Visa & Mastercard vs Merchants : What you don't know about the $30 Billion settlement over credit card fees

In a move that could reshape the world of credit card payments, Visa and Mastercard recently settled a massive $30 billion lawsuit brought on by merchants. This settlement comes after nearly two decades of frustration for businesses, who have long contended with high "swipe fees" charged by these credit card giants, which have monopolised credit card payments in the US. These swipe fees, which is nothing but a cut of every transaction made with a Visa or Mastercard card, eat into merchant profits and ultimately impact the prices we pay as consumers. The lawsuit aimed to force lower swipe fees, and while we delve into nitty-gritties of the details of the settlement are still unfolding, it represents a significant victory for merchants in their fight for a fairer playing field.

This issue of the Fintech Chronicler dives into:

• The decades-long battle for lower swipe fees by merchants.
• Key terms of the settlement and their real-world impact.
• The real reason behind why MasterCard and Visa chose to settle.
• How the lawsuit might affect credit card giants' profits and your rewards programs.
• Whether Rupay can disrupt the Visa-Mastercard duopoly.

And here is a TL;DR for those of you in a hurry?

So let's dive right in.?

Brief History of the case merchants raised against MasterCard and Visa

Tapping, Swiping or clicking away your card, to make those every day payments feels like such a breeze right? But while it may not cost you or me anything, somebody somewhere is footing the bill for processing those seamless transactions. And it is mostly small businesses and retail shopkeepers.

Visa and Mastercard have agreed to a whopping $30 billion antitrust settlement to put a lid on credit and debit card fees for merchants in the United States, potentially leading to some sweet savings for merchants, and who knows maybe even something for their loyal customers? If the courts signs off, this deal would put an end to most of the claims in a massive lawsuit that kicked off back in 2005, nearly two decades ago. For ages, merchants have been crying foul over the duopoly - Visa and Mastercard's sky-high swipe fees and interchange fees on credit and debit card transactions. On top of that, these card giants have been playing dirty by preventing merchants from nudging customers in the direction of cheaper payment methods through their "anti-steering" rules. According to Bankrate.com , swipe fees usually consist of modest fixed charges along with a percentage of the total sale amounts, typically ranging from 1.5 percent to 3.5 percent per transaction.

Under the settlement, Visa and Mastercard would reduce swipe rates by at least four basis points (0.04 percentage points) for three years and ensure an average rate that is 7 basis points below the current average for? the next five years. After that, well, because there isn't much clarity coming out I would assume that the card networks would be free to raise the rates again to their current levels?

To Know more about card network fees, refer to my MANIC post.?

But according to the settlement, merchants will have more discretion to impose surcharges on cards with higher interchange fees. Which directly means, higher variants of cards, apart from charging a higher joining and annual fees, would also attract (most probably) a surcharge for their customers at the point of check out.?

I, for one, don't really think this will happen any time soon in the US. Why? I mean, who do you think has more spending power? A customer with a premium credit card that has a higher limit, or those with a basic card and pretty low limits? And obviously you don't wanna leave those high paying potential customers feeling disgruntled, because you asked them to pay an extra 3-7 basis points right ?

Well, let me tell you, the fee reductions and limits are no joke - they add up to a whopping $29.79bn, as stated in those legal documents. And can you believe it? Visa and Mastercard actually crunched the numbers and found out that over 90 percent of the merchants benefiting from this settlement are small businesses. It's a big win for the little guys!

And oh, Visa and Mastercard as they settle, they also kinda deny any violation of antitrust that they merchants levied against them. Classic move, you guys!

What are Swipe Fees ?

But the big question is, why are swipe fees such big thing. And what really are swipe fees?? According to a Nilsan report, merchants in the US paid $172 billion in order to process transactions worth $11.2 trillion last year. That's about 1.56 percentage of the total transaction value. And 79% of that goes to the card networks- Visa, mastercard, considerig they hold a duopoly in the card transaction processing system.

But, what exactly is Swipe fees? Let us use the 5 levels of difficulties in getting to it.

Level 1: Toddler

Have you ever set up a lemonade stall? Wasn't it fun selling all those lemonades?

But, if you had someone helping you with collecting those big notes, reasonably they would have asked you for a tiny cut of what you made at the stand right? That tiny sip is called the MDR or swipe rate.

Swipe, because that is how cards used to be processed at the merchants end earlier,.?

Level 2: Teenager

Remember how Commissioner Gordon sometimes needs to use special channels to get Batman access to police files to bust those pesky Gotham villains?

Well, using your cards at a store is kind of similar. The store owner would wanna serve all customers while keeping those pesky criminals and fraudsters at bay. That's where the MDR comes in. It's like a small fee the store pays to access a special network, like a high-tech Batcave computer system, that checks your card info and makes sure everything's legit. It might seem like a tiny fee the store loses, but it helps catch fraudsters and keeps the whole payment system safe, just like Batman keeps Gotham safe.

Level 4: University Graduate

The MDR isn't a one-person show, unlike Joey's acting career. Several players are involved:

• Merchant (Monica): The business that accepts card payments and pays the MDR. If only Monica charged for all the times she organised the group.
• Acquirer (Monica's Bank): The merchant's bank that processes the transaction (like processing rent payments) and receives the MDR.
• Issuer (Chandler's Bank): The customer's bank that issues the credit or debit card (like Chandler's account that gets charged).
• Payment Processor (Central Perk's Payment Terminal): The company that provides the technology and infrastructure for card transactions (think the machine that swipes your card).
• Card Network (The Phone Company): Visa, Mastercard, etc., that facilitate the transaction (like the phone company connecting the call) and set interchange fees.

The MDR is a negotiation between these characters. It can be a fixed percentage (like a flat rent), a tiered rate based on transaction size (like higher rent for bigger orders), or a combination. Understanding these components helps Monica (and other merchants) optimize their processing costs and negotiate better rates, ensuring everyone (except maybe Ross with his leather pants) gets a fair deal!

Level 5: Expert (like? Walter White from Breaking Bad)

Just like everyone wanted a cut of Walter White's blue sky, there's a hidden fee (MDR) when you swipe your card. Here's the deal:

• The Store (Los Pollos Hermanos): They accept your card, but a piece disappears - the MDR, like a mysterious tax.
• The Store's Bank (Gus's Bank): They process the transaction and pocket the MDR, similar to Gus skimming profits.
• Your Bank (Jesse's Bank): They pay a fee to the store's bank, kind of like a rival gang cut for using their territory.
• The Card Machine (Walter's Lab): This processes the transaction.
• The Card Network (The Cartel): Visa/Mastercard control the flow and set fees, like the cartel with blue sky.

The MDR is negotiable, not fixed. Businesses have to hustle for the best rates, ensuring they don't end up "blue" from hidden fees!

Visa and MasterCard Market share of credit cards in the US

In the US there are only 4 processors, with Visa is killing it in the U.S. market with a whopping 61.6% share in 2021, more than double of closest rival MasterCard who them had 25.7% marketshare.?

And together, they kind of did set the merchant discount rates at around 2-3%, depending on the card variant, for merchants.?

But just given the high acceptance of both, it made sense. In fact, a study at Taco Bell found that introducing credit cards increased the average ticket sizes people spent per order at their stores .?

However, over time, that promise of increased revenues, came with increasing costs. SO much so, that some merchants claimed that their swipe fees was the highest cost item for them, even more than rent (although they did admit to getting a substantially low rental deed done during the peak of COVID).?

And that is what propelled the class action litigation against the payment network, with a $30 Billion settlement over credit card fees.?

Btw, if you thought this was huge win for merchants, Think again.?

This amount is spread out over a period of 5 years, and a part of the amount will also go towards retailers education on the different payment modes, beyond just cash and their benefits. Meaning more business for the card? networks!?

Also, Visa's annual revenue for the year ending in 2023 was $32.65 Billion, while MasterCard made $25.12 Billion. What I found out was that while network fees was indeed the biggest revenue line item, they also had a bunch of growing businesses too. Topic for another time for sure.?

The real reason behind the settlement?

But, all that said, $30 Billion is still a high amount to settle. So what was the incentive? Can't be the generosity of their hearts, or a sudden empathy developed for small merchants and retailers could it ? It could be the court? mandated "Education of merchants" acting a segue to them getting more deeply ingrained into the merhcant's ecosystem. But no.

What the card duopoly hoped was this settlement will result in merchants pulling support from the credit card competition act which Senators Dick Durbin and Roger Marshall are hoping to bring to vote this year.?

So,? if this legislation passes, big banks with over $100 billion in assets will have to give merchants the option to choose between two different transaction processing networks. One of them can be good ol' Visa or Mastercard, but the other has to be a different network. Lawmakers are calling out the fact that these two giants basically run the credit card show, with over 85% of the market share and control of a whopping 576 million cards.

Another interesting aspect is the proposal to set up a nationalised payment network, taking a leaf from India, with NPCI's Rupay card.?

Indian Card landscape: Has Rupay managed to break the duopoly of Visa - Mastercard in India?

Now, that brings us to, has rupay truly been able to break teh duopoly of card networks in India ?

Now, as per a Bloomberg report from the end of 2022, when RBI had introduced a ban on both the leading networks, Rupay had a 20% market share of cards in force. Inclusive of both Credit and debit cards.?

However, the way it went about achieveing that was not through pure play competition.? If you remember, our honorable Prime Minister had introduced Jan Dhan Accounts back in 2016? Well, if anyone opted for a debit card physically, they were only issued Rupay. And upon reaching a particular account balance, you also become eligible for a credit card, which you guessed it, happened to be Rupay.?

However, a lot of these weren't really active cards. So if you check RBI's stats for the month of March 2024, then Rupay's share has fallen to 14%. Still impressive given its a 6 year old network.

Coming to the merchant acceptance side, because the MDR on Rupay is very very low (0.8% for debit cards, 1.2% for credit cards) that has also been prettty easy to garner.

Who takes a cut of the Merchant Swipe fees ?

So, the next important question to ask really is, who gets paid what through these payment processing fees ? Here is a quick snapshot of it all, since I was in a bit of hurry, running behind my usual publishing schedule.

Now, if you wanna know why is it that issuers get such a big cut, that is topic for another discussion. But let me know and I'll do a deep dive into that as well.?

How are Credit Card reward programs Funded?

So, the fees that issuers charge mercahnts is ostensibly what fuels all those free lounge accesses and discounts isn't it? Well, not entirely. A study in 2022 by Kellogg School of Management found that most of the revenues which cross subsidised reward programs came from revolving credit card users. ?? In fact, in some issuing banks, the credit card transactors enjoyed rewards to the tune of $750 per card, thanks to the debt that revolvers had piled on to their cards, and then eventually paid off.?

Feels criminal right now??

Another source of cross subsidy of our rewards? As my friend, Abhishek Marda pointed out, comes from the lower end of the economy. Those users who transact on cash. becuase at the store front, teh differentiation is not yet there, to add a surcharge to non-cash based payments.

But this class action suit and its settlement looks to change that now.

That is it for this edition of the Fintech Chronicler. next week, we shall chronicle about the biggest crypto event of the year, Bitcoin Halving. And why this it really is different. So stay tuned.?