costs cards debit interchange

As I’m in Canada, I thought I might mention that a detailed investigation into the cost of payments at POS just released by the Bank of Canada shows (absolutely as I would have predicted given the scale and dynamics of the Canadian market) that

Debit cards are the least costly in terms of total resource costs, followed by credit cards, whereas cash is the most costly.

No surprise at all. What is surprising, however, is that the total cost of payments in the Canadian market is estimated at 0.78% of GDP (compared to 0.54% for Australia, which I would have e thought a reasonable comparison). I haven’t read every single page of the report but I suspect that the inefficiency must stem somewhat from the size of the country (distributing and collecting cash is expensive) and but mainly from much higher credit card use than in (say) the UK.

Me eating poutine in Montreal.

According to our Canadian cousins, cash only has the lowest cost to society for POS transactions below approximately $6, which means as far as I can see that it is irresponsible to produce banknotes above $10 since by doing so the central bank is making the economy less efficient. (I’m not familiar with their charter but this cannot be one of the goals.) It’s time for action.

The main point I wanted to make about the Canadian payment environment is how it illustrates the difference between incentives based on private costs compared to what is best for the economy. We cannot say what is the “best” payment mechanism since that varies by perspective. Indeed, as the report says:

If stakeholders make their payment choices based on their private costs alone, consumers would prefer to use credit cards, while retailers and financial institutions would prefer debit card payments.

But what we might say is that the best solution for society is the mechanism with the lowest total social cost, and that’s PIN debit (soon to be overtaken by credit push I expect). Hence that is what society should encourage. But it doesn’t: it allows a suboptimal payment system instead. The big winners with this arrangement are the credit card issuers because customer use credit cards to obtain rewards at the expense of other customers who are using debit cards and even cash. In Canada this results in unusually high credit card use because people just love their rewards, such as frequent flyer miles. These, incidentally, have turned into a huge business.

“Airlines are earning upwards of 50 percent of [income] from selling miles to a credit card company, which we believe is a great business to be in”

From Bloomberg

Scatchamagowza. Half? Seriously. Non-credit customers are subsidising a massive programme of wealth transfer to well-off people who like to fly a lot! I’m not complaining, by the way. I use my Amex card with frequent flyer rewards (well, Avios) all the time. And I’m clearly not the only Amex customer who prefers this kind of deal.

American Express says that Delta SkyMiles accounted for approximately 7 percent of its business last year and approximately 20 percent of its outstanding credit card loans as of the end of the year.

Do Loyalty Programs Make More Money for Airlines Than Flying?

It’s amazing what a big business credit card miles have turned out to be. Every time that the person in front of me at the supermarket pays using cash or a debit card I feel like hugging them (I don’t, of course, because I’m English) and thanking them personally for their selfless contribution to my cashback, miles and Uber credits.

Our good friends at Glenbrook summarised the final outcome of the Durbin process:

Debit interchange cap – $0.21 plus 5 bps (for both signature debit and PIN debit)
Fraud prevention adjustment – $0.01 (interim rule)
Routing restrictions and network exclusivity – Option A (two unaffiliated debit network)
Card Present vs Card Not Present – No distinction
[From Federal Reserve Issues Final Rule on Durbin Amendment]

Now there will be a lot of comment from people far better qualified than me on what all of this will mean for the payments industry, so I don’t want to get into those specifics here, but there’s something that bothers me about the whole thing. I went back to Steve Bartlett’s article on Durbin in the EFPLP [Bartlett, S. Announcing the death of the debit card in E-Finance & Payments Law & Policy (Mar. 2011)] and it prompted me to have another reflection on the Durbin process as it seems (to a foreigner!).

Plenty of lawmakers are anguished about their swipe fee position, but largely because they’re worried about falling out of favor with good friends in the corporate world.
[From Swiped: Banks, Merchants And Why Washington Doesn’t Work For You]

I think what this means is that they knew that government price-fixing is wrong, but that big companies (particularly retailers) spend a lot of money on lobbying. This isn’t something to be cynical about, it’s just the real world. I’m happy to offer these lawmakers a solution though. Why not go down the European route and create a regulatory framework that allows competition from non-banks? There is no reason for payments to be a banking business, and competition rather than regulation is a better way to reduce costs to the rest of the economy.

There are other ways to reduce total costs too, but these mean some short-term spending (which no-one wants to do) in order to improve the situation for the longer term (which, naturally, congressmen don’t care about).

The Federal Reserve could, and should, use the Durbin Amendment as a vehicle to move the United States onto the EMV smart card standard
[From Why The Fed Should Use Durbin To Push EMV ( – Industry Verticals )]

Why would this save money in the long term? It’s because one of the key reasons why US debit card fees are so much higher than elsewhere is that they are predominantly signature debit transactions. Moving to PIN, and offline PIN at that, and offline completely for low-value contactless transactions, ought to kill a few birds with the same stone.

the Fed has the power to change this equation. By allowing card issuers to recover some of the costs of issuing smart cards in the form of higher interchange, it could make it profitable for banks to issue smart cards. At the same time, card networks such as Visa and MasterCard could then impose a liability shift policy, similar to that deployed in other regions
[From Why The Fed Should Use Durbin To Push EMV ( – Industry Verticals )]

In reality though, none of the lobbying seemed to be about pursuing the best long-term strategy for USA Inc. It just all came down to fighting between banks and retailers. I assumed that banks were going to lose.

Lobbying on behalf of banks is a bit of a lost cause at the moment, so you can’t blame the retailers for striking while the iron is hot, but if Congress wants to reduce the fees paid by retailers for payments, then it should create a regulatory environment that allows new entrants to come in and provide (non-bank, if necessary) solutions to the marketplace.
[From Digital Money: If you don’t like cards, don’t take them]

Well, despite their (entirely deserved) lack of popular support, it looks as if I was wrong about the banks’ capacity to lobby. They mounted a serious campaign.

Last year US banks generated $536.9 billion of interest income, according to FDIC data, and while that is down from heights of the boom years, it is still a hefty amount of revenue. Non-interest income, which includes fees, climbed to $236.8 billion last year from $207.7 billion in 2008.
[From Bankers, Hear My Plea: Stop the Fee Insanity – Bank Innovation]

It’s very difficult to obtain an accurate picture as to what proportion of the non-interest income relates to payments. The last figure that I have that I believe to be reasonably accurate was 45%, but many commentators seem to think that this is too low. So let’s say that all of the “other” category of non-interest income reported is payments, and call it 50%. There was a paper published last year called “Banks’ Non-Interest Income and Systemic Risk” by Brunnermeier, Dong and Paliac that showed that the higher the proportion of non-interest income, the greater a bank’s exposure to systemic risk. In other words, the more a bank depends on income that comes from outside of the core business of savings and loans, the more exposed it is to changes in market conditions (eg, Durbin amendment, non-bank competition, that sort of thing). I read this as meaning that it’s better for the economy as whole if banks make less money from running debit card systems.

The lesson here is that if we want serious regulation of banks, we can’t trust it to be done by bank regulators.
[From The Fed Bails Out the Banks…Again – Credit Slips]

Therefore, it seems to me, that the ruling wasn’t that bad for banks. If you have to have a cap, from the banks’ perspective, it might as well be this one. Retailers wanted a cap, and they got it, but the cap is high enough that banks won’t suffer a catastrophic collapse in fee income, so the banks ended up with not such a bad deal provided that they shift signature debit to PIN debit. The banks will lose some fee income because of this, retailers will pay a bit less and customers won’t see much difference because the difference won’t be passed on them. I disagree with observers who think that Visa and MasterCard will see big trouble because of the loss of signature debit transactions. I think that Visa and MasterCard won’t be too affected because they will boost their PIN debit offerings to make them more attractive to banks and they will push PIN debit into mobile, online, retail and so on. This means that the income lost from signature debit transactions can be made up by replacing cash and other kinds of transactions with PIN debit (I think – but I’m keen to hear from others who know far more about the US market dynamics).

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