What’s Next with Card Regulation? The Next Steps with Dodd-Frank Act

The President will sign the Dodd-Frank Wall Street Reform and Consumer Protection Act later this week. That will set the clock ticking on number of deadlines established by the financial regulation reform bill.  Here are the two big ones to watch for.

The regulation of debit-card interchange is the one that is likely to have the most immediate impact on the payments business.  The legislation gives the Federal Reserve Board 9 months to establish standards for assessing  whether the interchange fee that an issuer charges is “reasonable and p;roportional to the cost incurred by the issurer with respect to the transaction.” It provides some guidance on this. The Fed is supposed to look at the “incremental cost” of the transaction but it can provide a boost under certain circumstances for expenditures that the issuer makes on fraud protection. While cost-based regulation may sound easy it is generally complicated and controversial. The Fed will be collecting lots of data and sifting through many competing claims from all of the parties involved in setting these standards. At a minimum the Fed will have to go through this exercise separately for signature and PIN debit. It may also have to do this at a very refined level to the extent issuers can credibly argue that their incremental costs vary by merchants, segments and types of cards.

How the Fed chooses to implement these regulations remain to be seen. Historically, the default for interchange fees is set by the networks.  The Dodd-Frank bill, however, regulates interchange fees at the bank level—for all banks that have $10 billion or more in assets.  It appears that a bank with less than $10 billion of assets can have any interchange fee it wants (and since law provides that the merchant can’t discriminate against issuers it does not appear that the merchant or its acquirer can refuse these cards).  Larger banks, again it appears, must have individual interchange fees that are consistent with whatever standards the Fed sets.

We have well over a century of experience with cost-based regulation.  Several things are pretty predictable:

  1. There will be long-standing controversy over how costs are calculated.  Remember in this business a tenth of a basis point multiplied times volume is a lot of money.  It actually matters whether the Fed standard suggests that 61 rather than 60 basis points is warranted for an issuer.

  3. The cost-based regulations will result in increases in costs.  That is why public-utility regulation moved away from cost-based pricing.  If issuers get to recover their transactions costs and fraud costs they don’t have an incentive to minimize those costs anymore.  There will be cost creep.

  5. The likely reductions in interchange fee revenues and caps on these rates will lead banks to make up the revenue elsewhere. That’s the effect everyone has already talked about and acknowledged. It is just inevitable that consumers are going to be paying more for either debit-card transactions or some other part of the checking-account relationship.

The Consumer Financial Protection Board will also likely have significant consequences on payment card business and especially on credit cards.  It is also the most unpredictable.  Much of the specifically intrusive aspects of consumer financial protection that had been proposed—like letting the new agency design and insist on its own “plain vanilla” products—got stripped out.  Now there is a vague prohibition of “abusive” practices and an agency that has a lot of discretion, but no obligation, to regulate pretty much all financial products.  The CFPB will be run by a Director who is the sole decision maker.  I think that is a recipe for disaster for everyone concerned.  It leaves the Director completely exposed and solely responsible for every decision, and it provides few checks and balances.  But in any case that’s what we have.

The President will need to nominate a Director soon and the Senate will have to approve his candidate.  The manner and extent to which the new agency gets involved in the credit card market depends on lot on who becomes Director.  Some of the people who the White House have suggested as possible candidates believe that credit cards have been very harmful to society and that the government should develop rules that prevent or deter people from borrowing. (My paper with Josh Wright has a section that discusses the intellectual basis for the consumer financial protection act and a discussion of the views of some of its proponents who belong to the “behavioral law and economics” school.)  Other possible candidates could take a more balanced view.  The payment card industry will be joined to the hip of whoever that person is for the next five years.

David S. Evans is an economist and a business advisor to payment companies around the world. His recent work has focused on helping companies create, ignite and profit from payments innovation. He is the originator of the Innovation Ignition Framework® , a tool provides a systematic way for companies to evaluate and implement innovative ideas and achieve critical mass.

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