The proliferation of payment cards has dramatically changed the ways consumers shop and merchants sell goods and services. Today, payment cards are indispensable in most advanced economies. Some merchants have started to accept only card payments for safety and convenience reasons. For example, American Airlines began accepting only payment cards for in-flight purchases on all its domestic routes since June 1, 2009. Also, many quick service restaurants and coffee shops now accept payment cards to capture greater sales and increase transaction speed. Wider acceptance and usage of payment cards suggest that a growing number of consumers and merchants prefer payment cards to cash and checks.
Greater usage of cards has increased the value of payment network operators, such as Visa, Inc., MasterCard Worldwide, Discover Financial Services, and others. In 2008, Visa had the largest initial public offering (IPO) of equity, valued at close to $18 billion, in U.S. history (Benner, 2008). Some industry observers have suggested that the high profitability of payment card providers has increased scrutiny by public authorities in many jurisdictions.
Partly in response to the scrutiny of these markets, economists constructed theoretical models to determine optimal fee structures for payment card markets. To date, there is still little consensus—either among policymakers or economic theorists—on what constitutes an efficient fee structure for card-based payments. In this article, Chakravorti summarizes several types of externalities that are present in payment networks and identifies key extensions to the first generation payment card models. In addition, he discusses the impact of some market interventions.
There are several conclusions that he draws from the academic models, recent interventions in payment card markets, and ongoing discussions about potential policy interventions. First, some economic models suggest that the socially optimal interchange fee structure may not be systematically lower than the network profit-maximizing fee. Second, removing merchant pricing restrictions generally improve market price signals. Third, merchant or network competition may result in lower social welfare contrary to generally accepted economic principles. Fourth, if warranted, fees set by the authorities should not only consider costs but also benefits received by consumers and merchants, such as convenience, security, and access to credit that may result in greater sales.
Finally, the motivation for why public authorities intervene differs across jurisdictions. The type of public institution that regulates payment cards also differs. The institution may be an antitrust authority, a central bank, or a court. Often public authorities intervene because the interchange fee is set by a group of competitors and the level of the fee is deemed to be excessive. In other cases, by mandating fee ceilings, authorities expect greater number of merchants to accept payment cards. Finally, some policymakers argue that lowering card issuers’ interchange revenue may reduce incentives to cardholders to use more costly payment cards (for example, credit cards instead of debit cards).
The article is structured as follows. In the next section, he discusses externalities in payment card markets in the context of theoretical models. He also explore two less researched areas of payment networks—fraud and incentives to innovate. In section 3, he investigates market interventions and whether public authorities met their objectives. In section 4, he offers some concluding remarks.