Banks seem to be getting quite generous with credit card rewards, particularly for premium cards. However, some Members of Parliament are unhappy with the fees charged merchants to pay for these rewards.
On the surface it all seems like a great idea. You buy stuff with your credit card and later you get back a percentage in cash or in points that can be used to fly of buy stuff. Premium cards are even better because the rewards are bigger. But we know there is no free lunch. Who pays for all this?
To answer this question we have to follow the money for a couple of steps. To begin with, merchants are charged fees for accepting credit cards. The amount they are charged is called the credit card interchange rate. This rate is higher for premium cards.
Of course, since merchants get to keep less of the money from a sale, they have to raise prices. So, ultimately, consumers’ credit card rewards are paid for by consumers. But, consumers actually pay extra because banks keep a slice of the interchange fees charged to merchants.
If the interchange rate is increased by 1%, prices will have to go up by about 1% to compensate, but consumer credit card rewards will go up by less than 1%. In the big picture, consumers would be better off with a rock-bottom credit card interchange rate and no rewards.
Banks have an interest in increasing interchange rates as much as possible to increase their profits. To this end they have been flooding their customers with unsolicited premium cards. Maybe merchants need to offer discounts for using either cash or credit cards with low interchange fees.