Pricing Payment Cards

In a payment card association such as Visa, each time a consumer pays by card, the bank of the merchant (acquirer) pays an interchange fee (IF) to the bank of the cardholder (issuer) to carry on the transaction. This paper studies the determinants of socially and privately optimal IFs in a card scheme where services are provided by a monopoly issuer and perfectly competitive acquirers. We develop a framework that distinguishes card membership from card usage (transaction) decisions (and fees). In doing so, we reveal the implications of a structural asymmetry between consumers and merchants: the card usage decision at a point of sale is ultimately delegated to cardholders. Merchants are not allowed to turn down cards once affiliated with a card network. We show that this asymmetry induces the card association to set a too high IF creating scope scope for regulatory interventions, e.g., caps on IFs. These qualitative results are robust to imperfect issuer competition, imperfect acquirer competition, and to other factors affecting final demands, such as elastic consumer participation or strategic card acceptance to attract customers