The Credit Card Competition Act (CCCA), put forward by Senators Durbin and Marshall, is a step toward trying to fix a growing problem in the U.S. payments system.
When you use a credit card, the merchant pays interchange fees to process the transaction. The 2022 Nilson Report tells us that, in the U.S., merchants paid $126 billion in fees for $5.8 trillion in credit card purchases—about 2.2 percent of the value sold. Secure funds transfer and fraud prevention are necessary costs to process a card transaction, but these costs are nowhere near 2 percent of trade volume, especially given the decades of advances in digital payments technology.
Card issuing banks offer higher rewards, such as cash back and points, to attract cardholders. Banks also pressure monopolist card networks (Visa and MasterCard) to raise fee levels. The lack of competition allows banks to fund rewards even as bank profits increase. Because merchants aim to earn a reasonable profit, they raise nominal prices to recover the costs of interchange fees. Consequently, interchange fees have increased over time. Absent some restraining force, this progression of ever-rising rewards, interchange, and nominal prices seems to have no end.
Economic theory explains the value of credit card rewards programs (technically described as “asymmetric pricing in two-sided markets”): Economic benefit comes from shifting consumers away from less efficient payment methods toward more efficient ones. Determining the optimal level of rewards is difficult and fundamentally hinges on consumer preferences over different types of payment. Setting interchange fees too high produces economic distortions. Evidence shows that rising rewards and interchange harm merchants and poorer households while benefiting financial intermediaries and richer households. When banks collect billions in interchange and pay out smaller billions in rewards, they profit from economic rents—including earning interest on rewards ‘float’ and pocketing abandoned rewards.
Banks bestow high income cardholders with higher rewards cards, and this disparity in rewards rates leads to a regressive transfer of money. Households without access to high rewards effectively pay more for purchases. By my estimate in a recent study, in 2021, U.S. households earning less than $75,000 collectively transferred $3.5 billion to households earning more than $75,000 via rewards disparities.
High interchange fees and rewards entrench the existing system and discourage innovation. So long as merchants post a single nominal price irrespective of payment method, a rational consumer will pay with a rewards card, unless the alternative payment method somehow offers greater benefits. New digital payment apps like Apple Pay merely provide a digital wrapper around credit (or debit) card payment, and others primarily serve as substitutes for cash transfers between individuals rather than as retail payments.
The CCCA is a positive, albeit modest step, toward arresting the continued rise in interchange fees. The CCCA's primary provision is to force large banks ($100B+ in assets) to allow card transactions on more than one card network so that merchants presented with a credit card from a big bank would route transactions over the payment network with the best cost-benefit tradeoff for the merchant. This competition would likely lower interchange fees charged to merchants and increase innovation in network services.
Defenders of the status quo, such as a recent article from the International Center for Law and Economics, mischaracterize rewards as entirely real economic benefits, rather than financial transfers. With this misdirection, the argument bemoans the potential reduction in interchange fees and rewards resulting from implementation of the CCCA. That article ignores the experience in other countries where rewards programs work with significantly lower interchange fees than in the United States. With their current high margins on credit cards, banks still have incentives to provide rewards, even if interchange revenues are reduced. By fracturing the monopolistic network effects of the current market structure, the CCCA prods the industry toward a more competitive and efficient system.
The CCCA's short-term effect on interchange fees is likely very modest, as compared to more forceful policies, such as Australia's cap on interchange fees. If enacted, the hope is that the growth in interchange fees will be arrested, as the economic rents of issuer banks and card networks decline and their profit margins gradually come more into line with other industries that need to compete for business. From the standpoint of total competitive efficiency of the U.S. economy, we should welcome that outcome.
