The Bilateral Negotiation of Interchange Fees in Payment Schemes

This paper considers the consequences of changing one feature of card payment schemes: the centralised setting of the default interchange fee, a fee banks pay each other for debit and credit card transactions. The level and setting of the interchange fee is currently under investigation in a number of jurisdictions. Policy makers and competition authorities have expressed concern over the apparent “agreement between competitors” that arises when the banks that compete to supply services to cardholders and merchants also determine the interchange fee paid between themselves. Our analysis focuses on a market-based alternative to setting interchange fees centrally that avoids the “agreement between competitors” allegation – the bilateral setting of interchange fees. We show that a move to bilateral negotiation of interchange fees would expose acquiring firms to hold-up by small issuers and lead to an escalation of interchange fees.