Interchange Debate Rears Its Head in Canada

The debate over the effects of interchange fees (the charges a bank levies on a merchant when one of its customers uses a credit or debit card at their store) is truly global. Since the US capped interchange fees on debit cards as part of the Dodd-Frank Act in 2010, the European Union has imposed a cap on both credit and debit fees, and Australia is poised to double down on its already stringent caps. The latest battlefield is Canada, where Walmart has fired the first shots by no longer accepting Visa cards in its Canadian stores.

As is usual, the debate is being characterized as one of rapacious banks versus suffering consumers. Walmart and its smaller allies say that they have to charge higher prices because of the fees asked by banks, and they are behind a bill in the Canadian Parliament that will give the Minister of Finance the power to cap fees. The implicit benefit is supposedly that customers will benefit from lower prices.

That rarely happens, and even when it does it is more than offset by the higher bank fees placed on consumers directly to offset the loss of revenue from interchange fees. Studies have shown that there is a significant welfare loss to consumers when interchange fees are capped. Moreover, merchants themselves often fail to see the benefit of a capped interchange fee. The Federal Reserve Bank of Richmond found that many small merchants paid more in interchange fees when they were capped in the US. In general, it is only large merchants – not consumers or small merchants – who benefit from interchange fee caps.

Moreover, capping interchange fees introduces a free rider problem into the mix. Merchants get several benefits from accepting cards that are of some value to them:

• Most obviously, more people are willing to buy from them if they accept convenient payment methods like cards
• The need to guard large amounts of cash is reduced, as is the moral hazard of theft of cash by employees
• Card networks guarantee the transaction. The consumer and merchant are both protected from fraud
• Customers tend to make larger purchases when they can use a card

In Australia’s case, the average amount of fraud per transaction already exceeds the average interchange fee, meaning that all the other benefits come free of charge. If the banks and card networks (who do not receive any of the interchange fee) fail to cover their costs, innovation and customer service will pay the price.

Walmart is, of course, entitled to refuse to accept certain cards and to try to push its own payments system. That is a business decision and is its right. However, using the law to cap interchange fees to the benefit of large merchants, especially using small convenience stores as its poster child, when experience has shown that they will suffer from those caps, is another matter. Canadian consumers should hope the Canadian bill fails to progress in Parliament.