PRICE CONTROLS ON PAYMENT CARD INTERCHANGE EES …

PRICE CONTROLS ON PAYMENT CARD INTERCHANGE FEES: THE U.S. EXPERIENCE

Todd J. Zywicki, George Mason University School of Law

Geoffrey A. Manne, International Center for Law and Economics

Julian Morris, Reason Foundation

George Mason University Law and Economics Research Paper Series

14-18

This paper is available on the Social Science Research Network at

Price Controls on Payment Card Interchange Fees: The U.S. Experience

By:

Abstract

Todd J. Zywicki Geoffrey A. Manne

Julian Morris

The Durbin Amendment to the Dodd-Frank financial reform legislation capped debit card interchange fees for banks with assets of $10 billion. Credit card and prepaid card interchange fees were not regulated. The cap, which took effect on October 11, 2011, cut the average interchange fee for covered banks from $0.50 to $0.24 per transaction.

The cap reduced annual revenues from interchange fees by between $6 billion and $8 billion. Covered banks have recouped these losses in indirect ways. In particular, they have:

? Reduced the availability of fee-free current accounts. The total number of banks offering free current accounts fell by 50% between 2009 and 2013. In comparison, fee-free banking actually increased at banks not subject to the Durbin Amendment.

? More than doubled the minimum monthly holding required on fee-free current accounts between 2009 and 2012, from around $250 to over $750.

? Doubled average monthly fees on (non-free) current accounts between 2009 and 2013, from around $6 to more than $12.

? These fee increases and loss of access to free checking contributed to an increase in the unbanked population of approximately 1 million people, mainly among low-income families.

? Consumers have shifted their payment usage from debit cards to credit and prepaid cards, which were not subjected to price controls.

Most large retailers have seen significant cost reductions as a result of the Durbin Amendment, yet to date there is no evidence that those cost savings have been passed-through to consumers. Interchange fees have increased for merchants that make small-ticket transactions, as networks have eliminated discounts that they previously received, and smaller merchants have not seen any reduction in their merchant discount rates. Thus, while consumers have seen large and immediate increases in the cost of bank accounts, to date there is no evidence of reduced prices at the pump or checkout. We estimate that as a result of the Durbin Amendment, there will be a transfer of $1 billion to $3 billion annually from low-income households to large retailers and their shareholders, which have been the primary beneficiaries of the Durbin Amendment to date.

ICLE | 2325 E Burnside Street, Suite 301 | Portland, OR 97214 | 503.770.0652 icle@ @laweconcenter |

Keywords: Durbin Amendment, Credit Cards, Debit Cards, Prepaid Cards, Free Checking, Unbanked. JEL Codes: D1, G2, K2

2

PRICE CONTROLS ON PAYMENT CARD INTERCHANGE FEES: THE U.S. EXPERIENCE

By Todd J. Zywicki, Geoffrey A. Manne & Julian Morris 1

Introduction

In 2009, the U.S. Congress passed the "Durbin Amendment" to the Dodd-Frank financial reforms. In October 2011, the Durbin Amendment was implemented by a Federal Reserve rulemaking that effectively halved the debit card "interchange fee" that may be charged by banks with over $10 billion in assets. This paper assesses the emerging data on Durbin's effects and provides an in-depth review of the actual U.S. experience with the Durbin Amendment.

The paper begins with a brief discussion of the role and benefits of payment cards. It then proceeds to a description of the Durbin Amendment's interchange fee caps, followed by an assessment of the effect of the caps on bank customers, comparing the differential effect on customers of banks subject to the caps versus those that are not subject to them. This leads to a discussion of the wider effect of the caps, with particular focus on the effect on poorer households, on the quality of banking services, and on the usage of different types of payment cards.

The Role and Benefits of Payment Card Usage

Electronic payments are rapidly replacing nineteenth century payment technologies such as cheques and traveller's cheques. By enabling faster, more secure, traceable transactions, payment cards have been a key element in promoting greater integration of the world economy. Indeed, the entire growth of e-commerce and Internet shopping would be inconceivable without the modern payment card network.

1 Todd J. Zywicki is George Mason University Foundation Professor of Law at George Mason University School of Law, Senior Fellow at the International Center for Law and Economics, and Co-Editor of the Supreme Court Economic Review. Geoffrey A. Manne is the Founder and Executive Director of the International Center for Law and Economics. Julian Morris is Vice President of Research at Reason Foundation, Visiting Professor in the Department of International Studies at the University of Buckingham, and Senior Fellow at the International Center for Law and Economics. ICLE, which funded this work, has received financial support from MasterCard.

ICLE | 2325 E Burnside Street, Suite 301 | Portland, OR 97214 | 503.770.0652 icle@ @laweconcenter |

Ubiquitous use of payment cards has reduced liquidity and other constraints that previously limited consumer purchases to the amount of money in their wallet. Both consumers and merchants benefit: consumers by being able to make purchases that otherwise wouldn't have been possible and merchants by making sales that otherwise wouldn't have happened. These benefits result primarily from three factors:

1. Ticket lift: merchants "ticket lift" occurs because consumers are not constrained in making purchases by the amount of money in their wallet (or the need to make a trip to the bank or cash machine).2 This relaxation of liquidity constraints benefits merchants significantly--for example, short-term sales and special discounts will be more effective if consumers are not limited by their cash on hand.

2. Faster throughput & greater efficiency: For a significant range of transaction sizes, payment cards enable businesses to process transactions more rapidly than cash and other payment methods;3 for many transactions, payment cards are approximately twice as fast as cash (and cheques are even slower). At the same time, the infrastructure required to support electronic payments is less cumbersome, piggybacks in part on existing communications networks, and reduces the need for physical security of currency (e.g., armoured cars and safes).

3. Outsourcing of credit risk: Credit cards enable retailers to off-load the cost and risk of offering their own credit operations. This has enabled small businesses to flourish and grow, enabling them to compete with larger companies without the need to run their own, expensive credit operations.

When all of these benefits to merchants are taken into account, payment cards are likely less costly for merchants than cash for a wide range of transactions.4 Indeed, when McDonald's made the decision to accept payment cards, its stock value increased 2.7 per cent on the news, an indication that these benefits to merchants are of even relatively low price items are substantial.5

These benefits to merchants and consumers translate into wider benefits to society. A study by the ECB of 13 EU representative countries estimated that if all retail payments in the EU were

2 Tamara E. Holmes, Credit cards can make you fat, BANKRATE (Jul. 4, 2007), ("According to a new survey commissioned by Visa, 82 per cent of respondents said fast food purchases made with debit or credit cards are more convenient than dealing with cash. And 68 per cent say using payment cards is faster than paying with cash. Importantly, 77 per cent say they can buy exactly what they want because they are not limited by the cash they have available."). 3 Indeed, to the extent that payment cards enable consumers to self-checkout or to pump gas without going into the store, this not only reduces the usage of employee time but potentially frees up employees for more highly-valued tasks, such as customer service assistance. 4 Anne Layne-Farrar, Are Debit Cards Really More Costly for Merchants? Assessing Retailers' Costs and Benefits of Payment Instrument Acceptance 57 (Charles River Associates Working Paper, Sept. 9, 2011), available at . 5 Ari Weinberg, McDonald's Goes Plastic, FORBES (Mar. 25, 2004), .

2

made electronically, EU countries on average would save almost 1 per cent of GDP. 6 In some countries, the savings might be far greater: In Hungary, where approximately 73 per cent of retail payments are made in cash, the savings of going electronic are estimated at approximately 1.5 per cent of GDP. The savings in Spain (74% cash), Lithuania (80% cash), Malta (82% cash), Italy (86% cash), Romania (93% cash), Bulgaria (95% cash) and Greece (97% cash) would presumably be similar or even greater.7

Increasing the usage of electronic payments can also reduce tax evasion and other illegal activity. Unlike cash, electronic payments create a trail that can aid the government in collecting taxes and restraining illegal activity, while at the same time providing law-abiding citizens with proof of their compliance. In fact, a 2012 study by Value Partners shows that higher levels of electronic payments usage is associated with a smaller shadow economy and less corruption.8

In short, greater use of electronic payments is good for the economy, good for the fiscal solvency and fairness of the country, and good for consumers and businesses. And all of these benefits are made possible by banks and the payment card networks, which enable the transactions between merchants and consumers to occur.

Banks act as both issuers (providing payment services for consumers) and acquirers (providing payment services for merchants). Meanwhile, payment networks (such as Visa or MasterCard) link together the issuing and acquiring banks through increasingly sophisticated and secure networks. Expansion of the use of these electronic payment systems has necessitated considerable investment on the part of the banks and the payment card networks. These investments have been funded by interchange fees, which in the U.S. amounted to approximately $20 billion in 2009 (i.e. before the Durbin Amendment).9 It is important to bear this in mind when evaluating the merits and drawbacks of introducing caps on interchange fees.

The American Experience under the Durbin Amendment

The United States experience with the Durbin Amendment provides a useful test case for understanding the costs of interchange fees and interchange fee price controls, as well as for predicting what the likely effect will be for the EU of price controls, for several reasons:

6 Heiko Schmiedel, Gergana Kostova, and Wiebe Ruttenberg, The Social and Private Costs of Retail Payment Instruments: A European Perspective, European Central Bank Occasional Paper Series No. 137 (September 2012), 7 Ibid. 8 Francesco Burelli, Charles Palmer, and Marco La Bianca, "Evaluating the social cost of cash: with recommendations for Brazil, Columbia, and Mexico," London: Value Partners (June 2013). 9 Dirk Lammers, Judge Rejects Injunction in SD Debit Fee Lawsuit, ABC NEWS (April 5, 2011), .

3

1. By examining the effects of the Durbin Amendment on banks covered by the fee caps (those with $10 billion or more in assets) across time, we should gain insights into the likely dynamics of the imposition of similar restrictions in the EEA.

2. The bright-line cut-off between covered and exempt banks (those with under $10 billion in assets) enables us to see how banks subject to the regulation responded compared to a control group that was not subject to it.

3. Because the Durbin Amendment applies only to debit cards but not similar substitute payment devices--credit cards and prepaid cards--the effect of interchange fee price controls on transaction volume and card usage can be examined by comparison to these unregulated alternatives.

The Basics of the Durbin Amendment

Passed as part of the 2009 Dodd-Frank Wall Street Reform and Consumer Protection Act, the socalled Durbin Amendment (named after its primary sponsor, Senator Richard Durbin), provides that the amount of any interchange transaction fee that any covered issuer (banks with more than $10 billion in assets) may charge on a debit card must be "reasonable and proportional to the cost incurred by the issuer with respect to the transaction."10

As interpreted by the Federal Reserve Board in a subsequent rule-making issued in June 2011, this cut the allowable interchange fee on a debit transaction to an average of $0.21 plus 5 basis points of the transaction value, plus an additional $0.01 for fraud protection.11 This had the effect of cutting the average interchange fee for covered banks from $0.50 to $0.24 per transaction, or approximately 52 per cent.12 In short, by defining allowable costs to exclude many of the necessary costs of operating a debit card program, the Durbin Amendment has effectively transformed debit card operations from a profit centre to a "loss centre" for covered banks.13

10 15 U.S.C. ? 16930-2(a)(2) (2012). 11 Debit Card Interchange Fees and Routing, 12 CFR ? 235.5 (2012), available at . 12 The average fee charged by exempt banks fell slightly as well, from $0.45 to $0.43. Fumiko Hayashi, The New Debit Card Regulations: Initial Effects on Networks and Banks, in FEDERAL RESERVE BANK OF KANSAS CITY ECONOMIC REVIEW FOURTH QUARTER 90-91 (2012), available at . At covered banks, interchange fees on signature debit declined from 59 cents to 24 cents per transaction and PIN declined from 34 cents to 23 cents. At exempt banks signature debit fell from 54 cents to 51 cents and PIN from 32 to 31 cents. Id. 13 Retailer interest groups have continued to criticize the Federal Reserve's rule, arguing that it defined the recoverable costs too broadly, and that the Fed must set a still-lower fee. Thus far the effort has been unsuccessful, and the Fed's rule was recently upheld against a legal challenge by a coalition of merchants in NACS v. Bd. of Governors of the Fed. Reserve Sys., No. 13-5270, (D.C. Cir. Mar. 21, 2013).

4

The Effect of the Durbin Amendment on Covered Banks and Bank Customers: Restricted Access to Free Current Accounts and Higher Bank Fees

The Durbin Amendment permits covered banks to recover only the incremental costs related to debit card transactions; it prohibits recovery in interchange fees for many of the other costs related to debit card operations, such as customer service, data services, branch networks, cardissuance, fraud and loss protection and the like. Unsurprisingly, revenue from debit card interchange fees have fallen as a result of the implementation of the legislation's fee caps. After Durbin went into effect, revenues from interchange fees are estimated to have fallen by between $6.6 billion and $8 billion annually.14

Confronted with a loss of billions of dollars in interchange fee revenues, banks and credit unions have had to make up for the lost revenue by increasing the cost and reducing the quality of bank accounts for consumers. Initially, some banks tried to recover the excluded costs from those customers who use debit cards through the direct imposition of a monthly debit card fee of $3-$5 in order to cover the capital and fixed costs of providing debit card services.15 After much public outcry, however, banks retreated on the imposition of a debit card fee.

This does not mean, of course, that the need for issuers to cover these costs disappeared-- instead, banks sought to cover the lost revenue through indirect means. As a recent report from the United States Congressional Research Service concluded, "Preliminary evidence suggests that, since 2009, some consumers experienced either higher charges or less availability of retail payment services provided by depository institutions," identifying the effect of the Durbin Amendment as one of the factors contributing to those effects.16

The primary way in which banks have sought to recoup the lost revenue seems to have been through higher bank fees and reduced access to free current accounts. Access to free current accounts, which had increased from less than 10 per cent of all accounts in 2001 to 76 per cent by 2009 (primarily as a result of the replacement of cheques by debit cards), fell dramatically. According to a study, only 39 per cent of banks offered free current accounts in

14 Bradley G. Hubbard, The Durbin Amendment, Two-Sided Markets, and Wealth Transfers: An Examination of Unintended Consequences Three Years Later 20 (Working Paper, May 20, 2013), . 15 See, e.g., Tara Siegel Bernard, In Retreat, Bank of America Cancels Debit Card Fee, NEW YORK TIMES (Nov. 1, 2011), ("The bank, the nation's second-largest, said it was abandoning its plan to charge customers a $5 fee to use their debit cards for purchases."). 16 Darryl E. Getter, Recent Trends in Consumer Retail Payment Services Delivered by Depository Institutions 1 (Congressional Research Service, Jan. 16, 2014), available at .

5

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download