Lower costs, unchanged prices: the changes to IFR
The recent changes to the Interchange Fee Regulation (IFR) have reduced the interchange rate that merchants pay on card transactions, but there is little evidence of lower prices for consumers. In fact, there are suggestions that prices might actually increase as a result. Jack Flowers examines the implications for the payment card marketplace, including the opportunities it may present to forward-thinkers.
Updates to the IFR mean it is now cheaper for merchants to process cards; however, three months after the regulatory change, there have not been any significant changes in merchant prices. Consequently, some in the industry are now questioning whether the promised customer benefits of the regulatory change are being realised.
Whenever a cardholder makes a purchase with their card, they are paying for services that are blended into the price of an item. These services are collectively known as the ‘Merchant Service Charge’ (MSC). MSC is composed of a variety of overheads, such as processing costs, terminal rental and interchange fees. The fact that these costs are all blended together and incorporated into the overall retail cost of a product means the impact of these charges on the price of an item is hidden from consumers.
The largest component of the MSC is the interchange fee. It has been estimated to account for 70% of the total. However, this may be about to change, as the total amount that banks can charge for the interchange fee has been capped. In theory, this should reduce costs for merchants, presenting them with an opportunity to reduce prices for cardholders.
What is the interchange fee?
The interchange fee is what banks charge merchants for transferring the money from a cardholder’s account into the merchant’s account. Historically, the amount charged has been set by the bank, and has been as high as 8% of the total transaction cost. The EU regulation caps the fee at 0.2% for debit cards and 0.3% for credit cards. The supporting documentation for this regulatory change argues that merchants should be able to pass on the savings, estimated to be between £480M and £700M, to their customers by lowering their prices accordingly.
The impact of the IFR on the Payment Card Industry
Despite the fact that this regulatory change came into effect in the UK in December 2015, it is not yet evident that the predicted savings are being passed on to customers. Although this might be because full compliance is not mandatory for banks and merchants until June 2016, it might also be due to the fact that the response to the IFR by card providers, banks and merchants has not been positive.
Visa and MasterCard, for example, claimed that the regulatory change would increase the amounts they have to charge banks, which would be handed down to cardholders as higher fees or reduced reward programmes.
Indeed, multiple providers, including Capital One, RBS and NatWest, have already cut their reward programmes. For many cardholders, the consequential loss in the value of their rewards is greater than any gains made through merchants reducing their fees. As a result, the potential consumer cardholder benefits have been undermined.
The Capital One Rewards Programme in the UK has been discontinued.
To make matters worse, the effects of this may be further exacerbated by the fact that several merchants have argued that the IFR may actually force them to inflate prices. This is because they need to recover the costs that would have been covered by the interchange fee.
Are cardholders being overcharged?
Overall, it would appear that cardholders are not yet seeing any significant gains from the implementation of the IFR, as only a minority of merchants have lowered their charges. The remaining majority argue that they have not yet seen savings that are significant enough to warrant lowering their prices. This implies that the fee structure for merchants continues to lack transparency. Although cardholders themselves are unlikely to be aware of these issues, they are still a cause for concern: without complete transparency, it is not possible for regulators to ascertain whether cardholders are being indirectly overcharged for the right to spend their money.
There are not many support options available to cardholders if this is the case. HM Treasury has designated the Payment Systems Regulator as the main authority for enforcing IFR. However, there is no IFR complaints authority that provides individual cardholders with support. This perhaps sends a message to cardholders that they have nothing to complain about and serves to exacerbate the extent to which customers are kept in the dark about the indirect charges they face when it comes to conducting transactions by card. As such, challenger brands have an opportunity to launch cards guaranteed to be transparent about the fees they charge their customers and the retailers they work with. This could be used as an attractive differentiator, to stand out in a crowded market, increasing competition and forcing incumbent providers to follow suit.
However, the IFR may also limit such opportunities. This is because any bank that has a market share of less than 3% will not be subjected to the interchange cap. This is to help ensure that new entrants can raise enough capital to enter the market and drive up competition. However, the fact that other providers are capped could mean that the ability of new entrants to compete with larger incumbents is actually undermined. If giants like VISA and MasterCard are forced to charge between 0.2% and 0.3% and a new entrant charges 2% to make up for their lack of scale, retailers are unlikely to be willing to support the uptake of the new card. For example, they may refuse to accept the card. The potential for this is illustrated by American Express (AMEX) cards, which some retailers refuse to accept because they have higher fees than other card providers. This could become even more pronounced in the coming months, because AMEX is exempt from compliance with the IFR.
The implementation of IFR raises difficult questions about the current and future state of the Payment Card marketplace. It is evident that IFR affects all of the parties involved with credit and debit card transactions, but does not currently offer any significant benefit to cardholders.
However, whilst cardholders have not received an immediate benefit from IFR, they could be offered better rates or additional payment options in the near future. For example, IFR provides an opportunity for providers who are willing to accept the loss in income caused by the interchange cap to attract new businesses by offering new reward programmes.
Forward-thinking card providers should capitalise on the current gap in the market for reward schemes and low interchange rates on payment cards. By educating customers on the nature of interchange fees, and how they could, unknowingly, be overcharged, an opportunity exists to be seen as a fairer and more transparent provider. Providers that exploit this opportunity could capture worthwhile market share in a part of the payment landscape that has been ignored by the card provider giants.
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