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Well, OK, what does planning for reduced interchange mean in a practical example? Let’s look at a specific case: a bank that is thinking of a launching a prepaid card. I’ve been in a few meetings about this kind of thing recently so I think it a useful case study.
According to a study of branded prepaid card programs by Boston-based Aite Group LLC released early this year, some 53% of payroll card transactions occur at the point of sale, followed by 40% at ATMs. Aite estimated that payroll card programs generate 50% of their revenues from interchange, 30% from float, 10% from fees, and 10% from breakage.
[From National ACH: Better Business Bureau Rolls Out Payroll Card]
So a reduction in interchange means a reduction in the single largest source of income for the product, and can therefore easily make or break the business case. And note that interchange doesn’t have to reduce much to make the product marginal. It’s not clear to me that either the politicians or the retailers understand how sensitive some new opportunities are to interchange calculations, so a reduction in interchange will inevitably mean a reduction in innovation. If that’s the goal, fine.
These opinions are my own (I think) and presented solely in my capacity as an interested member of the general public [posted with ecto]
The reduction of interchange will lead to the gap where new businesses will be able to emerge. The present card industry has proven that is will do everything to kill any outside innovation (let’s f.i. recall the iBill story) and is not going to innovate by itself (multiple new technologies acquired shelved and killed). The degree of monopolistic behavior in the payments industry is unprecedented, it is far beyond everything known in the past, incuding (but not limited to…hehe) Standard Oil, AT&T, Microsoft, you name it. Kill the beast of monopoly!
I think this approach is wrong. Innovation occurs when margins are lower and not higher. The more difficult an industry finds to continue its current path is where innovation flourish. Most (if not all) payroll/prepaid cards today are Mastercard/Visa based card, that’s not innovation, that’s more of the same. If interchange is high, no efficiency is needed, is enough to pay for all, including insecurity and inefficiency.
The problem with interchange is that it no longer bears any relationship to the costs for which it is supposed to represent. It is far in excess of the cost of transactions, and is an obvious profit centers for large networ operators which squeeze merchants and bedevil smaller issuers.
It is worth noting that the genesis of interchange in the 60s – 80/90s period was to incentivise the issuance of cards. While great for banks it was also good for merchants as the payment mechanism helped facilitate, hence boost, sales at relatively low cost while volumes were low. However, with cards at saturation, this need for an issuance incentive has gone, while the cost to merchants is now high, hence the heated interchange debate. But the fact that interchange has led to mass adoption of cards, a huge benefit to society and commerce, indicates that it has had a key role to play in incentivising new payment innovations. Therefore, whatever the rights or wrongs for interchange in mass products such as cards, I agree that its role in driving adoption of new innovation cannot be ignored.
“And note that interchange doesn’t have to reduce much to make the product marginal”. This statement is absolutely FALSE. Don’t believe this scare mongering.
In Australia, Visa and MasterCard’s weighted average interchange fee for credit products is regulated to be no greater than 0.50%. For debit products, weighted average interchange can be no greater than 12c per transaction.
The most notable change in the Australian credit card market post regulation is a noticeable reduction in the generosity of credit card rewards program.
The number of credit card accounts in Australia continues to reach new highs, as it did in the most recent data release for Nov 2008. Credit card transactions continue to grow with vigour, although current economic events have moderated growth in recent months.
http://www.rba.gov.au/Statistics/Bulletin/C01hist.xls
At first the argument for interchange was that interchange should be paid by merchants to encourage the formation of card networks. Now merchants, it is argued, should continue to pay large interchange fees to create a large slush fund for the banks to ‘innovate’. Well let’s see some innovation then. For the record, the card payments system is working just fine as it is for retailers.
In Australia there has been a rash of product innovation since our card networks, and their interchange fees, were first regulated in 2003. In particular, we have seen the introduction of low interest rate cards targeted at revolvers, EMV is now well established, and contactless payments are starting to emerge. As for systemic or network innovation, I don’t see how this will happen just by putting interchange fees in the coffers of issuers.
The death by lack of innovation story is the latest argument being trotted out around the world to scare regulators and competition authorities. And it is a myth. It is the sequel to the ‘death spiral’, another myth created to serve the same purpose. The death spiral argument (that reductions in interchange would cause a death spiral in card networks – Google it, it’s included in submissions to the Reserve Bank of Australia) failed once it became clear that significant cuts in interchange, such as in Australia, did not harm the health of credit card networks.
“‘And note that interchange doesn’t have to reduce much to make the product marginal’. This statement is absolutely FALSE.”
I apologise for being unclear: this statement refers to the prepaid card product under discussion, not card products in general.
Credit and debit do not become marginal under reduced interchange because a bigger proportion of their overall revenue comes from other sources (not interchange). But they do become less profitable, and the evidence from Australia appears to be that retailers gain most.