Picture of Christopher A. Hopkins, CFA

Christopher A. Hopkins, CFA

Is Congress coming for your credit card rewards?

If Neil Simon had instead written a play called “The Odd Quartet”, he might have cast 4 US Senators currently engaged in a curious coalition seeking to limit credit card processing fees. After failing to reach a vote last year, the Credit Card Competition Act (CCCA) has been reintroduced by Progressive Senators Dick Durbin (D, IL) and Peter Welsh (D, VT) joined by Populist Senators Roger Marshall (R, KS) and J. D. Vance (R, OH). The ostensible aim of the bill is to benefit consumers by reducing fees charged to merchants for accepting credit cards and hoping that merchants will pass along the savings. The result could instead be more bank fees and fewer rewards.

The stakes are high, and the issue has sparked a lobbying war between big box retailers and consumer advocates on the one side versus banks, payment processors, and frequent fliers on the other. Both sides have employed rhetorical excesses, but if the measure passes it will almost certainly impact cash refund and travel reward programs relied upon by banks to gain market share and by cardholders to fund their dream vacation to Maui. To cut through the noise, it is helpful to consider how credit cards work and how the CCCA might impact their cost.

A credit card purchase is simply a short-term loan from the bank issuing the card, but the process is complex with multiple players. Cards sporting logos of the Visa or Mastercard networks are issued by a commercial bank under a license agreement with the network. Any purchase made by the cardholder represents a loan extended by the issuing bank that is interest-free if repaid promptly. Discover and American Express issue their own cards and act as the lender and the network, more about which later.

When a customer presents the card to complete a purchase, a highly choreographed process begins entirely out of the cardholder’s view. The purchase information is captured and transmitted to an intermediary called a payment processor. The processor forwards the information to the credit card network (Visa or Mastercard), which validates card details and then sends a payment authorization request to the issuing bank.

The issuing bank then approves (or declines) the purchase and sends the answer back down same chain, all in real time, and the customer then leaves with a new pair of shoes or awaits the Ring doorbell notification.

Now it’s time for the merchant to get paid. Transactions are transmitted each day by the processor through the network to banks whose cards were charged that day. The issuing bank sends payment to the merchant’s bank (called the “acquiring bank”) less the fees charged by the network, issuing bank, and payment processor. The merchant’s bank deducts its own cut, and then deposits the remainder into the merchant’s account, typically 97 or 98 cents per dollar of sales.

These various “swipe fees” are paid by the seller and passed on to the consumer. By far the largest chunk of the swipe fee is called an “interchange fee,” the cut paid to the issuing bank but set by the card networks. The CCCA hopes to reduce this interchange fee and, at least theoretically, prompt retailers to pass along the savings to customers.

Mastercard and Visa control around 80% of all card transactions, creating an effective duopoly that keeps costs high. American Express and Discover issue their own cards and own their own card networks but command a small portion of the market for clearing. A smattering of smaller networks currently comprise a tiny additional share.

The CCCA would require issuing banks to offer merchants one alternative clearing network in addition to Visa or Mastercard, presumably producing a reduction in interchange fees through competition. The question of how much consumers might benefit remains an open one, particularly if they face increased bank fees and loss of valuable reward options to maintain bank profits.

Notwithstanding the question of whether government should intervene in private markets, prior experience suggests the greatest benefit would accrue not to consumers but to retailers. The Federal Reserve Bank of Richmond reviewed the 2010 law limiting similar fees on debit cards and found that in the two years following the cap, 98% of merchants either raised prices or held them steady, while less than 2% reduced them. Furthermore, account fees and service charges increased, and banks pared back other perks like free checking to recover the lost revenue.

In addition to raising fees if the CCCA passes, it is likely that issuing banks will be examine their costly rewards programs and potentially reduce eligibility and reward levels to protect profit margins. Here again 2010 is instructive: virtually all debit card rewards programs were axed in the wake of debit fee price controls.

It should also be noted that fat profit margins serve as a magnet for new entrants and disruptive technologies, and nowhere is this truer than in financial technology or “fintech.”. Alternative payment utilities like digital wallets, buy-now-pay-later plans, and the potential for cryptocurrency settlement are expanding rapidly and threaten to upset the status quo long before and more efficiently than federal intervention. Retailers are also free to add surcharges for credit or offer discounts for cash, although most have chosen not to do so.

Meanwhile, customers continue to vote with their plastic and toast their rewards on the beach in Curacao.

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