An interchange fee is paid by the merchant's bank to the cardholder's bank (that issued the card) after the cardholder purchases goods or services with a payment (credit or debit) card. At issue are increases in interchange fees set by the credit card associations like Visa and MasterCard and card-issuing banks or companies like Discover Card and American Express to enable merchants to gain access to the associations' and issuers' electronic payment network. Interchange fees have been rising since the 1990s, despite diminishing fraud losses and technological advances in communications that lowered the costs of accessing the electronic payment system. Merchants argue that the card associations have not negotiated these fees with them but instead present them as take it or leave it offers. Economists who have studied the payment card market attribute the higher interchange fees to the nature and structure of the market, which is not the traditional market but a two-sided market. The conditions are where the payment card issuers have market power and merchants have an inelastic demand for accepting payment cards. The report begins with a discussion of the nontraditional structure of the payment card market. The second section is an analysis of the problem of the optimum level of payment cards to achieve the highest social welfare benefit for cardholders and merchants. The last section discusses the implications of the analysis. In both the newspaper and the payment card cases, revenue transfers are necessary to maximize overall social welfare. In that regard, the economic assessment of the issue may contribute to the judicial and legislative determination of whether the Visa and MasterCard associations are monopolies and whether the domination of these associations warrants granting limited antitrust immunity to providers and merchants to negotiate interchange fees. 2695)

		The Durbin Amendment

Even though interchange fees were not considered a contributing cause of the 2007-2009 financial crisis, the Restoring American Financial Stability Act of 2010 ( S. 3217 ), which addresses the regulatory failures that caused of the crisis, also contains provisions concerning interchange fees. Senator Durbin's Amendment on interchange fees that was adopted as part of S. 3217 as amended by the full Senate and incorporated into the Senate-passed version of H.R. 4173 mandates specific regulatory actions. Its purpose is to ensure that small businesses and other entities that accept debit cards pay a reasonable and proportional price for the use of the payment card networks and prohibits the payment card network from imposing anti-competitive restrictions, such as prohibiting discounts to customers who pay with cash, on small businesses and other entities that accept payment cards. The effect of the Durbin Amendment would be to lower the cost to merchants for using the payment card network to process debit card transactions, but does not guarantee the cost to consumers will be lowered. The representative from Visa suggested that there is no evidence that merchants have lowered their profits by passing on the lower cost of interchange fees to their customers. The result could be that the social benefit of the electronic payment card system is lowered, because the government's action would lower revenues to the card-issuing banks, causing them to issue fewer than the optimal number of cards to cardholders.
Interchange fees in the processing of credit and debit cards have become controversial. An interchange fee is paid by the merchant's bank to a cardholder's bank (that issued the card) after the cardholder purchases goods or services with a payment (credit or debit) card. Merchants and cardholders assert that they must accept excessive and increasing interchange fees set by the card associations such as Visa and MasterCard and member card-issuing banks. Interchange fees have been rising since the 1990s, despite diminishing fraud losses and technological advances in communications that lower the costs of accessing the electronic payment system. Merchants argue that the card associations have not negotiated these fees with them but instead present the fees as "take it or leave it" offers.
Economists who have studied the payment card markets attribute the higher interchange fees to the nature and structure of the market. This is not the traditional market, they point out, but a two-sided market where suppliers compete for two types of customers with different demand responses, like a newspaper that must attract both readers and advertisers. In the payment card market, banks must attract cardholders and merchants, and a transfer of revenues is usually necessary to provide card-issuing banks an incentive to issue more cards, which provide more payment card users to merchants. This is similar to newspapers, where the lower the subscription rates, the higher the readership and the higher the advertiser revenues. For a payment card system that needs more cardholders to achieve the optimal benefits to cardholders and merchants, more revenue transfers may be needed to offset the cost of issuing more cards to cardholders. There could be cases, however, where the revenue transfers are excessive, which would mean that the interchange fees are providing excess profits to issuer banks.
Even though interchange fees were not considered a contributing cause of the 2007-2009 financial crisis, S. 3217 as amended by the full Senate and incorporated into the Senate-passed version of H.R. 4173, which addresses the regulatory causes of the crisis, also contains provisions on interchange fees. The Durbin Amendment (S.Amdt. 3989) on interchange fees was adopted. The amendment mandated specific regulations to applied debit cards to ensure that small businesses and other entities that accept debit cards pay a reasonable and proportional price for the use of the payment card network, and limit the payment card network from imposing anti-competitive restrictions on small businesses and other entities that accept payment cards. The amendment does not address what some believe to be a critical part of the interchange fee issue that relates to legal or regulatory caps on the fees. Specifically, presently there is not a mechanism that could be used to ensure that merchants lower their prices to pass the excess revenues back to the cardholders. In countries where interchange fees are capped, the governments have been relying on merchants to voluntarily lower prices. Yet, there is no evidence that merchants have done so.
This report examines the Visa and MasterCard card associations' systems. The report begins with a discussion of the nontraditional structure of the payment card market. The next section is an analysis of the problem of the optimum level of payment cards to achieve the highest social welfare benefit for cardholders and merchants. The third section discusses the provisions in Senator Durbin's amendment and other legislation in the House that was not acted upon by the full House of Representatives that would grant the payment card stakeholders limited antitrust immunity for negotiating access fees and terms for using electronic payment card system. The last section is a discussion of some implications of the analysis. This report will be updated as financial and legislative developments warrant.