willing and able to deal with the problem a long time ago while the US of A, the Mighty One, is seemingly incapable of doing anything sensible about this?

Are we that much more daft and imbeciles than our forefathers?

Other countries do not equate freedom of speech with spending money.

I am simply out of words after reading your blog. I want to appreciate the way you handled such a complicated subject.

Another week, another Adam article that could have been brought to you by the National Retail Federation.

1. Business CHOOSE to accept credit/debit cards. No issuer puts the gun to the head of the merchant they CHOOSE to accept credit/debit cards. Walk around here in NYC and there are plenty of business who refuse to take credit cards - they made that decision just like every other business in the countrycan. Besides, this same thought process goes into Amex acceptance and businesses have spurned Amex over the years because of the high interchange. The business makes the calculation as to whether they can make a go of it without accepting cards. If credit/debit cards were not delivering value do you think businesses would be accepting them today? Before you make that argument of correlation versus causation think about 50 years of psychological and financial data equating to literally trillions of transactions and hundreds of billions in interchange paid telling us otherwise. This would be the biggest scam in human history if businesses weren't making money from credit cards.

2. If interchange pricing has been such an issue to retailers why haven't retailers embraced competing forms of acceptance such as PayPal or Revolution Money? History is littered with multiple payment forms. Heck, retailers should be doing back flips to help out other forms of payment gain traction. Of course retailers would have to actually put skin the game and purchase upgrades to their equipment - another expense they are unwilling to accept. Retailers want a free lunch just like everybody else.

3. Why do retailers continuously complain about Visa/MasterCard/Amex but never lower the price of accepting a competing form of payment? Cash and Checks are free (nominally, still need processing), heck get into the Private Label space and the card company gives transactions free to the merchant and in some cases actually PAYS for the transaction. Yet we don't see this value passed along. Why? Because a slightly lowered price doesn't turn the customer on.

Walk into any Ikea and their are multiple lines for different forms of payment. Use a debit card or pay cash and you get 1% back on your NEXT purchase. Think about that for a moment. Ikea is willing to give back only 1% on a FUTURE purchase/not cash ant not the full 3% upfront in cash they would pay on interchange.

Estimate that Ikea has a gross margin of 30% and only a fraction of that 1% returned to the consumer through interchange rebate will ever be redeemed its likely Ikea is returning no more then .05% - .15% of the 3% saved through interchange differential. Ikea is a very savvy organization and is probably pretty indicative of what we would see widespread.

This last point destroys your argument on cost savings being passed along to consumers. If even today the best known users of transaction pricing differential will not return even a meaningful portion of the interchange back - you can take a guess at what would happen in the future if MasterCard/Visa got regulated on the credit side like the debit side is about too.

Adam you have continuously hidden behind economic theory somehow lowering prices (something we have never observed), all I have is 50 years of evidence to show that retailers continue to accept Visa/MasterCard regardless of the fees (it must be doing something right), retailers refuse to pass along savings they are KNOWINGLY receiving today from other forms of payment (how many places have a cash price?), and retailers are just as greedy as consumers and card issuers in that they want a free lunch (the card acceptance terminal technology that is paid for by merchants is woefully behind the rest of the world.).

All this adds up to:
Swipe Fees generate value for the issuer, consumers, and businesses.

As swipe fees have become more of a greater portion of PnL, retailers would rather see this values taken to near zero then rid themselves of their use.

There has been no documented instance of prices falling when interchange regulation has been instituted but plenty of evidence that when differentiations between payment methods are use the consumer never sees close to the value associated with the difference.


First, I resent the implication that I'm shilling for the National Retail Federation. My views on this subject have been on paper since 2004 and in published form since 2005, well before I had even heard of the NRF. The only compensation that I have ever received related to interchange has been from the Filene Institute (I wrote a report for their members) and the Credit Union National Association (related to the Durbin rulemaking). I say what I say on interchange because I think it's right, not because I have any financial bone in the fight. I suspect you do, however, as there's no one I know of who isn't getting paid by a financial institution who is worked up about Durbin like you are.

Second, the issue has never been whether there is value to consumers or merchants from debit and credit products--of course there is. The issue is whether the pricing of these products is anticompetitive or not. The mere fact that merchants receive benefits from debit and credit is irrelevant to the antitrust inquiry. Indeed, the fact that merchants continue to use the products is irrelevant to the question of fair pricing.

Third, the idea that merchants "choose" to accept debit/credit is rather strange. Have you tried operating an on-line merchant just on PayPal? A merchant that doesn't accept plastic is at a severe competitive disadvantage. The choice point is sort of beside the point--merchants also "choose" to have electricity and heat in their stores, after all. They could just operate like open air farmers markets, right?

Fourth, I've written extensively about why we don't see cash discounts. The answer is because the card networks make them near impossible to do. MC/V require item-level dual tagging for cash discounts. It isn't worthwhile to do this on every pack of gum. That's why cash discounts are rare except in cases where there are only a few items on sale: regular, super, and premium gasoline, for example.

Fifth, blaming merchants on the terminals is strange. There's no point in upgrading terminals unless cards are chip and PIN enabled. They aren't, and that's purely a matter of issuer voting, at least for MC. And, fwiw, I've noticed that some places, like CVS, now have Chip & PIN terminals (as well as contactless). CVS has also sued Amex over interchange, so it's put its money where it's mouth is.

Sixth, IKEA is sui generis in its offer and can hardly be taken as indicative of anything. I'm not sure how IKEA manages to do the discount under card network rules. I'm also skeptical that it has much effect. I think consumers recognize that they aren't getting a lot of value from the IKEA coupon. I know that I'd rather get the 5% cashback from my issuer than the 3% of my next IKEA purchase (which is probably in at least a year, and would require me to keep the coupon). That might explain why the IKEA discount hasn't been copied--it just doesn't generate a lot of savings for IKEA.

Look,m retailers aren't saints. They're profit-driven, like MC/V and the banks. Retailers don't _want_ to pass on savings to consumers. But they will if they have to because of competition. That's hardly economic theory--that's common sense. I'll go dollars to donuts that there's better price competition among retailers than among banks. And that means that the Durbin Amendment will inevitably result in consumer surplus.

Now you criticize me for not being able to point to any "documented instance of prices falling when interchange regulation has been instituted." Let's start with this: there aren't _any_ studies that look at this issue, period. Trying to sort out interchange impacts from all sorts of other economic factors (e.g., cost of gasoline) is near impossible. So we're left with economic theory/common sense. And that says that if merchants are more competitive than banks, we'll see greater consumer surplus with if interchange fees drop.

Obviously some types of merchants are less competitive than banks, and those merchants (like telecom and airlines in Australia) are always going to be exhibit A for the anti-regulation case, but let's recognize that they are exceptional, and that in most cases, it's just impossible for there not to be consumer surplus generated.

As it stands, we know that rewards are only about 44% of interchange. So as long as we get 45% pass-thru from merchants, consumers are better off. We don't have to get 100% pass-thru, and I wouldn't expect it.

If the Durban amendment is enacted then I can expect a reduction in the price of everything I buy - right? Well, now the merchants claim they are not doing this for their own profit, but are protecting all from greedy banks and their unwarranted inflated fees - right??? The Merchants don't want the money and they say the fees are causing prices to go up. Why is that?? The merchants aren't paying the fees the consumers are! Why do we need some politician to get involved with this? If the merchants have a problem they can buy a bank and set up their own credit card system. That cost too much?? Why would you say that - you just told me that the Banks are making too much money. THE FACT IS THIS IS BS LEGISLATION AND NO BODY WILL BENEFIT EXCEPT THE MERCHANTS AND THEY NEVER SUFFERED A LOSS BECAUSE OF CREDIT CARDS. Jackasses and the American public is too dumb to realize how badly they are getting screwed!


1a. - I said it could have been written by the NRF not that you wrote it for the NRF. I have read every article your have written here on Credit Slips and the consistent theme has always been that somehow retailers pay too much for swipe fees without the discussion of how much value retailers derive from them. Its the difference between pricing based on value vs. cost + pricing. Example: If I see you a tool that allows you to create $500 of additional value to your product but only costs me $5, your arguments have always been that the product should be priced at $5 - I prefer the other end.

1b. Yes I live in financial services - but only deal tangentially with interchange within a suite of other financial products sold. In much the same way you have staked out a career in academia based on research around interchange reform, I have staked out a career in various positions within the financial services industry and regardless of what happens with Durbin or future versions neither one of our livelihoods will be impacted. That said, I come from and understand the PnL dynamics around credit and debit cards, which brings me more to comment on these issues then just about any other because I feel the lack of knowledge of those PnL dynamics leads to poor understanding and thus poor judgements about interchange. I am always suspicious when others discuss how expensive interchange is for the retailer w/o knowledge of the issuer. I cringe every time I hear someone talk about wanting interchange to be straight sales or per transaction fees as it shows a complete lack of understanding of payments.

2. Anyone can enter the market for payments and in my position I have seen a number come, thrive, and also go. Part of the reason you say payments is "anti-competitive" is a product of how retailers do not make it easy for themselves to add new payment and card types to their POS systems. I previously worked with a major retailer where it took a full year to add a brand new card type that the company was extremely interested in offering for payment. If it took a year to get a new card type into place when this retailer was interested, no other payment type has a chance unless the price is effectively zero. Retailers in this case are their own worse enemy and perpetuate M/V dominance because that’s where the volume is.

3. Actually, the use of PayPal for purchases over the Internet has become quite popular. Given its use of either ACH or credit card it makes it quite easy for online retailers to lower their own interchange rate by encouraging its use. However, when it comes to payments POS is by far and away the leader when it comes to transactional # and $ volume.

Yes, retailers CHOOSE to accept debit just like they CHOOSE to heat/cool their establishments. Come up on the train this summer to NYC and start walking into many of the smaller bodegas and you will find out just how "cooling" is an optional expense. Again, the acceptance of payments is not a requirement for a successful business. I can walk around many neighborhoods and go into stores and restaurants that do not accept credit cards and they have done well for many years. Flip side - walk into a Sam's Club and you cannot use a Visa credit card. Even as late as 5 years ago, you could not use a MasterCard. Sam's Club seems to have been doing fine with this selective acceptance of credit. So yes, it is a CHOICE to accept a card-based transaction. Cards make business easier, but by no means is it a requirement.

4. MC/V require item-level dual tagging for cash discounts.

Maybe if you were talking 10 years ago this argument held water. Today, retailers with any size or any retail systems such as Re-Tek in place do not PHYSICALLY tag every product - this is all driven through bar coding and taken care of through the system and POS. All the retailer has to do is update a table and print out a new pricing slip to slide in front of the display. Ever notice when you walk into your favorite supermarket how there is a "club" price and regular price. How do you think that gets done? The same way dual print outs could be done if retailers so desired. I could get on-board with some legislation for a carve out here for business with < $1,000,000 in sales not having to do dual tagging, but by no means is dual tagging a hindrance to "cash" pricing any longer.

5. Again, terminals are part of the key to multiple forms of acceptance beyond V/M/A/D. Without POS that are flexible (look into the multiple POS terminals you will find in a normal gas station franchise network and it is stupidly different), you cannot accept new forms of payment and card types. If retailers are waiting for Chip/Pin it will never happen. My view: in much the same way the developing world skipped land lines and went straight to cell phones so will the US skip Chip/Pin and go straight to NFC. If retailers value competition they have to be willing to update their networks to accommodate new payment types or at the very least begin considering private ie store forms of payment.

6. Ikea somehow manages to do this so it has to be under the issuer rules otherwise there would be a lot lawsuits flying back and forth. As a consumer you want that 5% more than 3% off a next purchase (in Ikea's case 1%). Actually, the 1% has the direct opposite of savings. The value is so low that it only takes a few individuals moving over to pay with cash to increase the marginal profitability of a sale and make it worthwhile. Remember when we speak about Interchange we're talking a % of sales.

7. If we were to reform interchange and as you said consumers received the same pass through rate 45%, you would be satisfied. I believe I would be amenable to this prospect. Today we can monitor that value through bank card interchange and reward rates. However, it’s not that I don’t trust to change the system, but I want to cut the cards. The only way consumers today can extract meaningful value is through their use of payment method. As you have stated previously know one has been able to show that savings or "pass through" came back to the consumer in any reform effort including the last major one in Australia, but we should trust the market. This puts us in a predicament because I don’t give the market that much credit to lower prices especially in products with low elasticity of demand such as consumer staples.

So the Final Exam Question Professor Levtin:
If we’re to regulate interchange pricing, how would you design a system whereby consumers/regulators could monitor the pass through rate and determine if it was better or worse then what they were getting before. How would you allocate that value back to consumers?


First, to answer your final exam question: permit surcharging. I don't know what and require that the surcharge be itemized on the receipt (and maybe displayed at the POS). I would permit merchants to surcharge for all payment forms, including discrimination by network and discrimination by card type within network (debit/credit and rewards level). I would not permit issuer-by-issuer discrimination within networks, however, unless there were issuer-specific cost to merchants. Surcharging should reduce interchange rates to the point that it isn't efficient to surcharge, so there wouldn't be much surcharging. I much prefer surcharging to a price ceiling, as I think it is a market mechanism that would make interchange look like every other product.

Second, if you're so dubious about pass-thru, what makes this different than say a tax on merchants or the cost of gas? If taxes or the price of gas went down, we would expect some of the surplus to pass-thru to consumers, but for that pass-thru to vary depending on how competitive a merchant sector is. Why is this any different?

Some questions:

1. Why is NFC better than Chip & PIN? NFC replaces the mag stripe, which is a single factor authentication mechanism. Chip & PIN adds a second authentication factor (PIN) and makes it harder to counterfeit the primary authentication factor (via the Chip). I can see NFC filling the role of the chip, but what about the PIN?

2. I'm not following you on why interchange should be ad valorem rather than a flat per transaction fee. There's no change in the cost of processing a transaction based on its size. So what's the argument there?

First, kudos to Adam for continuing to engage Hangtime79. That's the kind of moxie that makes this site so interesting.

Second, I don't want to dive into the all of the disputes between Adam and Hangtime79, but I did find it interesting that Adam said that he'd favor the 5% cash back from his card over the usual discount that a merchant could provide at the point of sale. Geez, 5% cash back? That's a pretty good deal! Speaks pretty highly of the pass-through of your issuer if you're getting more back than what I understand interchange rates to be. You're clearly a good shopper when it comes to banking services! (What card do you have? B/c I gotta get me one of 'em.)

I suspect that you'd come back to the old "I'm rich and a good credit risk, which is why I get this card" argument. But I think that the problem there is not that you get this deal, but that others don't. In other words, why don't we focus on getting cards, especially cards with good deals, to low income households rather than screwing around with interchange fees? Perhaps we don't want to give them credit cards, if we're feeling paternalistic, but at least let's get them deposit accounts and debit cards with good rewards and other attractive terms. Heck, a debit card with a 1% reward would probably be better for most low income households than any relief in prices from the Durbin Amendment. And I certainly don't see how the Durbin Amendment will improve their access to debit cards. (Access to credit cards? Well, that's a different story. Talk about one of the unintended consequences of the Durbin Amendment - people may start shifting back to credit cards if debit cards become less attractive.)

More generally, if the problem is insufficient competition among banks, who appear unwilling to give sufficiently good cards to low income households, why not concentrate the policy attention on that problem? Give Wal-Mart a bank - that would be a pretty good way to get cards and accounts downmarket, and I suspect that Wal-Mart would give smashing rewards on its Visa debit cards, especially for use at its own stores. Why fiddle with interchange fees, with all of the associated dislocation in the market, rather than attacking the core competitive problem that causes difficulties for low income folks?

Even more generally, if the difficulty is being poor so that poor folks cannot get cards/bank accounts and end up getting screwed at the cash register, why don't we attack the core problem of poverty instead? Going after interchange fees as a way to correct regressive features of our economy seems to be a very indirect way to do so. Why not focus on redistribution through the general tax system, which would seem a more direct, and arguably less distortionary, way to achieve the ultimate result?

That having been said, I do have to agree with Adam about the restrictions on merchant pricing. I believe that Hangtime79 is correct that many of the purported restrictions, such as separate display pricing, are no long in effect, if they ever were, particularly after the recent DOJ settlement, which I believe removed any restrictions on discounts across payment methods, networks, or types of cards, at least for credit cards. Even still, I agree with Adam that when networks prohibit surcharges or other forms of differential pricing, even if they generally allow discounting, that seems to be difficult to justify. It's a bit silly because at some point, outside of framing issues, discounts and surcharges become the same thing, but I personally think that a merchant should be able to deal with its various costs however it sees fit.

But this gets back to my earlier point: Whenever I see a gas station with a cash and credit price, I do a quick calculation in my head and immediately decide to pay with my card. "Thank goodness," I quietly say to myself, "For my bank and its awesome 5% cash back on gas." And as for the unfortunate schlub trekking into the station to pay with cash, which requires the attendant to activate and set the appropriate amount for his pump, well, I pity both him and the gas station operator as I zoom through my unattended pump and am on my way. Now if we could only do something about that $4.00 per gallon price of gas... dangit, where's Durbin when you need him?

(Completely off point, but I read an article recently, can't recall where, about how Chuck Schumer has been calling for release of petroleum from the strategic reserves for years. He did so back in 1999 when oil rocketed to $25 per barrel and has done so repeatedly over the years whenever prices jump up, notwithstanding the fact that this strategy would likely have involved selling low from the reserves and buying high to replenish them. And his ilk are calling for such actions again now. Talk about a schlub. But I guess that I can make a relevant point here, which is that it's not very wise to get the government involved in the price-setting business.)

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