Interchange fees and inefficiencies in the substitution between debit cards and cash

This article examines the divergence between the profit maximizing and the welfare maximizing interchange fees when two issuing banks, which compete for deposits, share a debit card platform and their ATM networks. It suggests some guidelines for regulatory intervention to reduce inefficiencies in the substitution between debit cards and cash. For instance, when banks make profit on ATM transactions, if the volume of foreign withdrawals is high and if the opportunity cost of being paid in cash for merchants who accept cards is low, social welfare can be increased by reducing the interchange fee on withdrawals. If the value of the expenses paid by card is high, and if merchant demand is not very sensitive to the interchange fee on card payments, social welfare can be increased by reducing the interchange fee on card payments.

► I model a payment card platform in which issuing banks share their ATMs. ► I relate the choice of optimal interchange fees to the costs of cash for banks. ► I explain how interchange fees should be regulated to improve social welfare.