February 21, 2024 ☼ Payments
Imagine you don’t own a credit card and shop for $100 of groceries using a debit card. The supermarket pays a $1 interchange fee to payment networks like Visa or Amex, reducing its revenue to $99. This fee is split between the network and banks to cover processing costs.
Now consider a premium rewards cardholder making the same $100 purchase. The payment network provides $2 in rewards points, so it charges the supermarket $3 in interchange fees, leaving them with $97. To offset this loss, the supermarket raises prices, making the $100 purchase cost $102. The debit card user pays the full $102, while the rewards cardholder effectively pays $100 after receiving points.
Scale this, consider the 2X, 3X, 5X rewards on plush services like airlines, gas and streaming services and you see how reward points are made possible through higher interchange fees, leading to price increases paid for by lower-income consumers.
Should card rewards therefore be banned?
I’m skeptical of regulation. Even well-meaning regulations often have unintended consequences. Markets tend to self-correct. For example, interchange regulations in the EU, Australia, and Canada haven’t significantly reduced prices. Instead, banks offset losses by raising other fees, like annual or foreign transaction fees.
A better approach may lie in pricing transparency. Card companies could provide detailed billing statements showing fee breakdowns. Consumers would learn how much of their spending reaches merchants versus intermediaries.
Over time, this awareness could encourage merchants to disclose interchange fees separately, rather than embedding them in prices. Uniform card holds exceeding the sale price could offer a temporary solution until fees are calculated and shared with consumers.
Premium cardholders would see how much their rewards cost compared to other payment methods. Informed, they could weigh rewards against extra costs.
The result would maintain current pricing mechanisms while eliminating the regressive redistribution of costs. Rewards points would become more market-optimal, fair, and ethical.