The Costs and Benefits of Interchange Fee Regulation: An Empirical Investigation

We study the effect of government encouraged or mandated interchange fee ceilings on consumer and merchant adoption and usage of payment cards in an economy where card acceptance is far from complete. If the pre-regulatory interchange fee was optimal, any change in the interchange fee would result in lower aggregate welfare for consumers, merchants, and banks. Merchant acceptance of debit and credit cards increased when interchange fees were reduced via government intervention in Spain during a ten-year period. In addition, usage of credit and debit cards increased. Assuming that payment cards are preferred to cash transactions by cardholders and merchants when they choose to adopt and use them, we find that consumer and merchant welfare improved. Furthermore, we find that bank revenues increased suggesting that interchange fee regulation may also be beneficial to banks. Our welfare results are critically dependent on merchant acceptance being far from complete.