Comments on Kay, Manuszak and Vojtech Alan S. Frankel

Comments on
Kay, Manuszak and Vojtech
Alan S. Frankel
The Economics of Payments VII
Federal Reserve Bank of Boston
April 4, 2014
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Neutrality
 Perfect competition  complete offset of interchange fee.
 Existence and level of interchange fee would not matter.
 Higher interchange fee 
 Higher merchant surcharge (Baxter “side payments”)
 Exactly offsetting higher rebate from issuer to cardholder
 Claims persist that:
 Interchange fees are merely about the allocation of a fixed total cost between two “sides”
of a market.
 Allocation matters to efficiency.
 Criticism & defense of interchange must both concede lack of neutrality.
 Interchange fees matter. Not neutralized by “side payments” (long forbidden).
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“Waterbed” Effects
 Defenders of interchange fees:
 Interchange is complete wealth transfer from merchants to consumers.
 Merchant pass-through is zero: “pocket” any savings from IF reduction.
 Bank pass-through is 100%
Perfectly competitive. Recoup any lost interchange income from own customers.
 Impossible to reconcile with:

Increases in ATM surcharges on other banks’ customers.

Claims that Durbin Amendment was a “taking” of profits.

Fierce fights over interchange fees and regulation of interchange fees.

Why should banks care if competition lets them recover all fee income?

Bank claims and predictions were not credible.
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Why Banks Offer Payment Services
 Banks do sell payment services.
 But banks primarily profit from raising low cost deposits.
 Redemption and payments have been way banks raise deposits.
 TCF:
 Offered free checking in 1980s.
 Didn’t offer a debit card until 1994.
 Checks clear at par. No interchange fee.
 Debit cards reduce costs relative to checks.
 Why wouldn’t TCF offer free checking without debit interchange fees?
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Kay, Manuszak and Vojtech
 Public sector economists can play a key role. This paper is an example.
 Commendable empirical investigation into waterbed effects.
 Find banks only partially (30%) recouped lost interchange revenue.

Is anyone surprised?

Interchange fees increase bank profits, are not all rebated to cardholders.

Especially for debit cards.
Switching costs are significant.
Rewards were slow to come to debit.
“Decoupled” debit not a factor.
 Caveat: did exempt banks change their terms due to changed terms at nonexempt banks?
 Lower interchange fees  greater merchant acceptance?
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Competitiveness of Banks
 “Various sources have indicated that despite high concentrations, banking
is quite competitive… Evidence that treated banks were able to offset 30
percent of lost income challenges that general impression.”
 Competition through negative prices / rebates to consumers is imperfect.
 Behavioral economic issues.
 There is a reason why banks and networks care so much about interchange fees.
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