In the UK, both The Daily Mail and The Daily Telegraph have recently run articles stating that the cashback and loyalty points offered by the UK banks including Santander and Tesco Bank will be reviewed as a result of the new payment legislation, the Payment Services Directive 2 (PSD2) being introduced across Europe. Ironically this ill-thought-through legislation from Europe, prompted by the actions of Retailers and their representative organisations like the British Retail Consortium and EuroCommerce, is aimed at protecting consumers - but it will cut the profits that card issuers can earn and, in turn, bring an end to some of the perks they have until now passed on to consumers, according to Richard Sanders of the Customer Strategy Network.
Under these new EU rules to take force in October 2015, card firms will only be able to charge shops a maximum "interchange" rate of 0.3% for transactions on credit cards or 0.2% on debit cards. Is it the end of online credit card transaction fees? Probably not - but EU plans mean retailers will pay less to process payments than the 850 million a year the British Retail Consortium claim it costs to process card payments. The BRC say the Cap will see retailers pay 0.3% on credit cards opposed to the 0.9% average they currently pay.
The European Commission estimates the EU payment market is worth 112 billion and argues that the industry is 'fragmented and expensive'. This cap is a result of various competition law reviews into interchange fees by the Commission and national regulators over many years. The Commission has proposed this regulation due to concerns about:
- The possible upward pressure on interchange fees where card schemes compete to attract issuers by offering high interchange fees
- Retailers finding it difficult to refuse payment cards, or being obliged to accept all cards of a given brand as a result of the card scheme rules
Taking these concerns together, the Commission felt that competition between card payment systems can lead to increased costs of acceptance for retailers, which they pass on to all consumers (whether or not they pay by card) through higher retail prices.
However, banks warn that consumers will instead end up paying higher charges to use debit and credit cards, if the plans are approved in the form of an annual fee. For debit cards, MasterCard says consumers might have to pay an extra 11 a year. Credit cards, they say, could cost an extra 25 a year, per card, per household.
On average, debit card transactions cost the retailer less than credit cards, at about 0.2% of the bill - but as that is the level the EU has decided to cap fees, so many retailers might not see much of a saving.
The Payment Schemes Visa and MasterCard and the UK Cards Association have explained that Interchange is the fee paid by the retailer's card acceptance provider (acquirer) to the card issuer each time a card payment transaction occurs. It is an important means to:
- Balance the costs of operating a global card payment system fairly across all the users of the system - including retailers, who enjoy many benefits from card acceptance, including underpinning a secure infrastructure, guaranteed payment, fraud protection, interest free periods, provide loyalty schemes and ensure efficiency of payment.
- This interchange fee may be a unique rate that has been negotiated directly between the issuer and acquirer, or it may be a default rate called the Multi-Lateral Interchange Fee (MIF) that is set by MasterCard or Visa. Interchange fee levels also vary depending on the type of card, the type of transaction and its associated risk, and the country where the transaction takes place.
When a transaction takes place the acquirer will pay the retailer the value of that transaction after deduction of a Merchant Service Charge (MSC) that will include a number of components including interchange, processing costs, terminal rental etc. The MSC charge is negotiated directly between the acquirer and retailer.
Interchange is determined for each transaction based on the industry of the merchant, the type of card, the way the card is accepted, the transaction size, and other factors. Common examples of factors that drive interchange costs include:
- Manually entered and e-commerce transactions have higher interchange costs because without the chip or swipe data, there is a greater risk that the transaction may be fraudulent. (Address verification mitigates this risk.)
- Rewards cards have higher interchange costs to fund the reward programmes to the cardholders.
- Debit cards have lower interchange than credit cards because of the lower credit risk. (Debit card transactions are deducted directly from the cardholder's bank account.)
- Merchants with small ticket sizes can qualify for interchange rates that have lower transaction fees to reduce their costs.
- Commercial cards have higher interchange rates to fund corporate and purchasing card programmes that include rewards, spending controls and detailed reporting.
The International Card Associations regularly update their interchange programmes to promote more card issuance and acceptance after thorough cost studies have taken place. They add new interchange programmes and change rates and fees to do so. It is most common for the associations to implement changes in April and October each year, but changes may also occur at other times. Fees charged to retailers for credit card transactions can vary from 0.1% to 2.5%.
Retailers have welcomed the PSD 2 proposal to cap 'excessive and anti-competitive' card processing fees and say customers will benefit from lower prices in the shops. The BRC said it had been campaigning for a decade to cap the 'unjustifiably high' fees, which are absorbed into retailers' costs.
Helen Dickinson, director general at BRC, said: 'We're delighted with this landmark proposal. Capping these excessive and anti-competitive fees will support the UK retail industry by 362 million a year, boosting the industry's ability to invest and innovate while continuing to deliver lower prices and value for customers.'
But Javier Perez, president of MasterCard Europe has retaliated by saying 'While we support the Commission's goals, we are concerned that some of the legislative proposals that are proposed to be introduced such as the caps on interchange fees and restrictions on the honour-all- cards rule do not support these goals and will actually harm and inconvenience consumers and small merchants and hinder competition and innovation in the European payments landscape.
Fee-free credit cards, cashback payouts and interest-free borrowing will therefore be getting harder to come by. Capital One is the latest company to cut perks so that customers will no longer be able to earn 0.5% cashback on spending. It told customers: "Changes in our industry mean it is no longer sustainable for us to offer cashback on your card. This is because the fees we receive when you use your card are reducing."
It follows cuts made by Avios (previously known as Air Miles in the UK) and Sainsbury's Bank with more banks expected to follow suit.
"Generous introductory rates and cashback offers will be under heavy scrutiny and will probably be cut back in the future," said Jens Baumgarten, who advises British banks for the firm. Card providers are now looking for ways to tap into other sources of revenue, for example increasing APR charges for borrowers, said Mr Baumgarten. "As much as they would like to offset the interchange cuts, the solution for many banks will be to cut card offers," he said.
Bizarrely American Express, as it is a three-party and not a traditional four-party model for card payments, has no plan to scrap its 5% cashback cards as a result of the cap to in-shop fees. This is because the firm negotiates its price directly with shops and isn't covered by the interchange fees legislation, at least in the short term.
Mike Atkin Chairman of the Customer Strategy Network an Alliance of Loyalty Providers gave the following view for loyalty schemes:
- "Programmes operating exclusively on credit or debit cards (e.g. Banks, M&S, House of Fraser etc.) are not, in my opinion, loyalty programmes but are just Reward programmes. If customers have to take out a specific card to be considered 'loyal' then this, not only excludes many customers (who buy in store using other credit/debit cards) but also makes them 'invisible' to be tracked and to receive offers! For example, if my wife spends 50 a month in M&S using her Nat West card she is not considered a loyal customer by M&S and she will certainly not receive any offers from M&S even though she may be a valuable customer."
- "I expect these changes to see a reduction in the funding rate given by the banks for their programmes, although some are less than 1% any way and are certainly not influencing Member behaviour! Therefore the so called 'double-dipping' will change to, perhaps 1% from the programme operator but much less from the card provider. Cobranded cards will certainly be affected although when cardholders revolve their credit balance they may be able to improve the offer."
- "Card programmes in the US (the most common programmes) would certainly be affected should the changes apply there and there would have to be a rethink of the interchange fees paid to Apple Pay as part of their launch deal."
- "In South Africa the most popular programmes are where the banks totally fund the points (the retailers make no contribution at all) and these will certainly not survive although they do rely on a very low redemption rate anyway."
- "In summary, we do not think there will be much of an impact to large single brand programmes in Supermarkets nor to Coalition schemes in Europe e.g. Nectar, Payback etc."
The bottom line
In return for very little consumer benefit, the Regulation as currently drafted poses major risks. In particular, it will cause disruption to the UK card payments market, which accounts for more than �1.9tn per year across the EU, and which facilitates almost all of consumers' online spending.
The proposal is not backed by evidence or cost studies, unlike the rates set by Visa and MasterCard. The proposed caps are arbitrary and the impacts have not been properly assessed by any of the major markets affected all of which have very different card usage. The proposal is also unnecessary in the light of recent undertakings by Visa and MasterCard to limit interchange fees across the EU. It is likely to provide an uneven playing field as some of the measures proposed under the PSD 2 proposed to promote competition may actually deter it and cause some existing smaller players to exit or cut back their presence in the cards market because they can no longer afford the innovations they have put in place.
Interchange fees are critical to the success of card payments, ensuring a fair funding balance in the card eco-system and playing a critical role in motivating all participants to keep electronic payments secure, reliable and convenient.
Also, Interchange fees are not paid directly by consumers - they are inter-banks fees that are for the acceptance of card based transactions and passed on to retailers as their contribution to the maintenance of the card payment system. If retailers stop making a fair contribution to card payments then consumers will be left to pick up a disproportionate share of these costs. This shift in costs directly onto consumers through interest or charges will create an additional burden on the most vulnerable consumers who can least afford it.
Consumers will not benefit from reduced retail prices. If the full reduction proposed in interchange fees were passed on by retailers then consumers would save a mere 5p on a typical 48 transaction. However, evidence from jurisdictions where similar regulations have been passed shows that retailers tend not to pass any cost savings at all on to consumers.
This is not just an industry view. Consumer bodies in the UK have publicly warned that "the Commission's proposals will result in less competition in the market, thereby punishing both 'savvy shoppers' and more vulnerable consumers through restricting access to credit, limiting its flexibility and increasing its cost.
So what is the reality? When an interchange cap was introduced in Australia the post- implementation analysis showed that retailers did not pass the savings on to the consumer. However, there was a double whammy because the loyalty points per dollar spent were reduced and some fees either introduced or increased. This is clearly not what the European Regulators are trying to achieve. Marion King previously President of MasterCard argued the damage from regulation is already visible elsewhere, stating that these changes will have little or no effect on retail prices, where acquirers opt to pass on the changes in retail MSC charges it will be the retailer that will benefit in seeing his cost of processing payments by card reduce, in the case majority of cases the consumer will see no benefit what so ever.
An example would be where interchange fees have been capped in Australia, America and Spain. The merchants do pay less, but that saving is not passed on to the consumer,' she says. 'Meanwhile, the issuing banks have less income coming through and they are then forced to charge the consumer for using that card. The intention of the regulator has been to better balance the fees the merchant pays, but it's ended up with the consumer paying more.
So the upshot of the interchange caps is a significant reduction in costs to be realised by merchants, with no guarantee that these benefits will be passed onto the consumer. Other market developments demonstrate this. Reduction in interchange and loss of revenue to card issuers begs the following questions, where and how will issuers make up at least some of the difference/shortfall - from the customer? What will happen to innovation? Is there sufficient bandwidth in these rates to incentivise security and innovation best practices? As acquirers are increasingly more transparent and interchange becomes a lower figure as a value, will it not just highlight their own inefficiencies by exposing acquirer processing costs? Is it true that only large merchants understand the ramifications of interchange reductions, therefore smaller merchants will continue to subsidise? It is worth noting that as it stands today, Visa debit rates in the UK are temporarily higher than previously, before they are reduced again
This is a bad move for consumers. Card issuers are losing a large chunk of their income. How can they provide the security and innovation needed and provide other benefits to their cardholders? Acquirers will pass the lower rates on to the large merchants but they will not reduce their prices, as in many countries much of this is still paid by cash. So will merchants reduce prices if they have gained 0.5% in lower costs? Not a hope... also there is no such thing as a 3 party model only a 4 party model where one party plays 2 roles. So Diners and Amex with traditionally the highest MSC get to keep it all when the issuing banks that are members of MasterCard and Visa suffer. Visa and MasterCard will make or lose nothing from this at all - just their members.
Cutting interchange rates is not going to benefit consumers in any manner. As stated above, the processors often charge blended rates, linked to their highest costs for such as Amex and non-EU cards, at least to SME merchants, so the main beneficiary is the processor. In any event, the merchants are not going to hand on the improvement to consumers unless they see some real advantage in doing so in terms of extra sales.
That will mean the issuing banks will increase other fees to consumers, as seen in Australia when this cut in interchange happened, so the impact is going to be negative for the consumer overall. (As with many EU initiatives, there is little external advice sought, but decisions made on what sounds good politically.)
There is, however, real change in the air on the payment front, with the big marketing companies (Apple, Google, Facebook etc.) all identifying the data value of completed transactions being far higher making it justifiable, indeed profitable, for them to cut processing fees to zero in order to get the data.
Of course, they would want to encourage the underlying settlement to be by bank transfer, as managed by PayPal, rather than paying the card association fees, no matter how low they become. So, expect more on that score, along with greater Mobile Network Organisation (MNO) interaction. But, one way or the other, the consumer will get to have much better value - and service - from the users of the data.
Finally, the Regulators have taken no notice of the Apple Pay model introduced in the US where the Banks have foregone some interchange fees that are paid to Apple.
"In the new capped interchange environment they do not have this flexibility and will Apple want to enter the European markets if there reward is less? How good is this for the consumer if mobile commerce stalls. Not surprisingly there is no comment from the Regulators on this," concluded Sanders.