University of Melbourne

Credit Card Interchange Fees, No-surcharge Rules and Neutrality

Email address: s.king@ecomfac.unimelb.edu.au

Abstract:
There has been considerable public debate over the effect of bank interchange fees on credit card transactions. Regulators in Australia and Europe have argued that these fees can be set by banks to have an anticompetitive effect. In the US, it has been argued that these fees, together with a rule that prevents a surcharge for credit purchases, might create a cross subsidy between cash and credit customers. Academic authors have noted that, in particular circumstances, interchange fees have no real effects in the absence of such a no-surcharge rule. This paper considers two aspects of credit card interchange fees. First, it provides a general neutrality result. We show that in the absence of a no surcharge rule, interchange fees can never have any real effects. This result does not depend on the degree or nature of competition at either the bank or the merchant level. Second, we consider the potential for a bank with market power to manipulate interchange fees in the presence of a no-surcharge rule in order to raise bank profits. We show that such cross subsidisation is not profitable if there is adequate competition from 'cash only' merchants. We then consider the special case of a single imperfectly-competitive merchant that accepts credit cards and provide both necessary and sufficient conditions on demand and the merchant's profit function for such manipulation to be feasible.

PDF file of paper: king_stephen.pdf

Session: Economics of Payment Systems

Time: Friday, 6 July, 3:30pm - 5:30pm

Room: A