Credit Card Bitter Pills: You Are Paying for Your Card “Rewards”

Credit cards have effectively disrupted the daily lives of the consumer with the benefits it offers to both merchants and consumers. Merchants are guaranteed payment (assuming no chargebacks) once the transaction is authorized — removing the uncertainty of receiving a bad cheque and consumers are granted a credit line where they do not have to calculate their remaining balance in their bank account before making a purchase as long as it does not exceed the maximum credit granted by the issuing bank.

These benefits are essentially conveniences to both merchants and consumers, but what consumers do not realize is the cost of convenience. The following is a simple diagram of how a typical credit card transaction takes place.

Do U.S. Consumers Really Benefit from Payment Card Rewards?

It seems straightforward enough that on a $100 purchase, a cardholder gets $1 in rewards. However, in truth, these rewards are paid for by the consumers in fees that are not apparent to the consumer during a purchase. The diagram below illustrates the breakdown of interchange fees paid by merchants to the acquirer.

Issuer rewards account for 44% of interchange fees paid for by merchants. Which are subsequently passed on to consumers.

Issuer rewards for cardholders account for 44% of the fees payable by merchant and these fees are not optional for merchants that choose to partake in the payment network. From the merchants’ perspective, these fees are merely selling expenses that are ultimately passed on to the consumers.

“Available empirical evidence and existing theoretical models suggest that current U.S. payment card rewards programs are likely inefficient. That is, social welfare is likely to be lower with currently provided rewards than without rewards. Similarly, consumer welfare is likely to be lower unless rewards are accompanied by the card service providers or the merchants giving up their profit margins”

- Federal Reserve Bank of Kansas City

This article has made one point apparent. Credit card rewards are inefficient as consumers are paying more on a purchase to get rewarded and the reason that the practice of charging consumer more for their own rewards exists is because the fees are not transparent enough during the decision-making process of the buyer.

Fumiko Hayashi, 2009.
"Do U.S. consumers really benefit from payment card rewards?," Economic Review, Federal Reserve Bank of Kansas City