- Briefing Room
- Consumer Engagement
- Commerce 3.0
By David S. Evans, Robert E. Litan, Richard Schmalensee[*]
February 22, 2011
(Executive Summary of Comment Submitted to the Federal Reserve Board Regarding the Implementation of the Durbin Amendment)
The Board's December 16, 2010 proposal would, if implemented, impose direct, immediate and certain harm on consumers, especially lower-income consumers, and small businesses that use checking accounts.
- We estimate that the proposed rules will eliminate $33.4-$38.6 billion of debit card interchange fee revenues for banks and credit unions during the first two years the rules are in effect.
- The proposed reductions of the fees that merchants pay for debit card transactions will dramatically reduce the profitability of checking accounts that banks and credit unions provide to consumers and small businesses. Based on 2009 debit interchange fees, the average consumer checking account will lose between approximately $56 and $64 in annual revenue and the average small business checking account will lose between $79 and $92, if the Board's proposals were implemented.
- To offset these lost revenues, banks and credit unions will increase fees to their retail customers for checking accounts, for the debit cards that are usually provided with their accounts, and for other retail banking services. Our analysis indicates that these changes will take place quickly after the implementation of the proposed rules. Some banks have already implemented changes in anticipation of the regulation, others have announced plans, and still others are reviewing changes in prices.
- Banks and credit unions will likely modify some features of the debit cards for which they cannot recoup their costs and earn a fair rate of return under the proposed price caps, and the networks may be forced to do so as well. These changes could include limiting the use of debit cards for payment in situations such as high-value transactions that impose high levels of fraud and other risks on the banks and credit unions, or charging for cash back at the point of sale.
- According to our analysis and research, banks and credit unions will pass on much of the $33.4-$38.6 billion reduction in interchange fees to consumers and small businesses in the form of higher fees or reduced services during the 24 month period following the implementation of the regulations.
These harms to consumers and small businesses will not be offset significantly by merchants charging lower prices for goods and services as a result of lower interchange fees. In fact, if implemented, the effects of the Board's proposal on merchant prices will occur slowly, and the amount of future reductions in retail prices is uncertain.
- Merchants will save roughly 10 cents for a typical $59.89 purchase of a basket of goods from the proposed debit card interchange fee reductions if their merchant processors pass on all of the interchange fee savings to them. Merchants in this case will save less than 2 cents for a $10 item. It is unlikely that most merchants will pass along such small reductions quickly. In fact, economic research has shown that retail prices are sticky and do not change often in response to small changes in costs and demand conditions.
- Approximately three quarters of the merchants that accept debit cards, and almost all small businesses, have contracts with their merchant processors under which the merchant pays a blended price covering all card transactions and is inclusive of all fees including interchange fees. Merchant processors are unlikely to pass on all of the debit card interchange fee reductions to these smaller merchants and may not pass on much, if any, of the reductions in the near term.
- The Board staff has observed that merchants that operate in highly competitive industries will pass on most of debit card interchange fee savings to consumers. While we agree with that observation as a matter of theory, there is no basis in fact for assuming that there is intense competition in the merchant categories that account for most debit card transactions. In fact, for several key categories, such as big box retail and supermarkets, the antitrust authorities have defined product and geographic markets that indicate that there is not a high degree of competition in local markets in most parts of the country. Certain large retailers also are likely to have sufficient market power that they will not be compelled to pass on the entirety of the cost savings to consumers.
The proposed regulations will have several distributional impacts across different segments of the economy.
- Lower income individuals have obtained significantly greater access to affordable retail banking services in the last decade, partly as a result of the debit card interchange fee revenues that have helped banks and credit unions defray the fixed costs of providing checking account services to accounts that maintain low average balances. It is likely that the reduction in debit card interchange fee revenues will result in a reduction in the number of lower income individuals with checking accounts and an increase in the number using alternative financial services, such as check-cashing services.
- Small businesses that have checking accounts will face higher fees and reduced services as a result of banks and credit unions losing much of the debit card interchange fee income from their accounts. Most of these small businesses do not accept debit cards and will, therefore, definitely lose from the proposed regulations. The small merchants that do accept debit cards will not receive much of a reduction in their merchant processing fees in the near term as a result of the debit card interchange fee reductions and will not receive the full benefit of those reductions over the longer term; merchant processors would not have strong incentives to pass on interchange fee reductions to these small merchants, most of whom face blended pricing for all payment methods, quickly or fully. Overall, small businesses will likely lose, at least in the first two years, if the proposed regulations are put into place.
We conclude from this economic analysis that the overall impact of the proposed interchange fee reductions will be to harm consumers, lower-income individuals, and small businesses. Large retailers will benefit, at least in the first 24 months, from a significant windfall at the expense of these other groups.
[*] Evans, the Founder of Market Platform Dynamics, is Lecturer, University of Chicago Law School and Executive Director, Jevons Institute for Competition Law and Economics, and Visiting Professor, University College London; Litan is Vice President for Research and Policy at the Kauffman Foundation and a Senior Fellow in Economic Studies at Brookings; Schmalensee is Howard W. Johnson Professor of Economics and Management, Dean Emeritus, MIT Sloan School of Management, and Chairman of Market Platform Dynamics. The full paper is available at on SSRN by clicking Consumer Impact Study.
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