Overview of Recent Developments in the Credit Card Industry

by Douglas Akers, Jay Golter, Brian Lamm, and Martha Solt *

Since the 1980s, Visa U.S.A. (Visa) and MasterCard International (MasterCard), the bank-
controlled credit card associations that together account for approximately 70 percent of today's
credit card market, have been able to control the use of and access to their networks to the
advantage of their bank members. Recently, however, the credit card industry has been changing:1
some merchants are now large enough to exert their own leverage, legal defeats have impeded the
ability of credit card associations to control the market, and some participants have developed new
arrangements and alliances that may be a prelude to further changes in the industry. This article
surveys recent developments in an industry that is facing new competitive dynamics.

The article begins by describing the formation of the payment card industry and then its structure.
The article continues by explaining the functioning of credit card networks: the various kinds of
network models, and the significance of interchange fees in the most complex model. Next
discussed are recent industry-altering litigation involving Visa and MasterCard, and significant
aftereffects of the litigation. The article concludes by noting the main challenges facing the industry
today.

The Formation of the Credit Card Industry

Although merchant credit may be as old as civilization, the present-day credit card industry in the
United States originated in the nineteenth century. In the early 1800s, merchants and financial
intermediaries provided credit for agricultural and durable goods, and by the early 1900s, major
U.S. hotels and department stores issued paper identification cards to their most valued
customers. When a customer presented such a card to a clerk at the issuing establishment, the
customer's creditworthiness and status were instantly established. The cards enabled merchants to
cement the loyalty of their top customers, and the cardholders benefited by being able to obtain
goods and services using preestablished lines of credit. Generally these cards were useful only at
one location or within a limited geographic area–an area where local merchants accepted
competitors' cards as proof of a customer's creditworthiness.

In 1949, Diners Club established the first general-purpose charge card,2 enabling its cardholders to
purchase goods and services from many different merchants in what soon became a nationwide
network. The Diners Club card was meant for high-end customers and was designed to be used for
entertainment and travel expenses. Diners Club charged merchants who accepted the card 7
percent of each transaction. Merchants found that accepting Diners Club cards brought more
customers who spent more freely. The Diners Club program proved successful, and in the
following decade it spawned many imitators.

In the late 1950s, Bank of America, located on the West Coast, began the first general purpose
credit card (as opposed to charge card) program. At that time, banking laws placed severe
geographic restrictions on individual banks. Virtually no banks were able to operate across state
lines, and additional restrictions existed within many states. Yet for a credit card program to be able
to compete with Diners Club, a national presence would be important. To increase the number of
consumers carrying the card and to reach retailers outside of Bank of America's area of operation,
therefore, other banks were given the opportunity to license Bank of America's credit card. At first
Bank of America operated this network internally. As the network grew, the complexity of
interchange–the movement of paper sales slips and settlement payments between member
banks–became hard to manage. Furthermore, the more active bank licensees wanted more control
over the network's policy making and operational implementation. To accommodate these needs,
Bank of America spun off its credit card operations into a separate entity that evolved into the Visa
network of today.
In 1966, in the wake of Bank of America's success, a competing network of banks issuing a rival
card was established. This effort evolved over time into what is now the MasterCard network. In
addition, firms that were not constrained by interstate banking restrictions formed card networks on
the single-issuer model (the model established by Diners Club, in which many merchants accept
payments on a card with a single issuer; see the discussion of figure 2). For instance, the American
Express Company (American Express) introduced its charge card system in 1958, and Sears,
Roebuck and Co. (Sears) established the Discover Card credit card in 1986.3

Among the challenges each of these networks faced was bringing together large numbers of
cardholders with large numbers of merchants who accepted the cards as payment. Achieving a
sufficiently large network was hard, partly because merchants, especially larger retailers, were
reluctant to honor credit cards that would compete with their own store-branded credit cards. Some
smaller merchants, however, viewed general-purpose credit cards as a way they could compete
with larger merchants for customers.4 Merchants of all sizes were averse to having fees imposed
on them by the credit card network.

Currently the U.S. credit card industry is a mature market. Today credit cards are widely held by
consumers: in 2001 an estimated 76 percent of families had some type of credit card.5 Recent
estimates suggest that among all households with incomes over $30,000, 92 percent hold at least
one card,6 and the average for all households is 6.3 credit cards.7 Credit cards are also widely
accepted by merchants, and with the recent addition of fast-food and convenience stores to the
credit card networks, credit card payments are now processed at nearly all retail establishments.

The Structure of the Credit Card Industry

As noted above, the general-purpose card market is dominated by Visa and MasterCard, two bank-
controlled card associations. Table 1 shows the U.S. market share of the top four card networks,
with Visa and MasterCard together holding about 70 percent of the market share.

Table 1 - Total U.S. Transaction Volume

The four major card networks have a variety of corporate structures. Visa is a nonstock for-profit
membership corporation that as of 2004 was owned by approximately 14,000 financial-institution
members from around the world.8 Until 2003 MasterCard was a nonstock not-for-profit membership
association, but then it converted to a private-share corporation known as MasterCard Inc., with the
association's principal members becoming its shareholders. MasterCard has more than 23,000
members (including the members of MasterCard's debit network).9 The Board of Directors of Visa
is elected by the member banks with voting rights based primarily on transaction volume.10 Control
of the Visa and MasterCard card associations is roughly proportional to the transaction volume of
member issuing banks. American Express is an independent financial services corporation, and
Discover Financial Services (Discover) is now a subsidiary of investment bank Morgan Stanley
Dean Witter & Co. (Morgan Stanley).11

The issuance of credit cards is concentrated among five banks (table 2). Further concentration will
result from two acquisitions announced in June 2005: Bank of America is acquiring the holding
company MBNA Corporation, including its subsidiary MBNA America Bank, NA (MBNA), a
monoline credit card bank,12 and Washington Mutual, Inc. (Washington Mutual) is acquiring
Providian Financial Corporation, including its Providian National Bank (Providian), another
monoline credit card bank. The implications of these transactions are addressed below.

Table 2 - Top Bank Credit Card Issuers

In the industry today, debit cards are a fast-growing product line. Debit transactions reached a
record $15.6 billion in 2003 (see table 3). Debit cards are essentially ATM cards that can be used
on Visa, MasterCard, or other networks as well as at ATM machines. The amount of a payment
made using a debit card is immediately withdrawn from the cardholder's checking account, with the
result that, for the card issuer, both the opportunity to earn interest on revolving balances and any
inherent credit risk are eliminated.

Table 3 - Annual Number of Noncash Payments

The ability to use the Visa and MasterCard networks to post debit transactions was developed in
the 1970s, but not until the 1990s was there a significant volume of transactions in these systems.
If a merchant has a personal identification number (PIN) entry keypad at its sales location, the
transaction is routed much the way an ATM transaction is. In the absence of a keypad, the
merchant can have the customer sign a transaction authorization. These transactions then travel
through the payment systems much as a credit card transaction does (except that the cardholder's
bank will be informed of the transaction immediately and will be able to hold the customer's funds
until settlement is completed). The differing fees charged to merchants for transacting PIN debits
and signature debits became the basis for an important lawsuit that is described more fully below.

Control of debit card transaction processing is mostly in the hands of banks. In Germany, however,
half of all debit transactions are processed via a merchant-controlled debit card system by
piggybacking on the low-cost Automated Clearinghouse network, and the system has no
interchange fees. In the United States, Debitman Card Inc. has been working on such an effort for
PIN-based debit transactions.13

The Functioning of Credit Card Networks: Models and Interchange Fees

The most complex form of credit card network is the one with the greatest number of participants:
the multi-issuer card model. The cards in a multi-issuer network represent a complex form of two-
sided markets whereby merchants are more willing to accept cards that have many cardholders,
and cardholders want cards that are accepted at many establishments. The payment network
benefits the merchant and the buyer jointly and entails joint costs, and it must price its service so
that it gets–and keeps–the two sides participating in the network.14 It does this largely by setting
interchange fees at levels that will maintain balance in the incentive structures of issuing banks
(banks that issue credit cards) and acquiring banks (banks that service merchants and process
their credit card transactions).15 Interchange fees are collected by issuing banks when they send
payments for purchases to acquiring banks.

Network Models

Figures 1 through 3 illustrate the increasing complexity of a credit card network as more parties
participate. Figure 1 illustrates the simplest bilateral model, where information and funds flow
between a merchant and a cardholding customer when the merchant extends credit. On a monthly
basis, the merchant will present a bill to the cardholder listing all transactions for the month. The
cardholder then remits payment.

Figure 2 illustrates the single-issuer model, which has a more complex closed-loop card-
association system in which many merchants accept payments on a card with a single issuer. In
this system, the merchant sends information about each purchase, including the customer account
number, the transaction amount, and verification to the card issuer. With modern
telecommunications and data processing technology, these steps are usually completed at the
point of sale. The card issuer pays the merchant and sends a monthly statement to the cardholder
listing all transactions which occurred during the statement period. The customer then pays the
balance due, in whole or in part, based on the credit terms that were extended to the cardholder by
the issuer. This description applies to the original Diners Club model and, until very recently, to the
Discover Card and American Express models (which have now converted to the multiple-card-
issuer model, see figure 3).

Finally, figure 3 provides a basic illustration of the most complex model, the model with one card
association, many cardholders, many merchants, and multiple banks. In this model, the card
association (or network) plays an important role by imposing rules for issuing cards, clearing and
settling transactions, advertising and promoting the brand, authorizing transactions, assessing
fees, and allocating revenues among transaction participants. Further, each participant in the
credit card transaction has an incentive for participating in the network.16 Figure 3 shows the
typical flow of information and funds for a sample $100 credit card purchase. The process begins
when the cardholder presents the credit card to the merchant to purchase a good or service. The
merchant transmits to the acquiring bank the cardholder's account number and the amount of the
transaction. The acquiring bank forwards this information to the card association network
requesting authorization for the transaction. The card association forwards the authorization
request to the issuing bank. The issuing bank responds with its authorization or denial through the
network to the acquiring bank and then to the merchant. If approved, the issuing bank also sends
to the acquiring bank, via the network, the transaction amount less an interchange fee.17 The
interchange fee is established by the card association. The example illustrated in figure 3 shows
$98.00 ($100.00 purchase price minus 200 basis point interchange fee) flowing from the issuing
bank, though the network, to the acquiring bank. The acquiring bank, after subtracting its own
service fee, passes the payment on to the merchant.18 In figure 3, the merchant receives $97.50
($98.00 minus a 50 basis point fee).19

Acquiring banks can outsource these functions. One such company that provides outsourcing
services is First Data Corporation which handles over 50 percent of all MasterCard and Visa
transactions processed at the point of sale.20 The profit margins for servicing merchant processing
of credit card payments are thin,21 and the competition is based on discount fees, support services,
and the handling of chargebacks (which are the reversals of charges). The issuing bank bills the
cardholder for the full amount of the purchase and receives payment from the cardholder. The card
association receives a small fee, usually around $0.05, for each transaction.

Figure 4 lists the costs and benefits to each type of participant in the credit card industry. In order
to benefit from economies of scale, the card associations must construct rules that balance each
party's needs so that large numbers of participants of each type choose to join (and stay in) the
network. Over time, the dynamics among the various parties may change, with the result that
network policies may need to be reassessed.

Interchange Fees

Interchange fees are set by the card associations and in 2004 were a source of some $25 billion in
revenue to card issuers.22 At the same time, interchange fees are a source of irritation to merchants
and can be among the largest and largest-growing costs of doing business for many retailers.23 A
standard interchange fee is around 200 basis points, plus $0.10 per transaction, but many
transactions have lower fees and some have higher fees. Large merchants can negotiate directly
with the card association for very low interchange fees, but these fees are not publicly circulated.

The pricing structure of interchange fees is complex. The specific interchange fee depends on the
card association, the type and size of merchant, the type of card, and the type of transaction.
Merchants that sell low-margin items–for example, convenience stores, supermarkets, and
warehouse clubs–have lower rates. Hotels and car rental establishments have higher rates. Newer
premium credit cards that offer more rewards have high rates. Credit card transactions have higher
rates than signature debit card transactions, whose rates are higher than PIN debit card
transactions. Sales transacted over the telephone or Internet have higher interchange rates,
ostensibly to compensate for the greater risk of fraud associated with transactions that are not
conducted in person.

There is considerable friction among network participants over the issue of interchange fees, and
card associations are being challenged on the structure and application of those fees. Merchants
increasingly view interchange fees as an unnecessary and growing cost over which they have no
control. Furthermore, banks are now issuing credit cards with even higher interchange fees.
Merchants are unable to refuse transactions made with these cards. Therefore, merchants
perceive issuing banks as earning revenue at their expense, with no added value to merchants.
Merchants pass on the costs of interchange fees to their customers, who are largely unaware of
this cost.

Among other factors, the interchange fee structure that favors large merchants over smaller ones is
inspiring merchants to challenge the interchange system more actively. Early in 2005, merchants
formed a trade association for the purpose of changing interchange fees.24 In addition, Visa and
MasterCard will be defending the interchange arrangement anew from litigation filed in June 2005
by a group of smaller merchants.25

Despite merchant discontent, card issuers have incentives to maintain or increase interchange
fees. Issuers are marketing credit cards with reward or loyalty programs that encourage greater
card use and reinforce customer loyalty to the brand. An estimated 12 to 24 percent of cards held
by consumers have rewards associated with them,26 and in 2003 an estimated 60 percent of credit
card spending was attributed to cards with rewards.27 Card issuers are funding these increasingly
popular reward programs through interchange fees.

Figure 4 - Benefits and Costs for Participants in the Credit Card Industry

Outside the United States, Visa and MasterCard have come under additional pressures to reduce
interchange fees. Regulators in Australia, the European Union, Israel, and the United Kingdom,
among others, have reviewed the effects of interchange fees on competition. Overseas, Visa and
MasterCard have been pressured to reduce these fees.28

Significant Litigation against Visa and MasterCard and Its Aftereffects

As indicated above, when Visa and MasterCard were building their dominant credit card networks,
they imposed exclusionary rules and restrictions on other parties to credit card transactions. In two
cases, whose outcomes are described in this section, merchants and the U.S. Department of
Justice (DOJ) successfully challenged some of these practices. The decisions in the two cases29
weakened some barriers to competition and reduced the control exercised by the card
associations, thus influencing the future of the credit card industry. In fact, the aftereffects of the
decisions have already begun appearing.

Successful Legal Challenges

One case dealt with restrictions on banks' ability to issue cards that competed with Visa and
MasterCard. The other related to a requirement forcing merchants to accept all types of
MasterCard and Visa payment cards regardless of the fees associated with those transactions.

The decision in the first case prohibited Visa and MasterCard from banning member banks from
issuing cards on rival networks. This litigation ended in October 2004, when the U.S. Supreme
Court refused to hear an appeal of the case. The case began in October 1998 when the DOJ
claimed that Visa and MasterCard, by not allowing their member banks to issue credit cards on
other networks (including American Express and Discover Card), were limiting competition in the
credit card market and therefore violating the Sherman Antitrust Act.30

The second case illustrated merchants' unwillingness to accept conditions and costs unilaterally
imposed on them by the card associations. Some of the largest U.S. merchants–including Wal-Mart
Stores Inc. (Wal-Mart), Sears,, and Safeway Inc.–joined forces to battle rules imposed on them by
MasterCard and Visa. These rules required the merchants to accept for payment any card that had
the Visa or MasterCard logo. Merchants challenged the "Honor All Cards" rule because certain
types of cards–namely, signature debit cards–had significantly higher processing fees than PIN
debit cards, and merchants had no role in establishing these fees. Merchants argued that fees
should be established in some proportion to the risks that the transaction poses to the network. As
part of a 2003 settlement, Visa and MasterCard agreed to: pay retailers collectively $3 billion over
ten years, temporarily reduce debit card fees, permanently change the "Honor All Cards" policy as
it relates to debit cards, and establish lower transaction fees.31 The settlement did not address
requirements for merchants to accept premium credit cards.32

The primary significance of these cases is that merchants have become a much stronger
bargaining partner in negotiations over the responsibilities and fees associated with credit card
transactions. Merchants are no longer likely to tolerate quietly what they view as uncompetitive
practices or unreasonable fees imposed on them by the card associations. One can assume,
therefore, that the long and costly battle with Visa and MasterCard has not ended. Because
sizeable segments of the merchants' customer base will want to use credit cards for payment,
retailers will continue to have difficulty refusing to accept them, but by pursuing alliances with Visa
and MasterCard's competitors and by encouraging their customers to use cards with lower
merchant fees, merchants may find it easier to win cost concessions.

The Aftereffects: Recent Business Alliances and Developments

Already, merchants' freedom to refuse certain higher-fee cards and banks' freedom to issue any
type of credit card have generated new alliances in the reinvigorated credit card industry. Some
important deals have since taken place in the wake of the resolution of these cases. It remains to
be seen how successful these new partnerships will be.

American Express cards, marketed mostly to wealthy customers on the basis of the cards' superior
rewards program, are now offered by banks that were previously prohibited from offering those
cards. In January 2004, MBNA became the first major issuer of Visa and MasterCard in the United
States to offer American Express as an option to its customers;33 Citigroup Inc. followed suit in
December 2004,34 and USAA Federal Savings Bank in May 2005.35 In addition, a dual-branded
American Express and Visa card (a charge card for American Express, a credit card for Visa) that
provides a consolidated rewards program is anticipated to be offered by UBS in late 2005.36

Another dual-branded card was announced by MasterCard and the much smaller Diners Club.
Diners Club will reissue its cards to include the MasterCard number and to carry both the Diners
Club and MasterCard brand marks, with the cards processed as MasterCard transactions in North
America but continuing to receive the much superior Diners Club rewards. This deal creates more
transactions on the MasterCard system enabling greater economies of scale. It also may bring
additional cardholders and merchants into the MasterCard system.37 Diners Club and its
cardholders benefit because the card now will be accepted at almost three times as many
merchants.38

Discover also announced some potentially important deals. In January 2005, Discover announced
plans with Wal-Mart and GE Consumer Finance (a unit of General Electric Company) to launch a
new credit card on the Discover network.39 Wal-Mart will benefit from this arrangement because the
arrangement is structured in a way that enables the merchant to avoid paying interchange fees on
any transactions made on that card on the merchant's own premises. GE Consumer Finance, the
issuer for many large retailers' private credit cards, will issue the card–the first time that an entity
other than Discover has issued one of Discover's cards. Should the Wal-Mart–Discover Card
product prove successful, Discover may be able to persuade other stores to create similar
products, thereby extending the size of its cardholder base. However, this arrangement will not
provide Discover with much revenue on card transactions.

Earlier, in November 2004, Discover acquired the Pulse EFT Association for $311 million. Pulse is
the third-largest PIN debit network in the country and had been owned by the more than 4,000
financial institutions that were its members, with 90 million debit cardholders.40 Discover's
acquisition of Pulse provided Discover not only with a debit product but also possibly with a greater
opportunity to market its credit card product to Pulse's member financial institutions or directly to
their customers.

Consolidation among credit card issuers has increased. During a four-month period in 2005, the
three largest monoline credit card banks–MBNA,41 Capital One Financial Corporation (Capital
One),42 and Providian43 (the third, fifth, and seventh largest credit card issuers, respectively)–all
announced transactions that signaled significant changes in the structure of credit card issuers.
MBNA is being acquired by Bank of America, and Providian is being acquired by Washington
Mutual. In a mirror image of these transactions, Capital One is purchasing Hibernia Corporation,
the holding company for a regional bank.

These transactions will affect the structure of the credit card issuer market. Bank of America now
will become the largest issuer. Upon completion of each of these deals, the largest ten issuers will
control 90 percent of the market. Greater concentration among card issuers also means that a
smaller number of banks will control the card associations.

Conclusion: Challenges Facing the U.S. Credit Card Industry Today

The challenges facing the U.S. credit card industry are substantial. The largest U.S. merchants are
now better able to negotiate lower interchange rates from all networks and may pressure other
participants in the credit card transaction to lower costs. They could also develop innovative
arrangements to retain a greater portion of the revenue stream. Additionally, other merchants are
attempting to replicate these efforts. If successful, these developments could lead to a decline in
pricing flexibility for the interchange rate structure on which the multiple card issuer networks are
based.

At the same time, Visa and MasterCard's smaller competitors–Discover (the smallest of the major
card networks) and American Express–are facing challenges of their own. As noted above,
Discover has made moves that may give it access to the debit card market and opportunities to
increase its cardholder base; alliances with other large retailers eager to reduce interchange fees
may follow. Hindering Discover's efforts are lack of an international presence, limitations
associated with its less affluent customer base, and its small number of cardholders and
merchants. The future of Discover is largely dependent upon the objectives of its parent company.
Management of Discover's parent company, Morgan Stanley, and decisions about Discover's
continuing corporate relationship with Morgan Stanley have been uncertain since early 2005,
impeding Discover's ability to develop and execute a clear business strategy for its own future.

American Express has made progress in increasing its cardholder base.44 However, it is facing
new competition for its higher net worth customers from MasterCard's World and Visa's Signature
programs, both of which offer higher rewards than their traditional programs. The World and
Signature programs charge interchange rates that are lower than those of American Express but
higher than the two card associations' other programs.45 American Express may therefore find it
hard to maintain high fees, at least with some larger merchants. Finally, greater numbers of
consumers are expecting rewards with their card use.

The industry is also facing serious challenges from credit card fraud, identity theft, and the need to
secure confidential information. These challenges have always been an operational risk, but the
problem has intensified now that large quantities of confidential information are maintained in
Internet-accessible systems and criminals are becoming more sophisticated in obtaining and using
sensitive data. Besides being a costly drain on banks, these problems have the potential to erode
consumer confidence in the credit card industry. Consumers' concerns about the security of credit
cards and confidential information need to be addressed. Otherwise, consumers may become
reluctant to continue using credit cards as freely as they do now.46

Consumers' growing sophistication in the use of their credit cards goes beyond their greater
awareness of fraud issues. An important element of the business model of credit card issuers is
interest income. However, increasing numbers of cardholders–an estimated 55 percent of them–
are "convenience users," paying their balances in full each month to avoid interest charges.47 On
the other hand, others are having difficulty managing the use of their cards, incurring debt
potentially beyond their means to repay and representing credit risk to card issuers.

In short, the highly competitive credit card industry is in flux. Credit card associations, controlled by
a diminishing number of large card issuers, are caught between cardholders seeking greater
rewards and merchants trying to lower the cost of accepting payments. At the same time, the card
associations are not only incurring increasing expenses because of fraud and fraud prevention but
they are also bearing the costs of recent and pending litigation. For decades it was not hard to
envision what the credit card industry would look like five years into the future. This is no longer
true.

FOOTNOTES

*
All the authors are in the Division of Insurance and Research at the Federal Deposit Insurance
Corporation. Douglas Akers is a research assistant, Jay Golter a financial analyst, Brian Lamm a
senior financial analyst, and Martha Solt a senior economist.

1
The term "credit card industry" as used in this article refers to the four major payment card
networks: Visa, MasterCard, American Express, and Discover. In addition, Diners Club is a very
small participant.

2
The holder of a charge card, unlike the holder of a credit card, must pay the monthly statement
balance in full.

3
Whereas American Express processes all of its credit- and charge-card activity through the
American Express Bank, a wholly owned subsidiary it has held for nearly 100 years, Discover
processes all of its card-related transactions through Greenwood Trust, a wholly owned subsidiary
of Discover's parent company, Morgan Stanley Dean Witter & Co. (In order to process the Discover
Card transactions, Sears, Roebuck and Co. purchased Greenwood Trust through its Allstate
Enterprises subsidiary in 1985 and converted it to a nonbank bank. Morgan Stanley purchased the
bank, along with Dean Witter and Discover, in 1997.)

4
For more information on the history of credit cards, see Evans and Schmalensee (2005) and
Mandell (1990).

5
Aizcorbe, Kennickell, and Moore (2003). This is the most recent data on this topic from the
Federal Reserve Board.

6
Gould (2004).

7
Day and Mayer (2005).

8
Visa U.S.A. Inc. (2005).

9
MasterCard International (2005).

10
Evans and Schmalensee (2005).

11
See Note 3. Whether Discover will remain a subsidiary of Morgan Stanley is uncertain as of this
writing and is discussed more fully below.

12
A monoline bank engages primarily in only one line of business.

13
FinanceTech (2004).

14
Evans (2002).

15
Schmalensee (2001).

16
See also figure 4.

17
Funds flow between the card association and participating banks, not on a transaction-by-
transaction basis but on a batch basis, several times per day, with the card association effecting
settlement among the participating banks by determining each of their net positions in order to
balance the system.

18
The Acquiring Bank sets its own fee which is deducted from the merchant payment. That fee
must be high enough to cover the cost of the interchange fee and the Acquiring Bank's own
expenses for the transaction. Interchange fees amount to a large portion of the fees charged to
merchants by Acquiring Banks, and changes in interchange fees in the past have led to roughly
equal changes in fees charged to merchants. See Schmalensee (2001).

19
Chakravorti (2003) presents a fuller description of the participants in the credit card industry and
of the costs and benefits to each.

20
Kissane and Duca (2005).

21
Wong (2004a).

22
Aite Group (2005).

23
Wilke and Sidel (2005).
24
Digital Transactions (2005) and American Banker Online (2005).

25
Kuykendall and Lindemayer (2005).

26
The lower estimate is from Swartz et al. (2004), and the higher estimate is from Wong (2004b).

27
Wong (2004b).

28
These efforts are criticized by Swartz et al. (2004) for not considering the benefits to all parties of
payment card usage, and by Schmalensee (2001) for not considering the proper role of
interchange fees.

29
They are: United States v. VISA U.S.A., Inc., 163 F.Supp.2d 322 (S.D.N.Y., 2001) (original
decision), with final decision in United States v. VISA U.S.A., Inc., 344 F.3d 229 (2d Cir. 2003) and
In re VISA Check/Mastermoney Antitrust Litigation, 287 F.Supp.2d 503 (E.D.N.Y. 2003) (original
decision), with final decision in Wal-Mart Stores, Inc. v. VISA U.S.A., Inc., 396 F.3d 96 (2d Cir.
2005). The second case is commonly known as the 'Honor-All-Cards' case.

30
After the final disposition of this case, both American Express and Discover filed lawsuits against
Visa and MasterCard for unspecified damages.

31
On April 30, 2003, MasterCard settled the dispute. Terms of the settlement included agreements
to (1) pay retailers about $1 billion over ten years, (2) reduce the debit card fees it charges
retailers, (3) change its "Honor All Cards" policy beginning in January 2004 by giving retailers the
choice of accepting either online or offline debit cards, and (4) establish a separate interchange
rate for its debit transactions (previously it had blended credit and debit transactions into a single
interchange rate), reducing the interchange rate for its debit transactions by at least one-third.
Visa's settlement agreement contained similar terms, some of which were that Visa would (1) pay
retailers $2 billion over ten years starting in 2004; (2) modify its "Honor All Cards" rule so that
beginning in 2004 merchants may accept Visa check card only, Visa credit card only, or both; and
(3) lower its fees for certain types of merchants.

32
Premium cards are a type of credit card typically targeted to more affluent customers that have
more rewards and higher interchange fees.

33
American Express (2004a).

34
American Express (2004b).

35
American Express (2005b).

36
American Express (2005a).

37
Diners Club (2004) and MasterCard Inc. (2004).

38
Lieber (2005).

39
Wal-Mart (2005).

40
Discover Financial (2004).
41
Bank of America (2005).

42
Capital One (2005).

43
Washington Mutual (2005).

44
However, it is unclear whether Bank of America, after its acquisition of MBNA, will implement
MBNA's previous decision to issue American Express cards.

45
Mason (2005).

46
Both Visa and MasterCard have recently instituted zero-liability policies in an effort to combat
these concerns. Visa states: "Use your Visa card to shop online, in a store, or anywhere, and
you're protected from unauthorized use of your card or account information. With Visa's Zero
Liability policy, your liability for unauthorized transactions is $0–you pay nothing." MasterCard
states: "As a MasterCard cardholder you are not liable in the event of an unauthorized use of your
U.S.-issued MasterCard card. This coverage extends to purchases made in a store, over the
telephone, or online."

47
Aizcorbe, Kennickell, and Moore (2003).

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–––. 2005a. UBS Selects American Express, Juniper Bank, and Visa to Provide Its Dual-Card
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–––. 2005b. American Express and USAA Announce Card-Issuing Alliance. Press Release May
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Figure 4
Benefits and Costs for Participants in the Credit Card Industry
Type of
Participant Function Benefits Costs
Cardholder Purchases goods Convenience of Interest rates and fees
and services making purchases Difficulty managing
without carrying cash credit
Ability to time
payments to match
cash flows
Access to credit
Access to float
Use of bonus
features
Merchants Sells goods and Access to large Need to pay
services number of consumers interchange fees on sales
 Ability to sell to to cardholders
consumer needing Loss of private credit
credit without carrying accounts (customer loyalty,
credit risk marketing information,
Guaranty of interest income)
payment
Issuing Bank Collects payments Ability to collect Operational costs
from cardholders fees from cardholders Fraud risk
Extends credit to Ability to share in Credit risk
cardholders interchange fees from
Distributes cards merchants
Finances receivables Ability to cross-sell
Authorizes to consumers
transactions
Ability to collect on
interest rate spreads
Acquiring Bank Issues payments to Shares in Operational costs
merchant interchange fees from Some fraud risk
Routes information merchants
enabling authorization,
billing, and payment to
merchant
Card Association Promotes the brand Collects Marketing costs
Establishes rules, transaction fees Cost of fraud reduction
standards, and protocols Collects programs
governing participation in assessment fees Operational costs of
network maintaining network
Sets interchange fee
structure
Source: Federal Deposit Insurance Corporation.