New study by Fed blasts credit industry

The Federal Reserve Board released a paper by Scott Schuh, Oz Shy, and Joanna Stavins on Monday, July 26, 2010, criticizing fees that credit card companies charge to merchants for allowing customers to pay with credit cards. Although new rules by the Fed aim to increase competition between banks responsible for handling merchant credit card transactions, and forcing them to lower their rates, this study details how the cost of these fees to consumers falls disproportionately upon the lower-income demographic of American society.

Merchants are generally forced to raise their prices as a result of credit card companies charging them to allow credit cards as a means to pay for transactions. However, until new rules by the Fed take effect, many merchants-in particular, convenience stores and gas stations-could not charge lower prices to customers who paid in cash or check. Since households with lower incomes are not as likely to have a credit card, this means that they are forced into helping the merchant recoup the fees charged by card issuers, despite the fact that they cannot take advantage of credit cards. The study estimated that as much as 83 percent of card-issuing banks' revenue from credit card fees is thus procured from customers who only pay cash.

Additionally, rewards programs offered by card issuers may benefit the wealthy at the expense of lower-income cardholders. Higher-income households are associated with more card activity, meaning that they reap more of the benefits of rewards programs. Schuh, Shy, and Stavins stated that 20 percent of all card benefits, such as cash back and frequent flyer miles, went to high-income households. When money paid to merchants was calculated with card rewards factored in, the Federal Reserve study showed that low income households earning less than $20,000 each year ended up paying $23 yearly to banks, whereas households earning more than $150,000 per year received $756.

The study stated that while this phenomenon represents a clear transfer of wealth from the poor to the rich, possible solutions to alleviate the problem include reducing cash rewards as well as merchant fees.

-Seth Berger