The Federal Reserve’s New Debit Card Rule Threatens Consumers and Banks
Banks will find other ways to make up for lost revenue.
While some lawmakers and regulators are targeting credit cards, the Federal Reserve has plans for your debit card. The likely result will be to make your pocketbook lighter — with less cash and fewer cards.
The threat from the Federal Reserve is an update to something called Regulation II (Reg II), which governs the amount that card issuers are allowed to charge vendors in exchange for the convenience of accepting their cards. Currently, the central bank is still considering its proposed changes to the rule, including a reduction in the maximum interchange fee that debit card issuers can charge merchants.
The proposed rule would lower the government-imposed cap from 21 cents (plus an ad valorem component that is 0.05 percent of the transaction value) to 14.4 cents, plus 0.04 percent of the transaction value. For comparison, a typical credit card interchange fee for businesses is 1.5 to 3.5 percent of each transaction, normally significantly higher than 21 cents.
Regulation II was added in 2011 to the Dodd-Frank Wall Street Reform and Consumer Protection Act in a last-minute amendment offered by Senator Dick Durbin (D., Ill.). The “Durbin Amendment” includes provisions such as the interchange fee cap, which limits the fees that debit card issuers can charge retailers, and network exclusivity, which requires that debit cards be processed on at least two unaffiliated networks.
The results of this change were disastrous for consumers — banks reduced free checking account offerings for low-balance accounts, and debit card rewards have since almost entirely disappeared. Although there are purported exemptions for smaller banks and credit unions, in practice, they often get swept up by these rules.
This was a direct result of the reduced revenue from interchange fees, which forced banks to find other ways to cover their costs. As usual, it was consumers on the margin who bore the brunt of these increased costs. A study by George Mason University law professor Todd Zywicki and Geoffrey A. Manne and Julian Morris of the International Center for Law and Economics found that the Durbin Amendment led to more than 1 million Americans losing access to banking services.
The Federal Reserve’s proposed update of Regulation II will, yet again, slash the already low-ball price cap. As our Competitive Enterprise Institute colleague John Berlau wrote in his comments to the Fed, this will shift even more of the costs of debit card processing to consumers. The American Bankers Association also wrote to the Federal Reserve Board, urging them to withdraw its proposed rule on debit card interchange fees.
This hit to debit cards is a puzzling move considering the appetite of both regulators and some lawmakers to increase competition in the credit card market. The most obvious competitor to credit cards in a consumer’s wallet is the debit card.
For instance, the proposed Credit Card Competition Act aims to introduce more competition into the credit card market by requiring large banks to offer alternative networks, potentially reducing these fees. However, decreasing the already marginal profitability of debit card transactions will only further reduce competition to credit card issuers.
There is little evidence that businesses pass on savings from reduced interchange fees to consumers. Hence, they provide no visible consumer benefit. But, for their part, banks will want to replace the revenue they lost. Consequently, banks will probably increase fees for other services to make up for lost revenue like they did when they were hit with the previous price cap.
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