Battlefield: Interchange

Card lenders poised for escalating opposition from merchants, Congress

WASHINGTON -- Visa Inc., MasterCard Inc. and JPMorgan Chase & Co., already squeezed by new U.S. curbs on how credit cards are marketed to consumers, are girding for a renewed battle over $48 billion in fees levied on merchants, reported Bloomberg. Lawmakers are promising new rules to bring down the interchange fee, a charge on purchases sometimes topping 3% that is split by the two banks serving the customer and merchant. Supporters of the legislation include the biggest retail chains, as well as restaurants and convenience stores, which say the fees erode profit and inflate [image-nocss] prices.

The debate pits the largest card lenders including JPMorgan and the two biggest payment networks, Visa and MasterCard, against Wal-Mart Stores Inc. and Target Corp. Interchange is the second-biggest cost after payroll, Target said, and merchants want to negotiate lower payments collectively without running afoul of antitrust law.

"The real question is whether the government is going to jump in and get into the game of price control in the free market," Chris McWilton, MasterCard's U.S. markets president, told investors at a June 4 conference. San Francisco-based Visa said June 5 the legislation would raise consumer costs and cut rewards. A similar bill failed last year, the firm said.

The limits would be added to rules signed into law on May 22 by President Barack Obama that curtailed consumer fees and interest-rate increases, which card issuers and analysts said will crimp profit.

Lower earnings may derail the rally for shares of card companies including Visa, New York City-based American Express Co. and Purchase, N.Y.-based MasterCard. Each gained 14% or more this year through yesterday. JPMorgan, ranked first among card lenders last year by American Banker, added 6.25%. Retailers are grappling with an annualized sales drop of 9.6% because of the recession.

The Credit Card Fair Fee Act (click here for details) would let merchants bargain together on interchange rates and designates the Department of Justice as arbiter. Card networks and lenders would be forced to disclose components of the fee and how banks share the money.

House Judiciary Committee Chairman John Conyers (D-Mich.) introduced the bill June 4. Senator Richard Durbin (D-Ill.) followed on June 10. During a hearing a day earlier, Durbin complained to Treasury Secretary Timothy Geithner that U.S. agencies paid $200 million of interchange fees in fiscal 2007 and could not negotiate better terms.

Interchange accounted for 19% of revenue last year for card-issuing banks on the Visa and MasterCard networks, according to trade magazine Cards & Payments. The networks handled about 89% of worldwide purchases on general- purpose payment cards, according to the Nilson Report, an industry newsletter in Carpinteria, Calif.

Visa's and MasterCard's dominance allows them to "set these fees on a take-it-or-leave-it basis," said J. Craig Shearman, spokesperson for the Washington-based National Retail Federation. Shearman said interchange fees associated with the Visa and MasterCard networks tripled from about $16 billion in 2001 to $48 billion last year.

Ken Clayton, senior vice president for card policy at the American Bankers Association in Washington, said merchants want the benefits of electronic payments with none of the cost or risk. "Stores get enormous value," Clayton said. "They don't have to worry about fraud, and consumers buy more. The entity on the hook is the bank."

In a typical transaction, the retailer's bank deducts 1.9% from proceeds of the purchase, a sum known as the merchant discount rate. The largest portionthe interchange feegoes to the bank that issued the card. The bank for the merchant keeps what is left. Interchange fees average 1.7% of the purchase, according to JPMorgan analyst Tien-tsin Huang.

Visa and MasterCard get paid a processing fee from each bank of 15 to 18 cents on a $100 purchase, Huang said in a June 5 report. MasterCard and Visa process about 58 billion transactions annually, company filings show.

Visa told investors this month issuers use interchange to cover the growing cost of defaults. Moody's Investors Service said May 27 the industry average for bad loans will breach 10% in the months ahead.

The merchant discount at American Express averages 2.56% and doesn't have an interchange component, said spokesperson Christine Elliott. The legislation would have a "significant impact" on AmEx, which derived 49% of 2008 revenue from the merchant discount rate, Elliott said. "It's kind of unprecedented to give one industry that kind of negotiating leverage over their business partners," she said.

JPMorgan, Bank of America Corp. and Citigroup Inc., last year's biggest bank card lenders, do not detail interchange revenue. Betty Riess, spokesperson for Charlotte, N.C.-based Bank of America, and Matthew Towson at Riverwoods, Ill.-based Discover Financial Services, declined comment to Bloomberg.

JPMorgan and Citigroup, both based in New York, referred inquiries to the Electronic Payments Coalition. "Merchants don't want to pay their share of the interchange system and they want consumers to pay it instead," said Trish Wexler, spokesperson for the Washington-based group.

Wal-Mart's John Simley said the Bentonville, Ark.-based company, the biggest U.S. retailer, backs the legislation and referred queries to the Food Marketing Institute (FMI), which represents 1,500 companies. "In every other aspect, merchants have the ability to negotiate and reduce their costs except this one," said Jennifer Hatcher, spokesperson for the Arlington, Va.-based group.

Target lacks leverage because it's "simply not realistic" to stop accepting cards, said Eric Hausman, a spokesperson for the Minneapolis-based chain. "This is a significant issue for Target, as interchange fees are the second-highest company cost, only exceeded by payroll," he said.

Shawn Miles, group head of global public policy for MasterCard, said he is urging Congress to wait until the Government Accountability Office (GAO) conducts a study of interchange mandated by the law Obama signed.

Representative Bill Shuster (R-Pa.), co-sponsoring Conyers' bill, focused on interchange last year as gasoline prices soared and gas station owners complained the fees eroded profit. A station owner might have a gross profit of $1.50 on a $30 purchase, according to the Alexandria, Va.-based National Association of Convenience Stores (NACS). About a third of that income could go to interchange fees if customers use a Gold MasterCard, based on the firm's rate schedule, which runs more than 100 pages.