Who Pays for Credit Cards

The authors model side payments in a competitive credit-card market. If competitive retailers absorb the cost of accepting credit cards by charging a higher goods price to everyone, then someone must subsidize convenience users of credit cards to prevent them from defecting to merchants who do not accept cards. The side payment could be financed by card users who roll over balances and pay interest. It is rational for them to do so if their subjective discount rates are high enough. Charging different prices to different customers based on the underlying cost of the payment instrument would be more efficient for retailers. However, banks may offer incentives to attract convenience users because some of them may become interest-paying users ("revolvers") in the future. I view credit cards, bank originated or other, as a temporary but probably unavoidable retreat in the campaign to develop an efficient domestic payments mechanism.--Donald D. Hester (1972), p. 285 ********** Most payments researchers today would agree that the question of whether credit cards are "overused" is not a simple one. Credit cards appear to be an expensive retail payment instrument (Humphrey and Berger 1990), yet they too have passed a market test of acceptance in the United States and, increasingly, abroad. Thus, we need to understand why and how credit-card usage has turned out to be not a "temporary retreat" but a full-scale assault on the retail payment practices that existed previously. Credit cards are popular both among those who use them as a source of revolving credit and among those who routinely pay off their balances in full each month. This is somewhat surprising because credit cards require an expensive supporting infrastructure. When credit cards were originally introduced in the late fifties, they provided merchants an alternative to cash, which had safekeeping issues, and checks, which can bounce at the merchant's expense. However, credit cards are relatively expensive retail payment instruments for merchants to accept. Compared to cash, checks, and online debit cards, which cost supermarkets about 90 cents, 80 cents, and 80 cents per $100 of purchases, respectively, credit cards appear to be extravagantly expensive, costing $1.80, over two times as much (Food Marketing Institute 2000). A large component of a merchant's cost of accepting credit cards is the merchant discount, the fraction of the face value of sales receipts that the merchant's bank retains as its fee. Despite relatively high costs, credit-card usage is growing rapidly in the United States. The market share of credit cards increased from 14.5% to 23.8% in terms of the total dollar volume of consumer payments in the United States between 1990 and 2000, while market share in terms of consumer transactions increased from 13.9% to 17.7% (Nilson Report 1997 and 2001). (1) A prominent trade publication predicts that, by 2005, the market shares of credit and charge cards will rise further to 25.7% in terms of dollar volume, and slightly increase to 18.7% in terms of transactions (Nilson Report 2001). Recently, several credit card policies have been under scrutiny in various parts of the world. In the United States, the Department of Justice recently sued the two card associations--MasterCard and Visa--for alleged anticompetitive business practices. The two major issues were: (1) governance rules that allowed a member of the board of directors of one association to sit on key committees of the other association, and (2) exclusivity rules that prohibited member banks from issuing card products of competitors such as American Express and Discover/Novus. The court ruled in favor of the card association regarding dual governance but ruled in favor of the Government regarding exclusivity. The card associations have appealed the decision. In a second lawsuit, a large group of merchants accused the card associations of illegally tying their credit and debit card products via honor-all-cards rules. …