Academic journal article Economic Perspectives

Economics of Payment Cards: A Status Report

Academic journal article Economic Perspectives

Economics of Payment Cards: A Status Report

Article excerpt

Introduction and summary

The proliferation of payment cards--that is, debit, credit, and prepaid cards--has dramatically changed the way we shop and merchants sell goods and services. Today, payment cards are indispensable in most advanced economies. According to a recent U.S. survey, the percentage of payment cards used for in-store purchases increased from 43 percent in 1999 to 56 percent in 2005 (American Bankers Association and Dove Consulting, 2005). For Europe, Bolt and Humphrey (2007) report that the number of card payments increased by 140 percent across 11 European countries during the period 1987-2004. (1) Amromin and Chakravorti (2009) find that greater usage of debit cards has resulted in lower demand for small-denomination bank notes and coins that are used to make change. (2) Furthermore, without payment cards, Internet sales growth would have been substantially slower.

Debit, credit, and prepaid cards are three forms of payment cards. Debit cards allow consumers to access funds at their banks (3) to pay merchants; these are sometimes referred to as "pay now" cards because funds are generally debited from the cardholder's account within a day or two of a purchase. (4) Credit cards allow consumers to access lines of credit at their banks when making payments and can be thought of as "pay later" cards because consumers pay the balance at a future date. Prepaid cards can be referred to as "'pay before" cards because they allow users to pay merchants with funds transferred in advance to a prepaid account. (5) (We ignore prepaid cards in our discussion.)

Recently, some merchants have started to accept only card payments for safety and convenience reasons. For example, a cafe in Washington, DC, stopped accepting cash for purchases primarily because the cost of safekeeping cash was too expensive (Rafsanjani, 2006). Also, many quick service restaurants and coffee shops now accept payment cards to capture greater sales and increase transaction speed. Wider acceptance and usage of payment cards suggest that a growing number of consumers and merchants prefer payment cards to cash and checks.

As more consumers and merchants adopt payment cards, providers of these products may benefit from economies of scale and scope. In the United States, being able to operate on a national level allowed some issuers (banks that issue cards to consumers), acquirers (banks that convert payment card receipts into bank deposits for merchants), and payment processors to benefit from economies of scale and scope. Some European payment providers might enjoy these benefits in the future as greater cross-border harmonization occurs with the introduction of the Single Euro Payments Area (SEPA). (6) The primary focus of SEPA is to create a uniform framework not only for card payments, but also for electronic credit transfers and direct debits, so that these retail payments can be completed in the euro area without intermediation by other banks. The potential advantages of SEPA are increased competition among a greater number of payment providers and the realization of scale economies and more-efficient payment instruments. (7)

The increased usage of cards has increased the value of payment networks, such as Visa Inc., MasterCard Worldwide, Discover Financial Services, and others. (We describe how payment networks operate in more detail later.) Earlier this year, Visa Inc. had the largest initial public offering (IPO) of equity in U.S. history, valued at close to $18 billion (Benner, 2008). The sheer magnitude of the IPO suggests that financial market participants value Visa's current and future profitability as a payment network. One potential reason for Visa to change its corporate structure from a card association to a publicly traded company is to reduce antitrust scrutiny by regulators and to lower the threat of lawsuits filed by certain payment system participants. (8) In 2006, MasterCard Worldwide became a publicly traded company. …

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