Proposed Changes to the Credit Card Interchange Standard:
A Consultation Document – July 2005
2. Background

In April 2001, the Bank designated the Bankcard, MasterCard and Visa credit card schemes as payment systems under the Payment Systems (Regulation) Act 1998. It then, in August 2002, determined a standard for interchange fees in each of these schemes.[1]

The standard requires that in each scheme the weighted-average interchange fee be no higher than a benchmark determined on the basis of a set of eligible costs specified in the standard. The eligible costs include issuers' authorisation and processing costs, fraud-related costs, and the cost of funding the interest-free period.

The initial benchmarks came into force on 30 October 2003. They are due to be recalculated no later than 30 September 2006, with the revised interchange fees taking effect from 1 November 2006.

The credit card schemes are not required to publish their benchmarks, although each scheme is required to publish all interchange fees set by the scheme. The average interchange fee is lowest in the Bankcard system and highest in the MasterCard system (see Table 1). The differences in interchange fees across the schemes reflect differences in the weighted-average eligible costs of issuers in the schemes.

Table 1: Interchange Fees, June 2005
Per cent of transaction value
Bankcard MasterCard Visa
Standard* 0.49 0.62 0.60
Electronic* 0.49 0.46 0.44

Sources: Bankcard, MasterCard and Visa websites
*The electronic rate applies to transactions where the card is swiped and the signature verified.
The standard rate applies to most other transactions, including those using manual processing
and those over the internet or telephone. MasterCard and Visa also have separate interchange
fees for commercial cards.

Recently, some participants in the credit card schemes have argued that the scheme with the highest interchange fee enjoys a competitive advantage over other schemes. In particular, they have argued that issuers have an incentive to issue cards under the scheme with the highest interchange fee, as the high fee delivers more revenue per dollar spent by cardholders.

Whether this competitive advantage exists or not depends, in part, on whether the additional revenue is offset by additional costs. Here, two types of costs are relevant: those that are scheme specific and those that are issuer specific.

One of the eligible costs included in the standard is the fees charged to issuers by the schemes. To the extent that differences in interchange fees are fully explained by differences in these scheme-specific costs, there would appear to be little incentive to issue cards in the scheme with the highest interchange fee. While issuing cards in this scheme would generate greater interchange revenue, this revenue would be offset by higher payments to the scheme.

There is, however, one qualification to this argument. A scheme with higher scheme fees, and hence a higher cost-based benchmark, may obtain a temporary advantage over other schemes by rebating the scheme fees to its issuers. Issuers would thus receive the higher interchange fee but, after the rebate, would not pay it away in higher scheme fees. While this could provide a competitive advantage to the scheme (in attracting issuers) for a period of time, the benchmark, and thus the interchange fee, would be lowered when the benchmark was recalculated (since the scheme fees net of rebates are used in determining the benchmark).

While scheme-specific costs are potentially important in understanding the competitive dynamics, they account for a relatively small share of total eligible costs. Most of the eligible costs are specific to the issuer – these include the cost of fraud and fraud mitigation as well as the cost of the interest-free period. To the extent that these costs are largely invariant to which scheme cards are issued under, there may be an incentive to issue cards under the scheme with a relatively high interchange fee.

While the Bank has access to the cost data that underlie the calculation of the benchmark, it is not at liberty to disclose the data and thus the precise reasons for the differences in interchange fees. These data, however, indicate that the differences across the schemes are not fully accounted for by differences in scheme fees. Within a scheme there is significant variation in the eligible costs reported by various issuers, partly reflecting variation across issuers in the characteristics of their cardholders. For example, an issuer with a high percentage of cardholders who pay off their balance by the due date is likely to report higher eligible costs than other issuers. If this issuer issues cards predominately in one scheme then that scheme's eligible costs will be higher, and thus so too will the benchmark. Other issuers may then be attracted to this scheme to benefit from the higher interchange fee.

Given the potential for the current arrangements to affect competition amongst the schemes, the Bank called for submissions earlier this year on whether the credit card standard should be varied so that the same cost-based benchmark applied in all the designated credit card schemes.[2]