[Dave Birch] Thanks to our friends at Payments News, I found myself reading a fascinating piece in the Federal Reserve Bank of Kansas Economic Review called “Regulating Debit Cards: The Case for Ad Valorem Fees“. It says, in essence, that in the US most debit card transactions have a percentage fee (unlike, say, the UK where merchants pay a fixed fee of a few pennies per debit transaction) which, the economic analysis shows, reduces merchant profits but leads to an increased consumer surplus and overall social welfare. Were regulators to set fixed transaction fees for debit card transactions, merchants would benefit (which is why they are lobbying for it) at the expense of payment cards networks, but also at the expense of consumers and the overall social welfare. It concludes

Therefore, caution should be taken when policymakers consider intervening in the debit card market

[From Payments News for Payments Professionals from Glenbrook Partners]

I agree. And this isn’t just about debit cards. Suppose, as we were discussing recently, that there are surcharges for card use. What would happen? To be honest, it’s hard to tell. In Australia, the merchants applied surcharges much greater than payment costs and pocketed in the difference, but closer to home in the Netherlands, where merchants are free to surcharge for debit card use (over cash use), very few actually do and then typically only for very small transactions (under €10) — see S. Schuh and J. Stavins. “Frontier policy issues in consumer payment behaviour” in the Journal of Payment Strategy and Systems 3(4), p.333 (2009) — so there are clearly market-specific factors at work here. I suspect that they are something to do with the relative power of the different sectors (Australia has a concentrated retail sector) rather than the underlying economic dynamics. The point I’m trying to make is that the issue of overall social welfare is different from the welfare of banks or retailers. It’s not as simple as often presented.

…those who use cash-cards or cash for their purchases will no longer be forced to subsidise credit card users. The surcharge is expected to lead to a drop in the use of credit cards and Retailers Association chief executive John Albertson has pointed out the obvious: financial institutions and credit card companies do not like it… However, as we contemplate a possible return to carrying cash in our wallets and purses to avoid paying the credit card surcharge, there are those who make a very valid point about what is now an old-fashioned means of payment.

[From Card surcharges | Otago Daily Times Online News]

Which, if it were me making the point, would be that cash is expensive and unfair: it raises transaction costs for society as whole but also distributes those costs toward the less well off. Back to the point about debit cards though. What should the public policy be? In the US, there is a specific and interesting sort of case study within debit, which is the competition between PIN and signature debit.

Safeway, 7-Eleven and CVS drugstores automatically prompt consumers to do a less costly PIN debit transaction. The banks, however, still steer consumers toward the more expensive form of signature debit. Wells Fargo and Chase are among those that offer bonus points only on debit purchases completed with a signature.

[From The Card Game – How Visa, Using Fees Behind Its Debit Card, Dominates a Market – Series – NYTimes.com]

I can’t see what’s wrong with this situation. This is competition working, isn’t it? Surely the retailers should just compete in the same manner by offering double loyalty points on PIN debit transactions, or whatever. If there was a law in place preventing retailers from launching their own payment scheme, or pricing their own products, or forcing them to accept Visa or MasterCard, then they’d have a point. But there isn’t, so they don’t. Walmart and Safeway could have bought Revolution card, but they didn’t, so that’s that.

In this, as in some many other cases, there is a real problem at the intersection of business, technology and social issues. When the beneficiary of a regulatory change is the net welfare, that means each and every one of us consumers is a little bit better off. But a few people will be worse off. And these are the people (retailers, car manufacturers, farmers or whoever) who set the media agenda and lobby the regulators. This was well-understood by the noted French political economist Frederic Bastiat way back in the nineteenth century.

…the power which consumers wield with any governing body, while theoretically tremendous, is extremely diffuse in application. Producers, on the other hand, while not as powerful on the whole as the sum total of consumers, have the ability to consolidate their power in ways that make it much more attractive for governing bodies to service their needs.

[From Frédéric Bastiat – Wikipedia, the free encyclopedia]

This is true of all markets, whereas there are several additional, and fundamental, problems with regulating the payment card market, as the Wang article notes.

  • There is a lack of transparency, so the regulators find it hard to determine what exactly bank, merchant and scheme costs actually are.
  • The private costs do not reflect the social costs (which, in my opinion, should be the regualtors’ priority).
  • Regulators focus on exogenous factors because the endogenous factors are opaque to them: in other words, reducing the profit on transactions may reduce the incentives for stakeholders (eg, banks) to introduce new products and services or to invest in R&D. Neither the banks nor the merchants nor the regulators know what is coming next!

So what to do? I’m with Bastiat: competition, not regulation, is the answer. Not competition in banking, necessarily, but competition in payments. This means separating the regulation of payment systems from the regulation of “narrow banking” and the regulation of investment banking. I shall scour the manifestos of the main political parties in the UK to see who is committed to this important reform in time for the forthcoming general election.

These opinions are my own (I think) and presented solely in my capacity as an interested member of the general public [posted with ecto]

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