Thursday, July 16, 2009

The battle over Credit Card fees begins to heat up...

The New York Times has an article today on the brewing battle between Retailers and Credit Card issuers.

Card Fees Pit Retailers Against Banks --

At issue are the fees paid by retailers on every single credit card transaction they process. Some folks don't realize it, but when you pay for an item with a credit card, the retailer is making 2%-3% less then they would if you paid with cash or a check. Retailers would like to have this rate reduced, while issuing banks are adamant that the fees should not go down.

The Times appears to be approaching this story from the Retailer's perspective, and in doing so, glosses over the reasons credit cards exist in their current form.

Yes, banks make significant fees from processing these transactions, these fees help provide the incentive for these firms to continue to offer consumer credit, and along with their interest income, offset the risks inherent in the business.

But the banks aren't the only ones who benefit --retailers benefit too.

Imagine for a moment, a world without bank issued credit cards... Retailers would have to accept far more cash tranactions. Additionally, in order to increase sales, they would likely develop independent credit facilities -- i.e. store credit accounts -- and accept a large number of checks.

Sound familiar? That pretty much describes the world before Credit Cards. Granted, it was a simpler time, but what about the drawbacks?

Retailers had far more physical cash on hand. More cash on hand sounds like a good thing, but in reality, it forced more banking transactions, required more on-site cash management, and significantly increased security needs -- all at additional cost to the retailer.

Issuing store credit sounds great, but it moves all default risk to the retailer. It doesn't take many defaults to start adding up to a lot of money. It also requires retailers to have active credit departments -- with all the inherent staffing costs that entails.

Accepting more checks, also increases the number of banking transactions, and puts the retailer at risk of accepting checks that bounce.

These issues are a large part of what drove the market for modern credit cards, with banks taking on these risks.

The question really comes down to this -- do those potentially increased costs total up to more than 2%-3% of each CC sale. They sure did -- that is why we have seen an explosion in CC acceptance over the past 30 years.

See a brief history of credit cards (according to Wikipedia).

Whether those rates are still appropriate, or have become too high is a market discussion, and one in which the government should play no part. If the rates are too high, and the costs to retailers is too much for the market to bear, then the market will resolve the issue independently. Among the options:

1) Retailers start to discourage CC use, and the CC issuers, seeing a decline in business reduce their fees to an equilibrium rate.

2) Seeing an opportunity created by the high processing fees, a new player enters the market with competitive rates and the market reacts.

3) Retailers develop their own Credit processing network and compete directly with issuers.

I am sure that readers can think of many more.

The government's only role should be making sure that they are not interfering with the market's response to this issue. New competitors should be allowed to enter the market and earn the same regulatory acceptance that current players now enjoy, without undue bureaucratic hurdles placed in their way.