Statements on Introduced Bills and Joint Resolutions

Floor Speech

STATEMENTS ON INTRODUCED BILLS AND JOINT RESOLUTIONS -- (Senate - June 05, 2008)

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By Mr. DURBIN:

S. 3086. A bill to amend the antitrust laws to ensure competitive market-based fees and terms for merchants' access to electronic payment systems; to the Committee on the Judiciary.

Mr. DURBIN. Mr. President, I rise today to introduce the Credit Card Fair Fee Act of 2008. This legislation will provide fairness and transparency in the setting of credit card interchange fees. This bill is companion legislation to a bipartisan bill introduced in the House of Representatives by Chairman JOHN CONYERS of the House Judiciary Committee and Representative CHRIS CANNON. The Conyers-Cannon bill currently has an additional 19 Democratic and 16 Republican cosponsors.

This legislation is supported by the Merchants Payments Coalition, a coalition of retailers, supermarkets, convenience stores, drug stores, fuel stations, on-line merchants and other businesses. The coalition's member associations collectively represent about 2.7 million stores with approximately 50 million employees.

Interchange fees may not be well known to most Americans, but they should be. Last year, U.S. retailers, and by extension their customers, paid approximately $42 billion in interchange fees to the banks that issue credit cards. The billions that are paid in interchange fees each year significantly cut into the profit margins of retailers and pinch the pocketbooks of consumers. And neither retailers nor consumers have a say in how these interchange fees are set within the Visa and MasterCard systems, which together account for over 70 percent of the credit and debit card market. The current lack of meaningful competition, negotiation and transparency in the setting of interchange fees represents a market failure, one that affects every American retailer and every American consumer.

My legislation takes a measured approach to address this market failure. My bill would identify credit and debit card payment systems that have significant market power, and would permit the retailers who use those systems to collectively negotiate with the providers of the systems over the fees for system access and use. If the retailers and providers are unable to agree voluntarily on a consensus set of fees, the bill would direct an impartial panel of judges to consider the two parties' fee proposals, and to select the proposal that most closely reflects what a hypothetical perfectly competitive market would produce. As I will discuss further below, this approach will protect retailers and consumers by preventing credit card companies from using their market power to charge unreasonable fees through an unfair process.

So what are interchange fees, and why do they pose a problem? Whenever a consumer uses a credit or debit card to make a purchase from a retailer, the banks and credit card companies involved in the transaction charge a number of fees that are passed on to the retailer and ultimately to the consumer. The interchange fee is one such fee. It is a fee charged by the card-issuing bank to the retailer's bank.

Here is an example of how an interchange fee is charged. When a consumer buys $100 in goods from a retailer using a Visa or MasterCard, the retailer first submits the transaction information to the retailer's bank (the ``acquiring bank''). The acquiring bank submits this information, via the Visa or MasterCard network, to the bank that issued the card to the consumer, the issuing bank. The issuing bank either authorizes or denies the transaction. If the transaction is authorized, the issuing bank sends to the acquiring bank, via the Visa or MasterCard network, the purchase amount minus an interchange fee that is retained by the issuing bank.

As a result of the interchange fee and other processing fees imposed upon the retailer by the acquiring bank, collectively, these fees are known as the ``merchant discount fee,'' the retailer typically only receives approximately $97.50 out of the $100 sale. In order to cover this cost and continue to make a profit, retailers typically raise the retail price of their goods, meaning that consumers must pay more regardless of whether they pay with cash or plastic.

Visa and MasterCard set the interchange fee rates for all the banks and all the retailers that participate in the Visa and MasterCard systems. Those interchange rates are frequently charged as a percentage of the sale amount plus a flat fee; for example, an interchange fee might equal 1.75 percent + 20 cents per transaction. The interchange fee rate varies for certain types of Visa and MasterCard cards and transaction categories, and is typically higher for cards that involve rewards programs for cardholders.

What is the rationale for assessing interchange fees? According to Visa, MasterCard, and the banks that issue them, these fees are used to pay for important functions within the credit and debit card systems. For example, interchange fees can be used to cover the costs of processing and authorizing credit card transactions, including the costs of ensuring data security and safeguarding against fraud. Interchange fees can also help protect an issuing bank from the risk that a consumer may not pay his or her credit card bill, which would leave the issuing bank on the hook for the amount that it gave to the acquiring bank at the time of a credit card transaction.

In addition to covering these costs and risks, interchange fees have been used to generate income for issuing banks. This income can be retained by the issuing banks as profit, or can be devoted to other uses such as consumer marketing campaigns or rewards programs for certain cardholders.

In addition to the benefits that interchange fees provide for issuing banks, Visa, MasterCard and their participating banks argue that interchange fees have also provided benefits to retailers and consumers by helping to make credit and debit card transactions more efficient and more prevalent. Visa, MasterCard and the banks claim that the growing use of credit and debit cards saves retailers from certain expenses involved with transacting business with cash or checks. They also claim that their cards bring benefits to consumers, including extra convenience, the availability of short-term credit, and rewards programs that are offered to some cardholders.

It is clear that interchange fees do play an important part in the credit and debit card systems, and that overall these systems have created efficiencies and benefits for banks, merchants and consumers. However, it is also clear that those who must ultimately pay interchange fees--retailers and their consumers--have no say in negotiating how much the interchange fees should be. As a result, interchange fees are being set at rates that would not be agreed upon in a competitive market, and that may favor banks to the detriment of merchants and consumers.

Why are retailers unable to negotiate changes in Visa's and MasterCard's interchange fee rates? There are several reasons. First, because of Visa's and MasterCard's market power, the overwhelming majority of American retailers have no choice but to accept Visa and MasterCard as a method of payment. Credit and debit cards are currently used for over 40 percent of all transactions in the U.S., and that percentage is increasing, in part due to extensive marketing by the card companies and the banks. Visa and MasterCard control over 70 percent of the market for credit and debit cards. Most retailers simply cannot survive unless they agree to accept those cards.

Second, within an electronic payment system the only party with whom retailers are able to negotiate effectively is the retailer's acquiring bank, and interchange fees are not covered in those negotiations. In their efforts to obtain retailers' business, including the business of processing the retailers' credit card transactions, acquiring banks will negotiate and compete over many of the component fees that make up the merchant discount fee. However, the interchange fee is typically by far the largest component of the merchant discount fee, and acquiring banks do not negotiate with retailers on interchange rates nor do they compete to offer retailers lower interchange rates. Instead, interchange rates are set by Visa and MasterCard, who claim that their rates are set without the involvement of the banks. Accordingly, the acquiring banks tell their retailer customers that the interchange rate component cannot be negotiated or reduced below the level set by Visa and MasterCard.

The interchange fee thus serves as a de facto price floor for the overall merchant discount fee--a floor that is fixed in a nontransparent, nonnegotiable fashion by card companies with significant market power. Although I have asked the credit card companies on several occasions for information that would help me understand the cost components that contribute to their interchange rates, it is still unclear how much profit margin is built into that floor. The margin may be significant, and as long as issuers and acquirers are happy with it, there is no incentive for card companies to help merchants and consumers by reducing it. Additionally, it should be noted that many if not most acquiring banks also serve as issuing banks, and therefore have almost no incentive to compete to lower the interchange rates that they themselves receive. Because the acquirers and issuers are often the same banks, no one negotiates with issuers about interchange fees on the retailers' behalf, and the retailers are left to negotiate for themselves.

Third, while some retailers may try to negotiate directly with Visa or MasterCard to lower the interchange fee component of their merchant discount fees, most retailers have no leverage in these negotiations since at the end of the day they will likely have to agree to accept Visa and MasterCard in order to stay in business.

As a result of this vast disparity in negotiating power, Visa and MasterCard can essentially impose interchange rates upon retailers and those retailers have no choice but to accept them. Furthermore, Visa and MasterCard also frequently impose take-it-or-leave-it contractual terms and conditions on retailers, such as acceptance rules that require retailers to honor all cards issued by that credit card company, even if the card is a rewards card with a higher interchange rate.

Because there is no competition and no real retailer negotiation involved in the setting of interchange fees, it is not surprising that interchange fees are being charged at levels that would not be agreed upon in a fair and competitive market. This has been demonstrated in a number of ways.

For example, as economies of scale and advances in technology have brought down the cost of credit card transaction processing in recent years, normal market pressures would suggest that interchange rates would have similarly decreased. But as noted in a March 29, 2008 Wall Street Journal editorial, ``The Visa interchange fee has increased over the past decade to 1.76 percent from an average of 1.5 percent. Economies of scale should be driving fees down, as in most other service-fee industries.'' In March 2006, the American Banker reported that ``according to the credit card industry newsletter The Nilson Report, interchange rates for Visa and MasterCard International have risen steadily every year since 1997.''

Also, interchange fees continue to be charged as a percentage of the sale price, so even though the cost of processing a $1 credit card transaction is comparable to processing a $1,000 transaction, the interchange fee paid on that $1,000 sale is much higher and much more lucrative for the issuing bank.

Additionally, Americans are paying higher interchange fees than are consumers in other countries who use the same Visa and MasterCard cards. According to a report by the Federal Reserve Bank in Minneapolis, U.S. interchange fees average around 1.75 percent, while in other industrialized countries such as Britain interchange fees typically average around 0.7 percent.

In 2001, the total amount of interchange fees collected in the U.S. was $16.6 billion. By 2007, that amount grew to approximately $42 billion, an increase of over 150 percent since 2001. What are banks doing with the tens of billions of dollars they are collecting in interchange fees each year? There is a serious lack of transparency on this issue, but one study indicates that only around 13 percent of collected interchange fees are devoted to covering the cost of processing credit card transactions. According to this study, the majority of the collected fees went toward profits for the issuing banks, rewards programs that benefit mostly affluent cardholders, and marketing campaigns.

Visa and MasterCard and the banks that use them argue that their interchange fee rates are set at levels that best balance benefits and costs to card issuers and to merchants. If the card companies and the banks truly believe that interchange fee rates are already set at a level that is fair to merchants, it seems they should have no objection to formalizing a process for setting interchange rates that is fair and transparent and that gives merchants a legitimate voice in the process.

That is what the Credit Card Fair Fee Act would do. This legislation would apply to widely-used credit and debit card systems. Recognizing that these electronic payment systems have become nearly as important to our consumer economy as cash and that most retailers cannot stay in business without accepting them, the bill would ensure that retailers have access to these electronic payment systems at fair rates and terms.

Under the bill, if any electronic payment system has significant market power, i.e., 20 percent or more of the credit and debit card market, retailers would receive limited antitrust immunity to engage in collective negotiations with the providers of that electronic payment system over the fees and terms for access to the system.

The bill would establish a mandatory period for negotiations between the retailers and providers over fees and terms. If the negotiations between the retailers and providers do not result in an agreement, the matter would be brought before a panel of expert Electronic Payment System Judges, who would be appointed by the Department of Justice Antitrust Division and the Federal Trade Commission.

These Judges would conduct a period of discovery during which information about fees, terms, and market conditions for electronic payment systems would be disclosed. At the end of the discovery period, the Judges would order a mandatory 21-day settlement conference to facilitate a settlement between the retailers and electronic payment system providers. If the settlement conference failed to result in an agreement, the Judges would conduct a hearing where each side would present their final offer of fees and terms. The Judges would then select the offer of fees and terms that most closely represented the fees and terms that would be negotiated in a hypothetical perfectly competitive market where neither party had market power.

After choosing between the two offers put forth by the parties, the Judges would enter an order providing that these fees and terms would govern access to the electronic payment system by the merchants for a period of 3 years, unless the parties supersede this agreement with a voluntarily negotiated agreement. Decisions by the Judges would be appealable to the D.C. Circuit Court of Appeals.

The Credit Card Fair Fee Act is modeled after the Copyright Royalty and Distribution Reform Act of 2004, which created a similar system for the use of copyrighted music works.

Credit card companies and banks may claim that this legislation involves government price setting, but this is not the case. This legislation does not permit the government to establish on its own accord what the fees and terms for retailer usage of credit card systems ought to be. Rather, it sets up a process whereby retailers would be able to make their case as to what fees and terms are fair, and if the retailers and credit card providers fail to agree voluntarily on those fees and terms, independent judges would evaluate the parties' offers and select the offer that most closely resembles what the result would be in a fair and competitive market. In contrast, currently Visa and MasterCard can use their overwhelming market power to establish non-negotiable interchange fees and terms, and retailers are forced to abide by these fees and terms or else be denied access to payment systems that account for a huge percentage of all U.S. transactions. This type of unaccountable fee-setting runs far more risk of harm for retailers and consumers.

Under my legislation, if the credit card companies and the banks are able to persuade the Judges that current interchange rates are justifiable, then the rates would remain as they are today. If, on the other hand, the retailers are persuasive in arguing that current interchange rates cannot be justified by competitive market dynamics, then the Judges would likely rule that alternative interchange rates would better represent the result of a perfectly competitive market. In either case, at a minimum the interests of retailers and consumers would be much better represented in this fundamentally important market.

My legislation represents a measured approach to addressing the current market failure with interchange fee-setting. Other countries have addressed the problem of unfair interchange fees through far more drastic solutions. For example, Australia has imposed a system of direct regulation of interchange fees through its central bank, and Mexico's central bank has negotiated rate reductions with the card companies. My legislation represents a middle ground between the current flawed system and these aggressive foreign regulatory frameworks.

In short, the Credit Card Fair Fee Act would address the market power imbalance between retailers and credit card companies in setting interchange fee rates. It would create a forum where these fees can be fairly negotiated by parties with equal bargaining power. It would ensure that interchange fees and terms are fair to both banks and retailers. And if retailers are able to negotiate interchange rates that reduce the transaction cost of doing business with plastic, it would be beneficial to consumers as well.

How do we know that retailers will not just pocket any savings they get through any reduction in interchange fees that they are able to negotiate? We know because unlike the credit card interchange rate-setting process, the retail industry is highly competitive, and that competition is largely based on price.

Also, sometimes we hear the banks and card companies argue that if interchange fees are reduced, they will have to raise fees and penalties on cardholders to make up for the revenue shortfall. If these companies stand by this argument, I would expect them to stand by its converse and reduce their cardholder fees and penalties whenever their interchange fee collections increase. However, interchange fee collections have increased 150 percent since 2001, and we have seen no corresponding decrease in fees and penalties imposed upon all cardholders. Unless you are one of the small percentage of cardholders with a current balance, no annual fees, and a lavish rewards program, your issuing bank is probably taking two bites at your wallet--one with interchange fees and one with the fees on your statement.

The Credit Card Fair Fee Act will protect consumers and retailers by preventing credit card companies from using their market power to charge unreasonable fees through an unfair process. This is important legislation, and I urge my colleagues to support its passage.

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