Published in the Globe and Mail on October 20, 2014
By Mati Dubrovinsky
Mati Dubrovinsky is a senior policy analyst at the C.D. Howe Institute.
A few days ago, The Globe and Mail reported that, following up on a spring 2014 federal budget commitment, the Department of Finance is holding negotiations with the two major credit card companies, Visa and MasterCard, as well as major banks issuing them. The goal is to achieve a commitment, or an outright regulation if that fails, to cap the fees credit card companies charge merchants.
When a consumer swipes, taps, or enters a PIN for a credit card transaction, the merchant pays for the service. If a consumer paid $100 for a purchase, the merchant typically will receive slightly less than $98. The two-dollar charge covers fees for credit card network use, verification and anti-fraud measures. Currently, merchants are not allowed to surcharge credit card purchases – that is, they may not charge a customer an extra fee for using a credit card.
As the common argument goes, credit card companies collect these fees so they can encourage consumers to use cards more, through cash-back, air miles, or similar programs. Of course, this squeezes merchants’ margins, and may raise prices for all consumers – not just the ones paying with credit cards, but also debit card and cash users.
Economic research has shown that while the no-surcharge rule does raise some concerns of anti-competitive behaviour by card companies, over all it might be beneficial. Credit card transactions offer value to both consumers and merchants, because they substantially reduce merchants’ expenses for handling cash, limit theft, and provide convenience for shoppers. It may in fact be optimal for the merchants to bear the bulk of the costs.
Since every credit card transaction implies a higher cost of the product for the merchant, product prices are likely higher than they would be without the credit card fees.
How much higher are they? Probably not much. At the extreme, many commentators imagine that prices rise one-to-one with fees. This is highly unlikely. Even if the transactions for a merchant were all credit card based, raising the price by the full fee is likely to reduce demand too much, or create room for competitors to undercut the merchant, so the merchant must absorb some of the fee. Most merchants also have significant numbers of debit card, cheque and cash transactions over which to spread the cost of those fees. Australia has had experience with explicit regulation that allows merchants to surcharge credit card transactions. A significant variety of surcharges developed, causing confusion for consumers as to the final price, with some surcharges significantly exceeding the fees merchants pay. This required even further regulation.
Canada is currently examining the option of capping merchant fees, either voluntarily or through regulation. If this process is effective, and the fees indeed fall, the credit card business will become less profitable. Lower profits would imply lower incentives to invest in innovation, meaning Canadians could fall behind as new payments technologies become available every day in the form of mobile wallets, online payments, and e-currencies such as bitcoin, to name a few.
Concerns over market power, however, must be addressed. The best way is through introducing more competition. Players such as PayPal, the much anticipated launch of Apple Pay, and even newer technologies that are just around the corner, are potentially strong competitors.
To realize the full potential of the Canadian market, however, these new players need a better integration into our payments system. The Department of Finance, instead of negotiating credit card fees, should pursue an agenda of facilitating the entry of new innovators into Canadian retail payments.
This requires keeping systemic risk low and protecting consumers. Although we may not think much about how our payments system works, we and federal policy makers should.
