Credit card companies face crunch verdict from competition watchdog

As spending with plastic soars, the Office of Fair Trading looks to cut the costs for users

Like the summer, it has been a very hot year for credit card companies, which have been one of the main beneficiaries of the frenzy of spending which saw Britons rack up £10bn of extra debt in June alone.

But a big dampener may well be around the corner, in the form of the competition authorities. Within the next few weeks the regulators are expected to unleash a raft of measures intended to bring down the costs of credit cards for the end users.

The move follows a three-year investigation into allegations that credit card providers behave like a private cartel, fixing prices and charging extortionate fees to both retailers and consumers.

The Office of Fair Trading, which is set to report within the next month, has specifically been looking at MasterCard, though its ruling is expected to have serious implications for its bigger rival, Visa.

MasterCard and Visa are both private organisations owned by a consortium of international banks, a significant number in the UK. They are the number one and number two players in the UK's lucrative and complex world of settling the millions of credit card transactions which take place every year.

If the signals so far are anything to go by, the people at MasterCard will not be going out and flashing their plastic on any champagne in celebration at the OFT's conclusions.

In February the body issued "preliminary findings", saying MasterCard charged "unjustifiably high fees" to retailers for the privilege of allowing customers to pay with credit cards.

The OFT added that the charge was effectively a "tax on retailers" because they have little power to negotiate the sum they must hand over to the credit card company out of each transaction.

MasterCard has attracted a prolonged inquiry by the OFT because, like Visa, the banks which own it and also issue the vast majority of UK credit cards have sat down together and agreed how much to charge retailers for the cost of making the credit card system work.

The result is an "interchange fee" which the retailer pays through its bank to the credit card company whose piece of plastic has been used to make the transaction. Because the fee is a private trading agreement, MasterCard, whose logo appears on 21 million cards in the UK, had to apply for an exemption to normal UK trading rules. While it received one under regulations before the 1998 Competition Act, receiving a waiver under the new Act has so far been unsuccessful.

MasterCard says the fee covers a wide range of costs, from giving comfort to all retailers that fraudulent use of cards will be covered by MasterCard, to renting terminals which can take credit card payments.

However, it is a set up which the British Retail Consortium has called "completely unjustifiable", especially for small shops. Consumer groups have also complained, on the grounds customers are shouldering at least some of the burden for the high fees through higher prices.

It should, then, be good news that the competition watchdog is expected to follow up its damning February findings with a demand next month that MasterCard reduce its interchange fee, which is currently worth on average 1.1 per cent of the value of each transaction.

Not so, MasterCard unsurprisingly argues, saying that such a move would actually be bad not only for the major banks which pocket most of the profits it generates, but also for small players in the credit card market, retailers and for consumers. One of the most annoying consequences for consumers could be the end of the 30-day interest free period on payments which almost all credit cards offer. MasterCard has warned the OFT that the cost of providing the service is built into the interchange fee, so any tampering with that could force card issuers to return to the days when customers had to pay an annual fee.

Peter Crook, managing director of Barclaycard - Britain's largest issuer of credit cards - said the consequences of the OFT ruling would depend on quite how savagely it cuts the interchange fee.

"We have to assume there will be some level of reduction. If the OFT follows what happens in the Australian market, and cuts the interchange fee in half, it will likely be that we will see a dilution in the rewards programmes cards offer," Mr Crook warned.

Indeed, there is already evidence that this is happening. Halifax and Bank of Scotland, both part of the HBOS group, are two of a raft of card issuers that have already cut back on the free cash customers accumulate if they use their cards and MasterCard argues the trend will intensify if the OFT squeezes profit margins further.

Much depends on the fate of Visa, which controls 60 per cent of credit card transmissions in the UK and which is also in the OFT's sights.

However, the organisation is hoping to avoid being hauled over the coals because it has already come to an agreement with Mario Monti, the European Competition Commissioner, about cross-border fees and believes that the July 2002 agreement overrides any further concerns that Britain's regulators might have.

MasterCard also faces the prospect that foreign-owned rivals such as American Express might end up with a considerable competitive advantage. Because Amex is a company, not a cartel, it does not have to face the OFT's scrutiny. But those in the market say it charges retailers far more than its UK rivals do and they ask why handicapping the likes of MasterCard and Visa while allowing Amex to capitalise on the situation would benefit anyone who uses the credit card system.

MasterCard also feels its investigation by the OFT, which began well before the Government started to become alarmed about the dizzying levels of consumer debt, has now turned into a political campaign to hit out at lenders who have helped people to get so deeply into the red.

Paul Lucraft, manager of business services at MasterCard in Europe, said: "We are concerned that other issues related to debt and responsibility and lending may cloud the OFT's judgement about what is appropriate in a case which only relates to the way in which the interchange fee operates. The rest is outside the OFT's remit."