Low-income consumers are paying more than their share of the transaction cost bill that comes with expensive credit card rewards programs.
Premium credit cards that accumulate travel points and other perks cost merchants more than basic credit cards and experts say those costs are passed on in higher prices, the burden of those swipe fees higher falls unequally on low-income people who tend to pay by cash, debit card or basic credit card.
“Banks cost us a fortune and in many cases this is paid for by the poorest. Payments play a huge role in this,” said Andreas Park, professor of finance at the University of Toronto and director of research at the Financial Innovation Lab at the Rotman School of Management.
“People like me (who have premium rewards cards) get perks on the backs of the poor. That’s not true.”
Park said there was a “massive” redistribution of the cost of these rewards programs, pointing out research published last year by two senior economists from the Bank of Canada as well as economists from the Federal Reserve Banks of Kansas City and Boston.
What the research says
The researchers found that low-income consumers bear the highest net cost for payments as a percentage of transaction value compared to high-income consumers, who have greater access to credit cards. (It’s much cheaper for merchants to accept cash and debit.)
The net cost of payments includes the cost of merchants accepting credit cards (which is generally passed on to customers), the fees paid to financial institutions for processing these transactions, and the value of rewards points that some consumers receive.
“Consumers have a very limited awareness that their individual payment preferences generate costs for everyone,” said Angelika Welte, one of the Bank of Canada’s economists at a Rotman conference on payments in May 2021 (she noted that she was not speaking on behalf of the Bank of Canada itself).
The net cost of payments per dollar spent was 1.78% for Canadian consumers with incomes below $25,000, Welte said during his presentation of the research.
For consumers in the highest income bracket over $135,000, who tend to receive more value from credit card rewards, the net cost of payments was 1.21%.
How Credit Card Transactions Work
Visa and Mastercard, the major credit card networks in Canada, set the interchange rates that merchants pay to accept credit cards.
But it is the banks that issue the credit cards that collect these interchange fees, which represent the vast majority of transaction costs. Interchange fees help cover the costs for the bank to offer rewards.
In addition to interchange fees, smaller fees are charged to the credit card networks themselves and the merchant’s payment processor. These are companies such as Moneris (a joint venture of Royal Bank of Canada and Bank of Montreal), Clearly Payments and Square.
Interchange fees vary by circumstance – it costs more to accept payment over the phone than in person, for example – but are almost always higher for premium cards, most of which include a minimum annual income and spending thresholds for cardholders.
According to the most recent posted rates for Visa in Canada, the interchange fee for accepting a regular Visa credit card in person is 1.25% while the fee for a Visa Infinite Privilege card is 2.08%. For basic Mastercard credit cards, the interchange fee on in-person sales is 0.92%, while the premium Muse card comes with a 1.65% fee.
The Canadian Bankers Association, a lobby group that represents the country’s major banks, would not comment on the issue of premium credit cards that drive up overall prices and have an outsized impact on low-income consumers.
Visa and Mastercard also did not comment.
What could change?
As part of a legal settlement, Visa and Mastercard recently allowed Canadian merchants to pass on the cost of swipe fees to customers at an additional cost. Under the new rules, companies can also choose to overcharge premium cards only.
“It’s just not feasible,” said Gary Sands, senior vice-president of the Canadian Federation of Independent Grocers, noting that it’s very difficult for retailers to tell the point of sale what type of card a customer used.
Sands said the surtax is not the solution and he wants the federal government to live up to a promise made reduce the overall cost of credit card fees (as of 2020, credit card companies have voluntarily agreed to reduce the cost of credit card transaction processing fees to an average of 1.4%).
Welte said reducing credit card rewards along with the interchange fees that pay them could benefit low-income consumers because merchants could pass on fewer costs to prices.
However, she noted that the payments ecosystem is extremely complicated and changes could have unintended consequences. Reducing interchange fees, for example, could encourage banks to stop issuing credit cards to the most modest customers.
Park called for more innovation in payments, citing the example of Brazil, where the central bank has led the way in building an ultra-low-cost, real-time payment system. (A real-time payment initiative in Canada was delayed earlier this month and the federal government continues to consult on open banking.)
“Basically what banks do is move bits and bytes around,” Park said of the primary role financial institutions play in transactions. There are also costs associated with protecting against fraud, he said, but added: “It’s all real, but it doesn’t justify the revenue banks derive from payments alone.”
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