Payment Systems and Interchange Fees

20 Pages Posted: 14 Nov 2002

See all articles by Richard Schmalensee

Richard Schmalensee

Massachusetts Institute of Technology (MIT) - Sloan School of Management

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Abstract

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.

Suggested Citation

Schmalensee, Richard, Payment Systems and Interchange Fees. Journal of Industrial Economics, Vol. 50, No. 2, pp. 103-122, June 2002. Available at SSRN: https://ssrn.com/abstract=313489

Richard Schmalensee (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Cambridge, MA 02142
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