After 21 years, two failed settlements, and enough economic testimony to qualify as its own industry, the great interchange-fee war may finally be nearing a cease-fire. The terms are imperfect, and the case never had much economic merit. Even so, the proposed settlement may offer the best available escape from a dispute whose legislative sequels could do considerably more damage.
Last month, Judge Brian Cogan of the U.S. District Court for the Eastern District of New York gave preliminary approval to the third attempted settlement in the two-decade antitrust fight between merchants and payment networks. In re Payment Card Interchange Fee and Merchant Discount Antitrust Litigation, the sprawling multidistrict case filed in 2005, has already produced two rejected settlements, one 2nd U.S. Circuit Court of Appeals vacatur, a $5.54 billion damages fund, and perhaps more economist hours than any private antitrust case in American history.
The latest agreement, announced in November and valued by court-appointed experts at roughly $38 billion through 2031, would cut average credit-card interchange fees by 10 basis points for five years. A basis point is one-hundredth of a percentage point. The deal also would cap fees on standard consumer credit cards at 1.25% for eight years, a reduction of more than 25%, and freeze posted fees at their March 2025 levels.
The most consequential change concerns the “honor-all-cards” rule, which generally requires merchants that accept a network’s cards to accept all cards in that category. The settlement would divide acceptance into three groups—commercial, premium consumer, and standard consumer—and allow merchants to accept or reject each group separately. It also would expand merchants’ ability to impose surcharges on credit-card transactions.
Big-box retailers remain unimpressed. The National Retail Federation and the Merchants Payments Coalition oppose the deal, arguing that merchants would still pay too much, especially on rewards cards. Some analysts expect appeals that could delay final resolution until 2029.
That would be a pity. The settlement would distort the economics of card payments, and the litigation beneath it remains highly dubious. Still, it would end a case that has consumed more than two decades. It also compares favorably with the legislative “solutions” promoted by large retailers, including state efforts to exempt taxes and tips from interchange fees and the preposterously named federal Credit Card Competition Act.
Interchange Fees and the Art of Keeping Both Sides Happy
Start with the basic economics of payment networks and the role of interchange fees. In a four-party card system, the merchant’s bank pays a small share of each transaction—typically 1% to 2%—to the cardholder’s bank. That payment is the interchange fee.
A common misconception treats interchange as little more than compensation for processing a transaction. Its role is much broader. Interchange arose as a practical solution to a coordination problem in the original BankAmericard system and later became a way to balance the interests of merchants and consumers.
When BankAmericard, the forerunner of Visa, launched in 1958, it operated as a three-party network. Bank of America issued the cards, signed up merchants, and processed the transactions.
That changed when Bank of America began licensing other banks to issue BankAmericard cards in 1966. At first, the amount an acquiring bank paid to the issuing bank depended on the merchant discount the acquirer charged, or claimed to charge, sometimes adjusted for processing costs. The arrangement proved difficult to administer and audit.
Merchant discounts varied across banks and merchants, which gave acquirers an incentive to understate them. The formula also left acquirers with little or no margin on transactions involving cards issued by other banks. Issuers could receive too little, acquirers had weaker incentives to recruit and serve merchants, and the system encouraged strategic misreporting.
In 1970, Bank of America and its licensees created National BankAmericard Inc., an independent company owned by participating banks. The new organization replaced the uncertain formula with a uniform interchange reimbursement fee.
Set at 1.95% in 1971, the standardized fee separated the issuer’s payment from the merchant discount negotiated by the acquirer. The acquirer could retain the difference between the merchant discount and the interchange fee to cover its own costs.
Interchange therefore began as a way to align the incentives of independent issuers and acquirers in an open payment network. The Interbank Card Association, which operated MasterCharge, the precursor to Mastercard, adopted a similar approach about a year later. Economists later developed a fuller account of why the mechanism worked.
William Baxter’s seminal 1983 paper explained that interchange helps payment networks solve the central problem of a two-sided market. A card network must attract enough merchants and consumers at the same time. Each side becomes more valuable as participation on the other side grows.
Consumers benefit from convenience, less need to carry cash, and the ability to spend beyond the money in their wallets. Credit cards can also provide short-term financing, rewards, and various forms of insurance.
Merchants benefit from higher sales, lower cash-handling costs, and access to customers who value the convenience and liquidity that cards provide. Baxter argued that these gains form part of the system’s total value. Interchange helps distribute that value between merchants and consumers.
His analysis also showed that the optimal fee depends on the value each side places on an additional transaction. The fee could, in principle, be positive, with merchants helping fund cardholder benefits, or negative, with consumers subsidizing merchants. Baxter found that a positive fee will often be efficient because it lowers consumers’ effective cost of using cards through rewards and other benefits, encouraging adoption and use.
Later economists, including Jean-Charles Rochet and Nobel laureate Jean Tirole, extended this analysis. They showed that the optimal fee depends on how sensitive each side is to price, how participation on one side affects demand on the other, and the degree of competition among issuers, acquirers, and networks.
When merchants are less likely than consumers to leave the network in response to a price increase, the usual result is that merchants bear more of the cost. Interchange then allows issuers to fund benefits that encourage consumers to carry and use cards.
Interchange is therefore best understood as a tool for balancing participation and increasing the network’s value. Treating it solely as reimbursement for issuer costs misses most of its function and makes cost-of-service regulation a poor fit.
Interchange helps fund rewards, up to 45 days of interest-free credit for cardholders who pay their balances in full, zero-liability fraud protection, chargeback rights, and continuing investment in authorization, tokenization, and fraud detection. Tokenization replaces sensitive card information with a temporary digital identifier, reducing the value of stolen data.
Merchants benefit from each of these features. Studies consistently find that card acceptance increases average transaction size and total spending relative to cash. Consumers who lack enough cash at checkout simply buy less.
Guaranteed payment also shifts credit and fraud risk away from merchants. When a cardholder defaults, the merchant has already been paid. Card acceptance reduces the costs of handling cash, including theft, armored transport, delayed access to funds, and register reconciliation. It also speeds checkout.
For online commerce, cards have proved indispensable. E-commerce now accounts for roughly one-sixth of U.S. retail sales. Without reliable card payments, online retail would have developed more slowly and remained much smaller.
Merchants Want the Cards, Just Not the Price
Large retailers have spent decades trying to shrink the cross-subsidy that helped make payment cards ubiquitous, even though they benefit heavily from the system. At first glance, they seem determined to have their card-generated cake and eat it too.
Each successful fee cut makes cards less attractive to consumers and can reduce card use over time. That would eventually hurt merchants as well. Smaller merchants would bear more of the damage because the fixed costs of acquiring and serving them make up a larger share of the merchant discount. Large retailers understand that arithmetic.
The first major legal challenge came from National Bancard Corp., or NaBanco, an acquiring bank whose interests closely tracked those of merchants. NaBanco sued Visa to eliminate the default interchange fee, arguing that issuing banks had engaged in per se price fixing.
Drawing on William Baxter’s work, the 11th U.S. Circuit Court of Appeals rejected the claim. The court held that a collectively set default fee was necessary for a four-party card system to function and ruled for Visa. National Bancard Corp. v. Visa U.S.A. Inc. (11th Cir. 1986).
Merchants scored a larger victory in Wal-Mart Stores Inc. v. Visa U.S.A. Inc., which settled in 2003 for $3 billion. The settlement allowed merchants to accept Visa and Mastercard credit cards without also accepting their signature-debit cards. The broader objective was already clear. Merchants wanted lower fees without giving up card acceptance.
The current case, known as MDL 1720, began in 2005. It rests on several unproven and highly implausible claims. The plaintiffs contend that Visa and Mastercard operate as a cartel, that default interchange fees are cartel prices, and that rules governing card acceptance, surcharges, and customer steering help enforce the arrangement.
When litigation moved too slowly, merchants turned to Congress. In 2010, Sen. Dick Durbin (D-Ill.) added a provision to the Dodd-Frank Act that imposed price controls on debit-card interchange fees.
Retailers then sued the Federal Reserve for setting the cap too high in NACS v. Board of Governors of the Federal Reserve System. After losing, they revived the challenge a decade later in Corner Post Inc. v. Board of Governors of the Federal Reserve System. A district court ultimately vacated Regulation II, finding that the rule allowed issuers to recover too much. The case is now before the 8th U.S. Circuit Court of Appeals.
Europe followed a similar path. A 1992 complaint by the British Retail Consortium helped launch the enforcement campaign that produced the European Commission’s 2007 Mastercard decision, the European Union’s 2015 Interchange Fee Regulation, and a series of English damages cases stretching from Sainsbury’s Supermarkets Ltd. v. Mastercard Inc. to Merricks v. Mastercard Inc.
Large retailers have pursued the same objective through every available institution, including antitrust suits, legislation, and regulation. They want the government to force interchange fees lower.
Their conduct tells a more complicated story. After two decades of insisting that interchange fees exceed the value of card acceptance, almost no major U.S. retailer has stopped accepting the cards.
Kroger briefly dropped Visa credit cards at two regional chains in 2018 and 2019. The experiment lasted only months before the company reversed course. In opposing the current settlement, the National Retail Federation’s general counsel explained why retailers will not reject even the most expensive rewards cards. More than 80% of customers carry them, she said, and refusing them would cost merchants substantial business.
Quite so.
Merchants continue buying the service at the posted price, year after year, while insisting that it is worth far less. Their behavior suggests that card acceptance creates substantial value. Their campaign seeks to use state power to capture more of that value for themselves.
That is rent-seeking with a consumer-protection soundtrack.
The campaign has never aimed to restore a market price. Large retailers want legal rules that transfer a larger share of the card system’s gains to merchants, with little regard for the costs imposed on consumers, issuers, or smaller businesses.
A Court-Ordered Discount on Other People’s Cards
Against that backdrop, consider the settlement’s design.
The rate provisions amount to price controls. Average credit-card interchange fees would fall by 10 basis points for five years. Much of that reduction would likely come through the eight-year cap of 1.25% on standard consumer cards, roughly 25% below current average rates. All other posted rates would remain frozen at their March 2025 levels.
The three-tier acceptance framework would largely dismantle the honor-all-cards rule. Merchants could accept standard consumer cards while rejecting premium rewards cards or commercial cards.
Whether many merchants will do so remains doubtful. Rewards cards are common, and their benefits encourage cardholders to spend more. A merchant that rejects them risks losing those customers. Most consumers also carry only one credit card, so declining it may mean losing the sale altogether.
The settlement would also give merchants much more freedom to impose surcharges, including different surcharges for different cards. Australia’s experience suggests that merchants with unusual offerings or captive customers—such as taxicabs, airlines, and event-booking companies—are the most likely to use that power to extract higher payments from consumers.
Combined with selective card acceptance, differential surcharges could also steer customers toward cards with lower interchange fees.
Large retailers would therefore keep much of the spending, convenience, and risk-shifting benefits of card acceptance while contributing less to the benefits that encourage consumers to carry and use cards. They would obtain that transfer through a court-supervised shakedown.
When Swipe-Fee Savings Skip the Shopper
Contrary to large retailers’ claims, interchange fees do not create a pile of idle profits waiting to be redistributed. They allocate costs and benefits across the two sides of the card market. Merchants pay more than the narrow cost of processing a transaction, and issuers return part of that difference to consumers through rewards, fraud protection, interest-free credit, and other cardholder benefits.
When regulators force that difference lower, those benefits shrink.
The Durbin Amendment provides the best-studied example. After the Federal Reserve implemented it through Regulation II in 2011, debit-card interchange fees at covered banks—those with at least $10 billion in assets—fell by roughly half. Banks lost more than $6 billion a year in revenue.
They responded quickly. Most covered banks eliminated debit-card rewards programs, reduced the availability of free checking for customers with low balances, and raised monthly maintenance fees. Hundreds of thousands of lower-income customers then left the banking system.
Durbin also required all issuers, large and small, to place at least two unaffiliated payment networks on each debit card. That mandate sharply reduced interchange fees on personal identification number, or PIN, debit transactions because smaller networks were not bound by the default fees negotiated between issuing banks and the major national networks, Visa and Mastercard.
As I noted previously:
Following the introduction of mandatory “competitive routing” on debit cards, smaller PIN-debit networks saw a profit opportunity. But those networks were not focused on maximizing the value of the system, so they were willing to carry payment messages at a lower interchange rate than the major networks. Smaller issuing banks were forced to accept these lower PIN-debit interchange fees, and the major networks were forced to cut their PIN-debit fees to remain competitive. As a result, many smaller banks have experienced reductions in interchange revenue similar to their larger cousins and have responded similarly—by reducing the availability of free checking accounts.
The promised savings for consumers largely failed to appear. Surveys and empirical studies found that most merchants kept prices unchanged. Some raised them.
Consumers also changed how they paid. Many shifted from debit cards to credit cards used for routine purchases. That effect appeared mainly among consumers with strong credit scores who qualified for premium cards.
A law promoted as consumer protection instead transferred billions of dollars each year from bank shareholders and customers, disproportionately lower-income customers, to large retailers and their shareholders.
Australia’s experience followed the same pattern. After the Reserve Bank of Australia imposed interchange-fee caps in 2003, rewards declined, annual card fees rose, and any reduction in retail prices proved too small or diffuse to detect.
Liberalized surcharging created another problem. Merchants imposed enough add-on fees that the Reserve Bank first capped “excessive” surcharges and, by 2025, proposed banning card surcharges altogether.
Australia also saw substitution. Banks began offering premium customers American Express-branded “companion cards” with generous rewards. American Express gained about 25% in market share before the Reserve Bank brought those cards under the same price controls.
The European Union’s experience after its Interchange Fee Regulation points in the same direction. Interchange caps reduced cardholder benefits and shifted costs elsewhere. The gap between credit-card annual percentage rates (APRs) and the European Central Bank’s base rate widened, suggesting that banks passed at least some of the burden to customers who carried balances.
Retail-price savings remained meager. As under Durbin and in Australia, merchants kept most of the gains.
The Savings Come With a Smaller Pie
There is little reason to expect this settlement to produce different effects, though their magnitude may be smaller. Issuers facing fee caps and possible rejection of premium cards will likely trim rewards, raise annual fees, tighten approval standards at the margin, and shift their portfolios away from newly unprofitable customers.
Surcharging carries its own costs. It slows checkout, can prompt customers to abandon purchases, and annoys consumers by making the fee highly visible. Some customers will switch to payment methods they value less to avoid a surcharge that may exceed the merchant’s own card-acceptance cost.
Three-party networks such as American Express and Discover are outside the settlement. They will remain free to use merchant revenue to fund cardholder benefits and may respond by offering rewards that Visa- and Mastercard-branded cards can no longer match.
That competition could soften some of the harm to consumers, though at the price of added inconvenience and duplication. Consumers may need another card to retain the same benefits. Any shift toward American Express or Discover would also erase part of the savings merchants expect from the settlement.
Each response weakens cardholders’ incentives to carry and use Visa- and Mastercard-branded cards. Less generous rewards will reduce card use at the margin. Lower use will shrink the increase in transaction size associated with card payments and reduce merchants’ total sales.
Lower transaction volume would also spread the networks’ enormous fixed costs across fewer payments. That could reduce investment in payment technology. Recent advances such as tokenization, contactless payments, and real-time fraud scoring have made transactions faster and safer, especially online. Slower investment would make further improvements less likely.
Some spending will shift to three-party cards, but that substitution will provide only a partial offset. The likely result is less generous cardholder benefits, lower card use, less consumer spending, and slower payment innovation. Consumers and merchants would both lose some of the commerce that interchange-funded benefits now encourage.
The Least Bad Way to End a Bad Case
All that said, the proposed settlement would likely do far less harm than the legislative alternatives now on offer.
As we have documented elsewhere, the Illinois Interchange Fee Prohibition Act and similar state proposals would exempt taxes, tips, or other transaction components from interchange fees. Implementing those carveouts would require extensive changes to payment-network infrastructure and could fragment a national system into state-by-state payment rules.
The settlement may reduce issuer revenue more than those laws would, but it creates far fewer compliance costs. It also leaves the basic payment infrastructure intact.
The proposed Credit Card Competition Act (CCCA) offers an even starker comparison. Like the settlement, the act assumes that payment networks lack sufficient competition and that interchange fees are therefore inflated. Starting from that mistaken premise, it would require issuers with more than $100 billion in assets to make every credit-card transaction routable over at least one unaffiliated network.
That would amount to the Durbin Amendment for credit cards, with added hazards. Credit transactions bundle underwriting, revolving credit, fraud guarantees, and dispute rights. The issuer and network allocate those risks through their contractual relationship.
A second network may not price the credit risk, bear the fraud liability, or support the same security systems. Requiring issuers to route transactions through such a network could create large and poorly assigned liabilities.
Durbin already showed what happens when routing mandates compress interchange fees. Rewards disappear, account fees rise, and access tightens. Applied to credit cards, the pressure would fall on rewards, credit availability, and fraud-prevention investment, where the potential losses exceed those associated with debit cards.
Merchants claim that payment networks suffer from too little competition. Both the settlement and the CCCA would weaken competition where consumers experience it most directly—among card issuers offering different rewards, rates, fees, and benefits.
Artificially lower interchange fees would make it harder for issuers to sustain that variety. The settlement would likely produce a modest contraction. The CCCA would impose a much sharper one by compressing interchange fees across the market.
By comparison, the proposed Settlement would likely have only a modest effect.
The settlement also has the virtue of an expiration date. Its rate provisions last five or eight years, after which networks regain pricing freedom. The CCCA would continue indefinitely unless Congress repealed it. The settlement bends the price mechanism. The act would come much closer to breaking it.
The settlement would still advance large retailers’ long-running campaign. It would thin the cross-subsidies that fund cardholder benefits, participation, and payment innovation. At the margin, it would reduce some of the commerce that payment cards generate for merchants and consumers alike.
Yet the settlement remains a defensible resolution. It is temporary, negotiated, and less destructive of the card system’s pricing structure than any legislative alternative under serious consideration. It may also give lawmakers a reason to leave the industry alone.
After 21 years of litigation, peace has value. The trick will be convincing Congress to let it stand.
