Will credit cards shed their baggage? If so, will there be anything left?

Recently, Canada’s Finance Minister Joe Oliver mentioned that the government wants to work with banks and credit card companies to

Recently, Canada’s Finance Minister Joe Oliver mentioned that the government wants to work with banks and credit card companies to lower transaction fees to retailers on a voluntary basis.

This has drawn concern from investors in Canada’s big banks. The banks have been raking it in, particularly after the 2008 financial crisis as they emerged virtually unscathed. Their share prices have been climbing continuously. They’re still offering fat dividends as they set new earnings records each quarter.

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The credit card processing fees, or interchange fees, contribute a sizeable portion of their earnings. These fees effectively form their own revenue stream and their effects trickle through the economy.

A credit card today, especially in North America, is no longer just a credit card. It now has multiple functions, each putting bread on the table for another stakeholder:

– For many of us, it’s most useful as payment card, no different than debit and more convenient than cash.

– Taking it one step further, it’s slightly more lucrative than debit, even for those paying off their balance in full every month. If you’re earning interest on your savings, that’s an extra 30 days, on average, of interest. For those living off a line of credit, that’s 30 days, on average, of (lower cost) interest saved.

– For those breaking even with their expenses, it can provide a 30 day interest-free buffer zone to get your next paycheque before expenses are due.

– It can be used as a very expensive way of borrowing money if a balance is carried beyond the due date or if cash is advanced.

– If using a card which has some arrangement with a retailer, that retailer will reward loyal customers with cash back, discounts on store merchandise or other prizes. There are also rewards companies with plans offering similar perks, indirectly through their relationships with retailers and credit card companies.

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– Just by owning your credit card, you can be entitled to free travel insurance, collision damage waivers, tax returns and other perks.

– Chargebacks: Credit card issuers also act as dispute arbitrators. Depending on the jurisdiction, the customer usually has the upper hand and retailers usually have to write off a portion of their revenues.

Who pays for all this? The entities offering perks/rewards are compensated by the banks/credit card companies, who in turn charge the retailers, who in turn…. charge the consumer by baking in these fees into prices, consciously or otherwise. The customer is effectively buying “perks” through this mini-economy, except that it’s via a series of middlemen also getting a piece of the pie.

In Canada, interchange fees are in the neighborhood of 1.5-4%. For businesses operating on low profit margins, they are felt tangibly. The question becomes: can’t at least one emerge with a competitive edge by charging less when credit is not used? Presumably, a sizeable segment of customers would forego their perks and go for it.

Indeed, one of the greatest low-tech success stories of the past decade has been the Dollar Store industry, which has evolved beyond just selling things for a dollar. It has flourished into a multi-billion dollar industry, with companies posting record earnings every quarter. In Canada, you generally cannot pay by credit at such stores, which operate on margins on the scale of pennies to the dollar. They have thus become highly competitive, even without (fully) leveraging economies of scale.

The concept of offering lower pricing when paying without credit has been tried in the past but failed. Reasons have ranged from legal to optical in nature, but the bubble is still there.

Since there is little threat of an imminent revolution throughout the ecosystem, there is also the element of rate fixing by credit card companies. In Canada, the Competition Tribunal dismissed complaints from the Competition Bureau over rules imposed by Visa and MasterCard. In the US, the two card companies were charged by Target and Amazon for rate fixing.

Chargebacks are also becoming more costly. PayPal recently sent out a notice that effective October 8, chargeback fees will increase. The amount of the increase varies by currency. For USD, the fee will go up to $20 from $10. The increases are indicative of the rising costs and resource-intensity of the dispute resolution process. Although other means may not be any more economical, on average, it does raise the question of how much consumers are willing to pay if given a choice.

The prevailing philosophy inspired by payment systems such as Bitcoin may be exerting pressure for change. The question remains: what would credit cards have to offer if they moved in the direction of becoming lean, mean payment machines? The only revenue stream left is that of high interest.

If the bubble ever does deflate, the credit card of tomorrow may be more like the one of yesterday.

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