On May 13, 2010, the US Senate approved the so-called “Durbin Amendment”1 (“the Amendment”) to the financial regulatory reform bill, S 3217, the Restoring American Financial Stability Act, then pending in the Senate. Legislation, similar to the Durbin Amendment, pending in this Congress and in earlier Congresses has had difficulty moving on its own.2 The Senate passed the amended bill on May 20, 2010.
The Durbin Amendment does two things. It: (1) regulates fees that card issuers and “payment card networks” may charge for debit card (signature or PIN) transactions, and (2) limits certain restrictions that payment card networks may impose on merchants.
Fees
The Amendment authorizes the Federal Reserve Board to establish rules regarding any interchange transaction fee that an issuer of debit cards or a payment card network may charge with respect to an electronic debit transaction. The definition of “payment card network” appears broad enough to include not only conventional card networks,3 but also processors. Even if it did not include processors, clearly the revenue streams of card issuers that are customers of processors would be adversely affected, reducing their ability to pay processors.
The Amendment provides that the amount of any interchange transaction fee that an issuer or payment card network may charge shall be “reasonable and proportional to the actual cost incurred by the issuer or payment card network with respect to the transaction.” This might sound acceptable; however, the statute provides that, in issuing rules, the Federal Reserve Board is to distinguish between actual incremental cost incurred in the authorization, clearance, and settlement of a particular debit transaction and other costs not specific to a particular transaction. The former are to be considered, but the latter are not to be considered. Obviously, the latter include administrative overhead costs, research and development costs, and system creation and maintenance costs that have led to development of the state-of-the art payments systems we have today, as well as the costs of maintenance and application of credit policies, fraud prevention, and compliance programs.4 Non-specific costs also include advertising, rewards programs, and card issuance, which apparently Senator Durbin believes should not be passed on to merchants. All of these general costs would have to be excluded from computation of the fees that issuers and networks would be permitted to include in calculating their interchange fees.
Card issuers (but not networks) with less than $10 billion in assets would be exempt.
The fee restriction would be effective 12 months after passage of the bill.
Limits on Restrictions That a Network or Processor May Impose
Senator Durbin understands that both Visa and MasterCard include provisions in their form merchant agreements that prohibit the merchant from offering a customer a discount to use a competing credit card. He also asserted that Visa and MasterCard have threatened to fine merchants who offer discounts for cash, checks, or debit cards. Proponents of the Amendment have said that Visa and MasterCard impose fines of as much as $5,000 per day on small businesses that impose minimum transaction amounts.
Under the Durbin Amendment, networks are prohibited directly or through processors from inhibiting the ability of any person from doing any of three things: (1) providing a discount or inkind incentive for payment through the card or device of another network; (2) providing a discount or incentive for payment by the use of cash, check, debit card, or credit card; and (3) setting a minimum or maximum dollar value for the person’s acceptance of credit cards. In other words, a network and a processor will not be able to prevent a merchant from preferring one network over another or preferring the use of cash, or setting minimum and maximum transaction amounts for credit card transactions.
It appears that this second part of the amendment would become effective upon the bill being signed by the president.
Status
The House version of financial regulatory reform (H.R. 4173) does not include language similar to the Durbin Amendment, and, as the bills now go to a Conference Committee to reconcile differences, banking industry lobbyists reportedly have said that eliminating the Amendment is among their highest priorities.
Public Policy Considerations
I. Perspective of Proponents
Senator Durbin estimated that interchange fees range from one percent to three percent. He advised that one grocer has told him that the return in the grocery business is usually one or two percent, suggesting how significant interchange fees are to small merchants. Such fees are normally not negotiable.
The Amendment was sold as a pro-small business measure. It does not affect credit card interchange fees. Rather than capping debit card interchange fees, it leaves the matter to the Federal Reserve Board. It exempts small banks and credit unions5, which represent 99 percent of all banks and credit unions, but the 86 banks it covers account for 65 percent of credit and debit card transactions in the United States.
No Republican Senator spoke on the floor against the Amendment, and 17 Republican Senators voted for it.6 Ten Democrats opposed the Amendment.7
The financial regulatory reform bill to which the Durbin Amendment has been added is intended to prevent a recurrence of the financial crisis recently experienced. The connection between the crisis and debit card interchange fees may not be readily apparent, but Senator Durbin suggested that a purpose of financial regulatory reform is to prevent large banks from hurting small business, and that interchange fees is one way in which that harm occurs.
The significance of the Amendment is suggested when one considers that there are approximately one billion credit or debit cards in use in America. Last year, $1.7 trillion in transactions were performed with credit cards, and $1.6 trillion in transactions were performed with debit cards. Together, they account for half of the retail sales in America. Interchange fees range from one percent to three percent of the amount of the transaction. Approximately $50 billion in interchange fees was collected in 2008 with approximately 80 percent of that going to the 10 largest banks. Senator Durbin estimated that $20 billion was collected in debit interchange fees last year. Such fees of course, are deducted from the amounts paid merchants. Merchants do not incur such fees in the case of cash sales or sales by check. Senator Durbin suggested that merchants may cut back on employees in order to pay interchange fees, and, thus, his Amendment may be considered an indirect job creation effort.
Proponents of the Amendment suggest that Visa and MasterCard debit card interchange fees in Europe are much lower than those in the United States. and were reduced to 0.2 percent last month by Visa Europe from 0.5 percent when Visa increased debit card interchange fees in the United States to approximately 2 percent. Senator Durbin said on the floor of the Senate that, in the week prior to offering the Amendment, his office received petitions signed by 92,000 Illinois consumers, and that his Amendment has been endorsed by 203 trade associations., as well as by a coalition of 250 consumer, civil rights, labor, retiree, and business groups.
II. Perspective of Opponents
Opponents note that there have never been Senate hearings into the consequences of the Durbin Amendment.
The Amendment, while apparently aimed at preventing networks from passing on card marketing costs to merchants, has the effect of preventing networks from passing on other quite legitimate costs to merchants, including administrative overhead, research and development, credit policy, fraud prevention, and compliance costs (not to mention a mark-up for profit). The bill prohibits the Federal Reserve Board in setting price caps on interchange fees from considering such legitimate costs. Some predict that the effect will be to discourage research and development and to weaken credit policy and fraud prevention, including security. If that is correct, we will see less innovation than we would otherwise see in the area of card payments going forward. We also should expect to see higher credit losses in that case, as costs of complying with and improving credit policies are not covered, and we should also expect to see, in that case, increased fraud losses as, again, issuers, networks, and processors are unable to recoup the costs of such programs. One might wonder whether we might, if we have more fraud, see an increase in identity theft. We also likely will see more stories of breaches in data security. One would think it wiser to have limited the Amendment’s limits on what the Federal Reserve Board might consider merely to exclude marketing costs. Senator Durbin has responded that the current system gives banks no incentive to manage efficiently the costs of operating and preventing fraud.8
Instead of neglecting all of these areas in which costs will not be covered, issuers could continue to incur such uncovered costs and cover them through other fees, most likely increased fees on consumers. From a theoretical macro-economic perspective, merchants today recover interchange fees through increased prices to consumers and the effect of the Amendment then would be to shift such higher prices from consumer customers of merchants to consumer customers of card issuers, which might be the same population. Cynics, however, have suggested that consumer prices charged by merchants are not likely to drop by virtue of the Amendment, but rather merchants will pocket the cost savings. If that is true, consumers may see a price increase as issuers increase prices to cardholders to cover their necessary costs that are no longer covered.
Opponents of the Amendment have also noted that the history of price controls has not been satisfactory as they seem eventually to lead to shortages. In this case, if that analysis is correct, the Amendment would lead to an eventual reduction in offering of debit card service, as the costs of providing such service will not be exceeded by interchange fees. Such opponents suggest that the effect of the Amendment would be to make networks public utilities; however, public utilities are guaranteed a fixed rate of return, which would not be the case with issuers, networks, or processors under the Amendment. One analyst estimates that interchange fees will drop by more than 90 percent.
Another negative macro-economic consequence of the Amendment may be that by reducing card payment industry profitability, already scarce consumer credit may become even less available. Consumer credit drives consumer spending, and increased consumer spending, most economists agree, is necessary to energize the slow recovery and create jobs. By taking a step, such as adopting the Amendment, that is likely to reduce the availability of consumer credit, policy-makers may be potentially reducing consumer spending and retarding the economic recovery and the creation of jobs.
Opponents also predict that once the debit card interchange fee battle is won, Senator Durbin and his allies in Congress will turn to credit card interchange fees.
Finally as to fees, opponents have noted the exception for smaller banks and credit unions, limiting the effect of the Amendment on larger banks. That means that smaller banks will be able to charge higher interchange fees and support debit card programs with more attractions to consumer cardholders, such as lower prices and more rewards, while larger banks may have to increase fees to cardholders and reduce benefits. Such opponents suggest that this marks one more instance of a recent trend in which politics, rather than competitive market forces, determines economic success.
On the other hand, however, opponents have also suggested that smaller banks were exempted for political reasons ( i.e., in order to garner political support), but that in the final analysis competitive forces will force exempted smaller banks to maintain lower interchange fees in order to compete with larger banks whose fees will be restricted by the Federal Reserve under the Amendment.
Besides limiting fees, the Amendment permits merchants to require that transactions meet a minimum size threshold. Opponents have suggested that this will upset debit cardholders when their cards are rejected because a transaction is too small for a particular merchant. It has also been suggested this will force cardholders to make unnecessary purchases in order to meet minimums that merchants set for credit card acceptance. That could disproportionately harm low-income consumers.
The Amendment also permits a merchant to impose maximum purchase amount restrictions. Such restrictions could prevent consumers from purchasing big-ticket items with credit cards.
Also, the Amendment would permit merchants to incent payments in cash. It has been suggested that this could have the effect of forcing consumers to use their debit cards to get cash at ATM machines operated by banks that did not issue the consumer’s card, triggering higher ATM fees. This conceivably could eliminate the safety benefit of debit cards, which, enable consumers to carry less cash.
Conclusion
One may debate whether the Amendment is wise public policy. However, it does appear that the question of whether the Amendment is wise public policy is sufficiently complex and that policy-makers would have benefitted from hearings and extensive debate on the subject.
