Dodd-Frank Interchange Fee Price Controls Less Draconian, But Still Destructive

by John Berlau on June 29, 2011 · 5 comments

in Deregulate to Stimulate, Economy

Today, at around 3:30 pm, the Federal Reserve will vote on a final rule that will make price controls from the Durbin Amendment of Dodd-Frank less of a train wreck — but still very destructive — for community banks, credit unions, and consumers.

The Durbin Amendment puts price controls on the interchange fees — or “swipe fees” as the something-for-nothing retailer lobby calls them — that banks and credit unions charge merchants to process debit process debit transactions. Retailers pay a fee averaging 1.19 percent on each card purchase.  In return they get more sales and the guaranteed payment for all purchases that was lacking in the “good old days” of bounced checks.

But despite the benefits ATMs and payment card technology have brought to them, big retailers such as Wal-Mart and Home Depot have taken an entitlement mentality to this technology. They successfully lobbied to get — with assistance from both Senate Majority Whip Dick Durbin and 17 Senate Republicans — price controls in the Dodd-Frank “financial reform” bill stating that banks and credit union can only charge fees that are “reasonable and proportional to cost.” Never mind that there are no such requirement that retailers charge consumers prices that are “reasonable and proportional” to the cost of goods they sell.

In December, the Fed went beyond what the Durbin Amendment required in setting 7-to-12-cent fee cap for every debit card transaction, whether it be for $50 or $5,000. By the Fed’s own admission, these fees would not come close to covering the debit card infrastructure.

Since the Fed rule would not make costs of debit card processing disappear, much of these costs will be transferred to in terms of loss of free checking and debit card rewards, new charges for using an ATM, and other fee hikes and service cuts. In its rule, the Fed almost invited banks and credit unions to do this, “helpfully” pointing out that “the interchange fee standard would not limit the ability of an issuer to earn revenue from other sources, such as charging fees to cardholders.”

The draconian price controls from the Fed created a fury among credit unions, community banks and consumers that resulted in a bipartisan 54-vote majority earlier this month to delay the rule. But thanks to the GOP’s “Durbin Dozen” who, despite a letter opposing the price controls from 33 Center-Right leaders (including CEI, Americans for Tax Reform, and the Christian Coalition of America), voted to keep the price controls and prevent what would have been the first chink in Dodd-Frank’s armor. So the delay measure did not reach the 60 votes needed to clear the Senate.

Still, the concern of 54 senators appeared to be enough to convince the Fed to significantly hike the 12-cent cap, which is not set in stone in the statute, so that banks and credit unions can at least cover most of their costs. CEI and other groups had argued in comments to the Fed that setting price controls this low was “arbitrary and capricious” as well as a likely unconstitutional deprivation of the property right to a return on capital invested.

Ealier this morning, MarketWatch reports that “the central bank may ease up on the limits banks can charge retailers to around 20 cents a transaction.” The Fed just announced the cap will be 21 cents, with an addition 5-cent adjustment for fraud costs.

Though this “still would be a significant reduction in fees for banks” and credit unions, as MarketWatch notes, it still may be enough for a “modest rally” in financial stocks. And it hopefully will be enough to avert a warning by Federal Reserve Chairman Ben Bernanke that as written, the proposed rule may cause some community banks to fail.

Still, this will result in government-forced shifting of costs from some of the nation’s wealthiest retailers to the backs of consumers. And given the history of price controls, the very retailers lobbying for this will likely also lose out in the long run as the Durbin-Fed rules reduce investment in new mobile payment systems and anti-fraud technology. As the great free-market economist Thomas Sowell writes in his book Basic Economics, price ceilings mean “less is supplied at a lower price than at a higher price — less both quantitatively and qualitatively.”

Greg June 29, 2011 at 7:00 pm

The new debit limit benefits exclusively retailers, although their CEOs and lobbyists are telling us that consumers will be the ones who will reap the biggest advantage from the cap on debit fees. Any revenues lost by card issuers will translate directly into a positive revenue flow of an equal aggregate amount for retailers.

It is very unlikely that any of the windfall will be passed on to consumers. Anyway, even if that did somehow happen, consumers would still be net losers, due to the fact that banks will inevitably make up for their interchange-related losses by generating higher revenues elsewhere. Actually, they are already doing it.

Lori June 30, 2011 at 1:49 pm

1. Retailers still see chargebacks on debit, so it is NOT a guaranteed payment. Also, when retailers issue reversals on debit transactions, issuing banks have been known to “sit” on those funds for as much as 10 days before crediting a customer’s account. The retailer is then left dealing with an increasingly irate customer who insists that their bank says there is no credit, is angry thinking the retailer has charged them in error, when the retailer’s processing history clearly indicates the reversal was processed successfully.

2. In the general scheme of supply and demand, retailers who fail to charge prices that are reasonable and proportional to their cost, and prices that are within what the market will bear will soon see their customers going to other retailers. Retailers, however, do not have the same option as customers when it comes to card issuers. The only option retailers have in not accepting the costs associated with accepting cards is not to accept the cards at all. Given how ubiquitous electronic payments have become, that equates to an “absence of option”, and retailers choosing that course would likely find themselves struggling to stay in business.

3. It would be helpful if your article had provided justification for interchange fees within the context of how they really work. For instance, how many readers of this article understand that card issuance is the only business that I know of where issuers stay competitive by raising prices? There is really no such thing as free checking and ATM transactions and rewards. Those all come at a cost. Issuers attract more cardholders to their programs by offering more and more “free” stuff that is actually paid for by increased costs in the form of higher interchange fees to retailers. Fees that have increased at such an outrageous pace in the last several years that it is impacting the profits of the companies who accept cards. I’m not sure that even Ralph Nader could justify that consumers have a RIGHT to free banking services and rewards when it is only free to them because it is paid for by a third party (the retailer) who has an “absence of option” in the process (unless, again, the retailers is willing to risk going out of business).

4. Given that the outrageous increase in interchange fees have eaten at corporate profits, it is clear that the only way to recover the loss is to increase prices to the consumer. In theory, the card-using customer has a much better chance of coming out even or benefitting because even though the price of a good may be more today than it was yesterday, they are getting “free” stuff from their bank to offset it. But the customer paying with cash is paying the higher price and sees only detriment because the retailer could reward them for using cash. How can you argue that issuing banks have the right to force retailers to raise prices to consumers, but retailers are greedy to lobby for price controls and force banks to pay for the free stuff they were promising but not paying for, or admit that it isn’t free after all? What a double standard.

5. The preceding point suggests that it would also be helpful for readers to understand that by accepting cards, retailers were forced to comply with card acceptance rules that are, to use your own words, Draconian. Retailers had little to no choice on which network to process transactions because each network demands priority routing. Even though cards cost them more than other forms of payment, they could not offer incentives to customers to use other forms of payment. Again, retailers had “an absence of choice”.

Retailers understand that debit cards pose a better solution than checks, that there is a cost associated with the infrastructure related to processing cards, and that those in the business of issuing cards have a right to a reasonable profit over those costs. But there is nothing reasonable about how these costs have skyrocketed at the expense of retailers and to cash-paying customers.
Common sense would dictate that if the issuers had not gotten so arrogant and disregarding of the merchant slaves they were creating, there may not have been a need for price controls at all. Free market, supply and demand, what the market can bear when the players have a choice. Seems to me that some of the components we consider so important to a free market economy were missing and necessitated some authority stepping in to ensure some level to the playing field.

John Berlau July 3, 2011 at 1:21 am


Thanks for weighing in. However, I have to question the hyperbole used by you and members of the retail lobby. (I’m assuming you’re connected with retailers, and you should know — if you don’t — that we sympathize with retailers when government is on their backs as it is in everything from coercive card check unionization measures to costly cap-and-trade schemes. But we can’t back you or any other businesses when they are lobbying to get the government on other folks’ back — in this case those of banks, credit unions, and consumers).

You speak of “outrageous increases” in fees that create “merchant slaves.” But really, what’s so outrageous about fees that average 1.19 percent of the purchase price?! After all, merchants will give a reported 50 percent of the proceed of a transaction — in addition to the discount they give to the consumer — to online coupon providers such as Groupon. Given that, what’s so horrible about paying a bank or credit union less than two cents on the dollar for an instrument like the debit card that both increases sales and provides guaranteed payment? (The “chargebacks” you mention are for disputes on a charge between merchants and consumers. However, there is no risk to the merchant, as there was in the “good old days” of bounced checks, of a merchant having to hunt down thousands of dollars from individual consumers who had overdrawn their bank accounts. That’s all on the bank.)

You say “card issuance is the only business that I know of where issuers stay competitive by raising prices.” I don’t think card issuer networks compete by “raising prices,” but it is fair to say they compete on factors other than price, such as services offered to both their merchant and consumer customers. Many other businesses also compete on both price and service.

Take advertising, for instance. We do not find it evidence of a “market failure” when prices go up for ads during the Super Bowl. Businesses will gladly pay more for an ad if the bottom line is an even greater increase in their sales and profits. Similarly, some types of interchange fees have risen — and again, they still average less than two cents on the dollar for debit cards and less than three cents for credit cards — as plastic has brought in more sales in stores.

And that’s the bottom line. You and other retailers would not be taking plastic if you didn’t feel it would increase your bottom line. You argue that plastic is so “ubiquitous” that retailers choosing not to accept plastic “would likely find themselves struggling to stay in business.” You can say the same thing about the ubiquity of computers and cell phones, but no one is suggesting price controls for these items. If retailers don’t want to pay basic costs of running a business, perhaps they shouldn’t be in business.

But in this case, there are examples even in the biggest cities of retailers forgoing plastic when it suits their business model. The Carnegie Deli sits in the middle of Manhattan and refuses plastic. If its customers, a great portion of whom are tourists, come up short of cash, they have to get if from the ATM in the restaurant. Ironically, ATMs are an example of how the payment card system makes it easier to be cash-only if a merchant chooses to do so.

There are also choices for retailers among card networks. Costco, as its customers, gives two choices: cash or American Express.

This is not to say there aren’t government barriers that could be lifted to make the payment card network more competitive for retailers. CEI has long been on record in favor lifting the moratorium on retailer and manufacturer-affiliated banks called industrial loan companies. These would likely lower card processing costs and also give consumers more choices. But piling on more government intervention with price controls is not the way to go.

By the way, you had said that “those in the business of issuing cards have a right to a reasonable profit over those costs.” The Durbin Amendment actually doesn’t allow debit issuers to make any profit on what they charge retailers. They can only charge fees that are “proportional to cost.” The Fed’s new cap of 21 cents per transaction will cover more costs than 12 cents, but if issuers want to make a profit, they will still have to get that on the consumer side. And they will do so by continuing to reduce free checking and card rewards.

Readers can get more information on the interchange issue by reading a study I co-authored with Ryan Radia entitled “Payment Card Networks Under Assault: How Capping Interchange Fees Will Hurt Consumers, Charities, Community Banks, and Credit Unions.” Available here.

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