Half a Swipe, Whole Lot of Mess: Platform Economics and the Interchange Fee Cases
Interchange-fee regulation now anchors at least three federal appellate cases. Courts will get them wrong unless they recognize a threshold fact: payment-card networks are multisided platforms.
Interchange fees are the amounts card-issuing banks withhold from a transaction before paying merchant-acquiring banks. On a $100 purchase with a 2% interchange fee, the issuing bank keeps $2 and sends $98 to the acquiring bank, which deducts its own fees and remits the rest to the merchant.
Visa and Mastercard set interchange fees to balance the platform’s two sides—merchants and consumers. Issuing banks use the revenue to cover card-program operating costs, including fraud detection and chargeoffs, and to fund cardholder services such as rewards programs and, for debit cards, the costs of maintaining checking accounts.
The Supreme Court recognized the economic logic in Ohio v. American Express:
Sometimes indirect network effects require two-sided platforms to charge one side much more than the other… The optimal price might require charging the side with more elastic demand a below-cost (or even negative) price. With credit cards, for example, networks often charge cardholders a lower fee than merchants because cardholders are more price sensitive. In fact, the network might well lose money on the cardholder side by offering rewards such as cash back, airline miles, or gift cards. The network can do this because increasing the number of cardholders increases the value of accepting the card to merchants and, thus, increases the number of merchants who accept it. Networks can then charge those merchants a fee for every transaction (typically a percentage of the purchase price). Striking the optimal balance of the prices charged on each side of the platform is essential for two-sided platforms to maximize the value of their services and to compete with their rivals. [citations omitted].
Because payment-card markets are two sided, regulating interchange fees affects far more than banks and merchants. Evidence from the Durbin amendment’s debit-card price controls illustrates the point. After the law capped interchange fees for debit cards issued by larger banks, banks cut debit rewards, sharply reduced free-checking availability, and raised minimum balances needed to avoid maintenance fees. In the wake of those changes, hundreds of thousands of consumers left the banking system. Merchants, meanwhile, passed through little—if any—of the savings as lower retail prices.