The Role and Regulation of Interchange Fees
in European Payments Cards
Wilko Bolt
De Nederlandsche Bank
PYMNTS.com, Hotel Silken Berlaymont
Brussels, 15 June, 2011
The views expressed are those of the author and do not represent the views of De
Nederlandsche Bank nor the ESCB.
Introductory Remarks
 Payment economics is complicated because of the
interactions of a set of interdependent bilateral relationships
 The ongoing shift from cash and paper towards electronics
potentially confers large economic benefits. But card
payments in particular have remained expensive for
merchants
 Divergence of social and private incentives
 SEPA: integration and harmonization of European retail
payment markets. Focus on “electronics”. How to achieve
goals?
Key Questions
 What is the optimal structure of payment fees between
consumers, merchants, and financial institutions? Is the market
sufficiently transparent to generate the right price signals and
incentives?
 Will competition among payment providers, networks, or
instruments improve consumer and merchant welfare and
social welfare generally?
 What guidelines should policymakers follow when regulating
payment services?
Pricing and Usage Externalities
 Society will be best off when it relies on the most efficient
payment system
 In a two-sided market, a transfer (e.g an interchange fee)
between end-users may be socially optimal to balance
demands on both sides of the market. Different payment
instruments may require different transfer schemes
 However, (wrong) incentives on one network may affect
usage of another, e.g. cash, check, or payment cards
(example: in Holland, ‘cheap’ debit cards were surcharged
favoring ‘expensive’ cash use)
Merchant Competition
 Question: Why can’t most merchants refuse costly payment
instruments?
 Answer: Customers will go to competitors (however, depends
on consumer demand and merchant competition)
 Merchants may accept payment instruments to steal business
from competitors but aggregate sales may stay constant
 Merchants may be willing to pay higher fees than socially
optimal (weak “merchant resistance”)
Ability to Surcharge
 Merchant surcharges may alleviate “two-sided” tensions.
Interchange fee may become neutral
 Card acceptance becomes virtually costless, yet one does not
observe complete acceptance in countries that allow surcharges
 To what extent can card fees be passed on? Merchants also
benefit from cards, so should they not absorb some of these
costs? Complex issue of optimality. Competitiveness plays a
role for economic welfare as well
 In some cases, merchants may set higher prices than their costs,
e.g. Dutch debit cards (merchants charged 4 times their cost)
Network and Issuer Competition
 Platform or network competition does not necessarily
improve the price structure although the total price may
decrease
 Competition may result in low or negative consumer fees if
issuers compete too vigorously on the consumer side
 Intense issuer competition may tilt pricing against
merchants
 There exists a fine line between cooperation and
competition in payment markets
Interchange and Credit
 Credit provides another source of extraction for payment
providers. Debit and credit cards offer different credit options:
overdraft vs credit line
 But who pays for credit? High finance charges may affect
willingness-to-pay (fixed fees) thus influencing merchant fees
allowing different interchange fees for debit and credit cards
 When debit competes with credit, default risk and funding cost
may also affect debit card merchant fees. Competition and
complementarities may drive debit cards out of the market as
banks may have incentives to increase credit card acceptance
 There may be a tradeoff between extending credit to less
creditworthy consumers and the merchant fee
Cost-Based Approach and Innovation
 Due to externalities payment prices cannot be purely costbased (elasticities, benefit distribution)
 Cost-based approach may limit incentives to innovate
 Networks and issuers may require years to recoup investments
in new products
 May not introduce new products but upgrade existing rails
Conclusion
 Payment card economics is complicated because of the
interactions of set of interdependent bilateral relationships
 No consensus among economists and policymakers on
what constitutes an efficient fee structure for card-based
payments
 Too much regulation could frustrate dynamic efficiency
and innovation. Unintended consequences of regulation
 Initial conditions and market specifics matter, no one size
fits all. Theory alone is not enough. We also need to look
at the facts!