Canada’s credit card market is headed for some upheaval. With Finance Minister Joe Oliver asking Visa and MasterCard to “voluntarily” reduce interchange rates, or face the risk of regulation, Canadians can expect significant changes to their credit cards.
Here’s a brief primer on interchange. Interchange is a fee MasterCard and Visa set, which is charged to merchants each time a credit card on one of the respective networks is used to make a purchase. The entire interchange fee is captured as revenue by the bank that issues the credit card being used. The issuing bank then pays Visa or MasterCard a fee. Currently interchange rates in Canada average somewhere around 1.55%. However, interchange can be as low as 1.21% to as high as 2.65%. When merchants argue that they are being charged 4% in fees, that is because their merchant processor is charging them a fee on top of the interchange rate – a merchant processing fee, set by the merchant processor (i.e. Moneris, Global Payments, Chase Paymentech).
So what’s the implication of Visa and MasterCard reducing interchange by 20-40 bps? Think about it this way. Of the 2.65% interchange a bank receives from purchases made on a MasterCard World Elite card, some give back as much as 2% in rewards to the cardholder. If interchange is reduced to 2.25% on the World Elite credit cards, cardholders will see banks reduce the value of their rewards earnings from 2% to 1.6%.
The question is, who then keeps the .4% savings?
1. The banks certainly lose it, but they will make a corresponding reduction in the value of rewards programs and increase fees to maintain profits.
2. Retailers will be the first to get their hands on the .4%. The question is will they pocket the change, reduce prices or use it to fund their own loyalty programs. We imagine we’ll see different retailer behavior along the spectrum.
3. Consumers will most certainly see a degradation of many of their favorite credit card rewards programs. That said, depending on retail behavior, consumers may see a corresponding decrease in prices or increase in retail loyalty programs such as Shoppers Optimum, SaveOnMore, or Metro et Mois. With a reduction in interchange revenue, banks will also likely increase fees to shore up profitability.
There is precedence that could help us predict how the market will behave, based on what took place when other markets such as Europe and Australia regulated interchange.
When interchange fees were regulated in Australia in 2003, data has shown that retailers saved $2.2b, none of which was passed on to consumers. In fact, cardholder fees and interest rates rose by an average of $25, as banks attempted to recapture the $2.4b in lost revenues they experienced. Looking at data provided by CRA International, one can see that retailer won, banks lost (but recaptured some of their losses in increased fees) and, consumers lost.
It is our view that the Government of Canada should not regulate industry to benefit one party at the expense of another. If merchant acquiring costs are high, Government should encourage competition and innovation. There are tons of alternatives to Visa and MasterCard out there, whether it be American Express, Discover, Interac, cash, checks, paypal, money transfers and mobile payments. Literally thousands of start-ups world wide are trying to offer alternatives. The fact is, retailers go where the customers go, and customers prefer Visa and MasterCard in increasing numbers.
Rather, we believe the Government of Canada should encourage more competition among Canadian banks, and allow Canada to become a proving ground for many emerging payment technologies by fast tracking regulatory approvals, and facilitating proof of concept trials. Only competition will give the balance the market is looking for.