The REAL facts about credit card interchange fee capping

A couple of articles appeared in the UK press over the weekend linked to the decision by Capital One to scrap, completely, the rewards on its cashback cards.  The Daily Mail one is here.  This has led to a number of emails from readers asking what the impact will be on their reward cards.

The honest answer is that I don’t know.  Industry analyst Andrew Seftel wrote a guest article for Head for Points back in July 2013 outlining the discussions that were going on.  The reaction of the card companies in recent months since a final decision was made by the EU implies that the world is not going to end.  Most of what you have read on this topic has been confused because it fails to understand what is actually changing and what is not.

Here are the key facts:

  • The EU is capping the interchange fee (explained below) on credit card transactions at 0.3%.  This is the % of the purchase which the card issuer keeps.
  • Debit card transactions are capped at 0.2%
  • Only Visa and MasterCard are impacted
  • American Express is NOT impacted directly.  Additionally – and this is important for our niche – Amex cards issued by MBNA, Lloyds and Barclays are not impacted until 2019.
  • The exact implementation date will not be known until the regulations are formally approved by the EU Council in the Summer.

The interchange fee is NOT the fee that most shopkeepers pay when they accept a credit card.  That fee is set by the bank they work with and includes terminal rental and various other services, plus an amount to recoup the interchange fee.  There is no obligation for banks to reduce the fees charged to shops at all.

It is worth noting that the new rate of 0.3% compares with a rate of 1.77% charged in the USA.  The current UK interchange rate is around 0.8% – here is an earlier MasterCard rate card although some of these charges have come down recently.

Credit cards

To understand the impact of a substantial cap on interchange fees, you need to understand how the industry works.  A credit card issuer such as MBNA has a number of revenue streams, primarily:

  • Interchange fees
  • Annual card fees
  • Interest payments
  • Fees for late payment (£12 cap)
  • Foreign transaction fees

Against this, you have:

  • Customer acquisition costs
  • Funding costs (shops are paid immediately, you pay your bill 4-6 weeks later – the card issuer has to borrow money to fund its working capital)
  • Servicing costs (call centres, posting statements, processing payments)
  • Bad debt costs
  • Fraud costs
  • Cost of providing rewards
  • ‘Section 75’ recharges from bankrupt retailers

On the face of it, capping interchange fees at 0.3% on credit cards is nonsensical.  For a start, the card company is giving you up to 55 days free credit.  You won’t find many people willing to lend you money for 55 days for a 0.3% return. Even the cost of posting you a statement (lets say £1) becomes uneconomical unless you have spent £333 that month.

The argument for reducing interchange fees (apart from oligopolistic ones) is primarily that rich credit card users are being subsidised by poorer customers who pay cash.  This idea seems to fail on various levels:

  • retailers pay bank fees to deposit cash, which is why cashback is so popular in supermarkets
  • retailers incur other costs to handle cash, eg sending staff out to the bank
  • credit card customers are known to spend more than cash customers because of the psychological impact of not having to hand over real cash (as well as the convenience factor of being able to make a payment if they do not have money on them)
  • accepting credit cards is not actually a legal requirement!

Australia has had a cap on interchange fees for a number of years of 0.5%.  Anecdotal evidence is that this reduced the number of reward credit cards in circulation, increased the average credit card annual fee and increased interest rates.  The EU cap is substantial lower than that, at 0.3%.  When interest rates increase, card companies will not be able to even fund the 55 days of free credit at 0.3%.

Reward credit card have another problem.  Their users are generally professionals who clear their balance every month.  With no interest fees and no late payment fees, the only attraction of reward cards to card companies is that their holders charge substantially more than average per month.

Customers like us (who don’t pay interest) are NOT the core customer of the credit card industry because we do not pay interest – and that is where the big money is made.  However, we are incremental business and – with the back office infrastructure in place – it always made sense to chase this sort of customer as well.  This may no longer be the case.

What is the way forward? 

I don’t know, which is why I avoided writing about this topic before now.  Pointless speculation doesn’t benefit anyone and I wanted to see how the card companies reacted.  Any of the following could happen:

  • Interest free periods to be reduced or potentially ended entirely
  • Credit card annual fees to become the norm rather than the exception
  • Cards to require a minimum monthly expenditure or to face a monthly fee (say, £5 fee if you don’t spend £1,000)
  • Drops in mileage earning rates
  • Pressure on Government to see Section 75 protection scrapped – you can’t seriously expect a credit card company to pay you if a retailer goes bust if they are only getting 0.3% on the sale
  • Accounts closed – or a monthly fee added – if customers refuse to accept online statements instead of paper statements
  • Customers with good credit histories to find it harder to be accepted for free credit cards, as they will generate no fee or interest income
  • Reductions in sign-up bonuses
  • Foreign exchange fees to be increased
  • Airlines forced to accept lower payments for miles
  • Card benefits to focus more on additional features such as awarding status or 2-4-1 redemption vouchers rather than mileage.  You may see a move to more ‘statement credit offers’ as offered by Amex as these are funded externally by the merchants.

What does this mean for you?

You should bear the following in mind when considering what to do next with your credit card portfolio:

Existing card reward schemes will be unaffected in the short-term, but at some point the issuer will start losing money on every purchase you make and will consider devaluing ongoing earnings. Capital One has already done this.

Think carefully about closing generous non-Amex card accounts – you probably won’t be able to open anything as generous next year.

Diversification is probably a sensible strategy. Not every issuer will be as reliant on interchange margins to sustain their business model.  Some will be slower (by years) to take rewards from existing customers even if they close the door to new clients, especially if they have already committed to spending £x million on miles.

Third-party Amex cards (e.g. issued by MBNA) have a three-year stay of execution from the EU, so shouldn’t change too much. Eventually these cards will be as unattractive to issuers as MasterCard or Visa but for now they will continue to be profitable.

Amex-issued cards are not subject to any caps. Despite this, I would still expect their rewards programmes to become less generous over a five year period.  The obvious reason is that they will have to cut the fees they charge merchants to remain competitive against MasterCard or Visa.  The less obvious reason is that they will have less competition so won’t need to try as hard.

Small business cards are not included in these new rules. Cards targeted at small businesses may be an option for the self-employed. Whilst Amex currently dominates this market, we might see Visa and MasterCard providers taking a renewed interest. They may even have very lax requirements for what they call a ‘business’ – perhaps a bit of eBay selling would count ….

The three-year ‘stay of execution’ on Amex cards issued by MBNA, Lloyds and Barclays explains why the card companies are still chasing your business.  For example, MBNA has just launched a 25,000 mile sign-up bonus for the free Etihad credit card.  This is the best sign-up bonus on a free credit card for over two years!

It does not explain why Barclaycard made a big push recently to relaunch the IHG credit cards, which only come as a Visa.  Barclaycard does have an Amex licence, however, and I expect these cards to become an Amex / Visa double-pack.

The shape of things to come …

The Lloyds Avios Rewards Amex and MasterCard package seems to be to be the ideal model for an airline or hotel credit card for 2016-2019 until the cap on Amex fees on non Amex-issued cards kicks in:

  • The cards have an annual fee
  • The cards have a good earning rate on the American Express
  • The cards have a terrible earning rate on the MasterCard – so poor that you would be crazy to use it given a choice
  • The interest rate is relatively high if you do not clear your balance

This is the way forward, I think, whether we like it or not.

If you want to know more about how interchange fees work, and the impact of capping them in Spain and Australia, this report (PDF) is worth a read.

Industry analyst Andrew Seftel – @andrewseftel – generously helped me with this article.  Andrew has also offered to help answer any questions that you post below.  All views are his own.

(Want to earn more miles and points from credit cards?  Click here to visit our ‘Credit Cards Update’ page or use the link in the menu bar at the top of the page.)

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Comments

  1. Frenske says:

    This sounds like the end of reward credit cards as we know it. I always managed to squeeze about £300 worth of rewards on £10K spend per AmEx card. No way they can provide same level in the future.

  2. The naiveity shown by the EU is staggering. Do they really think retailers, who struggle with wafer-thin margins right now, will pass these transaction cost savings onto ‘poorer’ cash-paying customers?

    • I am a retailer and I have no intention of passing any reductions in credit card fee charges on to customers. However, I will end up doing so because some one else will and I will be forced to compete.

      • Come on, it doesn’t matter what your intentions are, the only thing that matters is how elastic demand for your products is to price.

        • JQ – exactly – my intentions are irrelevant – prices will go down because other market participants will reduce their price as they have a (tiny) amount of more margin to play with

    • Andrew (@andrewseftel) says:

      Indeed. It seems to me that the EU expect that it will all shake out eventually, leaving consumers better off. To save you digging through EU reports, here’s an infographic that the EU produced about the savings they’re predicting:

      http://www.europarl.europa.eu/resources/library/images/20150309PHT32408/20150309PHT32408_original.jpg

      • Interesting info graphic! 1.5 cards per person on average? Whoops I have 8 at last count!

        So it seems that €6.8bn will be saved by retailers and consumers, with 760million payment cards so about €9 euro per payment card or 0.75 €cents per month!

        I wonder how much it’s costing the EU to implement the changes and the knock on impact to the banks?

    • It says above that the cost to the retailer may not even be reduced. Like many small operations we don’t deal with Visa/MC direct but use a gateway (in our case Worldpay). At the moment the small charity I work for loses about 4% for each Visa/MC credit card payment we take (worldpay and bank charges) – we currently apply a card fee of 4% to cover this but from October we will be absorbing this as the publicity around this change has already made customers question the current surcharge. Unclear reporting in the mainstream media is not helping lift the fog.

    • Mr Bridge says:

      I wasn’t considering voting for UKIP, maybe I should!

  3. Do you think this will affect the acceptance of credit cards in Europe?

    • Andrew (@andrewseftel) says:

      If the acquiring banks pass the savings onto merchants, then it would seem like Visa/MasterCard card acceptance should continue to march towards ubiquity, especially if new players like iZettle and Square can keep their model working post-cap. I think Amex will have a challenge sustaining their higher rates and/or level of acceptance though. It may also stifle some emerging payments platforms (like PayPal): >0.3% is a small margin to be worth disrupting.

    • RIccati says:

      By the way, yes, acceptance of proper credit cards (Amex) is woeful in Continental Europe as it is. The Netherlands are run on debit Maestro or cash. Germany is similar.

      Scandinavian countries are OK.

  4. I always thought that the majority of customers pay their card bills in full. However since interest rates are so high they will make a lot of profit from customers who don’t.

    I will keep using credit cards as long as there is some form of reward but if these stop (which they may do depending on the next 18-year economic cycle) then it’s back to cash for anything under £8, unless debit card rewards come in…

    • Mr(s) Entitled says:

      Even without rewards you still benefit from consumer protection. Hard to see why one would ever return to cash.

    • Andrew (@andrewseftel) says:

      You’re right. A study from the UK Cards Association showed that 39% of customers don’t pay off in full each month. Of course some of these may be on 0% deals.

      Customers who pay interest certainly generate more revenue, but they’re also much more likely to default. Profitability is a matter of underwriting and managing exposure. Plenty of issuers have got it wrong in the past and taken painful losses in a downturn.

    • Why? Even without rewards, I would still use a card every-time its possible to do so. Why touch dirty notes and carry those heavy coins in my pocket??

  5. Colin MacKinnon says:

    Of course, in a German EU there would be no credit cards! They don’t use CCs in Germany, it seems.

    • Lady London says:

      They do now, a lot more than they used to. Although their credit card usage is still far behind that of several other countries.

      I always remember driving long distances in Germany on a Sunday and having to ensure I had enough cash for petrol, as back in the day a lot of petrol stations didn’t take credit cards!

      • Amazon Germany still lets you pay by bank transfer! When the money turns up, they despatch the goods.

        Hamburg Airport has a permanent Amex Gold sales desk in departures though ….

  6. EvilGazebo says:

    You mean the Daily Mail output doesn’t consist entirely of REAL facts? This is new and troubling information.

    Also, great article (as usual). My instinctive, petulant reaction to the bmi Mastercard Avios earning rate cut was that I would cancel my card. It was only the counsel of this site that stopped me. And this article just reinforces why that would probably have been a really bad idea…

  7. What about those 2 year interest free cards that seem to be frequently offered, surely they will disappear as well.
    I appreciate the balance transfer fee can be 4% + which is why I never use them but there is a cost to the card provider and I know a few people who are continually shifting debt from one card to another with reasonably large balances.

    • Andrew (@andrewseftel) says:

      The balance transfer business model tends to go around on a combination of 1) customers sticking around after the 0% period 2) BT fee 3) customers breaking T&CS and losing 0% rate and 4) ‘downselling’ some applicants to a worse BT offer 5) Using the card like a regular one and not making a BT. Only the last one is affected by interchange.

      I think the death of BTs will have more to do with funding costs increasing with base rate rises. Interchange could play a part though: if annual fees become commonplace, BT cards might face competitive pressure to fall in line, making them less attractive as a debt vehicle for consumers.

  8. Mr Bridge says:

    You know how good Industry is at finding loopholes (eg zero hours contracts) to avoid regulation.
    I am sure that somehow the cash lost by reduced interchange charges would be introduced in some clever way.
    Perhaps they will charge a fee to the retailers for a smaller transaction, perhaps they will charge a fee for using the card on a Monday.

    The worst thing about accepting credit cards, if say you are hotels.com, is when a person cancels the booking they don’t get their % fee back anyway, that surely would have been a better thing for the EU to tackle.

    I seriously doubt any changes to S75, as it relates to all credit, although i am guessing this could be the argument for a legal challenge, as a if you take a store credit card they are keeping a damm lot more than 0.3%

  9. Mario Prodi says:

    I expect the use of gift cards (which avoids funding costs for the issuers) will grow – ironic as you have little protection with those things, both from theft, fraud or default.

    I presume Charge Cards avoid the cap?

    • Good question. All Amex and Diners Club cards are excluded permanently, if directly issued, but at some point it may get revisited.

      Plan B for the banks is to become a vertically integrated provided like Amex and so escape the rules. Barclays and potentially MBNA may be up for this.

  10. Is this 100% going to happen now? Is there any point in signing the petition on My Card Matters?

    • 99.9%, just requires formal EU Council sign-off (which is presumably the same as the Queen signing-off new UK laws – she doesn’t tend to put her foot down).

      • The ECJ ruled the current system is anti-competitive so they don’t have much choice but to do something like this.
        Indeed the UK Competition and Markets Authority (which took over from the OFT) may well have forced something similar anyway – they only stopped investigating because this new regulation is coming in soon.

        I also spotted this:
        “The CMA is pleased to note that MasterCard has decided: to reduce the interchange fees applicable to its ‘premium’ cards down to the level of its ‘standard’ credit card fees on or before 1 April 2015, regardless of whether the interchange fees regulation is adopted, and once the interchange fees regulation enters into force, to implement graduated reductions of its consumer credit interchange rates ahead of the caps that are laid down in the regulation taking effect”
        My guess is this is why Capital One changed their cards so quickly. I am pretty sure the high earner CO card was a MasterCard World, which charge higher interchagne rates than normal MasterCards. (This was always pretty dodgy – the retailer had no choice but to pay this higher rate, and had no way of refusing these cards like they can Amex. Well, without refusing all MasterCards)

        • Correct. If you look at that MasterCard fee chart PDF in the article, you will see that World cards have high fees. These were cut to 0.8% on 1st April.

          If you search HFP you’ll find a funny story about Tesco and its ‘World’ MasterCard. Tesco Bank decided it would be a good idea to issue one of these. However, Tesco credit card holders spend a lot of money at Tesco – which meant the retail arm was suddenly paying far higher interchange fees! The ‘World’ MasterCard was quickly closed to new customers.

          • The real story behind Tesco Bank dropping its WorldCard is actually completely different but I guess it doesn’t matter now..

  11. I had the Lloyds Avios Rewards car until last November and really miss the double miles promotion for the first 6 months. Thinking of re-applying for one but a) would they be happy to see me back? and b) would they remember that I had the promotion the first time? Or should I wait? (I have some USA college fees to pay for No.1 son so will soon be needing it…..)

  12. Why is American Express exempt from these changes? Sorry I didn’t get that bit.

    • The shop is contracting directly with Amex, with Amex paying the shop. The view seems to be that this is a private negotiation between two parties who can decide for themselves whether to take it or leave it.

      With MC and Visa, the shop contracts with an intermediary bank. The card issuer has no direct relationship to the shop and arbitrarily sets the interchange fee which the shop has no power, at all, to influence.

  13. Lady London says:

    Wonder if this will affect the new Supercard?

    On another topic, I was trying to feel sorry for the card companies in recent years while interest rates were on the way down, and cards with respectable brand names were still charging 27% – 33% APR when interest rates were heading well below 10%. I fully understand and appreciate the card companies position now but I can’t feel sorry for them and feel sure they will devise more inventive ways of making excessive profits.

    in 10 years I think the whole card and money business will be international for many more people so that will be another change coming.

  14. The big question for cobrands is how much value does the partner (hotel/ retailer/ airline) place on the cobrand as a loyalty tool; typical commercial constructs between the issuer and the partner involve the partner taking a share of the interchange and using that revenue to fund the points/ miles on the programme. When the primary source of revenue (interchange) is reduced to this extent, it places a huge revenue gap to plug. For established, large portfolios, there may be a general acceptance that you used to make £x, and you will now ake £y, but there is enought revenue to fund to break even and keep the card as a valued loyalty driver. For smaller, newer programmes, I suspect both partners and issuers will look to walk away. Most contracts will have a clause allowing either party to walk away if regulatory or industry changes push a programme into unprofitability.

  15. Very insightful article, thanks

    JB

    • Yes, as Alan states below- ‘Thanks for the article, Rob and Andrew..’.
      Worz.

  16. Interestingly I read that third party schemes with other bank issuers don’t have to be capped if the member state decides it’s not causing competition issues. So the UK won’t necessarily cap Lloyds, mbna etc. cards anyway.

  17. Thanks for the article, Rob and Andrew – interesting if somewhat depressing reading! If you want a flavour of the impact in Oz, then take a look at the Qantas site to see the fees involved! http://www.qantas.com.au/cardselector/InitialLoadAction.do A few decent offers, but mainly quite hefty annual fees.

  18. Worth noting that it is only the credit card part of loyalty schemes that is affected. DM ran the article saying that the change in earn rate for BA economy flights and the changes in price in Avios charged for flights and the halving of the earn rate for nectar members spending in Sainsburys was because of this EU regulation. Shock horror they are completely unrelated.

  19. Camille says:

    “Every time you start taking away from credit card companies they’re going to make it elsewhere,” says James Wester, a global research director at IDC specializing in payments.

    Precisely. That is from one of the quoted articles and, upon this basis, I would argue nothing much will change and miles/points/perks will continue to be offered.

    An example – my businesses has a merchant account and we have just been informed our rate for MC is reducing even further to sub 1%. However, the letter also describes a “Peace of Mind” package “free for the rest of 2015″…..effectively customer service & support which we presently enjoy ‘for free’/part of our account service, but which will by implication be chargeable 2016 onwards.

    Cant help but think nothing will change. If one revenue stream is curtailed by legislation, CC companies will simply replace it with another.

    • That service is from your merchant bank though. None of the extra will go back to the card issuer.

      The way to keep rewards cards going is to mis-sell them to people who will pay interest, at an interest rate that is usually double the rate of a market-leading low rate card. And no-one wins of that happens.