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Regulating debit cards: the case of ad valorem fees

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  • Zhu Wang

Abstract

Debit cards have become an indispensable part of the U.S. payments system, accounting for more than a third of consumer payments at point of sale. With this development has come controversy: Card networks charge merchants fees that merchants believe are too high. And most of the fees are ad valorem that is, based on transaction value rather than fixed fees per transaction. ; Given that debit cards incur a fixed cost per transaction, why do networks charge ad valorem fees? How do ad valorem fees affect payment market participants, including consumers, merchants, and card networks? And should policymakers consider regulating debit cards by requiring fixed per-transaction fees? ; Wang explores this controversy about debit card fee structures. His analysis shows that, when card networks and merchants both have market power, card networks earn a higher profit by charging ad valorem fees than fixed per-transaction fees. At the same time, merchant profits are reduced yet both consumer surplus and social welfare are increased. As an alternative, policymakers might consider regulating the debit fee structure simply by requiring fixed per-transaction fees (but allowing card networks to freely set the fee levels). Wang suggests, however, that this alternative may increase merchant profits at the expense of card networks, consumers, and social welfare. Therefore, caution should be taken when policymakers consider intervening in the debit card market.

Suggested Citation

  • Zhu Wang, 2010. "Regulating debit cards: the case of ad valorem fees," Economic Review, Federal Reserve Bank of Kansas City, vol. 95(Q I), pages 71-93.
  • Handle: RePEc:fip:fedker:y:2010:i:qi:p:71-93:n:v.95no.1
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    References listed on IDEAS

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    1. Hayashi Fumiko, 2006. "A Puzzle of Card Payment Pricing: Why Are Merchants Still Accepting Card Payments?," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-31, March.
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    4. Zhu Wang & Fumiko Hayashi, 2011. "Product Innovation and Network Survival in the U.S. ATM and Debit Card Industry," 2011 Meeting Papers 725, Society for Economic Dynamics.
    5. Fumiko Hayashi & Richard J. Sullivan & Stuart E. Weiner, 2006. "A guide to the ATM and debit card industry - 2006 update," Monograph, Federal Reserve Bank of Kansas City, number 2006agttaadci2, August.
    6. Julian Wright, 2004. "The Determinants of Optimal Interchange Fees in Payment Systems," Journal of Industrial Economics, Wiley Blackwell, vol. 52(1), pages 1-26, March.
    7. Fumiko Hayashi & Stuart E. Weiner, 2006. "Interchange fees in Australia, the UK, and the United States : matching theory and practice," Economic Review, Federal Reserve Bank of Kansas City, vol. 91(Q III), pages 75-112.
    8. Terri Bradford, 2008. "Developments in interchange fees in the United States and abroad," Payments System Research Briefing, Federal Reserve Bank of Kansas City, issue Apr.
    9. Jean-Charles Rochet & Jean Tirole, 2002. "Cooperation Among Competitors: Some Economics Of Payment Card Associations," RAND Journal of Economics, The RAND Corporation, vol. 33(4), pages 549-570, Winter.
    10. Baxter, William F, 1983. "Bank Interchange of Transactional Paper: Legal and Economic Perspectives," Journal of Law and Economics, University of Chicago Press, vol. 26(3), pages 541-588, October.
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    Cited by:

    1. Oz Shy, 2012. "Who gains and who loses from the 2011 debit card interchange fee reform?," Public Policy Discussion Paper 12-6, Federal Reserve Bank of Boston.
    2. Oz Shy, 2014. "Measuring Some Effects Of The 2011 Debit Card Interchange Fee Reform," Contemporary Economic Policy, Western Economic Association International, vol. 32(4), pages 769-783, October.
    3. Kim, Young Sik & Lee, Manjong, 2016. "Who should bear the resource cost of electronic transaction?," Journal of Macroeconomics, Elsevier, vol. 47(PB), pages 270-280.
    4. Oz Shy & Zhu Wang, 2011. "Why Do Payment Card Networks Charge Proportional Fees?," American Economic Review, American Economic Association, vol. 101(4), pages 1575-1590, June.

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