Regulating Competing Payment Networks

Finance Seminar joint with LawFin Research Seminar

Abstract
Payment markets are two-sided. Networks like Visa and Mastercard charge merchant
fees to fund consumer rewards. I study how regulation, private entry, and public entry in
this market affect prices, distribution, and welfare in equilibrium. I model two-sided multihoming,
retail price-setting, and network competition. I estimate the model by matching
data on consumers’ card holdings, merchant acceptance, network pricing, and the effects
of debit reward reductions. The estimated model matches external evidence on networks’
costs, merchants’ margins, and the effects of AmEx’s 2016–2019 cuts in merchant fees. Using
the estimated model, I compare the effects of capping credit card merchant fees, increasing
entry of private credit card networks, and introducing a low-fee public option like FedNow.
Capping credit card merchant fees is progressive and increases annual welfare by reducing
rewards, retail prices, and credit card use. However, because consumer adoption is ten
times more price-sensitive than merchant acceptance, competition from private networks like
Discover or Buy Now Pay Later services like Affirm raises rewards without lowering fees,
lowering welfare. A public option struggles to gain consumer adoption without rewards,
limiting welfare gains.