How strong are merchant constraints on interchange fees?

This paper examines the ability of merchants to affect their customers’ choice of payment method. We demonstrate that merchants have a number of ways for steering their customers away from payment methods that are ‘expensive’ for the merchant, and that they generally should have incentives to do so provided that the administrative costs associated with such steering are not too high. We show that the benefits from steering are potentially large if customers are more likely to switch to another payment method than they are to switch to another retailer, and provide empirical evidence that this is indeed the case. This implies that merchants’ ability to affect their customers’ choice of payment method is an important constraint on merchant charges, which in four-party systems implies strong constraints on the setting of interchange fees.

The paper can be downloaded here

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