The Unintended Consequences of Durbin’s Proposed Routing Legislation

It’s a movie that everyone in the payments industry has seen at least once: Merchants challenging the card networks over interchange.

The latest attempt, spearheaded by U.S. Senators Richard Durbin (D-Ill.) and Roger Marshall (R-Kan.), is intended to pass a law that challenges the interchange fees set by Visa and Mastercard. A challenge that does not impose price caps but by giving merchants the ability to route the Visa and Mastercard credit cards presented by consumers at checkout over competing (aka cheaper) networks.

The Act mandates that, with each and every credit card transaction, at least two unaffiliated networks must be available. Visa or Mastercard can be included — but not together.

On Sept. 30, in a recent bit of procedural legislative wrangling, Durbin and Marshall proposed adding the legislation as a rider to the National Defense Authorization Act. That would avoid having members of Congress vote specifically on the Credit Card Competition Act.

Why This, Why Now

Sen. Durbin’s stated goal  is to increase competition by allowing  smaller networks to process credit card transactions,  including debit card networks too, who’d like to service credit transactions.

Competition,  through routing mandates, proponents say would   drive down the transaction costs for merchants since merchants could opt to send Visa and Mastercard transactions over lower cost rails. In a letter to Congress, the Merchant Payments Coalition (MPC) said  the credit card market is “not functioning,” since it is  dominated by Visa and Mastercard, with a combined 83% market share.

According to the MPC and its members, this purported lack of competition drives up prices for merchants and they say, ultimately consumers and “strangles” innovation. The four-party model that supports the general-purpose credit card market globally is monetized through credit card interchange rates set by the networks and paid by the merchants who accept credit cards issued by banks. MPC says that those fees mean that merchants are forced to pass those higher costs onto consumers.

Asked for comment, the MPC referred PYMNTS to MPC Executive Committee member and National Association of Convenience Stores General Counsel Doug Kantor’s recent observation that “this legislation would make card networks compete and give them incentives to improve service and security while keeping costs in check.” Costs, they say, will make it less expensive for the merchants to accept cards, with savings that will be passed back to the consumer in the form of lower prices.

Past as Prologue

But if past is prologue, that argument may be on shaky ground. It was the same argument put forth in 2010 as part of the Dodd Frank legislation in the summer of that year as part of Sen. Durbin’s successful effort to cap debit interchange.

The party line was that the  cap would free up funds for merchants to pass along to consumers, or to invest in their own rewards programs.

Those expectations did not jibe with reality since merchants didn’t lower their prices. A 2015 study examining Dodd-Frank’s capped debit interchange fees found that a vast majority of merchants in the survey (77.2%) did not change prices post-regulation, very few merchants (1.2%) reduced prices, while a sizable fraction of merchants (21.6%) increased prices.

Further the loss of debit card interchange, eliminated a source of fee income that subsidized checking accounts for middle income consumers, and led to banks’ cutting the availability of free checking accounts and debit card rewards programs.

Hobbling What Works

As Jeff Tassey, board chairman of the Electronic Payments Coalition, observed to Karen Webster, legislating only one side of the ubiquitous two-sided networks could collapse a system that has evolved over a period of decades. The modern credit card system took shape after retailers actually invented cards, and rewards (remember S&H Green Stamps?). They sold off their credit card portfolios to the banks, who could issue cards faster, relatively cheaper and manage the risk more effectively for the benefit of consumers and merchants.

“The banks have reinvested their interchange over the years and built these tremendous global electronic payments networks, platforms and protocols — and all of this has grown to become part of our daily lives,” Tassey said, secured with the robust data protections that have resulted from continued investments in advanced technologies.

Smaller networks could be  less secure since they’ve  not typically had the money to invest into state of the art technology and anti-fraud efforts.

Further, the rewards programs that are widely embraced and enjoyed by these same consumers are funded, in part, buy those same interchange fees — and the rewards themselves, of course, make the cards more enticing to consumers, who, by extension, spend more, and more often, with their favored merchants.

Allowing all sides of the multi-sided market to compete for consumers’ loyalty and allow them to use their cards of choice (and the rewards they value) is essential for that marketplace to function, as Global Economics Group Chairman David Evans has argued (and his arguments were instrumental in American Express’ win against antitrust litigation back in 2018).

So, when merchants are given the choice for how they want to route the Visa and Mastercard credit cards presented to them by their customers to be processed, the choice of lower cost rails has the potential to eliminate the benefits of rewards and fraud and security protections that consumers enjoy when using those cards. All without the knowledge of the consumer since few understand the complicated platform dynamics and various stakeholder incentives who have to be paid in order for things to flow smoothly. The connections between the banks, the issuers and the networks are fine-tuned and intertwined.

“There’s no doubt the consumer choice would ultimately go away if this bill were passed,” said Tassey.

The Unintended Consequences

Tassey maintained that taking credit card rewards away in the throes of an inflationary environment would also be tantamount to taking away some key levers that help consumers make the most of their spending (and apply cash back to future purchases). Judicious use of credit is a smart way to achieve financial goals, said Tassey, which is how the vast majority of consumers use these credit products.

He contends that there would be an outsized impact on smaller merchants, if consumers wield their cards less often, and that means less top line torque for these main street businesses. The banks and issuers, faced with higher costs (and lost interchange revenues) might wind up charging consumers fees on the cards that are issued, or may rein in card issuance overall, which would be a headwind to the cards in circulation. That, in turn, would translate to less money being spent in stores. Less money spent in stores would have an outsized impact on smaller firms, which tend to operate with thinner margins than larger merchants.

Mandated routing’s negative ripple effects would be widespread, predicted Tassey. “Once you disrupt the routing, then you devalue brands, the networks, and technology … This legislation will just cause disruption to an optimized and successful market.”