Durbin’s Folly: The Erratic Course of Debit Card Markets

Richard Epstein, Dec 22, 2011

The passage of the Durbin Amendment in July, 2010 followed extensive claims by Senator Durbin and retailers that the only consequence of the law would be to bleed out the excessive debit interchange charges that platform operators and issuing banks collected from retailers. In their view, the proper source of revenues was from debit card holders themselves, as in the Canadian system. Events have not played out that way. After the Federal Reserve authorized a $0.21 base interchange fee, which was generous given the narrow statutory language, the major banks found it impossible to raise rates in the face of sustained political and market pressure, goaded on in part by Senator Durbin himself. At the same time, there is no evidence that the reduction in debit card fees have been passed through by merchants to their customers.
The reason this adventure into regulation has failed is that Senator Durbin and his allies did not understand the operation of the fast-moving two-sided debit card market. In their view, platform operators like Visa and MasterCard operated a duopoly that afforded them the market power to extract rents from merchants while feeding oversized fees to issuing banks in order to attract new streams of customers.
That analysis ignores two brute facts. First, the only contest between platform operators, banks and merchants is over the considerable surplus generated by a debit card interchange system. Those fees are constrained because merchants always have the option to pull out of the system if interchange rates are set too high. Second, the interchange fees paid to the issuing banks are not just kept in a vault, but are spent in maintaining the fixed costs of running the system and recruiting new customers, so that all rents are dissipated by these competitive forces. There is, therefore, no unearned surplus, and issuing banks are now forced to adopt inefficient systems of fee collection to offset the nearly $8 billion in lost interchange fees.
Full awareness of the competitive nature of the debit interchange market should have led the courts to declare the current regulatory system a confiscatory form of ratemaking. The combination of higher administrative fees under the Durbin Amendment and lower returns necessarily pushes banks below a competitive rate of return on key debit card services, especially since subsequent events have made clear that there will be zero recoupment in revenues from charges to debit card holders. The level of confiscation is still greater because smaller banks-those with under $10 billion in assets-may continue to collect their full interchange fees in ways that tilt the market even further. Nonetheless, by adopting an all-too-forgiving rational basis test, the courts sustained the statute by showing excessive deference to Congress.
Given the situation today, tinkering will not fix the inherent structural defects of the Durbin Amendment, which should be repealed forthwith before it does any greater damage to debit card transactions.