Excessive swipe fees rooted in system
Lack of regulator in competitive card market burdens small business owners
By Kang Ye-won
Park Young-soo, a Korean barbecue restaurant owner, has run the family-owned business in Namsan-dong for the last 25 years and he never doubted that he would pass it onto his son just like his father did. But lately, he’s not so optimistic if that can happen.
In a time of recession, small business owners like Park have been hit the most: customers slowed and raw material and labor costs spiked. As one possible solution, they decided to tackle the continued issue: high credit card interchange fees or the so-called, swipe fees. That is what merchants have to pay to credit card issuers for processing transactions. In other words, every time a customer swipes a credit card, a small amount of fee is charged to the merchants.
However, experts say the fundamental problem lies not solely on credit card companies but rather rooted in the credit card transaction processing system.
A lack of regulator in the system
Korea is one of the top credit card user countries in the world. The shares of credit card use took up nearly 45 percent of its gross domestic product — a broad measure of goods and services produced ― in 2008, according to Lee Jae-youn, a senior fellow at the Korea Institute of Finance, in a research note. In comparison, the figure stayed at merely 15 percent and 8 percent in the United States and Britain, respectively.
Despite the dominating credit card companies’ share in Korea’s financial market, a regulator is absent in the transaction processing system.
In the U.S., credit card network holders such as Visa and MasterCard set the “appropriate” rate of interchange fees considering both credit card firms and merchants, Lee said, in a phone interview. In Australia, the government regulates the amount of swipe fees that credit card issuers can charge on merchants.
However, in Korea, there is no agent either like Visa or the government, which keeps the fee rates in check in the transaction process.
“It’s nonsense, given the size of the credit card market size,” Lee said. There are seven major credit card brands in Korea — KB Kookmin Card, Shinhan Card, BC Card, Hana SK Card, Samsung Card, Hyundai Card and Lotte Card.
And the government, instead of policing the market, has rather encouraged card issuers and banks to produce more plastic and attract users with perks like reward points and low annual fees — at the expense of merchants.
Also in the Korean credit card network, there’s a third party that connects credit card companies and merchants. The so-called, value-added network, or VAN, often forces retailers to contract with a bundle of credit card companies, which takes away the merchants’ option to select the issuers that they prefer, obviously the ones who offer low fees.
This Tuesday, some 50,000 small business owners went on strike as they gathered at the Olympic Stadium calling for a swipe fee cut by more than half. The group also asked for an amendment to give them a right to deal with the credit card firms on transaction fees as large merchants such as department stores do.
Currently, card firms charge about 2 to 2.4 percent in transaction fees to large department stores and discount stores like E-Mart, whereas the average rate for street markets and medium size retailers is 2.6 percent, according to a report by the Financial Services Commission, a government regulator.
In response to the fiery protest, many credit card companies including Shinhan Card said they would lower the transaction fees down to 1.8 percent for small businesses who make less than 200 million won ($174,000) a year.
But the restaurant association demanded a deeper cut as low as 1.5 percent, complaining of a persistent financial squeeze on them. The demonstration also triggered gas station owners to follow suit by rallying for lower interchange fees, which is currently at 1.5 percent.
This May, the government recommended that card firms slash the swipe fees to 1.6 percent for small businesses who make less than 120 million won ($103,700) a year, said Peter Cheong, the FSC deputy director, during a phone interview. But the agency has no enforcement power and it has not done a follow-up inspection since then, Cheong added.
Some lawmakers and regulators have also pushed for a plan to give them the right to refuse a card use for transactions under 10,000 won, or $8.55. In the U.S. and Canada, they currently set the minimum of $10 for a card use.
Under current law in Korea, retailers who refuse to take the consumer’s credit card may face up to one year in jail or fines of 10 million won.
The proposal made both business owners and consumers outraged.
“It is a Band-Aid response,” said Shin Hoon, a policy development director for the Korea Restaurant Association, in a phone interview. “We have many customers who eat a meal under 10,000 won and the new rule would just be inconvenient for them,” Shin said.
The YMCA in Seoul also criticized the policy saying it is bucking the trend of consumers’ credit card payment on small transactions and it would burden many of them who don’t carry a small change.
Due to the fierce backlash, the FSC stepped back from its earlier stance.
“The government has no plan to draw up a bill or make a new regulation to allow retailers to refuse the card use for small transactions,” FSC Chairman Kim Seok-dong told reporters on Oct. 13.
What does it mean for consumers?
If credit card issuers like KB Card or Hyundai Card continue to charge high swipe fees for merchants, it’s the latter who will suffer in the short term, but ultimately they will raise prices, which would take a toll on consumers whether they pay with cash or credit card.
Lee with the Korea Institute of Finance suggested that we adopt a credit card network provider in our transaction process, similar to the U.S. system. That way, business owners would work directly with the network provider instead of going through a third party processor like VAN when signing a contract with card firms. This would save processing fees and consequently, lower the swipe fees.
Consumers can help too, by using more debit cards or check cards. In countries like Britain and Switzerland, shares of debit card use in GDP are more than double the ones of credit cards, Lee said, in a memo. On the other hand, the percentage of debit card use in Korea is less than a quarter of that of credit cards.
Also cash advances ― a common practice among Korean credit card users, are easily accessible via ATMs. However, cash advances come with added risks, more than a direct loan or credit, and their processing fee rates reach up to 7 percent or more.
Most developed countries encourage the use of debit cards because it is relatively risk free since the card owners can only use it when they have a sufficient balance in their account. Also with a debit card, the swipe fee stays nearly at zero, because the transactions take place almost instantly whereas the credit card transactions can take up to a month, Lee said.
Card transaction process in Korea
The credit card was first adopted in 1969 when Shinsegae Department Store introduced it as a type of store card. Within the next 10 years, credit card users grew exponentially as many banks and corporations jumped into the industry, issuing the plastic that we use now.
Also in an effort to boost the economy in the early 2000s, the government embraced a business-friendly environment for credit card companies such as allowing them to decide interchange fee rates.
Small retailers have cried out over the “unfair” rate burden for some time.
“Things are only getting harder (for small business),” said Park, the barbecue restaurant owner in Namsan-dong.
Park and his wife, who both work fulltime, make roughly 500 million won a year ($435,000) and 2.6 percent of his profits, or about 13 million won (roughly $11,300), goes to the credit card companies. After taking off other operating expenses ― 30 percent for material costs, another 30 percent for labor, 12 percent for rent, 15 percent for various bills, Park claims that the couple is left with less than 25 million won a year.
Considering the rise in food prices, especially vegetables, Park said, “There’s nothing left in our hands at the end of the day.”