In “Bank Fees Squeeze Retailers, Cost Consumers,” I reviewed some of the problems with the hidden credit-card “swipe fees” charged to merchants but invisible to consumers.

  • The fees hurt merchants’ profitability, and, ranging between 1.5% and 3% of a transaction, interchange fees typically are one of the biggest expenses for merchants after labor.
  • They raise consumer prices by causing merchants to raise prices for everyone, including consumers who pay in cash.
  • They are discriminatory, being significantly lower for large merchants processing non reward credit cards, versus small merchants processing premium rewards cards.
  • They disproportionately impact US consumers vs. consumers elsewhere in the world, and US rate varies considerably.
  • They are the unnecessary result of antiquated technology, and “EMV” chips, far superior at minimizing fraud risk than normal magnetic-stripe encoding common in the US.have made Visa France’s system much simpler and far cheaper.  The case has been made that US issuers are dragging their feet on EMV to continue collecting high interchange rates on signature, resulting in substantial amounts lost to fraud every year.
  • They continue to increase: Interchange-fee costs for Visa’s and MasterCard’s premium cards increased 24% between 2005 and 2009, according to a 2009  Government Accountability Office report. Now, a new surcharge fee is expected to raise them even more.
New Surcharge Fee Coming: Visa and MasterCard  are looking to lift their no-surcharge rule under a potential settlement of long-standing lawsuits retailers have brought against the card networks and numerous banks that issue their cards, over the setting of the fees.

Merchants Negotiate a Settlement

The Suit: Large merchants led by Wal-Mart (“Everyday low pricing”), and including Kroger, Safeway and Payless Shoe Source looked at all the fees flowing to the credit-card companies each month and thought, what if that was mine? Teaming up in 2005 with entrepreneurial law firms including Robbins Geller (nee Lerach Coughlin Stoia), Berger & Montague and Robins Kaplin they assembled a class action that accused the credit card companies of conspiring to set processing fees too high.

The Settlement: Under the settlement, worked out over months of negotiations, Visa, Mastercard and a collection of banks including Barclays, Chase, Capital One and Wells Fargo will pay $6 billion in cash and reduce their so-called “interchange fees” by 10 basis points for eight months after the deal is signed.

They’ll also drop boilerplate language in their contracts with merchants that prohibit stores from charging more to customers who pay with plastic. Under this settlement, retailers will be able to “surcharge” up to a cap that is established yearly according to a formula.

Now, merchants can charge higher prices to consumers who decide to pay for their purchases with credit cards. A customer, for example, who buys a $100 item with a credit card might be charged an additional $2.50.

Until now, credit card companies used their monopoly power to prohibit this. Merchants could discount for cash, but their contracts with Visa and Mastercard flatly prohibited them from charging credit card customers more to cover the swipe fee — and card companies were adamant about enforcing this prohibition. The obvious reason was that they were afraid that this would cause people to use credit cards less.

The settlement also allows merchants to negotiate no-surcharge agreements with Visa and MasterCard, presumably in exchange for something of value, as long as they are of limited duration and individually negotiated.

 Parija Kavilanz in CNNMoney reported on the status of the settlement that unhappy merchants have brought against Visa, MasterCard and major banks. The companies have agreed to a $7.2 billion settlement, still requiring a judge’s approval, under which about 7 million merchants will get paid for damages stemming from the alleged conspiracy to fix the processing — or “swipe” — fees, as well as a reduction in the fees, but only for eight months.

Who Benefits?

Consumers? Will consumers be better off under a system where they pay the costs of operating the credit-card network directly, instead of indirectly through higher costs passed through by retailers on everybody? It’s difficult to tell. However, cash customers will win, while those with credit cards with rich rewards and cash-back programs will likely lose.

This paper by economist Richard Schmalensee of M.I.T. finds that consumers didn’t universally benefit after Australia mandated lower interchange fees in 2003.

All in all, it seems that in the short time since interchange fee reductions were imposed retailers have been made better off, issuers have been made worse off, and some consumers have been made better off (particularly those who tend to use cash a lot) and others have been make worse off (particularly those who use credit cards with reward schemes).

And many consumers were shocked after banks threatened to increase the price of checking accounts to make up for revenue lost when the Federal Reserve imposed new limits on overdraft fees in 2010. Instead of a payment network paid for by people who chose to bounce checks, it was becoming a network paid for by everybody.

Local Merchants? The reaction of local merchants is unenthusiastic.

While small merchants are relieved to be getting something from Visa and MasterCard, the settlement is not seen as anything resembling a windfall. Molly Brogan, spokeswoman for the National Small Business Association, which represents 65,000 small businesses nationwide said that “it’s a step forward, but not where we need to be.” The ideal scenario, she said, is one in which the swipe fees that merchants pay are equal to – and not more than – the actual cost of processing credit and debit card transactions.

The settlement also determined that banks will allow merchants to add a surcharge to a bill if their customers decide to pay with a credit card.  This also met with little enthusiasm. Seth Broman, vice president of business development with Merchant Cash and Capital, which provides alternative financing to small businesses said he didn’t think this was a big deal for small businesses. Most business owners, already assume the cost of processing a credit card – such as for labor, rent and merchandise – into the prices customers pay. So it is uncertain how many small businesses will want to suddenly openly advertise adding a surcharge to their plastic transactions – not be the shrewdest move for a small business. Says Broman:

As we have transitioned into a cashless society, a smarter competitor to a restaurant charging a surcharge is one that advertises it doesn’t charge a surcharge.

One business owner noted that, when he first heard about the settlement, he thought he was getting a rebate from the bank, but was disappointed to find that it is more like a temporary break in his fees. He stated that, although 85% of his customers pay with a credit card, he still won’t add a surcharge to their bill to help pay for his own credit card processing fees, even though they totaled $19,000 in 2011. Why not?

If I were in a non-competitive business I would do it. But I’m not. We have a lot of auto repair businesses around us. I don’t want to lose my customers.

Additionally, since his state of Oregon has no sales tax, he said consumers in the state aren’t used to paying anything extra at checkout.

Dodd-Frank Reforms Are More Welcome

A government cap that was imposed last year under the Durbin Amendment of Dodd-Franks, is reported to have already cut the interchange fees that MasterCard, Discover and several smaller companies charge for each debit card transaction was already reduced and now averages 24 cents, down from 43 cents in 2009, according to a Fed report.

Retail and grocery industry trade groups said this week that the measure has largely helped businesses. The cap, which went into effect Oct. 1, has pushed down costs and revealed just what each card processing company charges on average.

Mallory Duncan, a National Retail Federation lawyer who lobbied for the law’s passage said that “For the vast majority, this has been an improvement.”

Are Issuers and Banks Getting Around the Law?

The American Bankers Association published a piece entitled “Merchant Interchange Rates are Steady—Transaction Volumes Are Rising” claiming that interchange rates have remained basically static since 2000, and that the real issue is just that merchants are doing more transactions:

Consumers are using their debit cards more and more with each passing year.  Yet the interchange rate that merchants pay when they choose to accept debit cards for payment has remained relatively steady.  True, the total interchange fees paid have risen, but that is because of two important reasons:  (1) the volume of sales transactions has increased – which means greater total sales and profits for merchants; and (2) customers are choosing to increase their use of debit cards as a means of payment and merchants have encouraged them to do so. Simply put, since interchange fees are a relatively small and constant percent of transactions,the rise in total interchange fees paid is a sign of the success of retailers in selling more products, not a sign that merchants are being charged more.

This graph, sourced to the Nilson Reports was offered as evidence of the claim.

Nilson Graph

Unfortunately the ABA report refers to debit cards, while the graph shows average debit + credit interchange rates (plus network fees, etc.) because the Nilson Report does not break down interchange into credit and debit, and the blending of debit and credit interchange masks the real fact that both debit and credit interchange rates have risen significantly since 2000.


Further, the report don’t distinguish between PIN and signature debit, or account for the networks charging lower interchange fees for types of merchants who are reluctant to take cards (landlords, utilities, e.g.) and the higher rates for those who are already locked in.

The ABA also omits the 2009 data, available since March 2010, which shows an uptick in the blended rate. It is clear that rates have gone up significantly for credit and debit between 2000 and 2010, as illustrated in the graph from the New York Times shown at the top of this article and this graph from a Merchants Payments Coalition Fast Facts Sheet, which shows a dramatic increase in PIN debit interchange:

Following the Fed’s report, the retail federation issued a statement saying debit fees haven’t fallen far enough. Since fees have more than doubled in recent months, reaching the 24 cent average, Duncan says that retailers selling 99-cent cups of coffee may now be paying almost a quarter in fees on a sale. He says that card companies “followed the rule but not the spirit of what the Fed said.”

The Real Winners:  Large Retail Chains

K. Craig Wildfang, a partner at Robins, Kaplan, Miller & Ciresi, a Minneapolis-based law firm representing a portion of the plaintiffs says that the settlement will help merchants:

The reforms achieved by this case and in this settlement will help shift the competitive balance from one formerly dominated by the banks, which controlled the card networks to the side of merchants and consumers.

The question is: which merchants?

Small merchants are unlikely to make use of the surcharge to charge one class of customers more, although this has been practiced in gas stations and some other retailers that place a very high premium on cash. On the other hands,  the large retailers that negotiated the settlement would appear to be more likely to impose the surcharge, since they already enjoy a price advantage over local merchants.

The real result of the settlement may well be a new source of revenues for large chains, while small merchants continue to be crowded out of the market.