Rewards Margins are High Enough to Withstand Competition
With the recent introduction of the Credit Card Competition Act, there’s hope that the credit card market may experience a well-deserved injection of competition. With this new competition, CMSPI estimates that credit card rewards are unlikely to disappear based on current issuer margins on rewards and experience from other markets.
Given the absence of direct competition between payment networks for transaction routing, credit card fees for Visa and Mastercard have risen from 2.02% in 2010 to 2.24% as of 2022, with overall fees paid rising from $26 billion to $93 billion in the same period.1
Despite the hefty rise in card fees, the margins on interchange revenues net against rewards has remained largely unchanged. This begs the question, can the credit card industry benefit from more competition while maintaining consumer rewards?
Bank Margins on Credit Card Rewards
Six of the top ten credit card issuers, representing 72% of overall credit spending2, report gross interchange revenues and rewards expenditures. From an analysis of the data ranging 2018-2022, the average net margin on interchange income was 30%, as rewards expenditures only accounted for 70% of overall interchange revenue in this period (Figure 1). For comparison, the general retail industry maintained an average net margin of 2.35% as of January 2023.3
Figure 1. Average Rewards Expenditure and Net Income for Six of the Top Ten Credit Card Issuers (2017-2022)
Impact of Falling Interchange on Rewards
Despite the healthy margins on interchange revenues, falling interchange revenue may result in a decrease in rewards. But based on experience, how large is that drop?
From a review of available data, markets that have drastically cut interchange fees through caps have not seen a like-for-like drop in rewards expenditures. For example, in Australia, average credit card fees sat at 2.01% as of 2002.4 However, with the introduction of interchange caps in 2003, an individual credit card transaction couldn’t be charged more than 0.80% per transaction, representing a 121 basis point drop in average interchange. Despite the significant reduction in interchange fees, the impact on rewards has been moderate. From 2003 to 2013, the average rewards per transaction fell from 0.81% to 0.49%, representing a 32 basis point drop in average rewards. From Australia’s experience we can impute that for every 10 basis point drop in interchange revenue, there’s an associated 2.6 basis point drop in rewards, which implies a 74% margin on interchange and rewards, aligned with the same margins identified by the issuers in the U.S.
Credit Card Competition Can Introduce Competition without Damaging Rewards
CMSPI estimates that merchants will save at least $15.2 billion annually from credit card competition, which would represent a 37 basis point reduction in average Visa and Mastercard credit card fees.5 Based on the experience of Australia, a 37 basis point drop in interchange would imply a 9.71 basis point reduction in average rewards. Bringing this back to the six credit issuers analyzed, CMSPI estimates that consumers would incur at most a less than 0.10% drop in rewards. Moreover, these six issuers maintain 30% margins on interchange transactions – more than sufficient margin to maintain current reward levels were average credit interchange fees to fall 37 basis points.
- Nilson Report
- Total credit card fees estimated from Nilson Report