Good afternoon Chairman Nava and members. My name is Pedro Morillas, Consumer Advocate for the California Public Interest Research Group (CALPIRG). CALPIRG is a statewide consumer group that stands up to powerful interests on behalf of California’s consumers.
In 2008 banks in the US collected $48 billion in interchange fees. Consumers and retailers are footing this bill, in theory, for some benefit, but the system is rigged to favor the banks.
My testimony today will focus on the impact of interchange fees on consumers with three main points:
1) All consumers, even those who pay with cash and checks, pay more at the store and more at the pump because these interchange fees are passed on in the overall cost of goods sold.
2) The card associations’ rules prevent merchants from informing consumers on the costs of payment and limit the ability of merchants to direct consumers to the safest, lowest cost, and most efficient forms of payment.
3) Finally, this oligopolistic concentration has allowed issuers to engage in a variety of unfair and anti-consumer practices.
First, I’ll give an example of the costs that get passed on to consumers. The so called free rewards are a great example of the “reverse Robin Hood” effect that interchange fees can have on consumers. It is reported that as much as forty-four percent of interchange fees go towards subsidizing rewards programs.
Currently, all consumers pay for rewards in the form of higher prices for the goods they purchase everyday. Only a small portion of cardholders actually receive rewards and the portion they receive is very modest compared to what cardholders pay in interchange. But most important, the most vulnerable consumers, those without credit cards, receive nothing from interchange, and subsidize the supposedly free gift of rewards programs for more affluent consumers.
Rewards programs are just one example of how all consumers end up subsidizing cardholders, and how even cardholders are not getting what they pay for. The $48 billion in interchange fees U.S. consumers paid in 2008 is more than double what Americans paid in credit card late fees and three times ATM fees. The $48 billion is an increase from $42 billion in 2007 and an increase of 33 percent from 2006. Did consumers benefit from this rapid increase? Did cash customers benefit? Obviously not. Did credit card customers benefit? Did rewards programs improve substantially? Were there greater benefits to cardholders in some other fashion? Did the welfare of all consumers increase? We doubt it.
My second point focuses on the question that many consumers have encountered at the cash register; debit or credit?. Most consumers are completely unaware that there is any difference between the two choices. The interchange fee system is hidden from consumers and the public. The card associations do not disclose publicly their fees or the basis for these fees. Most public reports maintain that, on average, interchange fees cost merchants up to 2 percent or more of each transaction on a credit or signature debit card. Offline (signature) credit transactions cost the most; online (PIN) transactions cost the least.
As the government does not regulate or compel disclosure of credit card interchange fees, most consumers have no idea that they exist and that they are paying for services that they may not even use. In fact, Visa, MasterCard and the card issuing banks engage in a variety of practices to prevent well-informed consumers from exercising their choices.
For example, Visa and MasterCard rules prevent merchants from disclosing fees to their customers or attempting to steer consumers to lower-priced payment options, such as cash or online debit cards. They cannot charge a distinctive price or surcharge based on payment options. They cannot attempt to direct consumers to lower cost options such as cash, checks and online debit.
To ensure that market forces of competition work, consumers must have accurate and complete information.
In conclusion, I’ll highlight a few of the unfair and anti-consumer practices that insufficient competition has created.
First, card associations and banks use misleading marketing to encourage consumers to use their credit cards or signature debit cards as frequently as possible. Reward incentives, such as frequent flier miles, are designed to seem as though customers are paid to use these cards. In reality, these consumers and other consumers are simply paying for those rewards. The recent efforts of the card associations to “convert” cardholders from regular credit cards to so-called “premium cards” such as the Visa “Signature” or the MasterCard “World” cards is a good example. These cards have a significantly higher interchange fee than traditional cards, among the highest of all interchange fees.
Second, although merchants can’t surcharge or use differential prices to direct consumers to the most efficient and lowest priced payment options, banks do have that power. Not surprisingly, they use it to direct consumers to less efficient, higher cost options. The debit card market illustrates this problem. Signature based debit is more expensive and less secure than online debit because online debit transactions are instantaneous. Online debit has a far lower rate of fraud. Online debit transaction interchange fees are capped at fixed levels; they only cost merchants between $0.17 and $0.50 per transaction. Conversely, credit and signature debit cards cost merchants up to 2% or more of the entire transaction, no matter how large. Instead of promoting online debit which is safer and less costly, banks increasingly surcharge consumers seeking to make these transactions with penalty fees of as much as 50 cents a transaction. Consumers are paying more for a less safe and more costly product. These penalties effectively steer consumers to the less efficient, less secure, more costly signature debit product.
These examples show that card associations and banks use some of the same deceptive practices against merchants as we have seen them use against consumers for years. Not only do the merchants suffer as a result, but consumers, unwittingly, do too.
While this issue certainly affects California consumers, the state can do relatively little to fix the problem due to federal preemption. I urge the members of this committee to weigh in with the congressional delegation of California in favor of proposed legislation that would create a consumer financial protection agency. An entity looking out for the best interests of consumers with regards to financial products would be beneficial in finding a solution to this and many other issues related to consumer credit.
We applaud chairman Nava and the banking Committee for holding a public hearing on this important consumer issue. We hope there is an opportunity to work with you on this and other efforts to protect consumers from anticompetitive tactics in this vital market. Thank you for the opportunity to testify today.
The California Public Interest Research Group Education Fund (CALPIRG) is a result-oriented public interest group that protects consumers, encourages a fair sustainable economy, and fosters responsive democratic governance.