Credit Card Rewards Have a Bright Future as Visa, Mastercard and Discover Prepare to Raise Merchant Fees

I’ve argued that the biggest threat to rewards credit cards is that interchange fees, the percentage of each transaction that the banks and payment networks take, will fall.

Currently banks work hard to incentivize consumers to use their cards, in order to earn these fees (as well as the chance of earning APR from customers who don’t pay off their cards in full each month). They’ll buy miles from airlines or points from hotels, or offer cash back, or entice with other rewards. It’s a competitive business and the most lucrative cards are giving consumers back nearly everything (and sometimes even everything) that the banks take in.

If interchange fees fall, it will no longer make as much sense to pay out rewards. That’s what happened to rewards debit cards. The Durbin Amendment to Dodd Frank financial reform legislation banned earning a profit on debit cards.

  • As a result banks largely stopped offering rewards for using a debit card — it no longer made sense to spend money to get consumers to push transactions onto a product which wasn’t making money.

  • Since debit cards were no longer profitable, that made many checking accounts no longer profitable. Banks started insisting on minimum balances or payroll direct deposit before waiving fees. That pushed some consumers out of the banking system and into check cashing stores and elsewhere. (Incidentally the idea behind American Express Bluebird and Redbird was to offer a product that earned higher fees, circumventing the Durbin Amendment, while offering better service to the unbanked — and meeting them where they already are, Target and Walmart. How on earth American Express failed to profit on this I cannot figure.)

There are (3) ways that interchange rates for credit cards could fall.

  1. Competition. Already we’re seeing big merchants like Costco, Amazon, and others negotiate very low credit card processing costs. American Express is voluntarily lowering rates to entice small businesses to accept their cards.

  2. Regulation. Australia and Europe have regulated interchange and their credit cards are far less rewarding as a result. Incidentally this hasn’t reduced consumer prices. We’re not likely to see regulation here out of a Trump administration, but it could become a priority for a future Democratic administration.

  3. Technology. This is in some ways a subset of competition. New payment technologies drive down the cost of processing payments, there won’t be as much of a margin to support rich rewards.

My long-term view has been that interchange rates are much likely to be lower 10 and 15 years from now than higher. That was almost an unheard of perspective when I started talking about it a few years ago, now it’s not all that controversial.

However what’s interesting to see is that the opposite seems to be happening. The Wall Street Journal is reporting that Visa, Mastercard, and Discover are set to raise interchange rates slightly this spring. That’s the opposite of what I’d expect, and it will be interesting to see how sustainable this is.

Ultimately whether current or increasing interchange rates are sustainable is crucial to airline and hotel businesses. Marriott used their new credit card deal to help cement hotels together in the new loyalty program. American Airlines only made money in 2018 because of their credit card deal, and not overall from flying airplanes. The biggest airline co-brand agreements are bringing in over $3 billion in revenue each year.

About Gary Leff

Gary Leff is one of the foremost experts in the field of miles, points, and frequent business travel - a topic he has covered since 2002. Co-founder of frequent flyer community, emcee of the Freddie Awards, and named one of the "World's Top Travel Experts" by Conde' Nast Traveler (2010-Present) Gary has been a guest on most major news media, profiled in several top print publications, and published broadly on the topic of consumer loyalty. More About Gary »

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  1. It’s clear consumers spend more money when using credit cards. It makes sense that businesses want to incentivize this behavior.

  2. Eventually the banks will figure out that the best bang for their marketing buck is to incentivize the customer and not the airlines. Why should a bank pay an airline more than the points are worth to their customer? It’s more efficient to give those point acquisition dollars to the customers to spend on whatever junk fees they are paying multiple airlines. Then the bank tells the airline if you want us to market your partnership to OUR customers then we’ll pay you 80 cents on the dollar when we reimburse those fees to you. Now the banks are making money on the airlines instead of the other way around. The big banks have been carrying airlines too long. It’s time to just let the weak ones go under.

  3. Doesn’t it smack of collusion when multiple payment systems all increase their rates at the same time?

  4. “Regulation. Australia and Europe have regulated interchange and their credit cards are far less rewarding as a result. Incidentally this hasn’t reduced consumer prices.”
    Gary this is right and wrong at the same time: When i was a child in Germany there was always a huge surcharge when you wanted to use a credit card in Germany! Now the price for cash, debit cards and credit cards is the same. People who used credit cards, when they did not have to, where considered to be dumb!

  5. I know this is not an investing blog, but….very long V & MA. Get on the train…. these are great stocks to own and have made me huge profits. They still have a HUGE runway for growth.

  6. OMG, has no one heard of disruptive technologies?

    V, MA and DSC raising fees is like a huge greenlight for Paypal, Applepay et al. This is a space bursting with emerging competitors already.

    How long do you think it will be before someone like Applepay realizes they do not need to pay the CC company to be the intermediary? Just wait until Hilton offers Diamonds 1000 points / night to send the bill to their checking accounts.

  7. @ gary leff – you misunderstand the point of the regulation of card fees in europe – the expectation was never that prices would immediately drop; it doesn’t make sense in most businessses to change your prices over a 0.7% change. But in the medium term, with any inflation at some point the businesses will have to choose to raise their prices to keep up with inflation and this lowering of the business’s costs will allow them to wait longer to put prices up and by less when they do. And the same will be true the following time they need to raise their prices. and the following time etc..

    TLDR, short term stickiness of prices doesn’t mean the long run affect won’t be good.

  8. @ Gary – in what way is it a stretch? if your costs go down in one area, it means others can rise more before you have to raise them? that does mean lower prices for customers, and so is consistent with the arguments

  9. When I was in Sydney my hotel charged me 2% extra for using a credit card I found this out when I was checking out, not when I made the reservation with a credit card, not when I showed up at the hotel. How do I you pay for 5 nights with out a credit card? bring cash from usa?

  10. Iceland is a heavy user of credit / debit cards. Pumping petrol there is done 24 hours a day with out an attendant at the station. Credit cards are used all the time and you need the chip.

    Businesses like credit cards vs cash because they are not robbed like cash is. Employees give back the wrong change all the time. Employees have been robbed and shot going to the bank to make deposits. Cash has to be counted at the register when opening, during the day, when closing, when cashing out for the day, when making the deposit and when reconciling the cash compared to the books. Change has to be maintained in the right amounts, pennys nickles dimes ones, fives. . etc. fake bills are common.

    With credit and debit cards swipe and cash goes into bank account. NOT all the problems like cash.

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