Credit Cards: Rising Interchange Fees Have Increased Costs for Merchants, but Options for Reducing Fees Pose Challenges
Published: 2009-11-19T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: When a consumer uses a credit card to make a purchase, the merchant does not receive the full purchase amount because a certain portion of the sale is deducted to compensate the merchant's bank, the bank that issued the card, and the card network that processes the transaction. The level and growth of these rates have become increasingly controversial. The 2009 Credit Card Accountability, Responsibility, and Disclosure Act directed GAO to review (1) how the fees merchants pay have changed over time and the factors affecting the competitiveness of the credit card market, (2) how credit card competition has affected consumers, (3) the benefits and costs to merchants of accepting cards and their ability to negotiate those costs, and (4) the potential impact of various options intended to lower merchant costs. To address these objectives, GAO reviewed and analyzed relevant studies, literature, and data on the card payment market and interviewed industry participants, including large and small card issuers (including community banks and credit unions), card processors, card networks, large merchants representing a significant proportion of retail sales, and small merchants from a variety of industries, and academic experts. GAO provided a draft of this report to the Department of Justice, the Federal Trade Commission, and federal banking regulators, and we incorporated their technical comments where appropriate.
section_title: What GAO Found
paragraphs: According to Federal Reserve analysis, total costs of accepting credit cards for merchants have risen over time as consumers use cards more. Part of these increased costs also may be the result of how Visa and MasterCard competed to attract and retain issuers to offer cards by increasing the number of interchange fee categories and the level of these rates. Concerns remain over whether the level of these rates reflects market power--the ability of some card networks to raise prices without suffering competitive effects--or whether these fees reflect the costs that issuers incur to maintain credit card programs. Issuers, particularly smaller issuers such as community banks and credit unions, report relying on interchange fees as a significant source of revenue for their credit card operations, and analyses by banking regulators indicate such operations traditionally have been among the most profitable types of activities for large banks. Some consumers have benefited from competition in the credit card market, as cards often have no annual fees, lower interest rates than they did years ago, and greater rewards. However, consumers who do not use credit cards may be paying higher prices for goods and services, as merchants pass on their increasing card acceptance costs to all of their customers. For merchants, the benefits of accepting credit cards include increased sales and reduced labor costs. However, representatives from some of the large merchants with whom we spoke said their increased payment costs outstripped any increased sales. These merchants also reported that their inability to refuse popular cards and network rules (which prevent charging more for credit card than for cash payments or rejecting higher-cost cards) limited their ability to negotiate payment costs. Interchange fees are not federally regulated in the United States, but concerns about card costs have prompted federal investigations and private lawsuits, and authorities in more than 30 countries have taken or are considering taking actions to address such fees and other card network practices. Proposals for reducing interchange fees in the United States or other countries have included (1) setting or limiting interchange fees, (2) requiring their disclosure to consumers, (3) prohibiting card networks from imposing rules on merchants that limit their ability to steer customers away from higher-cost cards, and (4) granting antitrust waivers to allow merchants and issuers to voluntarily negotiate rates. If these measures were adopted here, merchants would benefit from lower interchange fees. Consumers would also benefit if merchants reduced prices for goods and services, but identifying such savings would be difficult. Consumers also might face higher card use costs if issuers raised other fees or interest rates to compensate for lost interchange fee income. Each of these options also presents challenges for implementation, such as determining at which rate to set, providing more information to consumers, or addressing the interests of both large and small issuers and merchants in bargaining efforts.

section_title: Letter
paragraphs: Consumers are increasingly using credit cards to make payments for  goods and services. When a consumer uses a credit card to make a  purchase, the merchant does not receive the full purchase amount because  a certain portion of the sale is deducted and distributed among the  merchant’s financial institution, the financial institution that issued the  card, and the card network that processes the transaction. The majority of  this amount generally is called the interchange fee and goes to the  financial institution that issued the card. As card use has become more  popular, the costs for merchants of accepting them have been rising, and  considerable debate has been occurring over these costs, and particularly  the level of interchange fee rates. In the United States, merchants have  sued the card networks several times over card acceptance rules and  costs. Several congressional committees have held hearings on the topic of  interchange fees and Members of Congress have introduced legislation  regarding interchange fees.
In May 2009, Congress passed and the President signed the Credit Card  Accountability Responsibility and Disclosure Act of 2009 (CARD Act),  which directed us to conduct a study of credit card interchange fees. In  addition, we were asked by members of the Senate Small Business  Committee to review the market for interchange fees. In response to both,  we reviewed (1) how the fees merchants pay for accepting credit cards  have changed over time and the factors affecting the competitiveness of  the credit card market, (2) how credit card competition has affected  consumers, (3) the benefits and costs to merchants of accepting cards and  their ability to negotiate those costs, and (4) the potential impact of  various options intended to lower merchant card fee costs.
To address our objectives, we reviewed economic and other academic  literature and analyzed industry data on the structure of the credit card  payment market and merchants’ reported fees for payment acceptance.  We reviewed materials provided to us by the card networks about the  structure of interchange fees, how those fees have changed over time, and  the rules for payment card acceptance. We also conducted interviews with  more than 80 organizations, including U.S. federal banking and other  regulators, academic researchers, and industry participants. We also  interviewed and obtained information from regulatory officials in  Australia, which took actions regarding interchange fees in 2003. To learn  how card issuers compete to attract cardholders and the role of  interchange fee revenue, we interviewed representatives from national  banking associations, from some of the largest credit card issuing banks,  and from credit unions and community banks from across the United  States. To learn more about the role of acquiring institutions and  processors, we met with an acquiring bank association and several large  acquiring banks and merchant data processors. To learn more about the  fees merchants pay for card acceptance, we met with representatives of  large merchant groups from a variety of industries, including mass market  retailers, grocery store chains, and online retailers. These merchants  represent some of the largest retailers in the United States, including eight  that represented 42 percent of the wholesale and retail trade industries  listed in the S&P 500 in 2008. In addition, we obtained and analyzed data  provided by large merchants, merchant associations, and a large credit  card processor on the costs of accepting credit cards and interchange fee  changes over time. This information was used to corroborate some of the  statements they made about the benefits of card use, but we did not  independently verify these data. In general, publicly available data on  interchange fee revenues, card issuer costs, and other quantitative  information are limited or data could not be provided because of  contractual restrictions or ongoing litigation. We also selected small  merchants to interview from the Washington, D.C., and Springfield,  Virginia, Chambers of Commerce. These merchants represented a diverse  group of businesses, including boutique shops, sports clubs, and a health  care professional. Our interviews with industry participants, academics,  and regulators also provided us with an understanding of the potential  impact of various options to lower credit card fees. See appendix I for  more detailed information on our scope and methodology.
We conducted our work from May 2009 to November 2009 in accordance  with generally accepted government auditing standards. Those standards  require that we plan and perform the audit to obtain sufficient, appropriate  evidence to provide a reasonable basis for our findings and conclusions  based on our audit objectives. We believe that the evidence obtained  provides a reasonable basis for our findings and conclusions based on our  audit objectives.
subsections: section_title: Background
paragraphs: Payment card use has grown dramatically since the introduction of cards  in the beginning of the 20th century. Hotels, oil companies, and  department stores issued cards associated with charge accounts before  World War I. In 1950, Diners Club established the first general purpose  charge card that allowed its cardholders to purchase goods and services  from many different merchants. In the late 1950s, Bank of America began  offering the BankAmericard, one of the first general purpose credit cards.  Unlike charge cards that require the balance to be paid in full each month,  credit cards allow cardholders to make purchases up to a credit limit and  pay the balance off over time. To increase the number of consumers  carrying the card and to reach retailers outside of Bank of America’s area  of operations, other banks were given the opportunity to license Bank of  America’s credit card. As the network of banks issuing these credit cards  expanded, the network was converted into a membership-owned  corporation that became the Visa network. MasterCard began in 1966 as an  association of member-owned banks. American Express launched its card  network in 1958, and in the 1980s, Discover, then a business unit of Sears,  issued Discover card. In 2006, MasterCard became a publicly traded  company with a board of directors with a majority of directors that are  independent from their financial institution customers. Visa became a  publicly traded company in 2008, and its financial institution members  became common stockholders with a minority of shares.
Today, customers can choose among different types of payment cards.  Consumers can use debit cards with a personal identification number  (PIN) they enter on payment or with a signature. The payment is  transferred directly from the cardholder’s account to the merchant’s  account. With a debit card, the payment comes from the cardholder’s  checking account. Credit cards allow cardholders to access borrowed  funds to make a purchase and generally have a grace period between the  purchase of an item and the payment date. Then the cardholder can pay  the charges in full or extend the loan and keep making charges to the  credit limit. Cardholders who do not pay for the charges in full are  assessed finance charges by their financial institution and pay interest on  the remaining balance. Credit cards offer cardholders several benefits,  including  the convenience of not having to carry cash or a checkbook,   a convenient source of unsecured credit that allows consumers to finance  their purchases over time,   an interest-free period to finance purchases if balances are paid on time,  improved theft and loss prevention as compared with cash and easier  dispute resolution in the event of problems, and   an easy record-keeping mechanism that can be useful for budgeting,  planning, and income tax preparation.
subsections: section_title: Consumer Use of Credit Cards Has Grown Dramatically, while a Few Large Banks Have Come to Account for Most Card Issuance
paragraphs: The number of credit cards in circulation and the extent to which they are  used has also grown dramatically. The range of goods and services that  can be purchased with credit cards has expanded, with cards now being  used to pay for groceries, health care, and federal and state income taxes.  In 2007, U.S. consumers held more than 694 million credit cards from Visa,  MasterCard, American Express, and Discover, and as shown in figure 1,  the total value of transactions for which these cards were used exceeded  $1.9 trillion, according to data from the Card Industry Directory.
Many of the largest issuers of credit cards in the United States are  commercial banks, including many of the largest banks in the country.  More than 6,000 depository institutions issue credit cards, but over the  past decade, the majority of accounts increasingly have become  concentrated among a small number of large issuers. Table 1 shows the  largest bank issuers of credit cards as of the end of 2008, and their  percentage of the total United States credit card market, according to an  industry newsletter.
In addition, community banks, thrifts, and credit unions each issue credit  and debit cards. According to information provided by banking regulators  and banking associations, about 75 percent of community banks, 49  percent of credit unions, and 13 percent of thrifts issue credit cards.
section_title: Transactions through Card Networks Involve Multiple Parties and Fees
paragraphs: Merchants’ costs of payment card acceptance involve several different  fees that are divided among the parties involved in a credit card  transaction. The parties involved in processing credit card transactions  vary depending on the network used by the card. The United States has  four primary general purpose credit card networks. For the two largest  networks—Visa and MasterCard—transactions involve four parties: (1) the  financial institution that issued a cardholder’s card, (2) the cardholder,   (3) the merchant that accepts the cardholder’s card, and (4) an acquiring  financial institution. A merchant that accepts Visa or MasterCard credit  cards enters into a contract with an acquiring institution that has a  relationship with Visa or MasterCard (or both) to provide card payment  processing services. The merchant’s contract with the acquiring institution  or its agent specifies the level of services the merchant receives, as well as  the merchant discount fee and other fees that will apply to the processing  of the merchant’s card transactions. The acquiring institution charges the  merchant a merchant discount fee that is established through negotiations.
The majority of the merchant discount fee is generally paid from the  acquiring institution to the issuing institution in the form of an interchange  fee. A merchant does not pay the interchange fee directly. Rather, the Visa  or MasterCard network transfers the interchange fee portion of the  merchant discount fee from the acquiring institution to the issuing  institution. The acquiring institution retains the balance of the merchant  discount fee to cover its costs for processing the transaction. Figure 2  illustrates the four parties in a typical credit card transaction and how fees  are transferred among the parties. In this example, when a cardholder  makes a $100 purchase, the merchant pays $2.20 in merchant discount fees  for the transaction. This amount is divided between the issuing institution,  which received $1.70 in interchange fees, and the acquiring institution,  which receives 50 cents for processing the transaction.
For transactions on the other two major card networks—American  Express and Discover—generally only three parties are involved: the  cardholder, the merchant, and one company that acts as both the issuing  and acquiring entities. Merchants that choose to accept these two types of  cards typically negotiate directly with American Express and Discover  over the merchant discount fees that will be assessed on their  transactions.
Acquiring institutions provide the means for merchants to accept credit  cards, by forwarding the request for authorization through the card  network to the cardholder’s issuing institution. The issuing institution  authorizes the transaction by verifying that the account is valid and that  the cardholder has a sufficient amount of credit for the sale. For  merchants accepting cards in their stores, authorization generally occurs  automatically through electronic point-of-sale terminals that read cards.  Acquiring institutions clear and settle card purchases by providing  payment from the issuing institution to the merchant’s account, except for  the interchange fees and their own service fees. According to industry  estimates, the process takes between 24 and 72 hours for the merchant to  receive payment. Acquiring institutions also assume the risks of a  merchant defaulting on the promise of goods. For example, if a merchant  becomes bankrupt, its acquiring institution is responsible for settling  claims with the network and issuers whose cardholders are waiting for  goods or services.
section_title: Interchange Fees Represent the Largest Portion of Credit Card Payment Acceptance Fees
paragraphs: Interchange fees generally account for the largest portion of the fees for  acceptance of Visa and MasterCard credit cards. The card networks set the  fees, which vary based on several factors and generally range from 1 to 3  percent of the purchase price. Card network officials told us that they  have developed lower rates to encourage certain merchants to accept their  cards. Acquiring banks and card network representatives also told us that  certain merchants and transaction types are considered more risky than  others and pay higher interchange fees for accepting card payments.
According to Visa and MasterCard officials, four main factors determine  which interchange fee rates apply to a given transaction on their networks:    Type of card: Different rates apply to different types of cards. Visa and  MasterCard have separate interchange fee rates for general purpose  consumer cards, rewards credit cards, commercial credit cards (issued to  businesses), and debit cards. Debit card interchange fees generally are  lower than those for credit cards. Among credit cards, premium cards  such as those offering rewards and commercial cards generally have  higher rates than those for standard or traditional cards.
Merchant category: Card networks classify merchants according to their  line of business. Network officials told us they develop lower interchange  fee rates for industries that do not accept cards to encourage merchants in  certain categories to accept cards. For example, grocery stores and  utilities have lower interchange fees as a special incentive from the  networks. Interchange fee rates are higher for merchants in industries  such as travel and entertainment, in which network officials report  customers spend more with their credit cards, providing the merchant  with higher value.
Merchant size (transaction volume): Merchants with large volumes of card  transactions generally have lower interchange fee rates. Visa categorizes  some merchants into three tiers based on transactions and sales volume,  with top-tier merchants receiving the lowest rate. Visa and MasterCard  officials told us that the lower rates also were designed to promote the use  of their cards over other credit cards and forms of payment.
Processing mode: Interchange fee rates also vary depending on how card  transactions are processed. For example, transactions that occur without  the card being physically present, such as on the Internet, have higher  interchange fee rates because of the higher risk of fraud. Similarly, swiping  a card through a card terminal, rather than manually entering the account  number, would lower a merchant’s interchange rate. The swiped  transaction provides more information to the issuer authorizing the sale,  and issuers and card networks consider such transactions to be less risky  because the card was present.
Merchants generally learn of changes to their rates for accepting Visa and  MasterCard cards through their acquiring institution. Smaller merchants  generally receive one or more flat fees (known as a blended rate) for  payment acceptance that include both the interchange fee and the  acquiring institution’s fee. For merchants with blended rates, the costs of  acceptance are uniform for each card type and interchange fee rates may  not be disclosed on statements as a separate fee. In contrast, larger  merchants generally receive detailed statements from their acquiring  institution and card processors, which include interchange fee categories,  network fees, and fees from the acquiring institution. These statements  reflect “cost-plus” rates, because the acquiring institution provides the  merchant with the details of the costs passed on from the network along  with the acquiring institution’s own fees. Visa and MasterCard develop and  publish interchange rate tables (available on their Web sites) that disclose  the default rates that apply to various types of transactions. Visa and  MasterCard typically publish new interchange schedules twice a year.
section_title: Oversight of the Payment Card Market and Recent Legislative Initiatives
paragraphs: Various federal agencies oversee credit card issuers. The Federal Reserve  oversees issuers that are chartered as state banks and are also members of  the Federal Reserve System. The Office of the Comptroller of the Currency  (OCC) supervises card issuers chartered as national banks. Other  regulators are the Federal Deposit Insurance Corporation (FDIC), which  oversees state-chartered banks with federally insured deposits that are not  members of the Federal Reserve System; the Office of Thrift Supervision,  which oversees federally chartered and state-chartered savings  associations with federally insured deposits; and the National Credit  Union Administration, which oversees federally chartered and state- chartered credit unions whose accounts are federally insured. As part of  their oversight, these regulators review card issuers’ compliance with the  Truth In Lending Act (TILA)—the primary federal law pertaining to the  extension of consumer credit—and ensure that an institution’s credit card  operations do not pose a threat to the institution’s safety and soundness.  The Federal Trade Commission (FTC) generally has responsibility for  enforcing TILA and other consumer protection laws for credit card issuers  that are not subject to the enforcement authority of other federal  regulators. To the extent that the imposition of interchange fees would  constitute an anticompetitive or unfair business practice prohibited by the  antitrust laws or the Federal Trade Commission Act, the Department of  Justice (DOJ) and FTC, respectively, could take measures to ensure  compliance with those laws.
Interchange fees are the subject of several federal legislative proposals.  The Credit Card Fair Fee Acts of 2009, introduced in June 2009, would,  among other things, establish a process by which merchant groups and  providers of access to credit card networks could negotiate interchange  fees and other terms of network participation under an exemption from  federal antitrust laws. The interchange fee would be made publicly  available. Another proposal would require credit and debit card networks  to remove constraints placed on merchants for card acceptance, such as  requiring merchants to accept all cards from a particular network, and  require issuers to disclose networks’ fees to credit card users.
section_title: Fees Merchants Pay for Accepting Credit Cards Have Increased over Time and May Be Related to Competition for Issuers in the Credit Card Market
paragraphs: The amounts merchants pay to accept credit cards is increasing, as  Federal Reserve data indicate that consumers increasingly use credit cards  to make payments, but also because network competition in the credit  card market may be contributing to rising interchange fees. As Visa and  MasterCard have sought to attract new merchants to accept and issuers to  offer their cards, the number of different interchange fee categories has  grown. In addition, as the networks compete to attract financial  institutions to issue cards on their networks, they may have increased  their interchange fees to provide issuers with greater revenue from the  fees. However, concerns remain over whether the level of interchange fee  rates reflect the ability of some card networks to exercise market power  by raising prices without suffering competitive effects, or whether these  fees are the result of the costs that issuers incur to maintain their credit  card programs. Issuers, particularly smaller issuers such as community  banks and credit unions, report relying on interchange fees as a significant  source of revenue for their credit card operations, and analyses by  banking regulators indicate that card activities traditionally have been  among the most profitable types of activities for large banks.
subsections: section_title: Reasons for the Increase in Merchant Card Acceptance Costs Include Consumers’ Increasing Use of Credit and Debit Cards and Increases in Fee Rates
paragraphs: The amount of fees that merchants pay for card transactions has been  increasing in recent years, in part because of the increasing use of credit  cards to make payments. The Federal Reserve recently estimated that the  use of both checks and cash have declined, or at least grown more slowly  than credit and debit card use, since the mid-1990s as more consumers  switched to electronic forms of payment. According to data from the  American Bankers Association, since 2005 more than half of total retail  transactions have been paid for using cards (either debit or credit).  Although the total value of fees that merchants paid for card transactions  as well as the total value of interchange fees are not publicly available,  economists at the Federal Reserve estimated that the value of interchange  fees paid on Visa and MasterCard credit and debit cards has increased  substantially, from about $20 billion in 2002 to approximately $35 billion to  45 billion in 2007. As the total amount of interchange fees increased, so  did merchants’ total fees for accepting cards.
Merchants’ card acceptance costs also have been increasing as a result of  rising average interchange fee rates. Visa and MasterCard officials told us  that their average effective interchange rates applied to transactions have  remained fairly constant in recent years when transactions on debit cards,  which have lower interchange fee rates, are included. However, our own  analysis of Visa and MasterCard interchange rate schedules shows that the  interchange rates for credit cards have been increasing and their  structures have become more complex, as hundreds of different  interchange fee rate categoriess for accepting credit cards now exist (see  table 2). According to our analysis, in 1991, Visa and MasterCard each had  4 standard domestic credit card interchange fee rate categories, but by  2009, Visa had 60 and MasterCard had 243 different rate categories that  could be charged to card transactions, although not all of these rates  would apply to all merchants. According to card network officials, the  increase in the number of rates occurred as different types of merchants  and cards were added to their interchange rate schedules. For example,  the networks introduced new rates for certain industries that previously  had not accepted cards (such as energy utility companies or government  agencies) or for new methods of shopping (such as online purchases). In  addition to the increase in the number of interchange fee rates, the  maximum domestic credit card interchange fee per transaction also has  increased, as shown in table 2. While some of the networks’ interchange  fee rates remained the same during this time and a few decreased, another  reason merchant card acceptance costs are increasing may be that  individual interchange fee rates also are increasing. According to our  analysis, from 1991 to 2009, 43 percent of the individual Visa rates and 45  percent of the MasterCard rates that prevailed in 2009 had been increased  since they were originally introduced.
Our interchange fee rate analysis showed that the interchange fee rates  that increased the most during this period were for some standard card  types. For example, the rate that applied to MasterCard transactions using  basic nonrewards credit cards at merchants that would not otherwise  qualify for a special rate—called Merit III base—was 1.30 percent in 1991  and 1.58 percent in April 2009—representing a 22 percent increase. A  similar rate for Visa—known as CPS/Retail Credit—increased from 1.25  percent to 1.54 percent, or 23 percent, from 1995 to April 2009. In addition,  several of the networks’ higher interchange fee rates also increased during  this period. For example, both networks’ corporate card (issued to  business customers) interchange fee rates increased considerably—Visa  by 36 percent and MasterCard by 82 percent. Rates on other cards that had  lower-cost incentive rates for sectors that previously did not take cards  also increased. For example, MasterCard’s interchange rate for standard  credit cards used at a supermarket increased nearly 29 percent, from an  introduction at 1.15 percent in 1998 to 1.48 percent in 2009.
Analysis by Federal Reserve staff also showed that interchange fee rates  have increased, particularly for premium cards that have higher rates than  basic cards. As shown in figure 3, the interchange fee costs for Visa’s and  MasterCard’s premium cards have increased about 24 percent since they  were introduced in 2005. Interchange fee costs for basic credit cards have  stayed roughly the same since 2005, with a 3-percent decline for  MasterCard and none for Visa.
Although limited information about cost trends for accepting cards exists  for American Express and Discover, the rates these two networks charge  have not generated the same level of concern as those of the other  networks, in part because they are less widely used. Information on the  rates that American Express and Discover charge merchants to accept  their cards is limited; these networks do not publish the rates they charge  merchants, but instead generally negotiate these charges with merchants  on an individual basis. As discussed previously, American Express and  Discover, for large merchants, generally serve as both the issuer and  acquirer of their cards, so merchants’ fees for accepting those cards  represent their entire merchant discount fee. Representatives from  American Express told us that they do not have interchange fees but  instead contract directly with merchants for a fixed merchant discount  rate for all types of American Express cards. Discover officials told us that  Discover is moving from a single rate for each merchant that applies to all  of their cards to a tiered interchange fee model, with higher interchange  fees for rewards and corporate cards. Although these networks do not  make their merchant discount rate information publicly available, a recent  survey of 750 small business owners found that merchants with fewer than  250 employees paid an average of 3.2 percent to accept American Express  Cards and 2.5 percent for Discover cards, compared with the average  merchant discount fee (which includes the interchange fee and acquiring  costs) that these merchants reported of 2.3 percent for MasterCard and  Visa. According to data provided to us by American Express, the average  merchant discount rate for its cards has decreased in recent years, from  roughly 3.25 percent in 1990 to 2.56 percent in 2009.
section_title: The Structure of the Card Networks and Increased Competition for Issuers May Increase the Price of Card Acceptance for Merchants
paragraphs: The structure of the credit card market is different from that of other  markets and could be one reason why merchants’ costs for card  acceptance are rising. Economists and other researchers note that credit  card networks function differently from most markets because the card  market can be considered a “two-sided” market, in which two different  groups—merchants and consumers—pay prices for goods or services  offered by a producer. Other two-sided markets include newspapers,  which charge different prices to consumers who purchase the publications  and advertisers that purchase space in the publications. Typically,  newspapers offer low subscription rate or per copy price to attract  readers, while funding most of their costs from revenue received from  advertisers. Charging low prices to encourage larger numbers of  consumers to purchase the newspaper increases the paper’s attractiveness  to advertisers as a place to reach a large number of consumers, and thus  allows publishers to charge such advertisers more. As a newspaper  attracts more readers, it can charge higher prices to advertisers.
Similarly, card networks use interchange fees as a way to balance demand  from both consumers (who want to use cards to pay for goods) and  merchants (who accept cards as payment for goods). As with newspapers,  the costs to both sides of the card market are not borne equally. To attract  a sufficient number of consumers to use their cards, card networks  compete to attract financial institutions to issue them, and institutions in  turn compete to find additional cardholders. Just as readers have a variety  of sources from which they can receive their news, consumers also have a  number of different methods (such as cash, check, or credit card) by  which they can pay for a good or service. Because of the choices  consumers have available, card networks and issuers want to minimize the  costs for consumers to carry their cards to encourage greater acceptance  and use. In contrast, merchants have less choice about card costs,  particularly once a large number of consumers are using a particular  network’s cards. Whereas a consumer may not pay any fee or charge for  using a card, card networks charge merchants for accepting cards through  interchange and other network fees. Consumers’ payment choices, such as  using rewards cards with higher interchange fees, also affect merchants’  costs for card acceptance. As a result, some academic researchers have  argued that card networks can keep attracting cardholders by offering  them increasingly attractive terms while increasing costs to merchants,  whose ability to refuse to accept cards is more limited.
The concentration of participants in the credit card network market also  has raised concerns over competition and pricing. Visa and MasterCard  together accounted for about 71 percent of U.S. credit card purchase  volume in 2008, American Express for about 24 percent, and Discover for  5 percent, according to an industry newsletter. Some economists and  other academic researchers have argued that the large market share of  Visa and MasterCard provides these networks with market power—the  ability to raise prices without suffering significant negative competitive  effects such as lost sales or reduced transaction volume. As more  consumers demand to use Visa and MasterCard cards, merchants feel  limited in their ability to refuse these cards even as interchange fee rates  rise or as consumers increasingly use rewards cards that have higher  interchange rates. These researchers cite the low market share for  Discover as evidence that a new product has had difficulty breaking into  the mature market. With fewer cardholders, the attractiveness of this  network’s cards to merchants is reduced. In order for Discover or another  low-cost credit card network to enter the market, it has to compete against  the dominance of Visa and MasterCard, which already have successfully  recruited thousands of financial institutions to issue their cards and  millions of merchants to accept them. Card networks face initial fixed  costs, including building and maintaining the infrastructure to process  transactions and promoting card usage. Many of the economists that study  card market issues generally agree that card networks provide a valuable  service that benefits issuers, consumers, and merchants. However, some  have pointed out that once a network’s initial start-up and coordination  costs have been recovered, the justification for charging merchants higher  prices for card acceptance is reduced.
Competition among networks for issuers also may increase merchants’  card acceptance costs, as networks increase interchange fees. Although  greater competition generally produces lower prices for goods and  services, some economists have noted that competition among card  networks instead increases costs for merchants. To maintain or increase  their market share, networks compete for financial institutions to issue  their cards, and the revenues that the issuers earn from interchange fees  are an incentive to choose to issue one network’s card over another. A  recent court ruling increased the potential for competition among  networks for issuers. Before 2001, Visa and MasterCard had exclusionary  rules prohibiting their member institutions from issuing American Express  or Discover cards. In 1998, DOJ initiated a lawsuit charging, among other  things, that Visa and MasterCard had conspired to restrain trade by  enacting and enforcing these exclusionary rules. The trial court held that  Visa and MasterCard had violated section 1 of the Sherman Antitrust Act  by enforcing their respective versions of the exclusionary rule. As a  result of the court’s decision, an issuer of one of these network’s cards  now has the option to issue cards on the Visa, MasterCard, American  Express, or Discover network, or a combination of them. Network officials from Visa told us that they actively compete to retain issuers on their  network and interchange fees play a role in that effort. Our analysis of  interchange fee rate schedules showed that Visa and MasterCard  introduced several of their highest interchange fee rates after this  decision, which led to a significant increase in the average interchange fee  rates for both networks. According to our analysis, 46 percent of the  different Visa interchange rates that prevailed in 2009 had been introduced  since 2003, and the average of the new interchange rates created by that  network since 2003 was 18 percent higher than the average of interchange  rates introduced prior to 2003. Similarly, 89 percent of the different  MasterCard interchange rates that prevailed in 2009 had been introduced  since 2003, and the average of the interchange rates created by that  network since 2003 was 11 percent higher. According to analysis provided  by the Federal Reserve, Visa and MasterCard introduced higher  interchange fee categories in 2005 for premium cards. Visa and  MasterCard officials told us that Visa’s “signature preferred” and  MasterCard’s “world card” interchange categories were limited only to  higher-spending cardholders.
section_title: Although Offering Cards Involves Various Costs, Issuers Traditionally Derived Significant Revenues from Interchange Fees
paragraphs: Issuers report that the revenue they receive from interchange fees is use to cover a variety of costs in their card programs. Establishing a credit  card program by soliciting customers, offering them unsecured cred paying for any resulting credit or fraud losses involves many costs.  Representatives from issuers and networks reported that interchange fees represent a value to merchants, as issuers’ credit card programs provide merchants with increased sales and eliminate the need for merchants to create and maintain their own credit card operations or internal credit  departments. Among the costs that issuers told us they incur in running  their credit card programs were costs related to preventing and address fraud and data breaches; write-offs for credit losses from delinquent or  defaulting cardholders; funding costs associated with paying the merch before receiving payment from the cardholder; paying for rewards and  other cardholder benefits; and general op of cards and credit card bill statements.  erations, including the issuance  Although issuers incur costs for offering cards, concerns remain about th extent to which interchange fee levels closely relate to the level of card  program expenses or whether they are set high so as to increase issuer  profits. In a competitive market, the price of the product and the cost of  e  producing it would be closely aligned. However, producers with market  power—such as monopolists or those offering goods not generally offered  by others—have the ability to charge high, noncompetitive prices.  Representatives of issuers told us that interchange fees did not directly  cover specific costs of establishing and maintaining a credit card program,  but were one of several revenue sources for issuers, in addition to interest  charges on outstanding balances and cardholder fees (such as a late fee or  an annual fee). Representatives from a banking industry consultancy  group told us that the allocation of issuers’ revenue varied widely, as some  issuers provide more benefits through greater rewards and others by  offering more credit. For example, issuers derive revenue from  cardholders who pay interest charges and other fees on their outstanding  balances. However, issuers may receive little to no revenue from  cardholders who pay off their balances on time. Representatives from  large and small issuers told us that interchange fees provide them with  income that covers the costs of providing short-term credit during the  grace period and rewards benefits to those cardholders who do not pay  interest charges or other fees.
Representatives of credit unions and community banks reported that  revenue from interchange fees allowed them to cover expenses rel offering credit cards and compete with large issuers to offer their  customers credit cards. According to data provided by the Indep Community Bankers of America, the interchange fee portion of  community banks’ credit card revenue varies widely, with some receiving little income from interchange fees because of inactive cards and others  receiving nearly all of their income from interchange fees. Staff from thi organization told us that they have contracted with a vendor processor  that provides card processing for many of their members. They report that of the 689 community banks that issue credit cards through this  vendor, the average amount of revenue from interchange fees represented about 43 percent of these institutions’ total card revenues. Credit unions and community banks had a higher portion of cardholders who did no carry a balance or incur penalty fees, according to representatives of  financial institutions, so they had to rely more on interchange fee revenues than revenues from fee income and interest payments. Representatives o rds  the smaller issuers also reported that they felt they had to offer rewa programs to compete with the larger issuers, but for some, rewards  programs did not constitute a majority of their expenses. In addition, two  of the credit unions with which we met outsourc maintenance of a card program to a third party.  ed the issuance and  Information on the amount of revenues larger financial institutions coll from interchange fees and how those revenues compare with their costs o card operations and rewards programs is limited. We were not able to  obtain data from the largest card issuers about their revenues, profits, or  expenses to compare interchange fee revenues with expenses. Howe ver,  industry sources indicate that credit card issuers have derived a signific amount of revenue from interchange fees. According to an industry  newsletter, in 2007, roughly 20 percent of Visa and MasterCard issu card-related revenue—roughly $24 billion—came from interchange fees,  while their total costs (for costs of funds, charge-offs, operations,  marketing, and fraud) were about $90 billion, and their profits afte $18.3 billion. issuers pass on increased revenue from interchange fees to their  cardholders in the form of greater rewards. He reported that from 200 2008 one large credit card issuer provided an increasing portion of its  interchange fee income as rewards to its cardholders and that Visa’s  traditional rewards, premium rewards, and superpremium interchange fee  categories had minimum cardholder rewards programs associated with  them. Beginning in March 2008, national and state-chartered banks had to  submit data on revenues from credit and debit card interchange fees  quarterly reports on their condition and income (Call Reports) when such  amounts exceeded certain thresholds banking regulator cautioned that they were still reviewing the consistency  of the data provided on these forms.  r taxes   According to an economist working for the largest issuers,  . However, officials from one  Large issuers of credit cards traditionally have been among the most  profitable banking institutions. Although credit card issuers have suffered  losses in the recent economic downturn, a June 2009 Federal Reserve report points out that for large credit card banks, credit card earnings have been consistently higher than returns for all other commercial bank  activities, as shown in figure 4. shows that   Recent analysis by FDIC also shows that  credit card lending remains a profitable business for credit card issuers,  credit card lending remains a profitable business for credit card issuers,  and an FDIC official recently testified that credit card lending has been  and an FDIC official recently testified that credit card lending has been  one of the most profitable business lines for some time. However, FDIC  one of the most profitable business lines for some time.  these institutions experienced some of the highest rates of charge-offs.
Statement of Martin J. Gruenberg, Vice Chairman, Federal Deposit Insurance  Corporation. “Credit Cardholders’ Bill of Rights: Providing New Protections for  Consumers” before the Subcommittee on Financial Institutions and Consumer Credit of the  Financial Services Committee, U.S. House of Representatives. 110th Cong., 2nd sess. 2008.
FDIC Quarterly Banking Profile, second quarter 2009.
section_title: While Competition among Issuers Has Increased Benefits and Lowered Costs for Some Cardholders, Other Consumers May Be Negatively Affected by Increased Card Use
paragraphs: Some consumers have benefited from competition in the credit card  market, as those using credit cards enjoy lower fees and interest rates and  greater rewards. Benefits to cardholders vary depending on how they use  their cards; those with credit card debt accrue finance charges and may  pay additional fees. However, consumers who do not use credit cards may  be made worse off by paying higher prices for goods and services, as  merchants pass on their increasing card acceptance costs to their  customers.
subsections: section_title: Cardholders Benefit from Rewards as Credit Card Issuers Compete for Their Business
paragraphs: Although most cards in the United States are issued by the largest issuers,  consumers have a wide variety of issuers and cards to choose from.  According to the Federal Reserve, over 6,000 depository institutions issue  credit cards. These issuers range from some of the very largest financial  institutions—such as Bank of America and Citigroup—to credit unions  and community banks that range in size and can be small. While there are  estimated to be thousands of credit unions and community banks that  issue cards, the 10 largest issuers account for about 92 percent of all  outstanding credit card debt.
Given the large number of issuers and widespread use of credit cards by  consumers, issuers compete to obtain new customers and retain existing  ones. According to the Survey of Consumer Finances, in 2007, 73 percent  of U.S. families had a least one credit card. Issuers typically use mail  solicitations to market their card products—mailing 3.8 billion  solicitations in 2008—but representatives from one large issuer we spoke  with told us that they can also advertise online and at their branch  locations. Issuers target their marketing efforts depending on  cardholders’ payment and use patterns. Cardholders paying their balance  in full each month (convenience users) and high-volume card users may be  drawn to cards that offer rewards programs, while those cardholders  carrying a balance may be more likely to choose a card that offers a low  interest rate.
As competition for cardholders has intensified, issuers increasingly have  turned to rewards programs to attract and retain cardholders. As  discussed earlier, these programs are funded in part by interchange fee  revenues. According to an industry study, 71 percent of cardholders held a  rewards card in 2008. Representatives of all of the large issuers with  whom we spoke told us rewards cards represent a significant portion of  the cards they offer and are designed with incentives to increase their use  by cardholders. One issuer’s staff told us that all of their bank’s traditional  credit cards that are in active status have a rewards component and they  believe that rewards programs help them to build customer loyalty and to  retain existing cardholders. A representative of another large issuer stated  that about 51 percent of its cardholders have rewards cards, representing  about 81 percent of total volume for the issuer, and a representative of  another issuer reported that approximately 50 percent of its cards earn  points that can be redeemed for rewards or other benefits. Visa and  MasterCard also now allow issuing institutions to upgrade cardholders  with basic cards to those with rewards without reissuing the card.
Competition among issuers also can lower many cardholders’ credit card  costs. For example, issuers compete with one another by offering cards  with low interest rates. Representatives from one of the large issuers with  whom we spoke stated that they typically offer these types of benefits to  appeal to cardholders. For example, many issuers offer low temporary  rates to transfer existing card balances to a new account. In 2006, we  reported that many issuers attempted to obtain new cardholders by  offering low, even zero, introductory interest rates for limited periods.
According to an issuer representative and industry analyst we interviewed  at that time, low introductory interest rates were necessary to attract  cardholders in a competitive environment in which most consumers who  qualify for a credit card already have at least one. In addition to offering  low interest rates, issuers compete by offering cards that have no annual  fees and low fees for other actions associated with usage. These lower  rates and fees can decrease the cost of using credit cards for some  cardholders.
However, in recent months, changes in the economy and the passage of  the CARD Act have led many issuers to “reprice” their credit card accounts  by altering the rates, fees, and other terms that apply to cardholders’  cards. For example, increasing numbers of consumers have been falling  behind on their credit card payments. In the first quarter of 2009, the 30- day credit card delinquency rate reached its highest rate—6.6 percent—in  18 years. Provisions in the CARD Act—most of which will take effect in  February 2010—limit the ability of card issuers to increase the interest  rates, fees, or finance charges on outstanding balances to the conditions  set forth in the act. According to an industry publication, in anticipation  of the law taking effect, some issuers have increased the interest rates  they charge on consumer purchases as well as some of the fees associated  with card usage, such as balance transfer fees. According to Federal  Reserve data, interest rates on consumer credit card accounts have been  increasing steadily each quarter since the second quarter of 2008, when  rates were 11.88 percent. Since that time, rates have increased to 13.32  percent in the second quarter of 2009.
section_title: Increased Use of Credit Cards May Not Benefit All Consumers
paragraphs: Increased merchant costs for card transactions may lead to higher prices  for noncardholding consumers. As discussed earlier, merchants have  faced increased costs from accepting credit cards in recent years, in part  because of the increasing number of customers using credit cards and in  part because of the increase in average interchange fees, particularly from  higher-fee rewards cards. Representatives of merchants we interviewed  told us that they generally passed any increased costs—including the costs  of accepting credit cards—on to their consumers through higher retail  prices. Thus, all their customers may be paying higher prices for goods  and services, whether using a credit card or not.
Economists disagree whether the increased use of rewards cards further  increases costs for merchants. Some researchers state that the increased  use of rewards cards, which have higher interchange fees, increase costs  for merchants, as their customers switch from paying with cash, check,  and basic credit cards to using rewards cards. As a result all customers,  including cash and check users, may pay higher prices for goods and  services. In addition, some economists have stated that because rewards  cardholders do not pay for rewards cards directly, they use their rewards  cards more for transactions than if their cards included explicit costs. For  example, one study in which consumer survey data were used found that  cardholders with rewards cards were more likely to use their cards  exclusively than cardholders without rewards cards.
However, the extent to which merchants increase retail prices to account  for the costs associated with accepting cards is difficult to measure. Some  researchers argue that consumers—even those paying cash or by check— may still be better off because of widespread card use. While merchants  may pay more out of pocket to accept credit cards than they do for other  forms of payment, credit cards also provide significant benefits to  merchants, such as lower labor and processing costs and increased sales.  For example, one of these researchers has theorized that the benefits of  increased credit card use may lower merchants’ costs, which in turn  would allow them to sell their goods and services more cheaply.
section_title: Although Accepting Credit Cards Provides Benefits, Merchants Report Card Costs Are Increasing Faster and Their Ability to Negotiate or Lower These Costs Is Limited
paragraphs: Merchants can receive a wide range of benefits from accepting credit  cards, and some merchants we interviewed reported receiving increased  sales from credit cards. However, representatives of the large merchants  with whom we spoke with said that their increased payment costs had not  led to a corresponding increase in sales, particularly for cards with higher  interchange fees such as rewards cards. In addition, these merchants  reported that their ability to negotiate lower payment costs was limited by  their inability to refuse popular network cards as well as network rules for  card acceptance, which, among other things, preclude merchants from  adding surcharges for credit card payments or rejecting higher-cost cards.  Finally, although interchange fees are not regulated at the federal level in  the United States, concerns regarding card costs have prompted DOJ  investigations and private lawsuits, and authorities in more than 30  countries have taken or are considering taking actions to address such  fees and other card network practices.
subsections: section_title: Merchants Reported Benefits from Credit Card Acceptance Include Increased Sales, Faster Payments, and Lower Labor Costs
paragraphs: Merchants can receive a variety of benefits—primarily, increased sales— from accepting credit card payments. Increased sales can occur for several  reasons. First, a customer without sufficient cash can make a purchase  immediately using a credit card, resulting in a sale that the merchant  otherwise would not have made. In addition, some research has shown  that, when not paying with cash, some customers may purchase more than  they would have otherwise. These researchers say the additional  spending occurs because paying with a card can feel less like true  spending to some consumers than paying with cash. Representatives of  card networks and issuers also report that consumers with rewards cards  spend more because they factor in the price of the rewards they receive  from their issuing institution, which also results in greater sales than the  merchants would otherwise have made. One researcher noted that the  amount of additional sales merchants receive from accepting credit cards  can be greater for certain businesses. Customers more commonly use  credit cards for large purchases and for purchases that they might not be  able to pay off right away. Several of the merchants we interviewed have  seen some evidence that accepting credit cards has increased their sales.  For example, representatives from a national discount store and a small  home improvement store told us that customers paying with credit cards  spent more than customers paying with cash or debit cards. A dentist told  us that his patients spent more on procedures because of the credit that  their cards provided.
Representatives of the card networks also told us that they also are able to  increase merchant sales by providing merchants with customer  information to enhance their marketing efforts. For example,  representatives from one card network told us that they have specific staff  tasked with organizing marketing campaigns targeted to particular  merchants to increase the sales these merchants make from this network’s  cardholders. For example, if cardholders purchased particular items, their  next billing statement would include offers for additional discounts on  future purchases at specific merchants that accept their card that also sell  such items. The networks reported that through their respective  databases, they help merchants identify and better understand their  prospective, current, and lapsed customers and employ a variety of niche  marketing approaches that ultimately serve to increase sales.
Accepting credit cards also allows merchants to make sales on credit at a  generally lower cost than operating their own credit program. As noted  previously, individual merchants originally offered credit cards that could  be used only at their stores, but many such merchant programs have been  discontinued now that cards issued by third parties—banks, credit unions,  and thrifts—are available. Card network and issuer staff told us that credit  cards allow merchants to obtain sales from customers that want to finance  their purchases over time without the merchants having to incur the costs  involved with offering credit. For example, they said merchants avoid the  costs of credit losses, debt collection, credit quality assessment, card  production, and statement preparation.
Credit card acceptance benefits merchants in other ways. For example,  merchants can receive faster and more certain payment from customers  using cards than from customers using other means, such as checks.  Receiving the funds from a check can take as long as 5 days, but  merchants can receive the proceeds from card payments from their  acquiring institution in 1 or 2 calendar days. For example, the dentist we  interviewed told us that his credit card payments are credited to his bank  account the day they are processed, providing him almost immediate  access to the funds. A small flower shop owner told us that she receives  faster payments by credit card than from customers to whom she extends  credit by sending a bill. Several of the merchant and banking organizations  we interviewed also cited the certainty of credit card payments as a  benefit to merchants. For example, the home improvement merchant  noted that she preferred being paid by credit card to receiving bad checks.  Similarly, a sports club owner reported that he prefers the guaranteed  payment associated with accepting credit cards to the risks associated  with accepting checks. Staff of an association that represents credit  unions noted merchants that accept cards have less cash to handle and  less risk of employee theft. Staff from a banking association noted that  card acceptance reduces the need for merchants to make physical  deposits, since card payments are settled directly with their financial  institution. Economists have also documented the benefits of guaranteed  payments to merchants.
Card acceptance also can reduce the time merchants’ customers spend at  checkout and can reduce labor costs. For example, representatives of one  large merchant told us that their analyses indicated that processing a  check payment takes them an average of 70 seconds, processing a cash  payment averages 51 seconds, and a credit card payment 32 seconds. Staff  from card networks and card issuers told us that the efficiency of card  payments has allowed merchants to reduce their staffing, thus saving on  labor costs. For example, they noted that credit card customers at gas  stations and other retail stores often can pay for purchases without  necessarily interacting with an employee.
subsections: section_title: Large Merchants Report Rising Use of Rewards Cards Leads to Costs That Are Not Commensurate with Benefits
paragraphs: Despite the benefits of payment card acceptance, representatives of  several of the large merchants we interviewed reported that their costs of  card acceptance have increased disproportionately in comparison with  benefits, in large part because of increasing card use. Several of the large  merchants we interviewed reported that as a percentage of sales, payment  cards are more expensive to process than cash and checks, a fact they  explained reflects the technological advances in check processing as well  as a competitive market for check-processing services. They also reported  that even allowing for the operational and administrative costs associated  with processing cash (such as armored cars and losses by theft), credit  card interchange fees result in credit card payments being more expensive  for them overall. For example, staff from one large retail chain told us that  for a $100 transaction, a credit card payment generally cost the company  about 14 times as much to accept as cash. Other merchants reported that  transaction costs for credit cards were two to four times more than their  transaction costs for cash. Representatives from large national merchants  also provided us with data showing that sales made with cash and checks  have decreased in recent years, while sales made with credit cards— particularly those using high-interchange fee cards—have increased.
Although credit cards are supposed to generate increased sales for  merchants in exchange for their acceptance costs, representatives of large  merchants we interviewed told us that their card acceptance costs had  increased faster than their sales. For example, a large home improvement  retailer told us that although cards may have increased its sales in the past,  this has not been occurring recently. According to its own analysis, the  total cost the company has paid to accept MasterCard, Visa, American  Express, and Discover cards combined increased by 16 percent from 2002  through 2008; however, sales for those same cards increased by only 10  percent during this period. Representatives of this merchant also told us  that they had calculated that for every additional 1 percent their company  has paid in card acceptance fees and costs, it has received 0.63 percent in  additional sales. An official representing a large convenience store chain  said that although he believes that a decade ago people may have spent  more with credit cards than with cash or check because of the availability  of credit, he no longer thinks that is true.
Several of the large merchants that we interviewed attributed their rising  card acceptance costs to customers’ increased use of rewards cards. Staff  from these merchants all expressed concerns that the increasing use of  rewards cards was increasing merchants’ costs without providing  commensurate benefits. For example, one large merchant provided us  with data on its overall sales and its card acceptance costs. Our analysis of  these data indicated that from 2005 to June 2009, this merchant’s sales had  increased 23 percent, but its card acceptance costs rose 31 percent.  Rewards cards were presented as payment for less than 1 percent of its  total sales volume in 2005 but accounted for almost 28 percent of its sales  volume by June 2009. During this same period, sales processed on  nonrewards cards fell by 43 percent. Several of the other large merchants  we interviewed provided data that showed that the proportion of rewards  cards presented as payment by their customers also had risen significantly  in recent years. For example, representatives from one merchant said  about 70 percent of payments on one network’s cards transferred to  rewards cards over the past 5 years, representing an increase in rewards  cards use of 385 percent since rewards cards were introduced.
Further, several of the large merchants also told us that they do not always  see correspondingly increased sales from rewards cards compared with  other cards. For example, one large merchant provided us with data on its  average purchase (ticket) size by payment means. According to our  analysis of these data, in July 2005 the average ticket size for rewards  cards transactions was around $203, but the average ticket size for  nonrewards transactions was about $184—the average rewards card  purchase exceeded a nonrewards purchase by $19, or about 10 percent,  that month. However, during the 47 months from July 2005 through May  2009 for which data were available, the average ticket size for Visa  rewards cards was lower than for nonrewards Visa transactions in 9  months—or about 19 percent of the time.
Although representatives from the card networks and issuers provided us  with data indicating that rewards cardholders spent more than  nonrewards cardholders, their analysis did not demonstrate that rewards  cardholders spent more than they would have with other tender types,  producing increased sales for merchants. The largest networks and issuers  we interviewed provided data showing the total amount of spending by  their rewards cardholders exceeded that of their nonrewards cardholders.  One card network provided us with data that showed that according to its  analyses, its three levels of rewards cards had higher average ticket  amounts than its basic cards by over $4, almost $12, and over $26 for the  highest level of rewards. However, other factors suggest that attributing  increased sales to card use for merchants is difficult. For example,  rewards cards generally have been offered to higher-income cardholders.  Such cardholders might spend more than the average cardholder  generally. Thus higher total spending on rewards cards by individual  cardholders or increased ticket sizes for such cards may reflect only that  those cardholders spend more in general, and not represent additional  sales that a merchant otherwise would not have received. Similarly, higher  total spending on rewards cards compared with spending on nonrewards  cards could reflect that rewards cardholders tend to consolidate their  spending on fewer cards—sometimes onto a single card—in order to  maximize their ability to earn rewards. As a result, such cardholders may  not be spending more overall but just limiting their payment methods.  Furthermore, merchants may initiate other programs to increase sales. For  example, representatives from a large national retailer told us that when  the company started accepting credit cards, sales did increase, but they  attributed this increase to the simultaneous introduction of promotions for  their new products, and they did not feel that credit card acceptance  added any proven incremental sales volume. This spending also may not  represent additional sales to merchants. For example, some merchant  officials and others told us that cardholders can buy only so much gas;  they questioned whether cards actually increased gas station sales overall.  Similarly, payments for certain other goods or services, such as taxes or  business permits, are not likely to result in increased sales.
In addition, some of the large retailers and merchant trade associations  told us that one of the reported benefits of credit card acceptance— guaranteed payment—was not always provided to merchants. These  representatives also noted that merchants received significant amounts of  chargebacks—in which the card issuer subtracted amounts previously  credited to the merchant. Such chargebacks can occur either because of  fraud or when the customer alleges that the goods were not as described  or were never received. However, some of the merchants noted that  researching such instances to have the charged amount reinstated is a  labor-intensive process. As a result, some told us they had established  minimum amounts under which they would not attempt to research and  justify a charge. According to data provided by one large issuer,  chargebacks as a percentage of sales on one network’s cards ranged from  0.1 percent to 0.2 percent from December 2006 through June 2009.
Merchants also reported bearing costs for fraud detection and  prevention—another reported benefit of credit card acceptance. For  example, the increased prevalence of computer hacking incidents in which  criminals obtained unauthorized access to cardholder data prompted the  card industry to develop the Payment Card Industry Data Security  Standard. According to merchants, the card networks have also  mandated compliance with these standards, and merchants that fail to  meet them are subject to higher interchange fees and fines of $25,000 or  more. Although merchant officials acknowledged that such standards are  necessary, they noted that they have had to incur significant expenses to  comply with them. For example, representatives from one large merchant  told us their company spent around $20 million initially to become  compliant with these data security standards and has had to spend about  $4 million annually to maintain that certification. Officials from another  large retailer said their company also has spent millions of dollars  becoming compliant with these standards. However, they said that their  company has advocated increased data security for years, but noted that  instead of just increasing costs for merchants to secure card information,  the card networks should be developing payment types that are more  secure. For example, several merchants we interviewed noted that other  countries are moving away from cards that store sensitive data on  magnetic stripes on the cards, which can be duplicated by criminals to  create counterfeit cards, and instead are implementing cards that require  the user to enter a PIN, which merchant representatives told us is more  secure.
The small merchants we interviewed generally had mixed views about  interchange fees and the overall cost of card acceptance. Some merchants,  such as the owners of a private golf course and a flower shop,  respectively, chose not to spend as much time examining their payment  costs because the costs had remained either relatively constant or had not  risen significantly in recent years. Finally, a few merchants noted they  considered these fees as simply part of the cost of doing business.
section_title: Although Able to Negotiate to Lower Some of Their Card-Processing Costs, Merchants Reported Limited Ability to Negotiate Lower Interchange Fees
paragraphs: Increased competition for acquiring services provides merchants with  considerable choice and opportunities to negotiate and lower some of  their card acceptance costs. As noted previously, the merchant discount  fee that merchants pay to acquiring institutions has two components: the  interchange fee—which represents the bulk of the total discount fee—and  the processing costs. Hundreds of financial institutions and other firms  compete as acquirers to provide card-processing services. Staff from  merchants, issuers, and card networks told us that the acquiring market is  competitive. According to a 2007 report published by the Federal Reserve  Bank of Philadelphia, approximately 1.4 million merchants change  acquiring institutions each year. This report stated that this is the result  of the merchants seeking lower prices for acquiring services and better  services. According to acquirers and merchants we interviewed, acquirers  provide customized acquiring services based on processing volume.
Acquirers attract new merchant clients by pricing their services  competitively and offering a variety of services to meet merchants’ needs.
subsections: section_title: Merchants Reported Acquirers Competed for Their Business and Ability to Decrease Acquiring Fees
paragraphs: The competition among acquirers gives merchants the opportunity to  choose among competing acquirers and negotiate lower costs. Merchants  of varying sizes that we interviewed reported that they have multiple  acquiring institutions and processors competing for their business and  have been able to successfully decrease the acquiring fee portion of their  merchant discount fees in recent years. For example, several large  merchants told us they periodically issue requests for proposal soliciting  bids for acquiring services and receive several responses. However, some  of the largest merchants told us their choice of firms that can provide  them with adequate cost-processing services is generally limited to only  some of the largest providers of acquiring services.
Small merchants may choose among numerous firms for processing  services, including their own financial institutions. Eight of the nine small  merchants we interviewed reported getting solicitations—some  frequently—for their acquiring business or have shopped their acquiring  business. Several of the small merchants with which we spoke used third- party processors for electronic payments. Merchants formed these  business relationships with acquirers and processors through their own  research, through agreements with their financial institutions, and through  direct solicitations. Also, small merchants can find competitive providers  on the Internet; for example, a warehouse store partners with a third-party  processor to provide this service to small merchants.
section_title: Merchants Report Limited Ability to Negotiate with Networks to Lower Majority of Card Acceptance Costs
paragraphs: Although merchants have reported success in negotiating their acquiring  costs, several of the merchants we interviewed told us that their ability to  lower their interchange fee costs was limited. These merchants told us  they generally paid the rates listed in the Visa and MasterCard networks’  default interchange fee schedules. Although the ability to refuse to accept  Visa and MasterCard should provide merchants with the leverage to  negotiate lower interchange fees, merchants reported that they could not  refuse to take such cards because of customer demand. For example,  several merchants told us that if they did not accept credit cards from Visa  or MasterCard, their sales would decrease and they would lose business to  competitors that did accept those cards.
Merchants told us that without the ability to refuse to take the two largest  networks’ cards, their attempts to negotiate lower fees for these networks’  cards generally have not been successful in obtaining meaningful  reductions in their interchange fees. According to staff from Visa and  MasterCard, their networks are willing to negotiate with merchants. For  example, officials from one network told us that their network has  negotiated with merchants with sales that represent 26 percent of its  overall processing volume. Only one of the large merchants we  interviewed told us that the company had received a limited and  temporary reduction in its interchange fee costs as a result of negotiations  with Visa or MasterCard following the settlement of a lawsuit. Two of the  merchants we interviewed told us that they could receive reductions in  interchange fee rates on one network’s card if they did not accept another  network’s card. Other merchants told us that such negotiations were  difficult for their businesses, because they had limited control over which  type of credit card a customer would choose to use for a purchase.
Merchants we interviewed told us that other opportunities that Visa,  MasterCard, and their issuers offered to merchants to reduce interchange  fees generally have had limited success. For instance, merchants can  create a co-branded card. In exchange for promoting the co-branded card,  the merchant could receive compensation from the issuer or network or  reduced interchange fees. However, merchants we interviewed told us that  they have had limited success with co-branding because they had difficulty  encouraging their own customers to switch to these cards. For example,  representatives from several grocery store chains said that they have had  difficulty getting customers with six to eight credit cards in their wallet to  add an additional one for sales in their stores. They said that they would  have to offer customers rewards to compete for purchase volume with the  other cards. In addition, an owner of a convenience store chain started  offering a co-branded card in 2002. He said that his stores issued a total of  2,500 cards in 7 years although the issuing financial institution anticipated  that the convenience store would issue 10,000 cards annually; he told us  that the rebates these cards offered—a 2-percent rebate at their stores, 1  percent on purchases elsewhere—were not competitive to his customers.  Similarly, officials from a large national retailer told us that less than 1  percent of their sales were on their co-branded card. Smaller merchants  we interviewed generally did not have relationships with issuers and  networks. Representatives of issuers told us that the fact that merchants  chose to enter into co-branded relationships was evidence that merchants  receive greater sales and value from these programs.
In contrast to Visa and MasterCard, American Express and Discover  generally act as their own acquirers and negotiate directly with the  merchants accepting their cards. For example, representatives from  American Express told us they negotiate a merchant discount rate directly  with merchants for 1 to 5 year terms. While technically each merchant has  a separate contract and rate, American Express officials noted that for  many types of merchants, a standardized rate applies depending on  transaction volume, with higher-volume merchants likely to pay less. The  Discover card network conducts direct negotiations with large merchants  and sets the merchant discount rates based upon these negotiations rather  than publishing a schedule. Both the networks also use third-party  acquirers that negotiate with the smaller merchants on behalf of their  networks. As discussed previously, these networks have a lower market  share than Visa and MasterCard, so merchants have greater ability to  refuse to take such cards and a greater ability to negotiate costs and terms.  Representatives of two of the grocery store owners we interviewed said  that they had greater success in negotiating with American Express and  Discover because these networks had lower market share and were trying  to gain wider acceptance.
section_title: Merchants View Network Rules as Further Limiting Their Ability to Negotiate Payment Costs
paragraphs: Another factor that limits the leverage that merchants have to negotiate  lower interchange fees are the card network rules. Each of the major card  networks—Visa, MasterCard, American Express, and Discover—has  various card acceptance rules that limit the options that merchants have  for accepting or denying cards. These rules include the following:    No surcharges: Merchants may not impose a surcharge on consumers for  the use of credit cards or cards with higher interchange fees.
Honor all cards: Merchants are required to accept all credit cards within a  network’s brand.
No discrimination/differentiation: Merchants may not differentiate  between cards within a network or discourage the use of cards within a  network.
No minimum or maximum charges: Merchants may not impose a price  floor or price ceiling on credit card transactions.
Preferred treatment: Merchants may not direct consumers away from or to  a certain network’s cards.
Merchants, some academic researchers, and merchant representatives  argue that these rules constrain merchants’ ability to limit the costs of  credit card acceptance. For example, without the ability to surcharge for  credit cards generally, for a particular network’s cards, or for higher  interchange fee cards, merchants are unable to steer customers toward  lower-cost forms of payment or recoup some of their costs for higher-cost  cards. In addition, without the ability to influence customers’ payment  choices, merchants are unable to use their influence with the networks to  encourage them to lower interchange and other fees in general, or offer  more lower-fee cards. Merchants also told us that the rule requiring them  to accept all cards from a network means that they are forced to accept  higher-cost cards. Some of the merchants with which we spoke told us  that the inability to set minimum credit card purchase amounts meant that  they sometimes incurred card-processing costs that made some sales  uneconomical. For example, one merchant told us that when a customer  pays for a small item, such as a newspaper or a pack of gum, with a  rewards card, the costs to process the transaction could exceed profit on  the item. The rules provide cardholders with the ability to use any card at  any accepting merchant. However, cardholders may not realize that  different cards can affect merchant costs to different degrees because  merchants cannot take actions that either limit cardholders’ ability to use  certain cards or otherwise differentiate among cards.
Representatives of issuers and card networks told us that the network  rules are designed to promote the wide acceptance of their cards and  ensure that their cardholders have a positive experience with the card. For  example, they told us that the “honor all cards” rule ensures that  merchants will accept all cards from a particular network brand, which  ensures that even the cards from smaller, lesser-known issuers such as  credit unions and small banks are accepted. Issuers and card network  representatives also told us that surcharges are illegal in some states and  would diminish cardholders’ expectations for the use of their card. They  said that such prohibitions were intended to eliminate bait-and-switch  tactics, in which merchants would advertise a low price, only to increase it  at the point of sale if the customer used a credit card.
section_title: Although the United States Does Not Regulate Interchange Fees, Card Cost Concerns Have Prompted Investigations, Lawsuits, and Actions in Other Countries
paragraphs: Interchange fees are not regulated at the federal level in the United States.  The Federal Reserve, under TILA, is responsible for implementing  requirements relating to the disclosure of terms and conditions of  consumer credit, including those applicable to credit card fees. The  various depository institution regulators—Federal Reserve, OCC, FDIC,  Office of Thrift Supervision, and National Credit Union Administration— conduct examinations that can address how banks, thrifts, and credit  unions that issue credit cards are complying with the TILA card disclosure  requirements. However, Federal Reserve staff told us that because  interchange fees are paid by merchants’ financial institutions and not  directly assessed to consumers, such fees are not required to be disclosed  to consumers. Staff from some of the banking regulators told us that they  do not review the level at which interchange fees are set during their  examinations, but instead review interchange fees as a revenue source for  the institutions or the effect they may have on the financial stability of the  issuer. Additionally, through the Federal Financial Institutions  Examinations Council, the regulators also conduct annual examinations of  the card networks to ensure that these entities are adequately managing  the operational risks involved with card processing to ensure that such  operations are conducted so as to reduce the potential for them to create  financial problems for their institutions. Such examinations are done as a  part of a program to review the activities of vendors or processors that  provide services to depository institutions. Regulator staff told us that  their oversight does not involve assessing how the networks set  interchange fees.
Although no U.S. entity specifically regulates credit card interchange fees,  card networks’ practices can be subject to regulatory action by authorities  responsible for enforcing competition laws. In the United States, DOJ and  FTC have jurisdiction over credit card networks and issuers as part of  enforcing U.S. antitrust laws or the Federal Trade Commission Act. As a  result, DOJ and FTC can investigate if the imposition of interchange fees  or other network or issuer practice constitutes an anticompetitive or  unfair business practice prohibited by these laws.
The card networks’ practices, including interchange fees, have been the  subject of past and current investigations under these laws. As discussed  previously, in 1998, DOJ sued Visa and MasterCard for alleged antitrust  violations regarding, among other things, how these networks’ rules in  effect prevented issuers from issuing cards on their competitors’  networks. The court found that Visa’s and MasterCard’s “exclusionary  rules,” which prohibited member institutions from issuing cards by  Discover and American Express, were a substantial restraint on  competition in violation of the Sherman Act. Although the networks’  imposition of interchange fees was specifically not the subject of the DOJ  action, the trial court concluded that Visa and MasterCard had market  power in the market for network services, citing large market shares in a  highly concentrated market. DOJ officials reported that they currently  have another investigation under way in which they have been reviewing  whether some of the networks’ rules are anticompetitive. As discussed  earlier, these rules include those that prevent merchants from steering  customers to other forms of payment, levying surcharges for card  transactions, or discriminating against cards by type. DOJ staff told us  they have requested information from American Express, Discover,  MasterCard, and Visa as part of this investigation. They were not able to  provide an estimate for when any formal action resulting from the  investigation might occur.
Interchange fees and other card network practices also have been the  subject of private lawsuits. Since the mid-1980s, various lawsuits alleging  problems with interchange fees and other card network practices have  been litigated, as described in table 3. As of September 2009, a class  action was pending in the United States District Court for the Eastern  District of New York, in which merchants claim that interchange fees have  an anticompetitive effect that violates the federal antitrust laws. This case  is a consolidation of at least 14 separate lawsuits against Visa and  MasterCard and their member institutions that had been in four separate  districts.
While interchange fees are not regulated in the United States, as of  September 2009, more than 30 countries have acted or are considering  acting to address competition or card cost concerns involving payment  cards. Some actions taken by these countries include the following:  regulating relationships between merchants and issuers and card  networks, such as prohibiting card networks from imposing certain rules  on merchants;   establishing maximum interchange fees or capping average interchange    allowing more institutions to enter the credit card market by changing the  requirements to allow more institutions to qualify to act as issuers or  acquirers; and   conducting investigations into the functioning of the payment card market,  including legal antitrust proceedings.
For example, authorities in Australia have taken various actions regarding  credit card interchange fees and other card network practices since 2003  (see sidebar). In recent years, the European Commission has undertaken  proceedings against card networks and set caps on cross-border  interchange fees—those applying to card transactions in which a card  issued in one country is used to make a purchase in another country—that  affect transactions occurring in 31 European countries. In 2007, the New  Zealand Commerce Commission initiated proceedings against Visa and  MasterCard and issuers of their cards that alleged price-fixing in the  setting of fees. This resulted in an August 2009 settlement that included  various actions affecting Visa cards, including directing acquirers and  issuers to bilaterally negotiate interchange fees instead of having the  network set them, removing that network’s “no surcharge” rule and “no  steering” rules, and allowing nonbank organizations to participate in the  market as issuers or acquirers. Other countries are considering taking  actions. For example, in June 2009, Canada’s Standing Committee on  Banking, Trade and Commerce reported the results of an investigation into  this market, and recommended a number of actions, including permitting  merchants to surcharge and steer customers toward low-cost payment  methods, requiring merchants to disclose interchange fees to consumers,  and prohibiting card networks’ “honor all cards” rules.
section_title: Although Various Options to Lower Interchange Fees Exist, Impacts on Cardholders Could Be Mixed and Each Option Has Implementation Challenges
paragraphs: Concerns about the rising costs of card acceptance for merchants have led  to regulatory measures in some foreign jurisdictions and legislative  initiatives in the current U.S. Congress. These options generally have  involved one or more of the following approaches: (1) setting or limiting  interchange fees; (2) requiring their disclosure to consumers; (3)  prohibiting card networks from imposing rules on merchants, such as  those that limit merchants’ ability to discriminate among different types of  cards or levy a surcharge for credit cards; and (4) granting antitrust  waivers to allow merchants and issuers to voluntarily negotiate rates.  Industry participants and others cited a variety of advantages and  disadvantages associated with each option and suggested that the  categories of stakeholders—such as merchants or issuers or large  merchants versus small merchants—would be affected differently. They  also noted that, in some cases, the ultimate impact of the option was not  clear. A more detailed discussion of industry participants and others’  views on the merits of each of the options can be found in appendix II.
Each of these options is designed to lower merchants’ costs for card  acceptance. For example, setting or capping interchange fees would limit  the amount of interchange fees charged to merchants. Both RBA and the  European Commission have used this approach, and regulators in other  countries have worked with Visa and MasterCard to voluntarily reduce  their interchange rates. Requiring the disclosure of interchange fees could  lower merchants’ fees if consumers changed their behavior after seeing  the different costs associated with different forms of payment, and shifted  from higher-cost forms of payment such as rewards and other credit cards  toward less expensive forms of payment, such as debit cards. The option  to eliminate certain network rules, such as the no-discrimination or no- surcharge rule, could allow merchants to either refuse to accept higher- cost cards or receive additional revenue from the consumer to help cover  the costs of the interchange fees. For example, a study of surcharging in  the Netherlands reported that when merchants placed a surcharge on  payment cards, customers there used that form of payment less often.  The ability to take these actions could provide merchants with bargaining  power to more effectively negotiate with the card networks and issuers  over interchange fee rates, even in merchants did not exercise this ability.  Refusing to take certain cards issued by a network, such as those with  higher interchange fees, could prompt networks and issuers to reduce the  prevalence of such cards. Direct negotiation between merchants and  issuers under an antitrust waiver also could grant merchants increased  bargaining leverage in negotiating interchange fee rates and terms, with a  goal of lower costs to merchants.
If interchange fees for merchants were lowered, consumers could benefit  from lower prices for goods and services, but proving such an effect is  difficult, and consumers may face higher costs for using their cards. With  lower card acceptance costs, merchants may pass on their interchange fee  savings through lower prices to consumers; however, the extent to which  they would do so is unclear. As discussed previously, consumers—even  those paying with cash and by check—may be paying higher prices  because of merchants’ increased costs of interchange fees. By capping  interchange fees, RBA estimates that fees to merchants were lower by  about 1.1 billion Australian dollars for the period of March 2007 through  February 2008, but officials acknowledged that it would be very difficult to  provide conclusive evidence of the extent to which these savings have  resulted in lower retail prices because so many factors affect such prices  at any one time. Moreover, the degree of savings depends on whether or  not merchants are increasing their prices because of higher interchange  fee costs. Some merchant representatives we interviewed told us that  merchants would take different steps to improve customer service if  interchange fees were lowered, such as hire more employees. Customers  also may not experience lower prices if merchants’ overall costs do not  decrease. Several industry participants speculated that if merchants were  allowed to refuse higher-cost cards, merchants would lose sales from  customers using premium credit cards, who, network and issuer officials  told us, spend more than customers using basic credit cards. A study of  the Australian reforms by several economists reported that because the  actual decrease in merchant costs was very small, merchants may have  hesitated to lower prices, especially when their other costs might have  been changing.
Lowering interchange fee revenues for issuers could prompt issuers to  increase cardholder costs or curtail cardholder credit availability. In  Australia, issuers reduced rewards and raised annual fees following that  country’s interchange fee cap. In addition, with less interchange fee  income, representatives of smaller issuers such as community banks and  credit unions told us that they likely would not offer rewards cards and  therefore would be unable to compete with the larger issuers in the  market. One credit union official told us that the credit union could not  offer credit cards because of the expense involved with running such a  program. In addition, representatives of credit unions and community  banks we interviewed said that they benefited from a network system that  developed interchange rates to attract both merchants and issuers.  Allowing merchants to refuse certain cards or negotiate rates directly with  the issuers would eliminate smaller institutions from the process.  Representatives of larger issuers told us that with less revenue from  interchange fees, they would consider reducing the amount of credit they  make available to their cardholders. Australian officials reported that  since their reforms were instituted, the number of credit card accounts in  Australia has continued to increase and smaller credit unions have  remained in the credit card business, albeit with some of their operations  outsourced.
Each of these options for lowering card fee costs presents challenges for  implementation that would need to be overcome. For example, if  interchange fees were capped or limited, an oversight agency or  organization would have to be designated to determine how and to what  level such fees should be set. In addition, economists and other  researchers noted that determining an optimal level that effectively  balances the costs and benefits among the networks, issuers, merchants,  and consumers would be very difficult to do. When Australian officials set  their interchange fee cap, they did so based on their assessment of the  benefits and costs of different payment methods, but they also told us that  many years of data would be needed to determine the effectiveness of the  rate cap. If interchange fees were disclosed to consumers, issuers and  merchants said that consumers might find the additional information  confusing, and some merchants said that their cashiers might not be able  to clearly communicate the correct interchange fee for the specific  transaction. For the option that would allow merchants to discriminate  among cards and add a surcharge for more expensive credit card  transactions, merchants said that it would be difficult for them to  determine which cards carry higher interchange rates. Finally, the  proposal to allow merchants to directly negotiate with issuers raised  several issues from the industry participants we interviewed. They said  that such negotiations could harm small merchants and small issuers,  which do not have as much leverage as larger participants and, in some  cases, lack the resources to participate in bargaining sessions. In addition,  prudent exercise of this option would require an exemption from federal  antitrust laws, which include provisions designed to protect consumers  from the consequences of agreements in restraint of trade. DOJ officials  have expressed their historical opposition to efforts to create exemptions  to antitrust laws, stating that these exemptions should be used only in the  rare instances in which a public policy objective compellingly outweighed  free market values.
Although each option had advantages and disadvantages and difficulties in  implementation, removing the networks’ antisteering rules and restricting  interchange fees with a cap or other limit were the two options that  appeared to receive the most support from the large and small merchants  and merchant trade associations with which we spoke. Removing the  antisteering rules appears to have various advantages, including providing  merchants with the ability to send signals to cardholders about which  cards increase merchant acceptance costs, a change that could improve  merchants’ leverage in negotiating their payment costs. Merchants’ ability  to surcharge or refuse certain cards also could cause cardholders using  rewards cards to be more aware of and to bear more of the cost of the  rewards from which they currently benefit. This option also may require  the least intervention, as merchants could decide whether to add  surcharges or refuse certain cards based on their own customer mix. In  addition, the potentially anticompetitive effects of these rules are also the  subject of the current DOJ investigation and some of the private lawsuits.  A significant advantage of capping or limiting interchange fees would be  that it would reduce interchange fee costs most directly. The experience in  Australia indicates that this option does lower merchant costs and  Australian regulators and merchant representatives insist that consumers  have also benefited, arguing that merchants in competitive markets  generally lower prices. The main challenges to implementing this option  are determining the right level of reduction, such as capping interchange  rates at a level below that of rewards cards, and tailoring the change to  avoid unintended effects on other networks or on smaller issuers.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to the Department of Justice, the Board  of Governors of the Federal Reserve, the Federal Trade Commission, the  Federal Deposit Insurance Corporation, the National Credit Union  Administration, the Office of the Comptroller of the Currency, and the  Office of Thrift Supervision for their review and comments. Through  informal discussions, staff from DOJ, the Federal Reserve, Federal Deposit  Insurance Corporation, and the National Credit Union Administration  noted the quality of the report. Each of these agencies, as well as the  Office of the Comptroller of the Currency and the Office of Thrift  Supervision, also provided technical comments that were incorporated  where appropriate. Federal Trade Commission staff noted they had no  comments on the report.
We are sending copies of this report to interested congressional  committees and members, the Department of Justice, Federal Trade  Commission, Board of Governors of the Federal Reserve, the Office of the  Comptroller of the Currency, the Office of Thrift Supervision, the Federal  Deposit Insurance Corporation, the National Credit Union Administration,  and other interested parties. In addition, this report will be available on  our Web site at http://www.gao.gov.
If you or your staffs have any questions about this report, please contact  me at 202-512-8678 or cackleya@gao.gov. Contact points for our Office of  Congressional Relations and Office of Public Affairs can be found on the  last page of this report. GAO staff who made major contributions to this  report are listed in appendix III.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: Our objectives were to describe (1) how the fees merchants pay for  accepting credit cards have changed over time and the factors affecting  the competitiveness of the credit card market, (2) how credit card  competition has affected consumers, (3) the benefits and costs to  merchants of accepting cards and their ability to negotiate those costs, and  (4) the potential impact of various options intended to lower merchant  card fee costs.
To assess how the fees merchants pay for accepting credit cards have  changed over time, we reviewed relevant literature and analyzed available  data on interchange fee rates provided by Federal Reserve staff, a large  merchant, and a large credit card processor. To describe the factors  affecting the competitiveness of the credit card market, including how  credit card competition has affected consumers and merchants, we  summarized economic and other academic literature. Our literature review  built upon key studies to which experts we interviewed referred and  which we found by reviewing research databases such as Econlit and  through general Internet searches. In our literature review, we sought to  summarize a diverse body of literature that described various views on the  economics and policy implications of interchange fees. We also  interviewed representatives and analyzed data from the four major credit  card networks (American Express, Discover, MasterCard, and Visa) and  several banking and acquiring trade associations, the members of which  include large and small institutions that participate in the credit card  system: the American Bankers Association, the Electronic Transfer  Association, the Independent Community Bankers of America, the Credit  Union National Association, and the National Association of Federal  Credit Unions. In addition, we conducted interviews and analyzed data  from three of the largest credit card issuers as measured by total  outstanding credit card loans, as of December 31, 2007, in the Card  Industry Directory and three of the largest credit card acquirers in the  United States. We also met with representatives of several small credit  unions and community banks that issue credit cards. However, public  information on interchange fee revenue, card issuers’ costs, and other  quantitative data from card networks and issuers is limited and ongoing  litigation limited these entities’ ability to share such information with us.
To learn more about merchants’ costs for accepting credit cards, we  consulted relevant literature and interviewed and reviewed payment cost  data provided by several merchant trade associations, large national retail  merchants, and small merchants from two local Chambers of Commerce.  We met with officials from the National Retail Federation, the National  Grocers Association, the Food Marketing Institute, the National  Association of Convenience Stores, the Retail Industry Leaders  Association, and the Small Business and Entrepreneurship Council. We  met with representatives of 10 of the largest retail merchants in the United  States; 8 of these represented 42 percent of the wholesale and retail trade  industries listed in the S&P 500 in 2008, as well as one privately owned  large company and one publicly traded large company that were not listed  on the S&P 500. We selected the wholesale and retail categories because  merchants in these industries accept and receive payments from  consumers. We also selected small merchants to interview from the  Washington, D.C., and Springfield, Virginia, Chambers of Commerce.  These merchants represented a diverse group of businesses, including  boutique shops, sports clubs, and a health care professional. In addition,  we interviewed representatives of other organizations from across the  country that accept payments from consumers, including hospital owners,  utility companies, and a city government official. Although we selected  merchant representatives to provide broad representation of merchant  experiences with accepting credit cards, their responses may not be  necessarily representative of the universe of small and large merchants. As  a result, we could not generalize the results of our analysis to the entire  market for merchant experiences with accepting credit cards and paying  interchange fees. Where possible, we obtained information from card  networks about benefits to merchants.
To describe the regulation of interchange fees both in the United States  and in other countries, we met with officials from the Board of Governors  of the Federal Reserve System, the Office of the Comptroller of the  Currency, the Office of Thrift Supervision, the Federal Deposit Insurance  Corporation, and the National Credit Union Administration. We also  reviewed studies of the impact of interchange fee reforms in other  countries, and interviewed officials from the Reserve Bank of Australia on  their actions related to interchange fees because Australia was one of the  first countries to act, and sufficient time has passed to allow information  on the impact of their actions to be available. To discuss federal antitrust  activities, we interviewed officials from the Department of Justice and the  Federal Trade Commission and updated our summary of major federal  antitrust actions surrounding interchange rates from our 2008 report. Our  interviews with industry participants, academics, and regulators also  provided us with an understanding of the potential impact of various  proposals to lower interchange fees.
Quantitative information used in this report was attributed to its source  and supported by other corroborative evidence, such as industry sources,  federal regulatory data, or interviews. In some instances we were able to  do some testing of the data. We believe that these data are sufficiently  reliable for the purposes of showing general trends in the credit card  industry and merchant experiences with accepting credit card payments.
We conducted this audit in Washington, D.C., from May 2009 to November  2009, in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
section_title: Appendix II: Review of Options to Regulate Interchange Fee Rates and Terms of Credit Card Acceptance
subsections: section_title: Option 1: Limiting or Capping Interchange Fees
paragraphs: Options to address increasing costs of interchange fees include setting or  limiting interchange fees, with the intent of lowering costs for merchants  and, potentially, consumers. For example, a regulatory agency could cap  interchange fees at a single rate or an average rate or work with industry  participants—such as networks, issuers, and merchants—to decrease the  fees. Some countries have limited interchange fees using such methods.  The Reserve Bank of Australia (RBA) has set a limit under which the  weighted average of MasterCard and Visa interchange fees must fall. The  European Commission recently reached an agreement with MasterCard  that limits the average interchange fees that it can charge for cross-border  transactions (purchases made in one country using a credit card issued in  another) in the European Union. In addition, governments in other  countries, such as Mexico, have worked with industry participants to  voluntarily decrease interchange fee rates.
Merchants could realize lower costs if interchange fees were limited. As  discussed previously, many merchants are concerned that their  interchange fee-related expenses have increased significantly in recent  years. Some merchants in very competitive industries, such as retail and  gas stations, told us that because they were unable to increase prices to  cover increases in their interchange fees, their slim profit margins had  further decreased in recent years. A representative of one franchise told us  that even if interchange fees were capped at their current rates, this cap  would help ensure long-term profitability.
Furthermore, consumers might benefit if merchants passed on their  savings through lower prices. However, many industry participants  acknowledged that it would be difficult to prove a direct link between  lower interchange fees and lower consumer prices. Merchants and  representatives of merchants in the retail industry have argued that  because retail is one of the most competitive industries, retailers would  have to lower prices if their interchange fee-related costs decreased.  However, other industries may face pricing constraints. For example,  representatives of two utility companies told us that they could not change  their prices without first getting approval from their respective regulatory  bodies. Several economists have argued that the ability of merchants to  pass on their savings from lower interchange fees would depend heavily  on the respective merchants’ size and market share, as well as other  factors. While the amount of the price reduction might depend on these  factors, some studies have demonstrated that a reduction in retailer costs  in the competitive gasoline industry can lead to savings for consumers.   The Reserve Bank of Australia has estimated that savings to Australian  consumers from decreased interchange fees and other interchange  reforms likely exceeded 1.1 billion Australian dollars for the period of  March 2007 to February 2008, but officials acknowledged that it would be  very difficult to provide conclusive evidence of these savings. Others have  argued that Australian merchants have not passed savings on to  consumers, some of them citing economic literature that argues that such  a reduction in merchant costs would not affect retail prices very quickly,  even in the context of extensive competition.
In contrast, limiting interchange fees could decrease the interchange  revenues of issuers, but the impact on issuers would depend largely on the  way in which the option is implemented. For instance, if an interchange  fee cap were set at a level significantly below the current rates and applied  to all interchange fees charged, then all issuers could be affected. But a  cap also could be set at a relatively high rate, such as at the maximum rate  for standard credit cards, or certain issuers could be excluded from the  regulation. Card issuers, especially small issuers, oppose any option that  would decrease their interchange fee revenues significantly. According to  some industry participants, smaller issuers such as credit unions and  community banks rely more heavily on such revenue than large banks,  which receive more income from interest and other cardholder fees.  Representatives of a credit union association told us that revenue from  interchange fees made up over 20 percent of most credit unions’ total card  revenues. Several representatives of community banks and credit unions  told us that they likely would not be able to offer rewards cards without  the revenues they received from interchange fees, and not offering such  cards would decrease their overall ability to compete with larger banks.
In addition, many industry participants and others agreed that the costs of  card acceptance might shift from merchants to cardholders if interchange  fees were limited, card surcharges permitted, and interchange revenues  decreased. However, they did not agree on whether the shift would be  positive or negative. Some researchers have argued that such a shift would  lead to more efficient outcomes, because cardholders would pay for the  benefits—such as rewards—that they enjoyed. Or, as some economists  have noted, cardholders faced with higher costs for using their credit  cards might change their behavior by using rewards cards less frequently  and opt for alternative payment methods such as debit cards, which could  result in lower costs for merchants. Other economists have argued that  any consumer savings from lower prices would not be sufficient to offset  the negative impacts on cardholders. Representatives of issuers and card  networks we interviewed told us that this option would affect cardholders  negatively, because issuers likely would respond to their reduced  interchange fee income by increasing cardholders’ annual fees and other  user fees, decreasing the value of rewards points, and possibly increasing  interest rates and decreasing available credit. In Australia, cardholders’  benefits as a portion of spending dropped an average of 23 percent from  2003 to 2007 following the interchange fee reforms.
Moreover, a limit on interchange fees could affect merchants negatively if  this option led to decreased overall retail sales or available credit. Some  industry participants and others pointed to studies that illustrate that  consumers tend to spend more when paying with credit cards than when  using other payment methods, and that rewards cardholders spend even  more than nonrewards cardholders. If consumers shifted from using  rewards cards in response to decreased rewards and increased annual and  user fees, merchants might realize lower sales revenues overall. Issuers, if  faced with lower interchange fee revenues, could decide that some credit  card programs were too expensive to maintain and might cut credit to  cardholders, including merchants that depend on credit to finance  business expenses. For example, the results of the National Small  Business Poll indicate that about 74 percent of small businesses use  business credit cards and about 39 percent use personal credit cards for  business purposes.
If the fee limit option were chosen, a challenge for implementation would  be setting and maintaining interchange fees at a level that effectively  balanced the costs among networks, issuers, merchants, and consumers,  which economists and others agree would be very difficult to do.  Australian officials set their interchange fee limit using a cost-based  approach, which they characterized as practical and meeting legislative  requirements. They chose a cap based on the costs that issuers would  incur for authorization and processing, fraud and fraud prevention, and  funding the interest-free period; the costs of credit losses were not  included. Using such an approach would require specialized knowledge of  the benefits and costs of different payment methods, some of which may  be difficult to measure accurately. In addition, industry participants and  others do not agree on which costs should be covered by interchange fees;  some issuers and card networks have argued that the fees should cover  credit losses, but others have argued that issuers should cover credit  losses with their interest revenues. Considerable cost also could be  involved for an agency to collect and analyze extensive data from industry  participants on interchange-related costs and benefits.
section_title: Option 2: Requiring the Disclosure of Interchange Fees
paragraphs: A second option to address concerns about interchange fees would require  the disclosure of interchange fees to consumers and is intended to  increase their awareness of the fees and change their payment behavior.  The fees could be disclosed to consumers on sales receipts, on consumers’  card statements, or through generic notices that merchants would post  advising their customers about interchange fee costs. Although Visa and  MasterCard officials told us that their rules currently do not prohibit  merchants from posting their interchange fee costs, other merchants and  representatives from a large acquiring bank told us that this option is  difficult to implement because merchants are unable to ascertain  interchange fee costs until they submit payments for processing. As  discussed previously, interchange fees vary depending on the type of card  used and the method of processing used.
Disclosing interchange fees to consumers could result in lower costs to  merchants, which then could pass the savings to consumers, but only if  consumers responded to such disclosures by decreasing their use of  relatively expensive cards. Proponents contend that consumers deserve to  understand interchange expenses facing merchants because consumers  could be paying for at least a portion of these fees. If consumers shifted  from using relatively costly credit cards to less expensive forms of  payment, this would decrease interchange costs for merchants, which in  turn could lower prices for consumers. However, many of the industry  participants and others with whom we spoke predicted that most  consumers would disregard information about interchange fees.
Such disclosures could be confusing for consumers. Merchants, issuers,  and card networks expressed concern that their customers might not  understand the information and might misinterpret the fees listed on the  receipt or bank statement as an additional charge, rather than as a  component of the total price. Merchants told us that it is very difficult for  cashiers to distinguish between the numerous types of debit and credit  cards, which have varying interchange rates. Thus, it could be very  complicated for a cashier to clearly communicate to the consumer the  correct interchange fee for the specific transaction.
Additionally, whichever party is responsible for disclosing information  about interchange fees to consumers would incur the costs of updating its  technology to allow for such disclosures. For disclosure in merchant  receipts, merchants would incur the cost of changing their receipts.  Issuers have reported that changes to card statements, such as the  inclusion of additional disclosures, would generate costs for them.
section_title: Option 3: Loosening Restrictions on Merchants for Card Acceptance
paragraphs: A third option would prohibit card networks (and other entities) from  imposing rules on merchants that limit their ability to discriminate among  different types of cards, or levy a surcharge for accepting credit cards.  The broad intent of this option is to decrease the costs to merchants of  accepting cards by allowing them to steer their customers toward less  expensive forms of payment. As discussed earlier, card networks generally  impose rules on merchants that accept their cards, such as not allowing  merchants to add a surcharge or discriminate among cards issued by the  same network and prohibiting minimum purchase amounts.
For merchants, the primary benefit of removing one or more of the  restrictions for card acceptance could be lower costs. If the rule that  merchants must honor all cards from a network were relaxed, merchants  could refuse to accept cards with high interchange fees. For example,  many of the merchants we interviewed with small average purchase  amounts, such as convenience store owners, told us that they would  receive significantly more benefits from accepting cards if they could steer  consumers away from using cards with high interchange fees, especially in  cases in which the purchase amount was lower than the total merchant  discount fee. Several merchants told us that they would apply a minimum  purchase amount for credit cards if they were allowed to, while one small  merchant told us that its store already did so. If merchants could levy a  surcharge, they also could receive additional revenue to cover their  interchange fee-related costs. Although card networks allow merchants to  discount for cash purchases, as required by law, some merchants and  others have argued that the network rules and state requirements  surrounding cash discounting make the practice too complicated.  Merchants explained that currently they have to post a cash price and a  card price for each item to offer cash discounts, which could confuse or  irritate their customers, so an option that allowed merchants to add a  surcharge and refuse certain cards would be a more feasible way for  merchants to decrease their interchange fee-related costs.
This option also could improve merchants’ bargaining power with card  networks and issuers. According to some industry participants and  researchers, the only leverage that merchants currently have to control  their interchange-related expenses is to refuse to accept all of the cards of  a given network. As discussed previously, given the large market share of  Visa and MasterCard, customers expect to be able to use those cards at a  wide variety of merchants, and several of the merchants we interviewed  told us they would lose sales if they refused to accept all cards from either  of these networks. Some merchants told us that they would have a greater  ability to manage their costs with the option to surcharge for credit cards  or not accept cards with higher interchange fees.
This option also may reduce merchant costs as consumers shift away from  higher-cost forms of payment (such as rewards cards) to less expensive  forms of payment (such as debit cards). Some industry participants and  academic researchers have argued that such a shift would lead to more  efficient outcomes such as lower prices for consumers (merchants might  lower prices if interchange costs decreased). As mentioned previously, all  consumers, even those paying with cash or check, bear the cost of  merchants’ costs for card acceptance. Proponents of this option reason  that without signals about the costs of different payment mechanisms,  such as limited card acceptance, surcharges, or cash discounts, consumers  likely have overused cards with relatively high interchange fees. There is  some empirical evidence that illustrates that surcharges can change  consumers’ choice of payment method. For example, a recent study  conducted in the Netherlands, which allows surcharges, showed that  consumers there altered their behavior in response to surcharges for debit  cards. While 25 percent of consumers surveyed said that they would use  their debit cards regardless of an applied surcharge, the majority stated  that surcharges affected their choice of payment, with most using cash for  sales tickets of less than 15 euros. A survey conducted in Norway also  illustrated that consumers there were quite sensitive to consumer prices  that reflected payment costs.
However, removing merchant rules for card acceptance also could affect  cardholders, issuers, acquirers, and card networks. More specifically,  cardholders might not be able to use their cards in as many locations and  could face higher direct costs for card usage. Credit networks, issuers, and  acquirers also argued that consumer protection issues would arise  because card users would be treated differently than consumers using  other payment methods such as cash. Some industry participants and  others were concerned about the ability of merchants operating in less  competitive markets to set surcharges at a higher level than would be  needed to cover their merchant discount fees, thus resulting in a new  stream of revenue for merchants. Also, some noted that consumers  would have less choice if small issuers were forced out of the market by  reduced interchange revenues.
Additionally, if fewer consumers used cards and fewer merchants  accepted cards, the overall benefits of the credit card network could  decrease. As discussed previously, card networks can bring benefits to  both consumers and merchants, and economists have argued that the  benefits of a credit card network increase as more consumers use its cards  and more merchants accept its cards. However, some economists have  reported that the change of rules for card acceptance in Australia has not  decreased the use of credit cards significantly and that credit card use has  grown by at least 5 percent per year since 1995.
If consumers shifted from using cards with higher interchange fees,  issuers could see decreased revenues. As mentioned previously,  interchange revenues make up a larger percentage of total revenue for  small issuers than for large issuers. Representatives of some credit unions  and community banks told us that they were concerned that under this  option, merchants might discriminate against their cards. These  representatives also told us that without sufficient interchange revenues,  many credit unions and small banks likely would not be able to issue  credit cards. However, representatives of RBA have reported that  removing this network rule did not appear to have significantly decreased  the number of smaller issuers offering credit cards. They said that some  smaller institutions have found it commercially beneficial to outsource  some or all of their issuing activities to larger financial institutions or  specialist issuers. In such outsourcing arrangements, the cards still carry  the small issuer’s name but other providers provide the credit processing,  and the credit. To preserve the ability of small issuers to successfully issue  cards, some industry participants, including a large merchant, suggested  that merchants could be allowed to refuse cards on the basis of costs, but  could be prohibited from discriminating against cards on the basis of  issuer.
The extent to which merchants would take advantage of changes to  network rules on card acceptance was unclear. Many merchants of various  sizes told us that they would not apply surcharges or refuse certain cards  because they feared losing business, or because they thought that this  could slow their checkout times. In addition, some merchants told us that  they found it nearly impossible to distinguish among different types of  credit and debit cards, making it difficult for them to determine which  cards they should refuse or to which they should apply a surcharge  because of higher interchange rates. In the Netherlands and Australia,  where merchants are allowed to levy a surcharge, many merchants have  opted not to do so. In Australia, the number of merchants that apply a  surcharge for credit cards has been increasing since the practice was  allowed in 2003. However, according to a banking research firm that  collected data on behalf of the Reserve Bank of Australia, as of June 2009,  only about 18 percent of very small merchants, 20 percent of small  merchants, 26 percent of large merchants, and 34 percent of very large  merchants levied surcharges for credit cards. A study of surcharges on  debit cards in the Netherlands found that about 22 percent of merchants  added a charge for paying with a debit card (for sales below a certain  amount). The results of a national poll by the National Federation of  Independent Business indicate that 29 percent of U.S. small businesses  who accept credit card payments would apply a surcharge for card  payments if their contracts with card networks allowed, and about 13  percent currently have a minimum purchase amount for credit card sales.
section_title: Option 4: Allowing Merchants and Issuers to Directly Negotiate Interchange Fees
paragraphs: A fourth option would allow merchants to directly negotiate with card  issuers to reach an agreement on interchange fees and terms, which likely  would result in lower costs for merchants. Because collective bargaining  by commercial groups, such as groups of merchants or businesses, can  violate U.S. antitrust laws, an exemption from those laws would be  necessary to facilitate such a process. According to DOJ, the granting of  antitrust waivers in the United States can be justified only in very rare  cases, but participants in specific industries have been granted antitrust  waivers, including those in the insurance industry and agricultural  cooperatives.
According to its proponents, this option would allow merchants more  leverage with card networks and issuers in negotiating interchange rates  and terms and potentially lead to lower merchant costs. As discussed  previously, some have argued that merchants, especially small merchants,  are not able to negotiate interchange fees or terms with card networks or  issuers, partly because of the large market shares of Visa, MasterCard, and  the largest issuers. The large merchants we interviewed told us that their  negotiations with card networks have been unsuccessful because they  need to accept Visa and MasterCard cards to retain their customers and  thus have to pay whatever prices Visa and MasterCard charge. Two of the  small merchants we interviewed told us that they were unaware that such  negotiations were possible. Some merchants and others have argued that  allowing collective bargaining could result in a fairer interchange fee  system because card networks would have less ability to set different rates  for merchants based on industry type, volume of sales, and other factors;  collective bargaining could result in one rate for all merchants.
However, as mentioned previously, any option that decreases interchange  fees may have opposing effects on different stakeholders (for example,  decreased costs but decreased credit availability for merchants or lower  prices but higher fees for cardholders). If negotiations resulted in lower  interchange fees for merchants, then merchants could pass these savings  to consumers through lower prices. However, given that representatives of  issuers and card networks told us that issuers would likely respond to  decreased interchange revenues by increasing annual fees, decreasing the  value of rewards points, and possibly increasing interest rates and  decreasing available credit, cardholders could be harmed.
In addition, it could be difficult to ensure that small issuers and small  merchants benefited from collective negotiations. Representatives of small  issuers said that small issuers would not have sufficient market power to  negotiate favorable interchange fees with a group of merchants.  Furthermore, several of these representatives said they were concerned  that merchants could come to agreements with large issuers under which  the merchants would accept only the large issuers’ cards. Some merchants  with whom we spoke were skeptical about the potential for small  merchants to benefit from the collective negotiations with networks and  issuers. One small merchant told us that her store would not be able to  participate in such negotiations because of limited staff resources.
A significant legal barrier to implementing such negotiations is the need to  obtain antitrust waivers, which DOJ has argued have been justified only in  very rare instances in the United States. Credit card issuers and card  network officials expressed concerns about removing antitrust  exemptions that are designed to protect consumers from anticompetitive  practices. In addition, DOJ officials have expressed their historical  opposition to efforts to create exemptions to antitrust laws, stating that  these exemptions should be used only in the rare instances in which a  public policy objective compellingly outweighed free-market values.  Furthermore, in response to a prior proposal that would have allowed for  collective negotiations of interchange fees, DOJ officials expressed  concern about the role that their agency would play in such negotiations.
section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: Cody Goebel, Assistant Director; Michael Aksman; Jessica Bryant-Bertail;  Rudy Chatlos; Katherine Bittinger Eikel; Christine Houle; Nathan  Gottfried; Yesook Merrill; Marc Molino; Rachel Munn; Barbara Roesmann;  Paul Thompson; and C. Patrick Washington made key contributions to this  report.