I’ve argued that the biggest threat to rewards credit cards is that interchange fees, the percentage of each transaction that the banks and payment networks take, will fall.
Currently banks work hard to incentivize consumers to use their cards, in order to earn these fees (as well as the chance of earning APR from customers who don’t pay off their cards in full each month). They’ll buy miles from airlines or points from hotels, or offer cash back, or entice with other rewards. It’s a competitive business and the most lucrative cards are giving consumers back nearly everything (and sometimes even everything) that the banks take in.
If interchange fees fall, it will no longer make as much sense to pay out rewards. That’s what happened to rewards debit cards. The Durbin Amendment to Dodd Frank financial reform legislation banned earning a profit on debit cards.
- As a result banks largely stopped offering rewards for using a debit card — it no longer made sense to spend money to get consumers to push transactions onto a product which wasn’t making money.
- Since debit cards were no longer profitable, that made many checking accounts no longer profitable. Banks started insisting on minimum balances or payroll direct deposit before waiving fees. That pushed some consumers out of the banking system and into check cashing stores and elsewhere. (Incidentally the idea behind American Express Bluebird and Redbird was to offer a product that earned higher fees, circumventing the Durbin Amendment, while offering better service to the unbanked — and meeting them where they already are, Target and Walmart. How on earth American Express failed to profit on this I cannot figure.)
There are (3) ways that interchange rates for credit cards could fall.
- Competition. Already we’re seeing big merchants like Costco, Amazon, and others negotiate very low credit card processing costs. American Express is voluntarily lowering rates to entice small businesses to accept their cards.
- Regulation. Australia and Europe have regulated interchange and their credit cards are far less rewarding as a result. Incidentally this hasn’t reduced consumer prices. We’re not likely to see regulation here out of a Trump administration, but it could become a priority for a future Democratic administration.
- Technology. This is in some ways a subset of competition. New payment technologies drive down the cost of processing payments, there won’t be as much of a margin to support rich rewards.
My long-term view has been that interchange rates are much likely to be lower 10 and 15 years from now than higher. That was almost an unheard of perspective when I started talking about it a few years ago, now it’s not all that controversial.
However what’s interesting to see is that the opposite seems to be happening. The Wall Street Journal is reporting that Visa, Mastercard, and Discover are set to raise interchange rates slightly this spring. That’s the opposite of what I’d expect, and it will be interesting to see how sustainable this is.
Ultimately whether current or increasing interchange rates are sustainable is crucial to airline and hotel businesses. Marriott used their new credit card deal to help cement hotels together in the new loyalty program. American Airlines only made money in 2018 because of their credit card deal, and not overall from flying airplanes. The biggest airline co-brand agreements are bringing in over $3 billion in revenue each year.