Will the merchant settlement help merchants?
Not that much unless they surcharge
Introduction
It’s finally over. After ~15 years in the courts, the merchants settled with the networks and issuers over interchange. Some merchants have opted out and may continue litigating, but the bulk are expected to opt-in. I previously wrote on this topic here and here. The second of these posts reviews what is effectively the same settlement that was approved this week.
The question now becomes how the networks and banks implement this, and how the merchants take advantage of their gains. These benefits include:
Lower interchange
10 bps reduction in combined average credit interchange for 5 years
Interchange capped for 5 years
“Standard Cards” capped at 125 bps for 8 years
Limits on “Honor all Cards”
Credit surcharging is authorized at the brand or product level
Merchants can decline cards in three broad categories: Premium cards, Standard cards, and Commercial cards
The rest of this post will address these points, focusing on winners and losers among the stakeholders.
Lower interchange
My key open question concerns the 125bp cap on Standard Cards. Those cards are named as specific products in the V/MC portfolio: For Visa, Traditional Rewards and Traditional; For MasterCard, Core and Enhanced Value. To qualify for a Premium card, the minimum credit line is typically $5,000.
Standard Cards
According to the sources I found, these capped products account for only ~10% of total spend. Can issuers game the system to move some of these cardholders into the Premium products? The poster child for this is the Chime Card.
The Chime Card is a secured Credit Card with no credit line at all. It is basically a debit card dressed up as a credit card. Yet it qualified for Visa Traditional interchange rates which were higher than exempt debit. Then Chime relaunched the card with a minimal rewards program (2% cash back on one merchant category) and got the card reclassified as Traditional Rewards paying a third higher interchange. That card now accounts for 20%+ of Chime volume, and growing fast.
Conventional issuers often pull a similar trick, migrating lower value customers onto higher IC cards. The question here is whether the settlement governs the credit line thresholds that qualify cardholders for the higher IC products. Inflation alone erodes the $5,000 threshold, but could the industry just drop the threshold to $4K or $3K?
The $5K threshhold means that Chime cannot graduate the Chime Card into the Premium category since that card has no credit line at all. The card will instead be capped at 125bps, which is not much more than exempt debit interchange. The limited rewards proposition may even push net interchange below exempt debit.
In general, the cap hurts subprime issuers the most. They are lend-centric, so may not care as much, but it does impact their revenue on non-revolvers.
An open question to me is whether the 125bp cap is included in the 10bps reduction. If Standard cards account for 10% of spend but see a 50bps reduction in interchange, that alone accounts for half the required average reduction. It won’t be that hard for premium card issuers to shave rewards costs to recover the remaining 5bps. They can recover more of it by graduating some Traditional Rewards customers to entry-level premium products.
