Loyalty rebates block new competition in payment card markets
A De Nederlandsche Bank (DNB) working paper examines how dominant payment card networks use rebates to issuing banks to deter new market entrants. The study reveals conditions under which high rebates make profitable entry impossible for competitors, impacting payment regulation.
Strategic rebates stifle new competition
Payment card markets are globally dominated by a few large card networks, such as UnionPay, Visa, and Mastercard, which collectively processed up to 91 percent of global card expenditure in 2022.
These networks achieve exceptionally high net profit margins, significantly exceeding those of major technology companies.
Policymakers express growing concerns regarding rising merchant fees and an overreliance on these foreign card networks, leading to efforts to support domestic payment alternatives, often with limited success.
This paper investigates how dominant card networks strategically use rebates to issuing banks to prevent profitable entry by competitors.
The analysis explores conditions under which a network sets rebates at a level that effectively blocks new market participants, offering three strategic options: setting monopolistic rebates under blockaded entry, collusive rebates to accommodate entry, or contestable rebates to deter entry.
Switching costs and transaction benefits
The study defines 'rebates' as the total money issuing banks receive for enabling card transactions, encompassing interchange fees and incentive payments, net of processing fees.
Issuing banks hold a crucial position as most consumers have payment accounts with them, but they incur costs when switching card networks, such as issuing new cards or adapting internal processing.
These switching costs grant card networks market power over issuing banks.
The paper demonstrates that entry deterrence becomes more pronounced as transaction benefits increase, particularly if issuing banks pass these rebates through to cardholders.
Conversely, high switching costs for issuing banks can reduce the effectiveness of deterrence, highlighting a complex interplay of market forces.
Rebates: a regulatory dilemma
The study highlights a critical paradox: while entry deterrence typically benefits welfare in one-sided markets, it can harm it in two-sided payment markets.
High consumer rebates, used to block new entrants, often lead to increased fees for merchants, ultimately distorting market efficiency.
This finding underscores the urgent need for regulatory scrutiny of rebate structures to foster genuine competition and reduce reliance on dominant foreign networks.