Regulation isn’t the solution to lowering credit-card processing fees for small businesses

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Ottawa is putting the credit-card industry on notice.

If Visa, MasterCard, banks and payment processors won’t voluntarily slash credit-card processing fees for small businesses, then the Liberal government will drop the hammer of regulation in the new year.

Deputy Prime Minister and Finance Minister Chrystia Freeland issued that warning as part of the government’s recent fall economic statement, setting the tone for talks at the bargaining table.

With draft amendments to the Payment Card Networks Act already in her back pocket, Ms. Freeland is making it clear to industry players that she means business. Too bad that government regulation of credit-card transaction fees isn’t the solution to this vexatious problem.

Although the threat of regulation certainly makes for good politics, it simply won’t result in lasting relief for small businesses. That’s because our banks – God love ‘em – are a wily bunch.

As credit-card issuers, they reap the lion’s share of revenue generated from transaction fees. If Ottawa ends up regulating those charges, banks and other payment players will engage in an endless game of Whac-A-Mole to recoup what’s lost.

New fees will pop up to replace old ones. It will be an irksome experience for all involved, especially consumers and small businesses.

“Bankers are typically not the type of people who say, ‘Oh, we just lost $2-billion in revenue. Oh well, let’s just move on,’ ” said Dan Kelly, chief executive officer of the Canadian Federation of Independent Business, or CFIB, a small-business lobby group.

“They typically will find all sorts of other ways to take their pound of flesh. And I’m not convinced that won’t find its way back into other fees that merchants pay. That’s why I think it is better to find a negotiated reduction in these fees.”

Yep. Regulation is a recipe for disaster.

Here’s why: Credit cards are high-margin loan products. In addition to collecting their cut of transaction fees, banks also make money by earning interest on customer balances and charging other costs such as annual fees.

In case you missed the dreary headlines from the industry’s recent earnings season, it’s tough sledding for financial institutions these days. Nary a banker on Bay Street would dare let a single dollar of revenue slip away.

To be fair, Visa and MasterCard – not banks – are responsible for setting the base fees, known as interchange, that help determine how much retailers must pay to accept plastic. Payment processors then add various other costs to interchange before determining the final merchant fee.

There are a number of parties and moving parts in the system, which is why government regulation of merchants’ processing costs is easier said than done.

Case in point: Small merchants in European Union countries continue to complain about rising transaction costs despite a cap on interchange rates.

Under the terms of their current Canadian agreements, Visa and MasterCard lowered their average effective interchange rate to 1.4 per cent from 1.5 per cent starting in 2020. (American Express, which negotiates its processing fee directly with retailers, struck a separate deal with Ottawa.)

Those fee agreements, however, presupposed a large proportion of in-store transactions for the entire five-year term. But the COVID-19 pandemic upended those assumptions because of the accelerated move to e-commerce.

Online payments cost more to process because they carry more fraud risk. That’s why many small businesses are paying more for transaction fees even though those rate agreements with Visa and MasterCard remain in place.

“In the beginning of the pandemic, we thought that touching a $20 bill was going to give you COVID, so people flocked to using cards,” Mr. Kelly said. “The massive increase in online transactions is almost entirely powered by credit cards.”

Credit-card points programs are also fuelling the rise in merchants’ processing costs. Although Ms. Freeland is determined to lower credit-card transaction fees for small businesses in a way that “protects existing reward points for consumers,” that may not be possible.

Let’s face it, if banks and global payment networks ultimately make less money, scaling back reward schemes for consumers is a rational response on their part.

“Credit-card companies and banks have gotten Canadians addicted to reward points,” said Mr. Kelly. “It’s the merchants that are paying for these reward points in a big way.”

As a result of all these factors, CFIB is calling for a substantial reduction in credit-card processing fees for small businesses.

“If rates were under 1 per cent, I think things would start to work a lot better,” Mr. Kelly said.

Additionally, there should be a smaller differential between the custom rates that large retailers pay and those paid by small businesses, he added.

The government’s voluntary code of conduct for the credit- and debit-card industry also needs updating to keep up with e-commerce developments such as in-app transactions.

These proposals are a sensible starting point for discussions.

Let’s hope that industry players can reach a negotiated solution. The heavy hand of government regulation would be disastrous outcome for us all.