Tying in Two-Sided Markets and The Impact of the Honor All Cards Rule

Payment card associations Visa and MasterCard offer both debit and credit cards and, until recently, used to engage in a tie-in on the merchant side through the so-called honorall-cards (HAC) rule. This rule has come under attack on the grounds that the credit and debit card markets are separate markets and that the associations lever their market power in the “credit card market” to exclude on-line debit cards and thereby monopolize the “debit card market”. The objective of this article is to analyze the impact of the HAC rule. We construct a simple model of the payment card industry in which there are two types of transactions, debit and credit, and two platforms: one offering only a debit card, and the other offering both a debit card and a credit card. In this benchmark model we show that in the absence of HAC, the interchange fee (IF, the transfer from the merchant’s bank to the cardholder’s bank) on debit is socially too low, and that on credit may be optimal or too high (depending on downstream members’ market power). In either case, though, the HAC rule not only benefits the multi-card platform but also raises social welfare, due to a rebalancing effect: The HAC rule allows the multi-card platform to better perform the balancing act by raising the IF on debit and lowering it on credit, ultimately raising volume. The paper then investigates a number of extensions of the benchmark model to allow for varying degrees of substitutability between debit and credit; different structures of cardholders’ information about merchants’ card acceptance policies; merchant heterogeneity with respect to their customers debit/credit mix; and platform differentiation. While the HAC rule may no longer raise social welfare under all values of the parameters, the basic and socially beneficial rebalancing effect unveiled in the benchmark model is robust.