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Rewards credit cards could soon be history

by Peter Andrew

Do you know what interchange fees (they're also called "swipe fees") are? Not many people do. But they're the cut of the value of every transaction that's taken by the processor (American Express, Discover, MasterCard or Visa) every time you use your debit or credit card. And most of what's charged, typically 2 percent or so, for a credit card swipe is passed on to your card issuer.

For many credit card users, interchange fees are a large part of what makes their financial world go round. Think about it. If you're one of those lucky (or responsible) people who don't pay either an annual fee or interest, you're getting an awful lot of services entirely for free.

Credit card use for free

You're not paying for the free loan from the transaction date until the settlement date. You're not paying for all the consumer protections your credit card gives you. You're not paying for the production or mailing either of it or the monthly statements you receive. You're not paying for the goodies your rewards credit cards give you, nor the perks your card delivers, nor the overheads of running your credit card companies.

But somebody is. Generally speaking, card issuers have just three main sources of income:

  1. Annual fees, usually paid by those who want special perks from their cards (for instance, privileges at airports) or who have too low a credit score to qualify for a card that doesn't charge such fees.
  2. Interest, paid at currently high credit card rates, by those who can't settle their accounts in full at the end of each billing cycle. You can also add into this category penalty fees paid for going over your limit or for making late payments.
  3. Interchange fees, nominally paid by merchants, but, arguably, a cost passed on to all customers in the form of higher prices. Some estimates suggest that interchange fees are costing U.S. merchants (or their customers) $50 billion a year.

The trouble today is, the first two of those three are often not delivering as much cash as they once did. Annual fees, except when they're delivering privileges that cost real money, are becoming rare. Fewer people are carrying credit card debt, with the Federal Reserve reporting in July that revolving credit balances in May were $870.2 billion, compared with over a trillion dollars in 2008. And, of course, the Credit CARD Act capped penalty fees. All this means that, even with today's high credit card interest rates, purveyors of plastic are relying increasingly on interchange fees to stay on top of costs.

Credit card companies and a perfect storm

So now for the big new threat. In mid-July, MasterCard, Visa and a number of big credit card companies offered to settle a law suit brought by retailers involving the interchange fee market. The defendants agreed to pay out about $6 billion in cash, and a further $1.2 billion in discounted swipe fees over the coming months.

More importantly for the long term, those defendants have also agreed to allow merchants to charge more to customers who opt to pay with credit cards, and/or to offer discounts to those who pay using cash, checks or debit cards. In other words, you could soon be faced with a stark choice: pay a lower price or use your credit cards.

What happens next is likely to depend on how consumers react to that offer. But if enough eschew their credit cards and turn to other payment methods, that almost inevitably should see credit card companies' revenues from interchange fees decline.

Rewards credit cards at risk

The first casualty of a squeeze on interchange fees could well turn out to be rewards credit cards' programs.

These are expensive to run. If the new rules bite, expect to see less generous offers alongside added terms and conditions that make redemptions more difficult to secure. If those new rules bite hard enough, you might also expect annual fees to become more common, and credit card interest rates to rise.

Credit card use and the wider good

Is all this bad? Some would say not. There's an argument that it's undesirable that an unemployed person, who's looking to stretch every dollar, has to pay more to put food on his or her family's table because the local store has increased all its prices to cover its merchant's interchange fees. If interchange fees really are $50 billion a year, that's an annual cost to each American man, woman and child of over $150, just to subsidize relatively rich people's rewards programs and free card use. A family of four could be $600 a year better off -- an enormous amount to those who are unemployed.

But what's going to happen if interchange fees are slashed? Who will see the benefit, the consumer or the retailer? How likely do you think it will be for retailers to pass that savings along to your family? Have your say below.

Published 08/20/12

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3 Responses to "Rewards credit cards could soon be history"
  1. Nessa Feddis August 24, 2012 at 3:34 pm

    The article makes a lot of good points. However, accepting cash -- and checks -- is costly for merchants so card users aren't necessarily subsidizing cash users. For example, cash has to be protected, while in the store and in transit to the bank. Merchants pay for employee time to count and recount cash and reconcile it with receipts. Checks also take more employee time to handle as employees wait for customers to complete check, check ID etc. Merchants also increase sales because customers aren't limited to the cash in their wallet.

  2. Bob August 23, 2012 at 5:32 pm

    Wow..another "the rich are being subsidized by the poor" arguement. Let's apply some basic math this. It is not costing $150 a year per person, it is costing $50bil a year accross all purchases, the proportion of which is borne by each person is based on the amount they spend. Therefore, that evil rich person who makes and spends 10X what the poor person makes and spends is paying 10X the burden.

  3. Nessa Feddis August 22, 2012 at 3:53 pm

    The article correctly highlights our extraordinary safe, reliable, and convenient payment system that tends to be taken for granted. However, the assumption that card users are subsidized by cash is inaccurate. Merchants incur significant costs for both cash and checks. Handling cash involves costs associated with: protecting it from loss and theft, in the store and in transit to the bank, transporting it to the bank or other safe place, using employee time for customers and employees to count it (including any change), reconciling it with sales, not being able to invest it until physically deposited. Checks also are expensive. Costs include: the cost of returned checks,(which can be significant) costs of employee time waiting for customers to manually fill out the check, checking ID, scanning the check to capture account information, and bundling and depositing the checks. Merchants also pay bank fees for processing checks (whether in electronic or paper form) Cards are faster for both the customer and merchant, and may be used at self-service machines, like gas pumps, which saves on labor costs and increases sales. Cards also instantly reconcile the sale with payment and allow transactions to be transmitted electronically --no need to protect or transport anything. Most important, customers save time, are safe from the loss or theft of their money, don't have to carry large amounts of cash around, and aren't limited to the cash in their wallet-- which can be a huge inconvenience when a person gets to the cash register with a cartful of a week's worth of groceries and insufficient cash.


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