Voters remain angry about higher prices, and politicians have been looking for scapegoats to deflect from their own culpability. To that end, some have accused companies of increasing markups and shrinking portion sizes and President Biden created a joint Department of Justice--FTC taskforce to investigate “unfair and illegal” pricing activity.
Another scapegoat that some Members of Congress have attacked has been the credit card companies for somehow contributing to the increase in inflation. In 2023 Senator Durbin reintroduced the Credit Card Competition Act, which would impose routing mandates on all major credit cards—in effect, a backdoor attempt to impose price controls on the market.
The immediate problem with Durbin’s legislation is that it is preposterous to suggest credit card fees contributed to inflation, since they haven’t increased since 2018. The bigger problem, which I show in my own research, is that it would reduce access to credit--particularly for low-income households--while virtually eliminating all credit card rewards programs.
Credit card revenues come from both transaction processing fees and the interest from extending credit. The latter constitutes the bulk of the income from credit cards.
There are three types of processing fees: First, banks that work with merchants charge a small fee for acquiring the funds from the shopper. Second, each network (Visa, American Express, Discover, or Mastercard) imposes a processing fee of about 0.10--0.17 percent. Finally, the bank that issues the card imposes an interchange fee on the merchant and acquiring bank.
However, rewards expenses have exceeded the net transaction margin for some time, which means more than 100 percent of the income going to credit card issuers comes from extending credit. In the last couple of years, the profitability net of rewards has been between negative -0.2 and -0.3 percent.
Source: Federal Reserve Board, Form FR Y-14M, Capital Assessments and Stress Testing, and FEDS Notes by Adams, Bord, and Katcher (2022).
In addition to rewards, the credit card ecosystem absorbs the costs of payment fraud, and since 2010 fraud costs have grown by nearly fourteen percent per annum. Total business sales--a nominal measure of economic activity correlated with credit card sales--grew just 4.5 percent during that period. After taking into account 0.3 cents of fraud losses for every dollar, the net profit per dollar of purchases for the transaction part of the credit card network is negative –0.5 cents per dollar.
There are negative returns for the payment network from transactions because--contrary to the assertions by Senator Durbin and FTC chair Lina Khan--there is fierce competition in the broader transaction processing network. Twenty percent of all transactions in the U.S. are still paid in cash and thirty percent of all spending is through debit cards. Payment apps bypassing credit card networks altogether are taking an increasing share of transactions as well.
What’s more, the four main U.S. credit card companies compete against each of these payment systems as well as one another to gain customers. Recent work from the Philadelphia Federal Reserve Bank shows that the entire banking industry remains highly competitive.
There is no free lunch in the credit card market: Imposing routing mandates is not going to magically make inflation slow, but it would cause banks to stop extending credit to their customers who are now only marginally profitable, a cohort that almost exclusively consists of low- and working-income households. Given the increasing number of businesses that eschew cash or debit cards as well as the increasing convenience (and for many a necessity) of purchasing goods online, enacting legislation that would result in millions losing access to credit would constitute a pyrrhic victory for some populists over the credit card industry.
