ESMT Working Paper

Pricing payment cards

ESMT Working Paper No. 10-005
Özlem Bedre-Defolie, Emilio Calvano (2010)
Subject(s): Economics, politics and business environment
Keyword(s): Payment card networks, interchange fees, merchant fees
JEL Code(s): G21, L11, L42, L31, L51, K21

Payment card networks, such as Visa, require merchants' banks to pay substantial "interchange" fees to cardholders' banks, on a per transaction basis. This paper shows that a network's profit-maximizing fee induces an inefficient price structure, over-subsidizing card usage and over-taxing merchants. In contrast to the literature we show that this distortion is systematic and arises from the fact that consumers make two distinct decisions (membership and usage) whereas merchants make only one (membership). These findings are robust to competition for cardholders and/or for merchants, network competition, and strategic card acceptance to attract consumers.

An earlier version of this working paper appeared in the European Central Bank Working Paper Series (No. 1139).

Pages 38
Publication Nr. 10-005
ISSN 1866–3494 (Print)