Merchants have been complaining for years about the cost of interchange fees and unnecessary profits the banks are earning.  Interchange fees are not regulated by the federal government, which in turn provides Visa, MasterCard and the issuing banks the right to raise fees for any reason.  Merchants and advocate groups claim that capping interchange fees would lower merchant costs and help prevent – or limit – bank profits from unnecessary fees.  For example, credit card companies and the banks that sponsor gas credit cards collect as much as 8 cents per gallon for interchange fees.  The Retail Industry Leaders Association said that last year “Visa and MasterCard represented 71 percent of the credit card market and 88 percent of all interchange fees were collected by the top ten managing banks.”

In 2008, U.S. merchants paid an average interchange rate of 1.82 percent per transaction, according to the Nilson Report, a Carpinteria, Califorinia-based newsletter that tracks the industry.  “A significant advantage of capping or limiting interchange fees would be that it would reduce interchange fee costs most directly,” the report said.  However, this type of legislation could create fees elsewhere in the cycle.

“U.S. card issuing banks receive an estimated $40 billion to $50 billion in income annually from interchange fees.”

A 2003 law to curb credit card fees in Australia was initially intended to lower costs for merchants – hopefully creating a more competitive pricing market.  The law has backfired a bit.  Australian consumers are seeing new costs associated with using a credit card.  Banks have added annual card fees, cut card perks and reduced rewards programs, like frequent-flier miles. The Australian central bank also allowed merchants to impose surcharges to card users.  Merchant fees for American Express and Diners’ Club were not affected because interchange fees are only related to Visa and MasterCard.  However, both card companies decided to reduce merchant fees to avoid losing customers to Visa and MasterCard.

Following the introduction of the Credit Card Interchange Fees Act, President Obama signed the Credit Card Accountability Responsibility and Disclosure Act of 2009, which directed the Government Accountability Office (GAO) to conduct a study of credit card interchange fees.  In November, the GAO released their report.  The GAO assessed four options to address merchants’ concerns:

• Limit or cap interchange fees
• Require the disclosure of interchange fees to consumers
• Prohibit card networks and other entities from imposing rules on merchants that limit their ability to discriminate among the different types of cards, or levy a card surcharge
• Allow merchants and issuers to directly negotiate interchange fees

The GAO determined that proposals to cut credit card merchant fees will be hard to implement.  The report did not conclude, however, if merchants were likely pass on any savings they obtained through lower fees to consumers or encourage consumers to decrease their use of higher rate cards.  They did conclude that disclosing interchange fees to consumers could be confusing and, of no surprise, interchange fees “account for the largest portion of the [merchant] fees for [the] acceptance of Visa and MasterCard credit cards.”

Congress is currently considering three bills that would regulate interchange.  If U.S. regulators put limits on fees or rates, the banks will find another way to generate revenue.  U.S. card issuing banks receive an estimated $40 billion to $50 billion in income annually from interchange fees.  The banks and card companies are obviously against any bill proposing fee and rate limits.  Reflecting on the aftermath of the new credit card rules in Australia, the U.S. Congress has the difficult task of deciding what to do.

There are two notable changes, one requires that off-site data storage locations be visited and validated as compliant with PCI DSS. The other imposes a sunset date on wired equivalency privacy (WEP) use. For those of us who don’t speak techie, WEP is a software application intended to protect data as it travels across wireless networks. In previous posts, I have talked about WEP having to be upgraded by June 30^th, 2010 to Wi-Fi protected access (WPA).

Here are the 12 core requirements as outlined by the card associations:

1. Install and maintain a firewall configuration to protect card holder data
2. Change all default passwords on all systems
3. Protect stored card holder data
4. Encrypt transmission of cardholder data across open public networks
5. Use and regularly update anti-virus software
6. Develop and maintain secure systems and applications
7. Restrict access to cardholder data on a need to know basis
8. Assign a unique ID to each person with computer access
9. Restrict physical access to card holder data
10. Track and monitor all access to network resources and cardholder data
11. Regularly test security systems and processes
12. Maintain a policy that addresses security information

Many acquirers and large ISO’s have begun charging PCI compliance fees to their merchants to offset the costs they have had to incur in becoming compliant. As a merchant, I would want to know why they were not compliant to begin with and why I am being charged an additional amount for something they should already be doing. Online merchants can take matters into their own hands and ensure that their networks are following current PCI DSS guidelines and dispute compliance fees that are charged to them directly by their processor.

Federal regulators jumped into action and passed laws to protect consumers from increased interest rates on existing account balances. Government rules seem to run at a snail’s pace as these laws will not take effect until July 1^st 2010; that’s a lot of money in the banks’ pockets in the interim. Millions of card holders will get raked over the coals, paying high fees on previously made purchases until these laws kick in.

Credit card companies will still be able to raise rates on new credit cards, future purchases or cash advances. Finally, the Federal Reserve and National Credit Union Administration are cracking down on arbitrary hikes in interest rates. It would seem that we  have learned a lot from subprime lending. These rules will also stop the issuing of credit cards to people that all ready have a large amount of debt, and who were previously getting approved by banks for high interest rate cards.

Some of the new rules include:

• Consumers will have to be given 45-days notice before any changes will be made to the terms of their account.
• Rate hikes will still be allowed on cards with payments more than 30-days late.
• Late fees cannot be charged without giving at least 21 days to make a payment.
• Most cards currently charge a different rate for different balances, such as purchases versus cash advance transactions. Card companies will now be required to apply any payment above the minimum amount due proportionally to all balances, or to the balance with the highest interest rate.
• Finance charges can’t be assessed on paid-off balances from prior months on a current month’s billing cycle

Credit card companies take huge risks in issuing credit to people who have below average credit, so they hike up the interest rate for everyone to make up for their losses. Because these guidelines are being tightened, banks will have to be more cautious as to whom they give credit to. With less credit circulating around, we will ultimately have fewer purchases at retail locations. Hardest hit will be the online businesses since some purchases can only be made using a credit card. The other areas it will affect will be revealed in time.

Overseas, many organizations have formed campaigns against Visa and MasterCard. In Canada, ad campaigns are being run by The Retail Council of Canada telling Visa and MasterCard to “stop sticking it to retailers.” The Retail Council of Canada is a non-profit association that represents more than 40,000 stores of all retail formats.

In Europe, ongoing Interchange battles have reached boiling points. EuroCommerce, the retail and wholesale governing body, is accusing MasterCard of raising interchange rates 160% after the release of MasterCard’s new interchange fee structure. On December 19^th, 2007, an agreement was signed prohibiting MasterCard’s multilateral interchange fees (MIF). These fees apply to almost all cross-border card payments in the European Economic Area (EEA). This card type was prohibited because it is said to inflate the base on which acquiring banks charge. Since 85% of businesses accept these card types in Europe, it is said to potentially harm businesses and their customers. Naturally, MasterCard will raise other card type fees in order to compensate for money lost on fees from MIF.

Australia has already won their battle against interchange. Fees in Australia are capped, and in some cases they pay half a percent. Of course lower interchange rates, in my opinion, have been the result of fear. Card associations are afraid that regulations will be imposed if they do not lower their fees.

It’s only a matter of time before Visa and MasterCard will have similar regulations imposed upon them. But, are these fees price gauging or just a fair network of profit? It seems to me that we are all happy with our sky miles and rewards point, but are oblivious to where money for these rewards comes from. The people that are coming up with these regulations could be forgetting we are in a capitalistic society. Would we haggle over the price of our dinner at a high end restaurant saying the restaurant charged too much, after we already read the price on the menu? Merchants are aware of the rates they are going to pay before they sign their agreements. Perhaps we need to do a better job of educating merchants about Interchange fees and what they are used for.

HR 5546 is also known as the Credit Card Fair Fee Act of 2008. This bill would require Visa and MasterCard to negotiate with merchants and reach an agreement on credit card terms and conditions. If an agreement is not reached, both sides will be required to submit their final offers to binding arbitration by a three-judge panel appointed by the Department of Justice and Federal Trade Commission.

Before a bill is passed it has to go through several phases:

1. It has to be introduced
2. Reported by committee
3. Voted on in House
4. Voted on in Senate
5. Signed by the President

HR 5546 is currently up for vote in the House. Before a bill can be passed, I think it is important that merchants, as well as the National Retail Federation, understand Interchange. This bill also seems more like a hostage situation. Retailers will be holding the Associations hostage until their demands are met. If passed, it may do more harm to consumers needing to pay with credit cards if these large retailers don’t get their way on fees. The arbitration may be drawn out, costing each party involved needless legal expenses. In a credit card driven society, we may be stabbing ourselves in the foot.

For example, car dealerships fear they will not be able to comply. Since car dealers extend auto financing, they are considered creditors. Dealerships argue that it is very difficult to detect suspicious or unusual activity, and most of their staff is not trained to look for these types of things. According to Andrew Koblenz, the National Automobile Dealers Association’s general counsel, “We want to fight identity theft, and dealers have a tremendous self-interest in not selling a car to an identity thief, but the real world impact is that it would burden dealers.” Auto dealers speculate it could add as much as five hours to the loan application process.

The healthcare industry also falls into the category of creditor. If a hospital offers payment plans so patients can pay in installments, the hospital would be considered a creditor as well. Non-profit organizations and government entities that defer payment for goods or services are also considered a creditor. For the healthcare industry, the Federal Trade Commission is responsible for interpreting and enforcing the Red Flag Rules.

Any industry that processes multiple payments or transactions such as credit card accounts, mortgages, car loans, or cell phone accounts, or any industry that has a reasonably foreseeable risk to the customers or the creditor of identity theft, is subject to these Red Flag Rules.

If you are in an industry that fits any of the above criteria, your time is winding down. Here are some basic steps to becoming compliant:

1. You must put your process for identifying theft in writing.
2. Your program must include policies and procedures for identifying Red Flags, and incorporate those Red Flags into the program. Ensure your program is updated periodically.
3. Make sure the program is appropriate for the size and complexity of the company and scope of activities.
4. The program must be approved, and regularly reviewed by a board of directors and appropriate committee of the board.  It must include training for staff to effectively implement the program.
5. Creditors must frequently conduct risk assessment to determine whether it offers or maintains revolving accounts.

On November 1^st 2008 FACTA has a deadline in place called the Identity Theft Red Flags Rule. Red Flags are indicators of a possible risk of identity theft. Red Flag rules listed in Section 114 of FACTA explains each rule and how to develop ID theft prevention programs. These rules apply to any business, bank, or issuer that offers credit or any type of finance option. Many financial institutions are not taking the deadline seriously since the first Office of Thrift Supervision audits will not occur until February of 2009. Merchants all together have become savvier and typically try to comply and report any red flags, but some may not know who to report these red flags to.

Although we all want our credit card information to be secure, it seems that merchants are not getting a fair shake when it comes to FACTA. Many class action lawsuits have been filed against a number of retailers. Recently, there was a class action law suit filed seeking willful damages based on printing of credit card expiration dates on receipts. The merchant was seeking $100 to $1000 for each violation. This applies to both paper and electronic receipts. Most mom and pop merchants would expect that their card processor would ensure that they are up to code. This is not always the case. Merchants should review the FACTA rules regardless of their size. The Supreme Court is currently reviewing willfulness and “reckless disregard” and expects to have a decision this quarter. 

Visa and MasterCard are under the gun in Congress as well, for price-fixing and price gauging practices. The Credit Card Fair Fee Act (HR 5546/S 3086) stops the price fixing by Visa and MasterCard by insisting upon the use of a transparent market-based process. Some may say these are anti competitive practices, while others speculate that regulation is necessary.

Competition is what makes our economy thrive. Are Visa and MasterCard really getting too big for their britches, or are they trying to keep things secure and regulated? Visa responds that “HR 5546 remains and anti-consumer bill that would mandate unnecessary regulatory intervention into a fiercely competitive industry that is benefiting consumers, merchants, and financial institutions.”

While merchants out there are probably cheering on the intervention of Congress, this may not be a great thing. The card processing industry is complex and involves more than just the rate a merchant is paying. The Credit Card Fair Fee Act allows merchants to negotiate Interchange rates, which could cause merchants to lose out on the service, customer support, equipment upgrades, and personal attention that their card processing company provides. Visa and MasterCard are not going to provide any extra services if negotiations occur; in fact lower Interchange rates will probably cause the opposite effect.

If this new bill is passed by Congress, it is could potentially create more of a mess and ultimately higher costs. I am sure there are millions of businesses in the U.S alone, and if it passes, Visa and MasterCard are going to be getting a lot of calls from people looking to negotiate their fees. This means they will have to hire more staff to take the calls, and possibly even create systems to track all the various negotiated rates. So will this bill help the situation, or only put a band aid on what merchants believe to be an issue? Fees collected generally go to rewards programs, credit losses, and operating costs.

There are a total of 23 Bills regulating the card processing industry; some of the key ones are as follows:

SB 349/HB 2856 – Disclosure

A contract authorizing a merchant to accept a credit card or debit card may not: (a) Give a financial institution the right to charge a merchant or deduct from the merchant account the cost of a credit card or debit card transaction because the cost of the transaction exceeds a predetermined amount; or (b) require a merchant to limit or waive its rights under this act.

SB 348 – Sales tax

Discount rates, transaction charges, interchange rates or any other charges or fees charged to merchants or deducted from credit card or debit card sales for processing credit card or debit card transactions shall not be applied to the tax portion of any credit card or debit card sales.

HB 7775/S5035 – Disclosure

Whenever a contract authorizing a merchant to accept a credit card or debit card specifies that the merchant is bound by the rules of a financial institution, the contracting financial institution must: (1) Give the merchant access to the complete rules referenced in the contract, notify the merchant of any rule additions or modification, and provide a copy of the new or modified rule; (2) provide a complete schedule of interchange fees, credit card and debit card transaction rates and any other fees that the financial institution charges to merchants, as well as provide an explanation of which rates apply to the merchant and the situations in which those rates apply; and (3) not require a merchant to agree not to disclose the contracting financial institution’s rules or rates as a condition of receiving access to the rules and rates.

Whether or not Congress takes action is still up in the air. The important thing is that they make an educated decision. I will keep you posted on the outcome.

Without sounding too obvious, the current credit crunch many are facing particularly affects merchants who are dealing with the rising cost of goods and services. The latter includes interchange fees. The two bills in Congress address the need for merchants to be able to negotiate the interchange fees they pay to credit card companies. Some of the debate in Congress calls interchange fees “hidden fees” that must be brought out into public focus.

While Congress is in summer session, I want to begin a series that will:

1. Shed light on what interchange fees are,
2. Talk about the history of these fees, and
3. Follow these two bills through the legislative process.

Do you understand what interchange fees are and how they affect not only you as merchants but your customers as well? As I begin this series, I want to hear from you about interchange fees. What questions can I answer for you?

Drop us a line. We look forward to hearing from you.