Payment Systems and Interchange Fees

Richard Schmalensee

NBER Working Paper No. 8256
Issued in April 2001
NBER Program(s):   IO

In a typical bank credit card transaction, the merchant's bank pays an interchange fee, collectively determined by all participating banks, to the cardholder's bank. This paper shows how the interchange fee balances charges between cardholders and merchants under imperfect competition. The privately optimal fee depends mainly on differences between cardholders' and merchants' banks, not their collective market power. In a non-extreme case, the profit-maximizing interchange fee also maximizes total output and producers' plus consumers' surplus. There is no economic basis for favoring proprietary payment systems, which do not need interchange fees to balance charges, over the cooperative bank card systems.

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Document Object Identifier (DOI): 10.3386/w8256

Published: Schmalensee, Richard. "Payment Systems And Interchange Fees," Journal of Industrial Economics, 2002, v50(2,Jun), 103-122.

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