Economics 101 tells us that competition leads to price reduction, but this isn't the case in the credit card market. The credit card companies have no direct relationship with either consumers or merchants. Instead, they compete only for the business of financial institutions, which they do by offering high returns to issuers using other people's money. This is a complete reversal of the normal effects of competition. The harder they compete, the higher the fees.
The best way to look at how Visa and MasterCard set their interchange fees is to think of it not as competition but as an auction, paid with money extracted from merchants and, ultimately, consumers. The quote on slide 9 from Dr. Philip Lowe, Assistant Governor of the Reserve Bank of Australia, says it all:
[C]ompetition between these schemes creates upward--not downward--pressure on these fees. A scheme with a higher interchange fee paid to issuers is able to pay larger subsidies to cardholders.
There is no better way to explain why the market has been flooded with premium cards that carry higher interchange fees.
Over the past 18 months, merchants in this captive environment have seen double-digit increases, as seen on slide 9. By way of example, one of our discount retailers, which sells some basic grocery items and a mix of other necessities, has experienced fee increases in excess of 30%. These increases are coming at the worst economic moment, when retailers are lowering their margins and cutting their costs just to survive.
Think about it. In a tough economy, most businesses sharpen their pencils, cut costs, and cut prices in order to boost sales. Similarly, governments are acting to provide stimulus, such as Ottawa's two GST reductions and interest rate cuts by the Bank of Canada. Only the commercial banks and the credit card companies are going the other way, actually raising fees and adding new charges in the midst of a recession. And who pays? Obviously it isn't the banks and the credit card companies. They are the beneficiaries. The people who pay are the businesses and consumers who are actually making the sales and purchases.