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Credit card networks, such as MasterCard and Visa, play a prominent role in the U.S. payments system. They link merchants that accept credit cards with the banks that issue them. When a credit card transaction is initiated, it is by way of the network that the transaction is authorized, processed, and ultimately settled.
Over the past few years, credit card networks have come under increased scrutiny from regulators, legislators, and merchants worldwide. One concern of regulators and payment system participants is the level and determination of a fee that credit card networks levy each time a consumer uses a credit card to buy goods and services from a merchant. This fee, commonly referred to as the "interchange," is typically calculated as a percentage of the transaction's value. This fee is paid by the acquirer, the merchant’s financial institution, to the card issuer and comprises a significant source of issuer revenue. A second concern is merchants’ ability to impose surcharges on credit card purchases. Some observers have argued that such rules prevent merchants from using price as a signal to encourage use of less expensive instruments. A third concern is the competition among payment instruments. Incentives such as frequent-use awards for credit card purchases may distort incentives for consumers to use less expensive payment instruments. Furthermore, the recently settled merchant case against MasterCard and Visa, often referred to as the Wal-Mart case, questioned honor-all-cards rules that require merchants that accept a network’s branded credit cards to also accept its branded debit cards.
In the European Commission and Australia, government officials and central bankers have recently negotiated or mandated a formula for calculating credit card networks to lower interchange rates. In Australia, merchants are allowed to surcharge card-paying customers. Australia joins the Netherlands, Sweden, and the United Kingdom in allowing merchants to impose surcharges on credit card transactions. These policymakers argue that the collective setting of interchange fees coupled with two networks comprising the bulk of credit card transactions has resulted in interchange rates that are too high.
On February 28, 2003, Sujit Chakravorti of the Emerging Payments and Policy Department at the Federal Reserve Bank of Chicago led a workshop discussion on recent scrutiny of credit card networks around the world. Specifically, he focused on credit card network competition and the efficacy of other countries' efforts to regulate interchange rates. The presentation was based on Chakravorti's research for a forthcoming paper titled "Theory of Credit Card Networks: A Survey of the Literature." This paper was published in the Review of Network Economics Volume 2, Issue 2, June 2003.
During the workshop, Chakravorti reviewed recent academic research on credit card networks. He explained the key assumptions that underlie the models presented in these papers and highlighted the challenges in fully capturing the complexities of these network relationships. He also discussed the arguments on both sides of the interchange debate and the economic implications of particular regulatory strategies. Ultimately, Chakravorti concluded, while existing models provide significant insight into the setting of fees and network rules, policymakers need to determine their own market conditions before implementing regulatory actions.