Florian Schalliol points me to a Brookings Institution piece arguing that the “poor subsidize wealthier consumers” in financial transactions from checking accounts to credit card rewards. I do not think this is quite right, but let me first lay out the argument.
- Financial services are cheaper the richer you are, and free checking accounts are a thing of the past.
- Credit card rewards are for the wealthy.
- Customers pay the same for a product in cash as they do with a credit card, but merchants make more money on the cash transaction.
- So the poorer customer without credit cards is subsidizing rewards for wealthier customers.
As long as merchants do not vary the price based on payment, economics dictate that people who pay using cash or debit cards are subsidizing people who use credit cards. The fancier the credit card, the larger the subsidy. Payment methods are correlated with income: lower income people are more likely to use cash, pre-paid or debit, while higher income use credit cards.
The Decline of Free Checking Accounts is the Result of a Policy Mistake
Free checking accounts aren’t as ubiquitous as they once were – for very good reasons – but they still exist. NerdWallet has a list of several but it’s far from exhaustive.
Banks have added fees, or required minimum balances or direct deposit or other transactions, because it’s no longer profitable to just offer free checking. That’s because of the Durbin Amendment to Dodd Frank financial reform legislation, which effectively outlawed banks earning a profit off of their debit cards. This is also why you no longer earn debit card rewards, banks aren’t making money on the transactions so aren’t competing for your debit business.
Financial institutions used to want checking account business because it would get them consumers’ debit card transactions. Once they no longer made money off debit charges, the subsidy for free checking was gone.
The broader point though is that banks want wealthy customers with lots of different service needs because there are more opportunities for them to profit. Giving a free checking account to someone without much money means it’s hard to cover costs, and so banks turn to fees.
Cash Buyers Aren’t Subsidizing Credit Card Customers
We often use the word ‘subsidy’ too loosely. Credit card customers are profitable customers. Stores accept credit cards because they can sell more goods and services to more people, and it’s profitable to do so. Their transaction costs are effectively a marketing expense to bring in customers and allow them to pay in the manner most convenient. There’s no subsidy required here. Credit card customers also spend more on average than customers using other payment methods.
The notion that credit cards are costly and other payment methods costless is simply a mistake. Accepting cash is costly to a store because of the need to deposit funds and because of the risk of loss or theft (whether by an employee, or getting robbed, and this also gets factored into insurance rates). Similarly people write bad checks, which stores can… pay to insure against if they don’t want to lose the money.
Eliminating Credit Card Rewards Benefits Retailers Not Customers
Concerns about the effect of interchange (credit card swipe fees) for the poor are largely a fig leaf for retailers who want to drive down their costs. Where interchange has been regulated (Australia, Europe) it has not resulted in lower prices. That suggests poor and cash customers aren’t paying more to account for credit card benefits they do not receive.
In fact when Australia began permitting retailers to charge a fee for card acceptance regulators came back in to cap those fees because they weren’t just about recouping card processing costs.
Make Accessing the Financial System a Priority – Rather than Crippling It
Ultimately there’s a real problem where unbanked consumers are driven to costlier options such as check cashing stores)but that was the predictable (and predicted) outcome of legislation that could be fixed.
American Express took a shot at earning a profit while addressing the problem of unbanked consumers with Bluebird but somehow it didn’t catch on.
Credit card rewards do require a certain level of income and credit to benefit from. Not ‘everyone’ can use credit cards to fly in business or first class around the world. But that doesn’t imply doing so makes those not in a position to benefit less well off.
Unfortunately big retailers co-opt the language of inequality for their own benefit. A lot of the arguments against credit cards and interchange are designed to benefit Walmart, Amazon, and other merchants who want to accept credit cards, but want to use political influence to force companies like Visa, Mastercard, and American Express to lower cost.
The result of that isn’t lower prices, or benefits for the poor. It redistributes income from payment processing networks and from consumers who today earn rewards back to those retailers.