Interchange fees and their recent Canadian history
In 2015, both Visa and Mastercard voluntarily agreed to cap their interchange fees at an average of 1.50% across all their cards for five years. In exchange, they avoided regulation by the Canadian Federal Government. Prior to the 2015 agreement, interchange fees for Mastercard were an average of 1.67%; the larger Visa network charged an average of 1.74%. After the Visa/Mastercard voluntary cap was announced, Finance Minister Joe Oliver said it amounted to a savings of $400 million annually for Canadian merchants.
But even with the reduction, Canadian merchants are still paying between $5 and $7 billion in annual interchange fees, an expense passed on to Canadian consumers in the form of higher retail prices. Dan Kelly, president and CEO of the Canadian Federation of Independent Businesses (CFIB), believes that this disproportionately affects lower and middle class consumers.
“This is an enormous wealth transfer from low income consumers to high income consumers, because while a wealthier rewards cardholder can often overcome their high annual fees in the value of the rewards they redeem, a poorer consumer — who can’t afford the fees or qualify for the credit card — is still paying for the rich guy’s free trip to Paris without receiving the benefit,” says Kelly.
According to the Retail Council of Canada (RCC), Canadians pay merchants at least $4.5 billion more annually in retail prices than they would if credit card interchange rates were comparable to most of the EU (generally capped at 0.3%) and Australia (capped at 0.8%). But a closer look at our overseas brethren indicates that’s only half the story. There are negative consequences to reducing interchange fees as well, including decreased credit card rewards values and higher annual card fees.
Your cards, worth less
In 2003, the Reserve Bank of Australia (RBA) introduced regulations meant to curb interchange fees. Credit card issuers made up for the loss of revenue by increasing their products’ annual fees and decreasing their reward values.
Between 2003 and 2011 the average spending required to earn a $100 shopping voucher in Australia rose from $12,400 AUD to $18,400 AUD—disproportionately higher than the rate of inflation. Between 2002 (the year before the regulations went into effect) and 2004, the average annual fee on a standard rewards card jumped from $61 to $85. Overdraft, late payment and balance transfer fees are now also higher than in pre-cap years, again outpacing the rate of inflation.
“Credit card issuers are recouping their costs in other ways by increasing annual fees and reducing the amount of rewards that people can earn per dollar spent,” says Julian Morris, Vice President of the Reason Foundation, a non-profit libertarian think tank based in the U.S. Julian co-authored a Canadian study analyzing the effect that interchange fee caps may have on the Canadian middle class.
What happened in Australia transpired in the EU as well. Legislation in 2015 capped interchange fees for debit purchases at 0.2% and credit card purchases at 0.3%, prompting the UK’s Marks & Spencer, Tesco and The Royal Bank of Scotland to devalue their respective reward points. Capital One eliminated its cash back offering entirely, and all four companies publicly attributed the changes to interchange fee caps.
Enjoy your rewards and cashback cards while their attractive features remain intact, but keep an eye out for possible devaluations and rising annual fees down the road.
As of now it’s difficult to determine if the voluntary interchange fee cap imposed in 2015 in Canada has decreased Canadian credit cards’ reward point values.
“Canada did reduce its interchange fees, but it wasn’t nearly as dramatic a reduction as the reductions that were imposed in Australia, so it’s much more difficult to discern here. I think presumptively one would say the card issuers didn’t offer as generous rewards as would have been the case had the interchange fees not been lowered,” says Morris.
Canadian consumers might be able to stomach reductions to their cards’ rewards rates and hikes to their annual fees, as long as these are balanced out with savings on the goods they buy. But the transference of said savings Down Under did not materialize.
Where are the savings?
In Australia, it was presumed that “vigorous competition” at the retail level would lead to lower prices, with the RBA estimating a reduction of 0.1 to 0.2 percentage points on the Consumer Price Index. RBA has since reported that merchants saved $1.1 billion AUD thanks to declines in interchange fees, but has not reported any corresponding benefit for consumers. In a 2013 study analyzing the economic impact of interchange fee regulation in the UK, the RBA was quoted as stating, “No concrete evidence has been presented to the Board regarding the pass-through of these savings.” Their conclusion has not been amended since, and in subsequent reports they no longer mentioned pass-through to customers at all, instead focusing exclusively on merchant savings.
This doesn’t bode well for Canadian consumers.
Even the Canadian Federation of Independent Businesses, which in 2017 and 2018 successfully negotiated lower interchange fees with Mastercard and American Express for its 110,000 members, hesitates to promise correspondingly lower prices on consumer purchases.
“Can I say to you that our members have saved $3,000 and they’ve lowered consumer prices by $3,000? No,” says Dan Kelly, the Federation’s president and CEO.
“But I can also say that when the premium cards were introduced, interchange rates were going up by 30 to 40% per year and our members didn’t pass on the entire increase to consumers either. It takes a while for costs to be embedded in the system and it takes a while for costs to come out of the system,” he added.
Meanwhile, legislative momentum in the fight for even lower interchange fees continues to build despite possible detriments to both merchants and consumers, and correlated economic risks.
The way forward
As of publication of this article, Bill C-236—a private member’s bill—is awaiting second reading in the House of Commons that would give the Canadian Government the right to cap interchange fees. Sponsored by Liberal MP Linda Lapointe, the bill aspires to amend the Payment Card Networks Act so lawmakers can limit how much credit card networks can charge merchants. Finance Minister Bill Morneau had also said in 2016 that the Trudeau Government would be reviewing the entire credit card system, including interchange rates.
“The Federal Government has kind of hinted that if the credit card networks don’t get a move on [in lowering interchange fees further] that Bill C-236 will be allowed to move forward,” says Karl Littler, Vice President of Public Affairs for the Retail Council of Canada.
“Of course it’s a private member’s bill, so the votes are not with the party—it’s up to individual MPs whether they want to support it or not—but the government is already actively reviewing the credit card industry, which we believe will ultimately benefit both merchants and consumers,” he adds.
The MacDonald Laurier Institute begs to differ, estimating that if Canadian interchange fees are forcibly reduced by 40%—making them comparable to the fees in the EU and Australia—there would be negative consequences for Canadian consumers and the economy as a whole. They estimate that the average Canadian would lose $89-$250 per year in reduced credit card rewards values and increased annual card fees; spending at merchants would decline by between $1.6 and $4.7 billion per year, resulting in a loss for merchants of between $1.6 and $2.8 billion; GDP would fall between 0.12 and 0.19% annually; federal government revenue would decline by between 0.14 and 0.40%.
Littler, however, questions Laurier’s conclusions.
“A lot of this is couched in terms of what may not and what might happen. It’s like we’re going to raise a question and we recommend no one do anything because we’re not sure of the outcome,” says Littler in reaction to the study.
Meanwhile, although the CFIB agrees with the RCC that interchange fees are unreasonably high, they don’t believe caps legislated by the federal government are the right approach toward reducing interchange fees.
“I don’t disagree that this is a broken market, but we’d like to use the government to help balance the power relationship between the credit card companies, the merchant and the consumer, as opposed to the government stepping in and saying, ‘This is the amount you should be charging and no more than X,’” says Kelly.
Negotiation not legislation
The CFIB was instrumental in creating the voluntary Code of Conduct for the Debit and Credit Industry in 2010, which all providers have signed. It guarantees that if the credit card industry increases interchange fees, a merchant has 90 days to leave its processing contract. In the past, merchants had to pay big penalties for leaving contracts, even if rates were increased.
With a balance of power restored in the market and the realization that their members represented $12 billion annually in processed transactions, CFIB was able to negotiate with Mastercard for its lowest rate, giving members a savings of 12.5% in interchange fees on core cards and 22% on some premium cards. In March 2018, they then negotiated with American Express, which wanted to increase its footprint in the Canadian small and medium business market, dropping interchange fees for its members from an average of 3% to an average of 1.8%.
“The voluntary undertaking in 2015 was a helpful instrument because the government asked providers to stay under an average. They didn’t impose a hard cap the way Australia did and the average was negotiated with credit card networks,” says Kelly.
There’s still work to do. Kelly is currently talking to Visa to once again negotiate better rates for CFIB members.
“Visa has not said no, but they have less to gain because they’re already the largest processor. It’s hard, but we’re actively trying to get them back to the table,” says Kelly. “We believe that we have to be careful with what we do because we could end up making the problem worse, not better.”
So where does this leave the average Canadian, using credit cards now more than ever and racking up rewards points and cash back with no end in sight?
Goodbye rewards
Although much has been made recently in Canadian finance media about the potential for dramatic interchange fee reform, this is one of those rare cases where just because there’s smoke, there’s not necessarily fire. Bill C-236 pledges to reduce interchange fees, but is in stasis at second reading. The voluntary undertaking by Visa and Mastercard still remains in effect for another few years. And at least 110,000 merchants are getting a break on interchange fees with Mastercard and American Express.
The trend is certainly toward further reductions, but as of now nothing has been put into law. There are no caps or regulations, and recent changes were negotiated, not forced. Enjoy your rewards and cashback cards while their attractive features remain intact, but keep an eye out for possible devaluations and rising annual fees down the road.
It could be a very different Canadian credit card landscape in a few years.
