Interchange: Recalibrating the Scale

Evidence suggests that it is time to re-examine the structure and motivation behind interchange.

Pressure is mounting for two of the most contentious rules governing the credit card industry. Interchange, a fee merchants pay to credit card issuers, and the No Surcharge rule, which prohibits merchants from charging a fee to credit or debit card paying customers, are facing new challenges. The rising threat of litigation and the changing economics of the credit card market raise questions about the future of the interchange and No Surcharge rules.

In a new report, , Celent considers many of the arguments being made in the market and their weight relative to market trends. Celent also looks for trends that may be indicative of an unhealthy market and that may begin to provide grounds for intervention, and analyzes the impact possible resolutions would have on merchants and customers.

Both sides of the debate have made strong arguments regarding the restrictions placed on merchants, the art of price fixing, and the question of whether the rules are socially optimal. "What has often saved interchange in the past is the inability to prove that it is harming the market, that a better pricing alternative exists, and that society would be better off with regulation," says Ariana-Michele Moore, senior analyst and author of the report. "However, the markets are maturing, and the old arguments in support of interchange are losing ground."

Issuers have not been helped by the recent spate of lawsuits. During the past nine months, over 40 merchant actions have been filed challenging the No Surcharge rule or interchange. Increased legal activity has some card issuers changing their stance. For instance, Discover recently announced it would drop its No Surcharge rule. If these legal battles continue, issuers will ultimately face pressure to lower interchange fees.

But if interchange fees are decreased, customers may not like the results. Recent rule changes in Australia illustrate that a decrease in interchange would cause issuers to increase annual fees and be more stingy with reward programs. It is also unclear how merchants would react to a lower interchange. The hope is that merchants would pass on the benefits to customers in the way of lower prices, but skeptics believe merchants may not be so generous.

One thing is clear: the payment card industry is a complex system involving numerous parties, and there is no easy resolution to the interchange debate. But ultimately the industry will need to install a fee-based system relative to the benefits that would: help issuers sustain their revenue models; shift the revolving consumer population to the debit card system; ease up on the margin pressure facing merchants; and give weight to a consumer's decision when using credit or debit card products.

The 39-page report contains 18 figures and 4 tables.

A table of contents is available online.