Credit card companies and issuing banks are under fire for overcharging on interchange fees, and are now under increasing pressure to justify their costs.Wendy Atkins reports.

September’s announcement by the UK’s Office of Fair Trading (OFT) that MasterCard and the banks issuing its credit cards have been overcharging their customers returned the controversial topic of interchange fees to the consumer agenda. Action on interchange fees is also being taken in the US and Australia, and merchants are realising how much power they have in the payments market.

The average consumer or business tends to regard the interchange fee as an opportunity for financial organisations to get their hands on even more of their money. However, the situation is not quite that straightforward.

In a speech to the Federal Reserve Bank of Kansas City, Santa Fe, in May 2005, Gertrude Tumpel-Gugerell, a member of the executive board of the European Central Bank (ECB), commented: “The interchange fee can be an important tool to increase the acceptance of a card scheme by bringing on board both sides of the market – the merchants and the customers – and by making this profitable for both the issuing and the acquiring banks.

“It can also be used strategically to extend the market, for example, in overcoming the chicken-and-egg problem commonly encountered in the inception of payment networks.” [This refers to the problem that without cardholders, merchants have no incentive to accept credit cards, and if merchants did not accept cards, customers would not carry them.]

In defence of fees

The OFT ruled that the interchange fee levied on UK merchants between March 2000 and November 2004 was deliberately set too high so that banks issuing MasterCards could recoup the money spent on promotions, such as offering introductory interest-free periods.

However, John Bushby, general manager, MasterCard Northern Europe, says: “We have consistently shown not only that default interchange fees have paved the way for a large number of new entrants into the UK credit card business over the past decade, but also that the UK payment system is one of the most competitive in the world.

“The ruling also fails to recognise that interchange fees have contributed to significant expansion in the use of new technology and a considerably more sophisticated and secure means of payment.”

Lawsuits and regulation

On the other side of the Atlantic, lawsuits against Visa and MasterCard in the US have been filed in recent months. They include a class action suit brought against both Visa and MasterCard on behalf of small retailers, and a lawsuit against Visa USA alleging price fixing.

In Australia, the situation is slightly different. According to Christophe Uzureau, senior analyst, banking, at research and analysis company Gartner: “The Reserve Bank of Australia is seen as the most active regulator, and the experience in Australia is having a strong influence on the decisions made by other regulators on a global basis to ensure more scrutiny and to improve the transparency of how card schemes set their interchange rate.”

The country’s cost-based approach to promoting transparency has had strong implications for card schemes operating in the Australian market. Cardholder fees have increased and loyalty benefits have fallen. “Visa, MasterCard and Bankcard have reduced their interchange rate but have lost market share to American Express and Diners Club, due to the increasing interchange fee differential,” says Mr Uzureau.

The Reserve Bank of Australia is now proposing the creation of an interchange fee benchmark taking into account the key processing costs of the card networks. This will push card schemes to demonstrate why their interchange fee is above cost.

Justifying the cost

The card companies are starting to justify the cost of interchange by leveraging the information created in the payment system, says Mr Uzureau. “In the US, Visa is providing more customer data to individual merchants (such as how people are shopping, where they are shopping and whether they are shopping at a competitor), which assists in justifying the higher interchange fee of card programmes dedicated to mass affluent customers.”

Analysts believe one consequence of the interchange debate will be to accelerate changes to the organisational structure of some card schemes, such as MasterCard. It announced a proposed initial public offering at the end of August, which could put a large amount of the company’s shares and voting power into the hands of the public, which in turn could increase the influence of merchants. Card schemes making such a move would be able to say that they are more independent of the banks and are not involved in monopolistic behaviour.

Another consequence is that card companies are now working more closely and communicating better with merchants. Co-branding schemes are becoming more popular and are providing new ways for credit card companies to reach potential customers.

“The bottom line is that card companies need to be prepared to justify and demonstrate the costs of their card schemes. So far, they haven’t been open enough about it,” says Mr Uzureau.

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