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Saturday, 26 May 2012

Cardholders Don't Seem All That MIFfed... Yet.

At long last we have a judgment in the MasterCard interchange case. And if the strength of MasterCard and the UK banks' resistance is anything to go by, you might've thought the impact will be profound. But does the decision really threaten the reign of credit and debit cards as the dominant retail payment method in the UK?

In essence, the multilateral interchange fee (MIF) is a share of every credit or debit card transaction that is retained by the bank that issues the card. As previously explained, we all end up paying for MIF, because it's passed through in the charge to retailers for the ability to accept card payments (see here for how card acquiring works generally). 

The saga of complaint, denial and escalation over MIF seems even worse than the Great PPI Robbery, which definitely ended badly for the banks. The first complaints about the anti-competitive nature of MIF were made to the European Commission by trade bodies representing retailers in 1992 and 1997 respectively. To escape allegations that the banks had a common interest in maintaining the MIF, MasterCard's member banks went so far as to agree to float MasterCard Inc. as a separate company on the New York Stock Exchange in 2006. This did not convince the Commission. On 19 December 2007, it outlawed MIF. In response, MasterCard (tellingly 'supported' by former member banks as "interveners" in the proceedings) applied to the European Court of Justice to overturn that decision on 1 March 2008. It has taken over four years to get a judgment dismissing their application. Only a limited appeal on points of law is possible.

The Commission had decided in 2007 that the MIF set a floor below which merchant service fees would not fall, and so restricted price competition to the detriment of retailers. It considered that the absence of a MIF would also reveal any bilateral interchange fees agreed between specific issuers and acquirers, making the acquirers' service obviously more expensive, and exposing them to competition. The Commission rejected the idea that MIF paid for various 'efficiencies' that justified its anti-competitive effect. It also considered that the issuing banks had tried to justify the MIF by including costs that are also inherent in other forms of payment, such as the costs of maintaining a current account...

The Court has now agreed with the Commission. Both believe that MasterCard and the card issuers make so much money out of their payment card businesses that the loss of the MIF won't significantly impact the scale of their activities, or their ability to drive cardholder demand. In particular, the Commission found that "issuing banks generated 90% of their revenues with income from cardholders (mainly [interest]) and only 10% from interchange fees." Debit card payments also drive cost savings for the banks by reducing the number of more expensive cash and cheque transactions they needed to handle. And a significant reduction in MIF in Australia did not have any of the effect the banks claimed an outright ban would have here. In fact, the Court found that to determine the level of MIF for credit and charge cards, MasterCard tries: 
"...to answer the question: “How high could [MIFs] go before we would start having either serious acceptance problems, where merchants would say: we don’t want this product anymore, or by merchants trying to discourage the use of the card either by surcharging or discounting for cash”’.
From the nature of this equation, the removal of MIF should mean lower costs to merchants, who can use these savings to invest in increased selection, to improve customer experience, to expand - or to simply survive in the current downturn. Those merchants who merely take the lower overhead as profit are clearly in a good position, and I guess there's a chance they may one day face their own competition investigation, but that's an entirely separate issue as I've pointed out before.

That's good news for consumers generally. But what of the impact in the market for new payment methods amongst cardholders themselves? What will prevent card issuers from reducing the value of loyalty schemes or otherwise charging cardholders more in interest and/or fees to make up for lost MIF income?

Interestingly, MasterCard and the banks said that removing MIF would mean "a move towards alternative products or services." But the Commission believes that consumers' strong preference for card payments means the pressure of other payment methods has been too weak to make any difference to the level of MIF (and therefore card issuing and acceptance). As mentioned, removing MIF should actually make card payments cheaper for merchants, so make them less inclined to explore alternatives. In those circumstances, a cardholder rebellion would seem difficult to achieve.

So while the ability to "extract rents" via the MIF has been curtailed, the dominance of cards as a payment method may be sustained. Indeed, card issuers may believe the strong consumer preference noted by the Commission allows them to compensate for the loss of MIF by raising interest rates and charges for cards. That would avoid the need to dip into interest income for the marketing budget to keep stoking demand in the midst of a downturn, pressure to repair bank balance sheets and Basel III capital constraints that attach higher risk-weightings to consumer lending. Such increases could happen soon. The Commission originally gave MasterCard 6 months to remove MIF and this timeline may be insisted upon. But card issuers might well try to raise interest rates and/or direct charges in advance of that date, pointing to the cost of systems changes to remove MIF as instructed.

Ironically, it would seem that we cardholders only have ourselves to blame for such a scenario.

It remains to be seen how high interest and charges on card payments will need to go before we'll rebel.

Image from GAO report on interchange.