Payment System Self-Regulation through Fee Caps

Abstract

This paper considers the organization of a single (domestic) payment system. When card issuers that are members of a payment system set their fees individually, this gives rise to a free-riding problem, as in providing access to different customers, card issuers are complements from the perspective of each merchant. When payment systems can threaten to exclude, in particular, card issuers with a smaller customer base that do not adhere to a common cap on fees, this allows to restore the full internalization outcome, leading to lower fees but higher profits and higher welfare. When payment systems cannot threaten to exclude card issuers, the full internalization outcome arises only when card issuers are sufficiently symmetric.