Yet More Financial Innovation

Andrew Martin has an article in The New York Times on the dynamics of the debit card industry. I don’t have any expert knowledge to add, but here’s the summary: Visa has been increasing its market share by increasing the prices it charges to merchants; it takes those higher transaction fees and passes some of them on to banks that issue Visa debit cards, giving them an incentive to promote Visa debit cards over other forms of debit cards. Not only that, there are different fees on debit cards depending on whether you use them like a credit card (signing for them) or like an ATM card (entering a PIN). Signing costs the merchant more, so the banks and Visa give you incentives to sign instead of using a PIN. The end result is higher costs for merchants, who pass them on to you.

Ordinarily this should create the opportunity for a new entrant (say, NewCard) to offer lower fees. But there are three problems that I can see. First, individual customers would have no incentive to use NewCard rather than Visa, since any savings get distributed across all customers of a given merchant (through lower prices). Second, there are massive technological and marketing barriers to entry. Third, even if merchants and customers want NewCard, the banks–the distributors of debit cards–don’t.

Tell me again, how does this benefit society? Theoretically having a couple of big transaction processing networks could lower costs relative to having a lot of smaller networks because of economies of scale. But we’re probably talking a couple of pennies per transaction there, while the fees that Visa charges are an order of magnitude bigger.

Originally published at The Baseline Scenario and reproduced here with the author’s permission.