Fed Reserve: “Interchange Fees and Payment Card Networks: Economics, Industry Developments, and Policy Issues

Finance and Economics Discussion Series

Divisions of Research; Statistics and Monetary Affairs

Federal Reserve Board, Washington, D.C. Interchange Fees and Payment Card Networks: Economics, Industry Developments, and Policy Issues

Robin A. Prager, Mark D. Manuszak, Elizabeth K. Kiser, and Ron Borzekowski

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In many countries around the world, electronic card-based payments have been replacing older types of payments at a rapid rate. In the United States, use of both debit cards and credit cards has been rising rapidly, while check volumes have been declining.

The increased use of electronic payment methods has generated a number of public policy debates. One prominent debate concerns interchange fees. This paper is intended to provide background for understanding the interchange fee debate. The paper describes the operation of a typical payment card system, presents a summary of the economic theory underlying interchange fees, and discusses various developments in the U.S. payment cards industry, as well as legal and regulatory developments abroad.

The paper concludes with a discussion and critical evaluation of a number of potential policy interventions.

Interchange fees typically involve a payment from a merchant’s bank to a card user’s bank for each debit card or credit card transaction, are determined at the network level, and are the same for all banks participating in a network. These fees are generally passed through to merchants by their banks and comprise a large fraction of the fees that merchants pay to their banks for processing card transactions. Card-issuing banks often use a portion of their interchange fee revenue to encourage card use by offering their cardholders rewards, such as cash rebates or airline miles, that increase with card use. In recent years, increases in interchange fee rates, together with growth in the volume of card transactions, have led to a dramatic rise in the total value of interchange fee payments and, consequently, in merchants’ cost of accepting payment cards. These cost increases have given rise to significant concerns among merchants.

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