So, what do you think of the Federal Reserve’s regulation of bank “interchange” fees, mandated by the financial reform law? Let us guess: Not much. Indeed, we’ll bet that nine of ten news junkies barely have a clue about what’s happened – other than the (correct) impression that it involved a fight between big retailers and big banks over a very big pot of gold.
Interchange fees, you may not recall, are the fees that banks charge stores to process credit and debit card transactions, mostly though the Visa and MasterCard networks. Since the dawn of recorded history (well, it seems that long, anyway), retailers have been complaining that the debit card fees demanded by individual banks are outrageously high. But they have been stuck paying them because few are willing to take the chance of losing customers who want to pay with a bank card. And, as a result, retailers say, they have to charge all their customers a bit more to recoup the cost.
That ends in April, when the Fed will cut fees on debit card swipes (by as much as 84 percent), down to what the regulators estimate to be the cost of processing electronic transactions. Now it’s the turn of card-issuing banks and the payments system companies to cry foul. Consumers will lose doubly, they say. Merchants won’t pass on their savings, while banks will lard on new fees (presumably to retail checking accounts) in order to recoup the lost revenue.
Who’s right? Economists disagree – and not entirely according to who’s paying their consulting fees. That’s because the market for payment card services is a complicated “two-sided” market in which there are distinct sets of co-dependent customers (card holders and retailers) who share the service. Actually, such markets aren’t so rare: for example, both advertisers and readers benefit (and pay for) newspapers. I’ll leave it to you to figure out the two sides of the markets for online auction services like eBay, dating services like eHarmony and electronic game machines like Xbox.
One of the peculiarities of two-sided markets is that, while competition can effectively limit the total fees charged, subtler forces determine the division of those fees between the two classes of customers. So, with debit cards, even if excess profits have been squeezed out by competition, one side of the transaction may shoulder a disproportionate share of the costs. (If you doubt that, consider how little of the cost of a glossy 300-page magazine like Vogue is covered by the subscription price.)
So where does that leave the debit card debate?
We know the amount the stores pay to the banks on transactions will fall sharply. And it’s likely that competition among retailers will force them to share the gain with customers. But because the savings will be spread so widely across transactions, it will be hard to measure. Consumers, for their part, can hope that banks and the payment card companies will bear the brunt of the hit. And in the short run, their wishes may be fulfilled because the profits of the very big banks are exceptionally high and the banks are sensitive to the publicity associated with raising fees. That certainly won’t last, though; somebody has to pay, and the only somebody left will be bank customers.
It’s hard to say how the new regulation will affect the efficiency of the payments system – in particular, the pace at which commerce migrates toward electronic transactions. Maybe it won’t make much difference. But the precedent here – the reality that customers on one side of a two-sided market can use political power to reduce their costs – can’t be good for a free market economy.
(This post was also published on Forbes.com.)