This note by Rosa M. Abrantes-Metz, Practice Co-Leader, Global Antitrust & Competition, Brattle, was prepared for the discussion “Competition and Payment Card Interchange Fees” held at the 19th meeting of the OECD-IDB Latin American and Caribbean Competition Forum on 22 September 2021. More papers and presentations on the topic can be found out at oe.cd/laccf.

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Competition and Payment Card Interchange Fees: A Brief
Note to the OECD Latin American and Caribbean
Competition Forum
Rosa M. Abrantes-Metz1
September 2021
1. Introduction
One cannot be a fully conversant antitrust practitioner or academic in today’s antitrust
environment without a basic, if not sophisticated, understanding of markets involving
multisided platforms or so-called ecosystems—multiple horizontal and vertical
relationships that center around certain platforms. And the goal is not just to understand
antitrust enforcement in various jurisdictions, including those that adopt or eschew the
U.S. Supreme Court’s analytical approach in AMEX,2
centering on market definition
and the nature and strength of indirect network effects. In today’s rapidly evolving
regulatory environment—where numerous jurisdictions are in the process of directly
regulating big tech platforms—it is equally important to understand the underlying
economics of platforms and, more broadly, the ecosystems in which many of them
operate, as well as consequences of proposed or actual regulations. Payment systems
are not an exception.
Network businesses provide value by facilitating interactions among their subscribers.
These businesses may be “one-sided,” meaning their subscribers value interacting with
1
Rosa M. Abrantes-Metz is a Principal at The Brattle Group in the Competition and
Securities Practices, and a former Adjunct Associate Professor of Economics at the New York
University Stern School of Business. She Co-Chairs Brattle’s Global Antitrust and
Competition Practice and formerly Co-Chaired Brattle’s Technology Practice;
Rosa.Abrantes-Metz@Brattle.com. The views expressed in this note are the author’s and do
not necessarily represent those of the organizations with which she is affiliated or their
clients.
2
Ohio v. American Express Co., 588, Supreme Court of the United States of America,
(2018).

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other subscribers of the same type (perhaps a professional networking site), or they may
be “multi-sided,” meaning they have subscribers who value interacting with those of
other types (perhaps a ride-sharing platform which brings drivers and passengers
together).
It is natural to expect that the value of a network will increase with its size. What makes
the economics of networks interesting is that each new subscriber increases the value
to other subscribers, which attracts more subscribers, which increases the value to all
again. This positive feedback, known as the “network effect,” creates a virtuous circle
and could potentially allow a very large incumbent to corner the market, but it could
also allow for significant positive, synergetic value. Hence, the strenght of the network
effect influences the pricing strategy of the platform as a whole, potentially creating
circumstances where it is profit maximizing for the platform to heavily subsidize one
side while extracting rents from the other.
Besides leading to interesting economic puzzles, the network effect can lead to
challenging antitrust puzzles as well. As the AMEX decision famously emphasized, if
the rents collected from one side are used to subsidize the other, then it may not be
procompetitive to reduce those rents under some circumstances. This is a particularly
important focus for payment systems, given the great focus by several jurisdictions over
the last many years on regulating one particular price of the platform, for example
placing caps on interchange fees. One could think of consequences of regulation on
platform pricing as a balloon full of air: if we squeeze one side (cap that the interchange
fee), it will stretch and inflate the other side (inflating the other side’s price and
potentially giving rise to more or new charges).
Have we really thought through all implications of capping interchange fees and the
overall effect on consumer welfare, efficiency and competition? What does economic
theory and the empirical evidence tell us to date?
2. Brief Background on Payments Systems
A card payment system results from the interplay of several stakeholders. They include
banks and other payment institutions that provide a wide array of cash and electronic
payment services to consumers and merchants.

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Payment systems enable commerce, save consumers time, and help them manage
household finances. They also make it easier for businesses, from very small to very
large, to engage in exchange with consumers, who may more easily and rapidly spend
larger amounts using these payment methods.
Credit and charge cards represent the preferred non-cash payment instruments in many
countries. A typical credit and chargeback card transaction generally involves five types
of players:
o Cardholder/Consumer: person using a card to make a purchase.
o Merchant: business or person from which the cardholder is purchasing
goods or services.
o Issuer: cardholder’s bank, which issues cards and maintains cardholder’s
account.
o Acquirer/Processor: merchant’s bank, which accepts and processes card
payments for merchants. The processing function is oftentimes handled by
a third party processor.
o Network Service Provider: organization that aids in the card authorization
and settlement process.
The Figure below depicts a simple structure of these connections and exchanges,
representing how a card transaction typically operates. The issuing entity (“issuer”)
assigns a line of credit to the cardholder/consumer based on the cardholder’s income
and credit score, and the cardholder agrees to repay the lender for goods or services
purchased via the card and to make payments over time. When a cardholder makes a
purchase from a merchant, that merchant submits the transaction to the acquirer, which
in turn sends the transaction through the network service provider (“network”) to the
issuer for payment. The issuer subtracts the interchange fee and submits the net amount
to the acquirer through the network service provider, which then pays the merchant the
transaction amount net of the interchange fee and other possible fees the acquirer may
charge the merchant. Finally, the cardholder pays the issuer either at once or over time.
Transactions with debit cards are processed similarly to those with credit cards.

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Figure
Structure of the Credit Card Industry
Through this process of general purpose cards transactions, the network service
provider ensures the functionality of the system by setting the rules under which the
transfer of funds takes place between the issuer and the acquirer. The role of the
network service provider is fundamental, as it brings together the other four players in
the card transaction, facilitating both the consumer and the merchant sides of the
transaction.3
Hence, network service providers are multisided platforms, defined as
markets in which one or several platforms enable interactions between different types
of end-users, and try to get the two (or multiple) sides “on board” by appropriately
charging each side.
3. Covering the Costs of Providing Payment Systems
Network service providers are businesses, they need to cover the costs of providing
these services and the investment required to be able to provide such services, as well
3
Todd J. Zywicki, “The Economics of Payment Card Interchange Fees and the Limits of
Regulation,” George Mason University School of Law, ICLE Financial Regulatory Program
White Paper Series, June 2, 2010.

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as to make a profit. Evans and Abrantes-Metz (2013) cover several of these cost
features in detail in a report for the Portuguese market.4
At first, these costs are borne by the financial institutions, including banks and
infrastructure providers who, all together, provide the payment services. These
institutions then proceeed to recover costs from the consumers and merchants who
make use of the payments services.
To understand how financial institutions cover these costs it is important to have in
mind not only how consumers and merchants access these services, but also how they
are charged for such services. Consumers and merchants obtain payment services as
components of various banking services they access. It is common for banks to include
many payment services as part of the current account for consumers. In some cases
there may be separate charges but in other cases the service is included as part of a
bundle of services. These may contain charges for ATM services, transaction fees for
using debit or credit cards for making payments, and others. Under certain conditions,
some of these charges may be waved.
Banks also provide various services to merchants as part of their overall relationship.
This typically includes a merchant deposit account and card acceptance services, and
may also include a line of credit. Sometimes, the bank will offer discounted merchant
fees for accepting cards and processing card payments as part of its bundle. Larger
merchants are often able to negotiate lower fees for these services, due higher
bargaining power.
While consumers and merchants receive some services “for free” or at a discounted
price, banks ultimately must charge these customers enough to cover their costs and
profit from these services. Financial institutions need to decide not only how to allocate
costs for these various services among consumers and merchants, both jointly
benefiting from these services, but also how to allocate costs across different products
and services often provided as complex bundles to each of the sides, and sometimes
also subject to price caps and other specific regulations.
4
Rosa Abrantes-Metz and David S. Evans, “The Economics and Regulation of the Portuguese
Retail Payments System,” November 2013, available at
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2375151.

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The first point is common to many multisided platforms, as they provide services jointly
to several interdependent groups of customers (here, consumers and merchants).
Therefore, pricing to one side is not usually independent from pricing to the other side.
The second point refers to the decisions on how to recover these costs from the
provision of a complex bundle of services involving a differing and complementary set
of services and products. For example, if banks cannot charge consumers for ATM
services, they will recover the costs associated with those services through other fees,
and possibly not just from consumers, but also from merchants.
The fact that payment systems benefit consumers and merchants, and that both
consumers and merchants receive complex bundles of services, means that all these
prices across customers and across products are interelated. If revenue for one service
declines, or costs for that service increase, or if price caps affect one of the products on
one of the sides, financial institutions have basically three ways of adjusting: increase
the price, reduce the quality of that service or related services, or absorb the loss, with
likely distortion of customers’ choices and allocations. While banks may partially
absorb some of the losses, we do not expect they would absorbe the entirity of the
losses. Given that these are for-profit businesses, they are expected to pass along at
least part of cost increases or revenues losses to their customers.
Over the last decade, policymakers have been increasingly proposing and implementing
price regulation of various aspects of payment systems. Depending on the jurisdiction,
these include prohibitions against charging consumers fees for using ATMs, price caps
on fees for credit cards, prohibitions on charging late fees, and limits on interchange
fees.
There are reasons to expect that price regulation of payment systems is likely to produce
unintended consequences, leading to consumer harm and overall lower economic
performance. This is particularly true in this industry given the interdependency of the
various sides of the platform as explained above, and the complex various bundles of
products provided to each of those sides.

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4. Capping Interchange Fees: Theoretical and Empirical
Evidence
Concerns have been raised for years that interchange fees might be too high and non
transparent. With that in mind, a variety of proposed and actual regulations have been
put forward to address “the widely varying and excessive hidden interchange fees which
are an obstacle to the Single Market and a barrier to innovation,“ using the European
Commission as an example.5
It is unclear, though, what the ultimate consumer and
overall welfare consequences will be, not only from a static perspective, but also
dynamically when thinking about quality and innovation.
There is a wide economic literature studying every aspect of interchange fees. 6
On the
one hand, the literature has identified conditions under which issuers set an interchange
fee that leads to the efficient usage of cards.7
This would happen, for example, if issuers
were perfectly competitive, and the optimal interchange fee (meaning, the one that
results in efficient card usage) involved issuers charging cardholders a usage fee. But
on the other hand, the literature has also found conditions under which the structure of
the interchange fee leads cardholders to “overuse” credit cards and merchants to pay
“high” merchant fees. This may happen if merchants accept credit cards in order to
take away customers from their competitors, in which case card networks may set
higher merchant fees than when merchants’ card acceptance decision is based only the
technological benefits such as convenience and fraud control.8
More recently, the literature has focused on credit card policies that restrict merchant
choice, policies that can arise from the fact that consumers make membership and usage
choices, while merchants make only acceptance decisions. When there are no-steering
restrictions, these may lead to distortions in prices between the two sides, with the end
result of over-subsidizing card usage by consumers, at the expense of charging
inefficiently high fees to merchants.9
In addition, rules that prohibit merchants from
5
See https://ec.europa.eu/commission/presscorner/detail/de/MEMO_16_2162.
6
Abrantes-Metz, Rosa, Mike Cragg, Albert Metz, and Minjae Song, (2021), “Understanding
the Economics of Platforms,” The Antitrust Magazine, forthcoming.
7
Baxter, William (1983), “Bank Interchange of Transaction Paper: Legal and Economic
Perspectives.” Journal of Law and Economics, 26(3): 541-588.
8
Rochet, Jean-Charles and Jean Tirole (2002), “Cooperation Among Competitors: Some
Economics of Payment Card Associations.” RAND Journal of Economics, 33(4): 549-570.
9
Bedre-Defolie, Ozlem and Emilio Calvano (2013), “Pricing Payment Cards.” American
Economic Journal: Microeconomics, 5(3): 206-231.

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surcharging on credit card transactions, can also result in over-usage of credit cards and
inflated retail prices.10
In general, price caps that reduce interchange fees have two offsetting effects. First,
they shift the cost of the payment system from merchants to consumers, due to the
interdependency of the two sides, meaning that any reduction in revenue from one side
of the platform is expected to increase the direct cost on the other side and/or reduce
the quality of the services provided. Second, with lower costs incurred by merchants,
they might reduce the price charged to consumers or increase the quality or quantitity
of the services. At the end of the day, it is primarily the passthrough rate of the
merchants’ savings to consumers due to lower interchange fees that will play a
determining role on whether consumers benefited or lost from these price caps on
interchange fees.
The international experience with the regulation of interchange fees is also informative
as to what effects may we observe when caps on interchange fees are imposed. Studies
of Australia, Spain and the United States systems document that reductions in
interchange fees have resulted partly in banks taking lower profits but also, as
economists would expect, banks recovering some of their losses through increased fees
and reductions in product features, thereby depriving consumers of benefits. It also
appears that merchants have kept a significant part of the cost savings they receive for
themselves.11
A study for the United states shows that some banks eliminated
previously free bank accounts, closed branches, and increased other bank fees as a
response to caps on interchange fees. After accounting for the possibility that
merchants lowered prices to consumers as a result of lower card fees, this study
estimated that the increased costs incurred by consumers represented more than $10
10
Edelman, Benjamin and Julian Wright (2015), “Price Coherence and Excessive
Intermediation.” Quarterly Journal of Economics, 130(3): 1283-1328.
11
Howard Chang, David S. Evans, and Daniel D. Garcia Swartz (2005), “The Effect of
Regulatory Intervention in Two-Sided Markets: An Assessment of Interchange-Fee Capping
in Australia,” Review of Network Economics, 4 (4): 328 – 358; Iranzo Juan, Fernández
Pascual, Matías Gustavo and Delgado Manuel (2012), “The Effects of the Mandatory
Decrease of Interchange Fees in Spain,” MPRA Paper No. 43097; David S. Evans, Robert E.
Litan, and Richard Schmalensee, “Economic Analysis of the Effects of the Federal Reserve
Board’s Proposed Debit Card Interchange Fee Regulations on Consumers and Small
Businesses”, David S. Evans, ed., Interchange Fees: The Economics and Regulation of What
Merchants Pay for Cards, Boston: Competition Policy International, 2011.

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billion for the first two years, as merchants retained a significant portion of their cost
savings due to the caps in interchange fees.
Retrospective studies are important to provide the empirical evidence to date on the
impact of these regulations and their effect on competition and consumer welfare.
Hopefully they can also provide important guidance for future decisions on antitrust
and regulation.