As of today, Canadian businesses are allowed to charge credit card fees on purchases.

For consumers and businesses, this change is bound to send shockwaves through our spending habits, not to mention the credit card rewards space.

Let’s explore the ramifications of this dramatic news.

Canadian Businesses Can Charge Credit Card Fees

Starting today, Canadian businesses can levy a surcharge for accepting credit card payments. This fee would then be paid by customers who choose to use a credit card to make their purchase.

For the past 30 years, this wasn’t allowed. There’s actually no Canadian federal legislation preventing this; instead, it was a rule put in place by Visa and Mastercard as part of the merchant agreement that they have with businesses who decide to accept credit cards.

This policy has been beneficial for credit card companies, as it incentivizes consumers to use their cards on a level playing field with cash prices for goods and services. As a result, credit card companies make money from businesses, and businesses make money from increased sales as customers enjoy the convenience of cashless payments.

This change is part of the settlement of a class-action lawsuit brought by businesses against Visa and Mastercard, alleging that the costs imposed on merchants to accept credit cards have been punitively high.

Going forward, Mastercard has modified their merchant agreement to allow businesses to levy a surcharge on customers up to 2.4% or the credit card processing fee, whichever is lower. Consumers using debit and prepaid Mastercards are still protected from having a surcharge imposed.

Visa has yet to confirm their exact policies, but I’d guess that they’ll align closely with Mastercard. American Express is not part of the decision in the class-action settlement, and they tend to do things a bit differently anyway, so it’ll be interesting to see how they respond.

Meanwhile, the Canadian government has also been exploring legislation that would reduce interchange fees. No action has been taken yet, and discussions have been stagnant through the pandemic.

How Do Credit Card Payments Work?

Consumer credit is issued by accredited lenders, including American Express, BMO, CIBC, RBC, Scotiabank, and TD. With the exception of prepaid cards, you have to apply to get a credit card, which lets you spend money that you don’t (yet) have.

Merchants must be set up with a payment processor, such as Moneris, Global Payments, Stripe, or Square, who provide the hardware and software to accept credit card payments. They also provide merchant accounts, where money from customers is received and held before being sent to a business bank account.

Visa, Mastercard, and American Express operate payment networks, which is the infrastructure that enables money to change hands in the credit system. You can think of this as the bridge between the consumer and the business.

At every step along the way, a third party is providing a service, and they’re all taking a cut of the transaction:

• Credit issuers make money from the consumer on annual fees, interest charges, and other banking products (investments, mortgages, etc.) that they can sell by having a cardholder embedded in their system.
• Payment processors make money from the business by charging for their hardware and service fees, which may be a flat rate, a percentage of each transaction, or a package deal of any form.
• Payment networks make money from the interchange fee, which is a percentage of the transaction paid from the merchant’s bank to the customer’s bank. Networks take a small cut as the middleman facilitating the transaction, while the bulk of the fee goes upstream to the issuing bank acting as the lender.

The Relationship Between Credit Card Fees and Rewards

While there are many factors that influence credit card rewards, it is commonly understood that the interchange fee is the most important driver of earning rates for cardholders. High interchange fees mean more money to the credit card issuer, which means they can return more value to the cardholder in the form of rewards on spending.

In fact, the only jurisdictions in the world with meaningful credit card rewards are the United States and Canada. By no coincidence, we are the only two countries with high interchange fees in the realm of 1.5%, while the rest of the world is generally under 0.5%.

Each network sets interchange rates based on factors such as merchant category and card tier. For example, rewards on grocery stores are universally high because interchange fees for merchants classified as grocery stores are higher.

This is obviously great for consumers, as we have lots of choice over which card we use at which store, and the highest interchange and rewards tend to be found at stores that make up the bulk of our daily spending.

It’s also no surprise why Amex has the best rewards in the industry. They’ve cultivated an identity as a high-end, consumer-friendly brand, with a reputation for charging higher interchange fees to businesses, who sometimes respond by simply refusing to accept Amex payments.

To balance consumer incentives with the interests of businesses, the networks also set a maximum total interchange rate, which issuers must adhere to. This is why Visa Infinite and World Elite Mastercard products have income requirements: as much as banks would love to have every cardholder paying high annual fees, they need a way to limit the number of cards in circulation with high interchange fees.

What’s the Impact for Consumers and Businesses?

During the pandemic, we’ve seen a shift in the direction of a cashless society. Through that change, businesses have shined a spotlight on the fees that they are charged to accept credit card payments.

By charging a fee for the privilege of using a credit card, businesses can transfer some of the costs of accepting credit cards onto the consumer.

On the surface, this change moves the needle in a pro-business, anti-consumer direction. While this is unquestionably true, it’s not quite crystal clear that businesses will actually benefit, or if consumers will stop using credit cards.

First, the costs of accepting credit cards are already priced in. Many businesses have raised their prices over the years to account for the costs of processing credit cards, and they don’t necessarily need to levy a surcharge to make the economics work – the system has already found equilibrium.

If anything, the pricing-in of credit card fees only serves to hurt people who pay cash: they pay a higher price than they would otherwise, without reaping any credit card rewards. In the grand scheme of things, credit card fees serve to widen the wealth gap between those who can and can’t be approved for credit cards.

In the current inflationary climate, I’d be concerned that businesses will tack on a credit card surcharge, despite the costs of the system already being accounted for in their pricing. After all, I don’t expect to see sticker prices coming down to offset surcharges.

As a result, I’m not convinced that consumers will benefit from a new system of surcharges, whether paying with credit or cash.

That being said, I’m not sure most businesses will even benefit from adding a surcharge. Just because they can, doesn’t mean they will.

Such a blatantly anti-consumer policy is bound to ruffle some feathers, especially with tensions running high as the cost of living skyrockets.

Consumers vote with their wallets, and many may simply choose not to patronize establishments that levy a credit card surcharge. Small- and medium-sized businesses may risk putting themselves at a competitive disadvantage by imposing a fee on customers.

Unfortunately, large corporations are best poised to benefit. Monopoly industries, such as telecommunications and airlines, can get away with credit card fees without their business suffering.

Indeed, Telus has already fired the first shot, charging customers a fee of 1.5% on all credit card payments.

This change strikes me as excessively favouring large businesses, who already have an advantage by being able to negotiate their own interchange rates anyway. Payment networks often charge a lower percentage to their partners who do enormous volumes of transactions.

Additionally, it’s worth noting that businesses in Quebec aren’t legally allowed to add any surcharges to the sticker price, with the exception of sales tax. Whether in Quebec or the rest of Canada, I can’t see many businesses having an appetite to juggle multiple prices per product.

Also, while there are certainly costs to maintain the technology that enables credit card payments, many people overlook the costs of a cash system. With a higher risk of theft and added burden of bookkeeping, the time, money, and training required to ensure secure cash-handling procedures can easily outpace the price and convenience of digital payments.

Because these hidden costs of cash don’t show up on a balance sheet, many short-sighted business owners are oblivious to the benefits of accepting credit cards.

I’ll continue using credit cards, as consumers can still benefit immensely. As products, credit cards don’t just offer rewards; they also offer things like fraud protection and chargebacks, which you don’t get with other methods of payment. As long as these unique benefits continue, credit card fees are more than just a cash grab by payment networks and banks.

What’s the Impact on Credit Card Rewards and Fees?

In spite of the potential for credit card surcharges, interchange remains unchanged. This means that, at least for now, credit card issuers have no reason to reduce their rewards rates, or to increase their fees for cardholders.

Credit card usage may take a short-term dip – it certainly won’t increase as a result of the potential for higher costs for consumers. For banks, with interchange representing a greater profit centre than interest, they may look for new ways to incentivize consumers to use credit cards frequently and for large purchases.

As a best-case scenario, we may see higher signup bonuses, or perhaps even higher earn rates on daily spending, as credit card issuers compete with each other more aggressively for a smaller market of cardholders.

However, it’s also possible that we move towards a long-term equilibrium where credit cards take a back seat. If credit card acceptance falls out of favour with businesses, payment networks may need to reduce interchange fees to lure merchants back in.

Of course, this would have the ripple effect of reducing rewards for cardholders. This could eventually lead to a system like the European Union, where costs to business are low and rewards to consumers are low, or it might end up a step further like in Australia, where credit card culture isn’t really a thing.

Meanwhile, banks in low-interchange jurisdictions make up for this on their balance sheets with high interest rates. So if you’ve been feeling guilty about transferring wealth from the underbanked, cash-paying folks to your creditworthy self via higher prices and higher rewards, rest assured that the middleman will always find a way to take its cut.

Most likely, though, as costs are simply being shuffled from the business to the consumer, I don’t think much will change with respect to rewards, at least not unless the federal government introduces legislation to reduce interchange fees.

Conclusion

With Canadian businesses being allowed to impose surcharges on credit card payments, the pendulum on the credit card system is moving in a decisively anti-consumer, pro-business direction.

Regardless of how you feel about the relationship between interchange and rewards, it’s hard to deny that credit card payments are inefficient. Value for businesses and consumers alike is being lost as “friction” to middlemen, namely credit issuers and payment networks.

Unfortunately, I’m concerned that credit card surcharges are the wrong solution. Instead of improving efficiency for the benefit of both parties to a transaction, the costs of the system are simply being shifted around.

I’m not convinced that this will benefit businesses or consumers on balance. We’re opening up the possibility of higher prices and less choice, all while fanning the flames of an economy on edge and a widening wealth gap.

Hopefully the effects will be minimal, and the decision-makers in our society will pull more effective levers to address any systemic deficiencies. With such unprecedented changes after so many decades of the status quo, it’s anyone’s guess how businesses, consumers, credit card issuers, and legislators will respond next.

Until then, savvy consumers like you should continue to reap the benefits of the credit card industry to the best of your ability. I’m optimistic that we will continue to gain more by using credit cards than the additional costs we may face.

Finally, these potential changes are also a sobering reminder that credit card rewards are merely a tool in the toolbox towards aspirational travel, and it’s essential to remain adaptable and creative as systems change outside of our control.