“Reverse Robin Hood” is a Myth and Capping Interchange Fees Would Harm the Poor

The claim that credit card rewards benefit the rich at the expense of the poor has been repeated over and over again by those who want to cap the fees charged to merchants by card issuers. Although the myth of this so-called “reverse Robin Hood effect” has been debunked several times, it continues to resurface from the grave. This is troubling for a variety of reasons, not least because capping interchange fees would actually hurt the poor the most.

In 2010, researchers at the Federal Reserve Bank of Boston published their findings that because merchants pay higher interchange fees for rewarded credit cards, consumers who pay in cash, debit and Unrewarded credit cards actually subsidize reward card users when they pay the higher retail prices that merchants charge in order to pass on the cost of interchange commissions. Since rewards card users tend to be wealthier than other customers, the paper concludes, this arrangement serves as an upward transfer of wealth.

To remedy this so-called wealth transfer, some are proposing to cap credit card interchange fees, just as debit card interchange fees are already capped under what is known as “the amendment.” of Durbin ”. The reasoning is that the cap would reduce costs for traders and that these savings would, in turn, be passed on to consumers in the form of lower prices.

But there is Serious problems with the “inverted Robin Hood” hypothesis. Indeed, the whole story is more mythical than Robin Hood himself. Rather than returning wealth to the poor, capping interchange fees would greatly benefit supermarkets and other large retailers.

Credit card networks connect merchants, banks and consumers through a complex series of agreements. Interchange fees and card rewards help balance this system for the benefit of all parties.

Interchange fees allow issuing banks to recoup their investments in the network, including in valuable features such as fraud prevention. This benefits both cardholders and merchants, who are able to engage in mutually beneficial exchanges with less risk of fraud and theft.

Meanwhile, the rewards motivate cardholders to use their credit cards. Consumers obviously benefit from the rewards themselves, while merchants benefit from the extra business they do because cardholders want to earn rewards.

While some merchants may complain about the high card fees, the reason they continue to accept them is that, compared to store credit and checks, payment cards are extremely safe and secure. The increased size and volume of purchases also more than outweighs the costs of accepting cards.

Understanding how each side of the market benefits from card networks helps explain what is really going on here: the public arguments about the regressive burdens on the poor aside, traders really just want a bigger slice of the pie.

For the “reverse Robin Hood” hypothesis to be true, each income group would have to purchase the same basket of goods and services from the same traders. In real life, consumers of different income cohorts shop in different places and buy different things. In this more realistic scenario, merchants are able to adjust prices based on the impact of card usage, thus weakening any redistribution effect. In other words, reward card users largely pay for their own benefits.

Merchants also typically do not pass 100% of the costs of interchange fees back to consumers in the form of higher prices. The Literature suggests a transmission range of 22% to 74%, with a long-term median of around 50%. This means that reducing interchange fees will not necessarily lead to lower prices either. This is exactly what happened after the Durbin Amendment imposed caps on interchange fees for debit cards in 2010: almost all of the savings from lower interchange fees have been captured by the biggest merchants, with very little impact on consumers.

Finally, unlike the narrative pitting rich rewards card users versus poor cash users, consumers from virtually all income groups have access to and use, rewards cards. In fact, the data suggest that the benefits of rewards relate more to credit rating than to wealth or income. And one Federal Reserve study suggests that credit scores are only weakly correlated with income, credit the story having a much stronger correlation.

Ultimately, we should learn from our experience with the Durbin Amendment that caps on interchange fees actually tend to hurt poorer consumers. Studies spectacle that banks have recouped lost revenue as a result of the Durbin implementation by increasing fees for ATMs and ending most free checking account offers. Traders, however, did not pass on lower prices to an extent that would offset those losses for low-income consumers.

Much like the debit card experience, caps on credit card interchange fees will likely hurt poorer consumers the most. Banks will make up for lost revenue somewhere, possibly by increasing annual fees for cards or reducing rewards. The richest rewards card users can afford a higher annual fee, but the poorest cannot. Australia’s experience is instructive. A to study there was a 40 percent increase in annual fees for standard rewards cards after the introduction of interchange fee caps.

Ironically, the interchange fees caps can generate a real “Robin Hood reversed” effect, the shareholders of supermarkets profiting to the detriment of low-income consumers.

Julian Morris is a senior researcher at the International Center for Law and Economics (ICLE). Ben Sperry is the Associate Director of Legal Research at ICLE.

Comments are closed.