Paying for Payments: Free Payments and Optimal Interchange Fees

Søren Korsgaard

Research output: Working paperResearch

Abstract

Do consumers and merchants use the most efficient payment instruments? I examine how interchange fees, which are fees paid from merchants' banks to consumers' banks when card transactions take place, influence the choice between cash and payment cards. I show that when consumers do not pay transaction fees to banks - a common feature in bank contracts - card use is declining in interchange fees, and surcharging does not neutralize interchange fees. According
to my model, banks set interchange fees at too high a level, resulting in too few card payments. I derive an optimal interchange fee which depends only on the relative costs of producing cash and card payments and can be used by regulators to assess privately set interchange fees. When calibrated to cost data, the model implies an optimal fee that is low and may even be negative. The findings are consistent with empirical evidence of high card usage in countries with no
interchange fees and have implications for the regulation of interchange fees.
Original languageEnglish
Place of PublicationFrankfurt am Main
PublisherEuropean Central Bank
Number of pages38
ISBN (Print)9789289910903
Publication statusPublished - Jun 2014
SeriesEuropean Central Bank. Working Papers (Online)
Number1682
ISSN1725-2806

Bibliographical note

This paper was submitted and accepted for the bi-annual retail payments conference titled “Retail Payments at a Crossroads: Economics, Strategies and Future Policies” organised by the European Central Bank (ECB) and the Banque de France (BdF), on 21 and 22 October 2013 in Paris.

Cite this

Korsgaard, S. (2014). Paying for Payments: Free Payments and Optimal Interchange Fees. European Central Bank. European Central Bank. Working Papers (Online), No. 1682 https://www.ecb.europa.eu/pub/research/authors/profiles/soren-korsgaard.en.html