On interchange, the Liberals have the best teachers
Whether they listen and usher in a new paradigm in payments is a different story
The battle between Visa and Amazon started quietly this year. In Singapore, Amazon announced that it would apply a surcharge to any transaction involving a Visa credit card. Then came the same announcement in Australia. Then Amazon told its customers in the United Kingdom that it’s no longer accepting Visa credit cards, prompting speculation about what this portends for other geographies.
The reason for the battle? Fees. Whenever you use your credit card at the point of sale or online, the merchant needs to pay what’s called an interchange fee. According to Amazon, interchange fees “should be going down over time with technological advancements, but instead they continue to stay high or even rise.”
The Liberal government should know a thing or two about battling with the major credit card networks, but it remains to be seen. For more than a decade, associations such as the Canadian Federation of Independent Business (CFIB) and the Retail Council of Canada (RCC) haven’t been shy about asking our federal government to reduce interchange fees. And for more than a decade, the federal government has tiptoed around the problem—which is that it’s almost impossible in Canada to launch what consumers and businesses consider a viable alternative to the major credit card networks.
If the Liberal government doesn’t want to repeat the mistakes of the past, it should learn from history. And if it wants to solve the problem, it should learn from the future, which the likes of Amazon, and the financial technology companies eager to process their payments, are vying to bring about.
A history of credit card policy, or a famous definition of insanity?
Depending on whom you ask, the federal government’s track record on reducing interchange fees has been either impressive or disappointing.
In 2010, the Competition Bureau alleged Visa and Mastercard were running afoul of competition law. Melanie Aitken, then Canada’s commissioner of competition, said Visa’s and Mastercard’s rules restricted competition. The rules were driving up costs for businesses and consumers, since businesses are understood to pass along their acceptance costs to their customers. Ultimately, the Competition Bureau’s allegation didn’t hold up for reasons of legal esoterica, although the official decision notes that one could have concluded “there had been an adverse effect on competition” under certain assumptions.
The federal government also passed the Payment Card Networks Act (PCNA) in 2010, following an inquiry by the senate banking committee into the credit card payment system in Canada. The senate committee noted its belief that “the relative power of the participants in the credit card payment system is unequal,” that “something is wrong when so many merchants, big and small and from across a variety of sectors, feel that other participants in the payment system are not adequately responding to their concerns.”
The PCNA gives the federal government the power to regulate payment card networks and their “commercial practices.” The PCNA lets the federal government pass regulations to do vague things. One of the things, as circular as it sounds, is to prescribe “anything that by this Act is to be prescribed.” Nonetheless, with the substance of the law standing at no more than five pages tall, the PCNA isn’t comprehensive regulation. It is, instead, the standing threat thereof.
Naturally, the federal government has used the standing threat of regulating the major credit card networks under the PCNA more than once.
About a decade ago, the federal government got the debit and credit card networks to commit to a voluntary code. The code promotes transparency, requiring card networks to notify merchants when fees change. It also restores some power to merchants, protecting their right to cancel their contracts after rate hikes without penalty. It also protects their right to give discounts to customers who use different payment methods. It’s a lenient code, in other words, which doesn’t do anything overt to lower interchange fees.
Over the years, the federal government has also squeezed voluntary agreements out of the major credit card networks to prevent interchange fees from rising. In 2014, Visa and Mastercard agreed to cap their effective average interchange fees at 1.5 percent. In 2018, the federal government announced new agreements that were to come into effect in 2020, reducing the effective average interchange fees to 1.4 percent.
But the code and agreements haven’t made for stable equilibria. Since the pandemic moved shopping habits from physical stores to online, where the fees are higher to de-risk the virtual environment, the CFIB and RCC have called on the government to reduce interchange fees again. And sympathetic editorial boards and columnists have joined the calls. This shouldn’t come as a surprise: codes and agreements only temporarily placate merchants and their supporters because they tiptoe around the problem—which is that it’s almost impossible to launch an alternative to the major credit card networks in Canada.
In the last budget, following calls from merchant groups and their sympathizers to get involved again, the Liberals promised to consult on ways to reduce interchange fees—including by amending the PCNA to regulate interchange fees “if necessary.” The Department of Finance launched the consultation before the recent election, noting that the government would speak about its next steps in the fall economic statement, which would include amendments to the PCNA to regulate interchange fees “if necessary.” The “if necessary” is another threat to the major credit card networks and their participating banks: figure it out or else we’ll figure it out for you.
It’s possible the federal government is serious about regulating interchange fees this time around, rather than using threats to squeeze more voluntary concessions out of the major credit card networks. Even if it is, merchants will continue to be only temporarily placated.
There are few laws more ironclad than this one: shops are shoppers, too. Interchange fees, regulated or not, will never be low enough until they reach zero. Rational as the are, merchants will always look for lower prices. Their lobby groups will do the same, calling on the federal government to lower interchange fees as they’ve done again and again. Why should we expect the cycle to stop just because the government decides to legislate a cap, instead of using moral suasion to secure a voluntary cap from the major credit card networks?
A different outcome requires a different approach
If the Liberal government is more interested in good policy than performative politics, it shouldn’t epitomize the famous definition of insanity by doing the same thing and expecting a different result. Instead, it should pluck the root of the problem—which is that it’s almost impossible for the Amazons of the world, and the financial technology companies eager to process their payments, to launch an alternative to the major credit card networks. Therefore, the Liberal government should let the Amazons of the world and financial technology companies try.
It sounds like a massive undertaking, but it isn’t. There are two things the Liberal government could easily do because they’ve already started.
First, the Liberal government could intervene, as it has a mandate to do, in the mess that is payments modernization. Payments modernization has long been touted as something that will promote competition and innovation in payments. But payments modernization has been captured by Canada’s largest financial institutions, who are unwilling to accept things that will make it easier for alternative payment methods to come to market. What better evidence of capture is there than the fact that bank-dominated Payments Canada tasked bank-owned Interac with building a payment system to support alternatives to—wait for it—bank-owned Interac? The Liberal government could tell Payments Canada to build systems that would make it easier for merchants and financial technology companies to incentivize their customers to use alternative payment methods.
Second, the Liberal government could get serious about open banking and throw its weight behind the inclusion of third-party payment initiation on Canada’s open banking roadmap. With third-party payment initiation, the Amazons of the world could more credibly threaten to either handle their own payments or have a financial technology company do it for them. There are already financial technology companies around the world that deliver on this exact promise, circumventing the major credit card networks.
The Liberal government has the best teachers. History has shown that state-backed, incremental price reductions are futile. A lower cap on effective average interchange fees? Get that garbage out of here. What about a world where there is more competition in payments, where businesses, both big and small, have somewhere to go for better deals if they don’t like what the major credit card networks are offering? That’s the paradigm forward-looking companies are vying to bring about. Regardless of what the Liberal government does to reduce interchange fees, this new paradigm is on the way. In fact, Visa and Mastercard are betting on it with their recent acquisitions.
The Liberal government should also be betting on it. Canada is a paradigm taker, not a paradigm maker. The choice for the Liberal government isn’t whether to bring about the new paradigm in payments or not. It’s whether to accelerate Canada into it. The alternative is to be dragged into it, confused and kicking and screaming. That’s not a good look for anyone. Though there’s a lot to learn from the federal government’s track record on interchange fees, and from the future of payments, the best teachers are only useful if their students are paying attention.
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As a payments consultant, I have researched and reported on the massive and complex intricacies of Visa and MC interchange rates, and organized negotiation sessions with the card schemes for negotiation of merchant swipe fee rates. Given the complexities of the rates structure (rates can vary by card product, by region, by vertical, by merchant velocity, etc. as well as by card scheme promotions, market targeting and precedents), I have found that there can be a number of opportunities for swipe fee rate reductions from the card schemes. Equally important, the complexity of the swipe fee structure can result in processor misallocation of swipe fee rates to card transactions being processed, which might also result in reduced swipe fee charges for the merchant. All of the above however, is tinkering with the existing system, not changing the payments processing fees paradigm as your very interesting article discusses.
Great article and well articulated. I think you raised some interesting points but I’d love to hear your perspective on how lower interchange fees would impact all the Fintechs that rely on interchange to fund their no fee banking services?