By Todd J. Zywicki
Late in the Senate’s proceedings on the financial regulatory reform bill, the Senate adopted - with no hearings and minimal debate - a controversial provision proposed by Sen. Richard Durbin, Illinois Democrat, that imposes price controls on interchange fees for debit and prepaid cards. The amendment also allows merchants to override several rules of payment card networks that currently protect consumers from abusive practices by merchants. While big-box merchants and convenience stores are declaring this a victory against the financial services industry, if the amendment survives in conference committee, consumers and small banks will be the real losers.
thThe Durbin amendment seeks to regulate interchange fees on debit transactions. This fee is an element of the price a merchant pays whenever a consumer uses a credit or debit card. It partially compensates the cardholder’s bank for the cost and risk of offering payment cards to consumers such as clearing costs, billing and collection, fraud recovery and customer service. In a provision reminiscent of Soviet-style economic planning, the Durbin amendment requires the Federal Reserve to determine interchange transaction fees for debit that are “reasonable and proportional” to the “actual cost” to issuers with respect to the transaction. But the amendment does not permit recovery of the actual cost to issuers from debit transactions, only the “incremental” cost of a particular transaction. The massive fixed costs of running the network and servicing cardholders would be excluded, guaranteeing that debit card issuers will lose money on their debit card operations. That’s not sustainable.
This means, inevitably, costs will be shifted from merchants to consumers. Consumers will see new fees or greater restrictions on their use of debit cards - reminiscent of times past when banks imposed a limit on the number of free debit transactions a consumer was permitted in a given month, after which consumers had to pay a fee. Consumers can also expect to see deterioration in customer service and investments in security, and efforts by banks to cross-subsidize debit card transactions through other bank services. Issuers may also try to steer consumers toward greater use of credit cards, whose interchange fees - although generally higher than those on debit cards - are not regulated by the Durbin amendment. Moreover, while the Durbin amendment excludes banks with assets of less than $10 billion from its price control regulations, payment card networks will be forced by competitive pressures to equalize its interchange fees across its various issuers, thereby nullifying this purported safe harbor for small issuers and their customers.
But the pernicious reach of the Durbin amendment goes beyond price controls. It also overrides several provisions of card network contracts that relate to credit cards as well as debit cards, such as rules that restrict merchants from setting minimum or maximum charges in order to use a card. Those provisions exist primarily to protect consumers, who will be the big losers if those contract terms are nullified.
Card network rules prohibit merchants from establishing minimum purchase floors in order to guarantee universal acceptance of cards. Merchants can request that consumers refrain from using cards for small transactions, but prohibiting card use below a minimum threshold is a violation of their agreements with the card networks. Does the profitability of Citi or Chase’s credit card operations turn on whether cardholders can purchase coffee and a donut with their card? Hardly. But those provisions matter a lot to consumers who value cards because of their universal acceptance. Universal acceptance matters especially to tourists, business travelers and residents of high-crime areas who find cash inconvenient or dangerous to obtain and carry. Merchants would instead force them to buy additional products in order raise their overall spending enough to use their card. Many states issue unemployment, welfare and retirement benefits through prepaid cards, meaning that some families who want to buy only a gallon of milk might be turned away unless they buy more. It is easy to see why merchants like this arrangement; it is less obvious how the rest of us benefit. Merchants argue that they lose money on consumers who don’t purchase enough to make a card sale profitable to the merchant. Perhaps, but merchants engage in all kinds of activities that guarantee that they don’t make money on every customer who walks in the door - from the customer who uses a sales clerk’s services without eventually buying anything, to free returns, to operating during hours when few customers shop. Yet even though merchants lose money on those who browse but don’t buy, they make a business decision that those occasional losses on some customers are justified by the overall business value of providing helpful service and free returns. The decision whether to accept payment cards is no different.
But the provision that exposes the Durbin amendment as a merchant-driven money grab at the expense of consumers is that which permits merchants to override network rules on maximum charge levels. The only apparent rationale for this provision is to enable merchants to steer purchases of bigger-ticket items to their in-house or proprietary credit plans, thereby giving merchants an effective monopoly for those credit sales. Consumers won’t benefit from restricted competition and reduced credit choice, especially when financing more expensive purchases.
The purpose of the financial reform bill purportedly is to prevent another financial crisis from happening. Price controls on debit cards, much less prepaid cards such as gift cards, have nothing to do with that goal. But they have much to do with a powerful special-interest group seizing the anti-bank mood in the country to ram through new mandates that will allow them to impose their business costs on consumers. Maybe next they’ll try to persuade Congress to outlaw free parking and friendly cashiers in order to reduce business costs.
Todd J. Zywicki is a George Mason University law professor and a scholar at the Mercatus Center.