Credit Card Companies Aren’t Charities

People who are fortunate–or clever–enough to pay their card balances on time, and in full every month have for years enjoyed free credit card use. Recently, that happy situation has become more rare, but plenty of consumers still have the privilege. Meanwhile, those who belong to credit card rewards schemes actually receive valuable benefits just for spending.

But credit card companies aren’t charities, and somebody has to be paying for their premises, staff, IT infrastructures, dividends, executive bonuses, and so on. So how–at least in good economic times–do they make money?

Two Sources of Income

The credit card industry has two principle sources of income. First, there are the fees, penalties, and interest paid by those who are less good at managing their money, or who find themselves–sometimes through no fault of their own–in financial trouble. Earlier this month, the Wall Street Journal quoted one analyst who said that, in 2009, penalty fees alone reached $22.9 billion, up from $19 billion in 2008.

The industry’s second major revenue stream comprises so-called “interchange fees” (also called “swipe fees”). Toward the end of last year, the Government Accountability Office (GAO) conducted a review of interchange fee practices. Its report found that, generally, anything between one and three percent of the total cost of every transaction is taken by the credit card industry in swipe fees.

It gives an example of a $100 transaction from which $2.20 is deducted for these fees. Of this, $1.70 ends up in the credit card issuer’s coffers, and 50 cents is kept by the “acquiring institution” (the biggest of which are Visa and MasterCard) for processing the transaction.

Credit Card Use Costs Everyone

Another Wall Street Journal piece, published yesterday, suggests that interchange fees add up. Quoting a Nilson report, it says that they amounted to $62.7 billion in 2008, up three percent from the previous year.

But, of course, the merchants who pay these fees have to recoup the costs somehow, and the only way they can do so is by increasing their prices. CBS4 reported earlier this week an example of this in action. It said:

Joel Campos, who owns a restaurant, says he tried to avoid these fees.

“We opened in 1995 and we accepted only cash because we knew that the fees from the credit card companies were high,” said Campos.

But as more customers requested to pay with plastic, Joel was forced to raise his prices.

“Once I accepted the first credit card, I put like 10% more in the prices,” explained Campos. “I prefer to have low prices for the customer than accepting credit cards.”

So everyone–not just card users, but those, including the poor, who pay cash–end up suffering. In fact, the CBS4 report went on to suggest that, in 2008, interchange fees cost every American family an average of $427.

Credit Card Regulation on Interchange Fees?

The National Association of Convenience Stores (NACS) is just one body lobbying for new credit card regulation to rein in swipe fees. It says:

NACS retail members cite credit card fees as their third largest store-level operating expense, following labor and rent. In 2008, the convenience and petroleum retailing industry reported a pre-tax profit of $5.2 billion and $8.4 billion paid in credit card fees…Since 2001, interchange fees have tripled…Interchange fees are far higher than the actual processing costs and risks involved, yet these transactions fees continue to rise.

The GAO looked at regulatory options, but concluded:

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.

So merchants and consumers may be stuck with unregulated interchange fees for a while.

Published 01/28/10 (Modified 04/23/12)