Reasonable Regulation of Debit Interchange Fees

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 for regulating debit card interchange fees is not “reasonable” because it would lead to a series of “unreasonable” outcomes, which, in significant part, flow from the predictable responses issuers of debit cards would take in response to the proposal. Policy makers cannot reasonably assume that banks in competitive markets will sit idly by while being forced to reduce their current market-determined debit card interchange fees, which comprise much of their debit-card revenues and a material portion of bank profits, by anywhere from 73 to 84 percent. To the contrary, banks will attempt to make up as much of the lost revenue as they can by some combination of higher fees on checking accounts, fees or reductions of benefits for debit card use, or more refusals by issuers to permit consumers to conduct higher-cost types of transactions that impose greater fraud risk. These easily anticipated responses, some of which are already under way or have been announced, make the proposal unreasonable for at least the following three reasons.

First, to the extent that banks respond by imposing fees on debit cards, many consumers are likely to turn to one or more alternatives, including credit cards, checks, and cash. These options could be more expensive for merchants, in direct conflict with one of the apparent objectives of Section 1075, which is to lower costs to merchants. In any event, the Board staff has provided insufficient analysis on this issue and thus the current record, at the very least, does not support the reasonableness of the proposal on this score.

Second, the banks’ expected offsetting actions are very likely to impose significant costs on consumers if the proposal is implemented in its current form. Such an impact would be directly inconsistent with another major part of the Dodd-Frank Act, which creates a new agency within the Board to regulate consumer financial products, with the express objective of helping consumers, and indeed with the thrust of the entire Act itself, which is to protect users of financial products from various practices that led to the recent financial crisis. While the Board staff did address this issue in its analysis of its proposal, it admitted it did not know what the consumer impact would be, another indication that at the very least the record does not support the reasonableness of the proposal. The Board staff also apparently did not consider the potential impact of the higher bank fees on small businesses as well.

The impact of any higher bank fees will be especially onerous for low income bank customers, who will thus have incentives to return to the ranks of the “unbanked”, or if they are already in that category, not to enter into a banking relationship. Both outcomes are clearly inconsistent with another part of the Dodd-Frank Act that explicitly is designed to encourage movement of the unbanked to formal banking relationships.  This result would also contravene the intent of the FDIC’s statutory reporting requirements on this issue.

Third, the Board’s December 16, 2010 proposal is unreasonable because it runs the risk of conflicting with another important social objective, which the Board has long encouraged: moving retail payments away from paper (checks and currency) and toward electronic alternatives (debit and credit cards, Internet payments, and, most recently, mobile payments).  Bank responses to the current debit card interchange fee proposal that discourage debit card use, which in recent years has done the most to move payments in the electronic direction, would have the opposite effect.

The Board should find that, in the absence of empirical evidence evaluated using the analytical framework governing two-sided markets proving otherwise, market-set interchange fees are reasonable and proportional to cost. Any other decision would lead to the unreasonable outcomes documented in this statement.

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[*] Martin Baily is the Bernard Schwartz Senior Fellow in Economic Studies at the Brookings Institution. Robert E. Litan is Vice President for Research and Policy at the Kauffman Foundation and a Senior Fellow in Economic Studies at Brookings. The authors received financial support from several large members of the Electronic Payments Coalition. The views expressed in this paper are our own and do not necessarily reflect the views of any of the institutions that provided financial support or any other organization with which we are affiliated.