With their flashy bonuses and hefty cash-back payments, credit card rewards have become as American as apple pie. In most other developed nations, by contrast, cards are about as flamboyant as, say, mortgages or bank accounts.
Unfortunately, some of the same forces that have made cards so subdued outside the U.S. now threaten to bring America’s card-rewards party to an abrupt end. The causes lie in several legal threats. One of those perils threatens the funding of rewards, while the other could see consumers essentially paying upfront for the rewards they subsequently receive for using their cards.
The Rumble Over Rewards Funding
The entire rewards ecosystem in the U.S. is essentially financed by merchants and business owners. Specifically, rewards are funded by the interchange fees merchants pay when they accept your credit card at their store.
The biggest chunk of those fees—which range from 2% to 4% of every credit card sale—is passed along to card issuers, who are mostly banks. Those companies then use a portion of that revenue to fund the rewards programs that so many American card holders know and love.
Though banks get to collect interchange fees, those fees are actually set by the card networks—the companies that own such card brands as Visa, Mastercard and American Express. A relatively small number of these networks control a huge portion of the credit-card market, and they’ve been accused of unfairly using that clout to set interchange fees too high.
For more than a decade, then, the networks have been in ongoing legal warfare with merchants over these fees. The war is being fought on two fronts, both of which could spell bad news for card holders if the merchants prevail.
The Battle Over Interchange Fees
This first fight is over the amount charged in interchange fees, those levies set by card networks. Merchants argue that these charges would be much lower in a credit-card marketplace that was truly competitive—as in one in which Visa, Mastercard and American Express, who set the fees for use of their cards, were less dominant.
Some of the suits are David-and-Goliath affairs—a challenge in New York State was launched by a hair salon—but there is also a multi-state, class-action lawsuit filed by some of the heaviest hitters in retailing, including Amazon, Wal-Mart, and Costco.
The suits seek a reduction in the level of the fees. It’s not difficult to imagine what U.S. credit card rewards would look like if the interchange fees weren’t as high as they are. In countries like England and Germany, regulations prevent credit card companies from charging interchange fees of more than 0.3%. When the EU Parliament first passed these restrictions back in 2015, Capital One Bank immediately responded by severely gutting their cash back programs in European countries affected by the new interchange limits.
There’s also the example of what happened after banks saw their revenue plummet from the interchange fees merchants paid to accept debit-card transactions, following passage of the Dodd-Frank Act in 2010. In that instance, consumers who used debit cards might have gained as merchants passed along the savings they realized in the form of lower prices. Instead, according to a 2013 study by the University of Chicago Law School, consumers lost more than they gained, as banks compensated for lower revenues through such changes to services as beginning to charge all debit-card holders for overdraft protection.
These examples suggest that a drop in the rates for credit-card interchange fees could essentially defund rewards programs that card issuers are bankrolling with revenue from those fees, as passed along to them by Visa, Mastercard and the rest. Card rewards might still be a party, but the prizes could well be far less generous and alluring than they are now.
The Threat of Consumer Card Surcharges
Let’s assume that merchants come up short in their bid to have interchange fees declared non-competitive, and they continue to pay the same rate of surcharges to the card networks. They have a Plan B that poses an alternative threat to card holders: Gaining the right to pass those fees along to consumers.
Currently, in eleven states that together represent more than a third of the U.S, population— California, Colorado, Connecticut, Florida, Kansas, Maine, Massachusetts, New York, Oklahoma and Texas—laws prohibit merchants from imposing surcharges on credit card transactions. Recently, however, a New York statute banning these fees was successfully challenged by merchants in the Supreme Court. The ramifications of the court’s ruling are beginning to trickle down to other states. The Texas Fifth Circuit recently sent a case back to lower courts that challenges their surcharge laws on the basis of the Supreme Court’s decision in the New York case.
Even a change in these and other populous states doesn’t necessarily mean a slew of surcharges will be introduced there, as the generally modest incidence of fee charges in the forty other states that allow them reveals. Merchants are discouraged, or even prohibited, from charging fees by such other factors as card-network agreements, requirements to post fee disclosures, and simple consumer resistance, especially if competing retailers do not follow suit.
Were such surcharges to become more widespread, however, at least some consumers could essentially pay a fee when they buy that eventually trickles back to them in the form of cash-back or other rewards. That could turn the rewards wars into a kind of zero-sum game; the bank taketh, via merchants who pass along fees to the banks, and the bank then giveth back, in the form of cash, points, or other perks.
A few card whizzes who know how to maximize rewards might gain at that game. But the clear losers would be the many card holders who are less adept at such card-play, or are less able to qualify or afford the credit cards, such as cash-back cards and premium rewards cards, that offer the best returns.