Interchange Fee Regulation Research Articles

Payment card interchange fee regulation and financial institutions: The effects on traditional and fintech financial conglomerates*

This paper investigates the effects of credit card interchange fee regulation on the performance of traditional and fintech financial conglomerates. Using data from 2017 to 2021 of individual financial institutions and conglomerates operating in Brazil and parameters estimated by previous studies, we simulate the impact of that regulation on financial conglomerates. We find that an interchange fee cap increases the return of fintech conglomerates, whereas it decreases the return of conglomerates led by traditional financial institutions. Furthermore, we find that such regulation reduces the return of all conglomerates, traditional and fintech ones, that provide greater financial sophistication and credit growth.

An empirical analysis of debit card interchange fee regulation: Evidence from Brazil

An empirical analysis of debit card interchange fee regulation: Evidence from Brazil

Interchange Fees and Card Payments: A Cross-country Analysis

We study the relationship between interchange fees and card transactions in a large panel of countries and assess the impact of the Interchange Fee Regulation, introduced in 2015 in the European Union, on card usage. For our purposes, we take advantage of a newly assembled dataset covering almost 50 countries in the last decade and carry out two econometric exercises. Firstly, we estimate the relationship between card transactions per capita and average interchange fees by means of a panel estimator including both country and year fixed-effects, thus exploiting the broad heterogeneity across countries over time. Our results point toward a negative and significant relationship between the number and the growth rate of card-based transactions per capita and the level of interchange fees. Secondly, we adopt a difference-in-difference approach and compare the change in card payments in EU member countries (the treated group), before and after the implementation of the Interchange Fee Regulation in 2015, with that observed in a group of comparable countries (control group), which did not experience any change in interchange fee setting regulations. We find a strong and significant one-off impact of the Regulation immediately after its introduction and considerable propagation effects in the following years. Overall, we support the view that policy actions aiming at containing, but not eliminating, interchange fees can significantly contribute to the diffusion of electronic payments.

An Event Study Analysis of the Impacts of the European Interchange Fee Regulation*

Abstract One of the key success factors of the regulatory involvement by the European Commission (EC) in card payment markets across Europe is the reduction of merchant service charges for retailers and final prices for goods and services for consumers. In light of the EC’s scheduled review of the impacts of the policy intervention, this paper evaluates the usability of the event study analysis to determine the impacts of the interchange fee regulation. Findings show that 1 April 2009 is the single, statistically significant date in relation to the regulation. Contrary to common rationale, positive excess returns are recorded for issuers (9 percent-pts), pure issuers (9 percent-pts), and merchants (4.8 percent-pts), primarily driven by previous uncertainty of investors around a potential ban on interchange fees. As a consequence, total market capitalization for the retail industry increased by 11.2 billion Euro. This results in a partial pass-through rate of 46 percent from acquirers to merchants. The event study is deemed a suitable methodology to complement existing research techniques in this field. To determine ultimate pass-through to consumers, further investigation on the prevalent manifestation of issuer–acquirers needs to be conducted.

European payments regulation: State of play at the start of the new decade

This paper addresses at high level, a selection of regulatory developments and expectations that will drive the agenda for payment service providers at the start of the new decade. More specifically, the paper will cover European sovereignty in payments, instant payments, the Interchange Fee Regulation, the cross-border payments regulation and VAT reporting requirements, while also commenting on the topic of cash. With respect to instant payments, the question is not if the European payments industry will move to instant payments but when. In the short term, the industry will have to work on increasing adherence levels and reachability rates. The latter can best be achieved by ensuring interoperability between clearing and settlement mechanisms. In parallel, the industry will have to develop end-user solutions based on instant payments that are attractive for all involved.

Payment services in the EU: price regulation to protect a duopoly

The EU Interchange Fee Regulation (‘IFR’) introduced price caps on the fees paid between banks in respect of credit and debit card payments. The Second Payment Services Directive (‘PSD2’) forces some payment schemes to open up their networks to any banks that want to use them. These rules, together with a wealth of related and ancillary provisions, are the legislative fallout from a series of antitrust investigations into Visa and Mastercard. But the rules are not limited to Visa and Mastercard, nor are they limited to schemes that operate in the same way as Visa and Mastercard. They extend to payment schemes with no interchange fees at all and with tiny market shares. One argument made for including all schemes within the scope of the rules was to create a level playing field for competition. Instead, regulation that was initially aimed at Visa and Mastercard has created high entry barriers and hamstrung the only realistic challengers to these four-party schemes. If rival schemes are unable to offer customers or merchants something different, all payment services will become commoditised. Without meaningful rivals, the duopoly of Visa and Mastercard will become more entrenched and customers will see a reduction in choice and innovation. The unintended consequence of the IFR and PSD2 could be to reduce competition in the market, the very thing they were originally designed to address.

Navigating the EU regulatory landscape for payments

Navigating EU regulation can be a daunting prospect for any firm operating in the payments sector. However, recent and upcoming changes have made understanding the EU regulatory landscape more important than ever. A firm’s ability to keep abreast of such changes, assess their potential impact on its business and develop and implement plans to adapt to new requirements can be a key factor in its overall success or failure in European markets. This paper provides an overview of the following topics and examines their relevance to firms operating in the payments sector: the revised Payment Services Directive (PSD2); the Interchange Fee Regulation (IFR); regulation of cryptocurrencies and other cryptoassets; other EU regulation relevant to payment service providers and systems; and the impact of the UK’s departure from the EU (Brexit).

Interchange fee regulation and service investments

This paper analyzes the impact of interchange fee regulation on the investment incentives of a payment card platform in the presence of full merchant internalization. We distinguish between investment in consumer and retailer services. We find that the optimally regulated interchange fee can be above the privately optimal one to induce the platform to invest more in retailer services. We also demonstrate that the two prominent regulatory benchmarks of a zero interchange fee and regulation according to the “tourist test” tend to set too low investment incentives under a total welfare standard. Instead, “tourist test” regulation can be a reasonable approximation under a total user surplus standard.

Interchange Fee Regulation and Service Investments

This paper analyzes the impact of interchange fee regulation on the investment incentives of a payment card platform in the presence of full merchant internalization. We distinguish between investment in consumer and retailer services. We find that the optimally regulated interchange fee can be above the privately optimal one to induce the platform to invest more in retailer services. We also demonstrate that the two prominent regulatory benchmarks of a zero interchange fee and regulation according to the “tourist test” tend to set too low investment incentives under a total welfare standard. Instead, “tourist test” regulation can be a reasonable approximation under a total user surplus standard.

A critical review of the European Commission’s Multilateral Interchange Fee Regulation

Following the implementation of the European Commission’s Multilateral Interchange Fee Regulation in 2015, interchange fees in the European card payments market recorded their highest ever reduction in size and regional scope. This paper reviews the motives and grounds of the regulation in relation to issuing banks’ revenue losses. Using data collected from Visa, MasterCard and the European Central Bank over a period of eight years, the paper assesses the relationship between interchange fees and selected payment metrics. In contrast to forecasts made by the European Commission, the results indicate that short-to-mid-term issuer losses are not offset by increases in card volume. Furthermore, no quantifiable improvement in social welfare due to the regulation can be identified. Policy intervention should not rely solely on complex theoretical models. Empirical data based on industry observations must be considered. The findings call for a more conservative regulatory involvement in card payment markets.

The Impact of the Interchange Fee Regulation on Merchants: Evidence from Italy

Interchange fees (IF) are fees that a cardholder’s bank (issuer) receives from the merchant’s bank (acquirer) when a card payment is executed. Interchange fees are an important part of the fees charged to merchants by acquirers. Because of their level and fragmentation, interchange fees can restrict competition and have thus been regulated in the EU. The Interchange Fee Regulation (IFR) came into effect for all EU member states in 2015 and sets maximum limits on interchange fees. By using a panel of Italian banks we assess the impact of introducing the IF regulation on the fees that acquiring banks charge to merchants (merchant fees), and on the merchants’ acceptance of card-based payments. We find that, in line with the regulatory intent, the ceiling imposed on interchange fees has led to a sizeable drop in merchant fees and to an increase in the acceptance of card payments, measured as transactions per terminal.

Separation of Card Scheme and Processing Entities: An Inappropriate Way to Promote a SEPA for Cardss

In the context of a new regulation of interchange fees for card payments, the European Commission proposes to force the splitting of the card scheme in two legally and organizationally independent entities: one that would develop the ‘brand” and continue selling licences to payment institutions and one that will focus entirely on the processing of transactions. We argue that the ambition of the Commission here goes beyond monitoring and facilitating the “establishment and functioning of a single market for card-payments in the EU”. Instead its goal is to rapidly bring “the market” close to economic efficiency. This ambition is, however, problematic: If one can agree whether a market is functioning or not, the question of efficiency is far more complex. As an illustration, the efficiency argument backing the proposition to split the governance of the scheme from its processing activities is largely inspired by a literature on essential facilities which does not appear relevant to evaluate card scheme businesses. If levels of efficiency are difficult to appreciate, one can however predict with almost certainty that such regulation will profoundly affect the existing and well functioning business models. What will develop in its place is far from clear and the risk that the new model(s) will bring unintended consequences is real and has been largely underestimated by the regulator. Over all, the surest way to go forward is probably through continued cooperation between stakeholders — in particular within the SEPA Card Framework — rather than following the path indicated by article 7 of the proposed regulation.

The Impact of Price Controls in Two-sided Markets: Evidence from US Debit Card Interchange Fee Regulation

We study the pricing of deposit accounts following a regulation that capped debit card interchange fees in the United States and provide the first empirical investigation of the link between interchange fees and granular deposit account prices. This link is broadly predicted by the theoretical literature on two-sided markets, but the nature and magnitude of price changes are key empirical issues. To examine the ways that banks adjusted their account prices in response to the regulatory cap on interchange fees, we exploit the cap's differential applicability across banks and account types, while accounting for equilibrium spillover effects on banks exempt from the cap. Our results show that banks subject to the cap raised checking account prices by decreasing the availability of free accounts, raising monthly fees, and increasing minimum balance requirements, with different adjustment across account types. We also find that banks exempt from the cap adjusted prices as a competitive response to price changes made by regulated banks. Not accounting for such competitive responses underestimates the policy's impact on the market, for both banks subject to the cap and those exempt from it.

Understanding Marginal Costs in Two-Sided Markets: Implications for Debit Card Interchange Regulation

The paper reviews the economic literature’s treatment of marginal costs in two-sided markets is discussed below with particular emphasis on literature discussing the payment card market. An underlying issue explored in this paper is the how financial reform legislation’s use of the term “incremental costs” compares with the use of the term in the literature and with the definition of marginal cost. Also discussed is the significance of the two-sided market phenomena to efficient pricing decisions, the need to consider costs incurred on both sides of the market, and estimates of the marginal cost to banks of processing debit card payments. The paper will conclude with a summary of five key principles that the Federal Reserve should apply when developing their proposed debit card interchange fee regulation.

Paying for Payments: Free Payments and Optimal Interchange Fees

Do consumers and merchants use the most efficient payment instruments? I examine how inter- change fees, which are fees paid from merchants' banks to consumers' banks when card transactions take place, influence the choice between cash and payment cards. I show that when consumers do not pay transaction fees to banks - a common feature in bank contracts - card use is declining in interchange fees, and surcharging does not neutralize interchange fees. According to my model, banks set interchange fees at too high a level, resulting in too few card payments. I derive an optimal interchange fee which depends only on the relative costs of producing cash and card payments and can be used by regulators to assess privately set interchange fees. When calibrated to cost data, the model implies an optimal fee that is low and may even be negative. The findings are consistent with empirical evidence of high card usage in countries with no interchange fees and have implications for the regulation of interchange fees. JEL Classification: E42, G21, G28

The Regulation of Interchange Fees: Australian Fine-Tuning Gone Awry

Two-sided markets are generally defined as markets in which the value attributed to the goods and services received by parties on one side of an exchange depends not only on the intrinsic properties of those items, but also on the number of parties located on the other side. In the credit card context, which I shall address here, the story plays out as follows: merchants accept credit cards only if customers are willing to use them to make purchases. Customers use credit cards only if merchants will accept them. Today, there also exists extensive literature describing the theoretical features of these markets, which, as this Article will explain, do not operate with the matchless efficiency of ordinary competitive markets. Given this starting point, the question of industrial organization faced in two-sided markets is that of selecting the second best option. Because the ideal solution cannot be achieved, we must locate the closest approximation to that ideal that can be attained under practical circumstances. Stated more generally, this inquiry can be reduced to the question of whether state regulation can improve the operation of two-sided markets. Fortunately, we do not have to examine two-sided markets solely from a theoretical perspective. We have available at least one real world example, namely the interchange fee restrictions that the Reserve Bank of Australia (“RBA”) imposed on the credit card industry in July of 2003. In a report entitled Reform of Credit Card Schemes in Australia, the RBA implemented a series of recommendations that had been announced in its comprehensive 2001 regulatory initiative. The RBA’s key initiatives focused on two essential features of the open credit card systems used by Bankcard, Visa, and MasterCard. The first of these was the regulation of interchange fees. The second was a contract provision that prevents merchants in these systems from offering lower prices to their cash customers. Ultimately, these regulatory interventions are intended to address what the RBA claims are efficiency and distributional concerns, thereby reducing the implicit subsidies that cash, check, and debit card users pay for credit card users. The RBA’s program is explicitly designed to improve the position of merchants (and their broad customer base) and acquiring banks relative to that of issuing banks and their cardholders (which are only a subset of all customers). This Article shall examine whether implementing these reforms has allowed the RBA to make good on its objectives.

Tourist Test or Tourist Trap? Unintended Consequences of Debit Card Interchange Fee Regulation

In this article we empirically analyze how the Tourist Test methodology affects the level of multilateral interchange fees (MIFs) for debit card payments over time. Using Dutch cost data for 2002 and 2009 we argue that this method leads to rising cost for merchants in the long run. The outcomes show that MIFs may increase from 0.2% to 0.5% of the transaction amount of an average debit card payment. If card acquirers would pass such an increase on to merchants by raising acquiring fees, merchants will face a considerable rise in operating costs. Our results indicate that an straightforward application of the Tourist Test methodology may not yield a suitable benchmark tool for interchange fee regulation, at least for countries such as the Netherlands with rising costs for cash and declining costs for debit card payments.

Regulating Two-Sided Markets: An Empirical Investigation

We study the effect of government encouraged or mandated interchange fee ceilings on consumer and merchant adoption and usage of payment cards in an economy where card acceptance is far from complete. We believe that we are the first to use bank-level data to study the impact of interchange fee regulation. We find that consumer and merchant welfare improved because of increased consumer and merchant adoption leading to greater usage of payment cards. We also find that bank revenues increased when interchange fees were reduced although these results are critically dependent on merchant acceptance being far from complete at the beginning and during the implementation of interchange fee ceilings. In addition, there is most likely a threshold interchange fee below which social welfare decreases although our data currently does not allow us to quantify it.

Regulating Two-Sided Markets: An Empirical Investigation

We study the effect of government encouraged or mandated interchange fee ceilings on consumer and merchant adoption and usage of payment cards in an economy where card acceptance is far from complete. We believe that we are the first to use bank-level data to study the impact of interchange fee regulation. We find that consumer and merchant welfare improved because of increased consumer and merchant adoption leading to greater usage of payment cards. We also find that bank revenues increased when interchange fees were reduced although these results are critically dependent on merchant acceptance being far from complete at the beginning and during the implementation of interchange fee ceilings. In addition, there is most likely a threshold interchange fee below which social welfare decreases although our data currently does not allow us to quantify it. JEL Classification: L11, G21, D53

Merchant Benefits and Public Policy towards Interchange: An Economic Assessment

We analyze the complex nature of interactions among participants in "two-sided" payments system markets, examine empirical evidence on benefits, especially merchant benefits, and re-assess the role of interchange in balancing interests and allocating costs between merchants and consumers. We conclude there are substantial potential harms to payments systems, consumers, and merchants from imposing cost-based regulation of interchange fees, particularly with network fixed costs. Competition policy, in our view, is the best prescription – through government intervention under the antitrust laws or private challenges to exclusionary strategies that hamper competition to the detriment of cardholders, merchants, and competing networks.