Credit Cards by Sean MacEntee is licensed under CC BY 2.0
In light of the OCC’s preemption order on the Illinois Interchange Fee Prohibition Act (IFPA), proponents of interchange fee restrictions continue to make misguided claims in order to pocket savings from government mandated price controls, all while falsely claiming consumers would benefit. The IFPA is a state law that prohibits card networks and issuers from charging interchange fees on the tax and gratuity portions of electronic transactions.
The OCC made it clear in its preemption order issued in April that states cannot interfere with powers that are federally designated under the National Bank Act, and payments are a critical component of bank powers that they are entitled to conduct.
Beyond the OCC, the NCUA filed a similar interim final rule on June 9th, establishing that federal credit unions may also charge interchange fees. The rule states that the NCUA believes that the Federal Credit Union Act already allows for interchange fees to be charged by federally chartered credit unions.
Proponents of interchange fee regulation keep making the same points that are easily debunked with a simple google search. The most common claim is that interchange fee regulations will help lower the cost of living and save consumers money that they would otherwise pass on to their customers. That experiment has already played out with the Durbin Amendment in 2010 when debit card interchange fees were capped, and the results remain instructive today.
The Federal Reserve Bank of Richmond released a study in 2015 finding that close to 99% of merchants did not lower prices following the enactment of the Durbin Amendment. Alternative theories such as inflationary pressures would fail to explain price movements. In the years following the Durbin Amendment’s enactment, annual CPI growth was subdued, averaging below the Fed’s 2% inflation target between 2010 and 2015. Nominal wage growth also remained historically weak and the minimum wage sat unchanged. Retailers should have transmitted the interchange windfall to consumers, but they did not. This observation is consistent with the explanation that merchants retained the savings for their own margins.
Economists at the Federal Reserve Board, the very institution that drafted and finalized the Durbin Amendment rule (Regulation II), found free noninterest checking account availability declined by 30 percentage points. Additionally, monthly fees on noninterest and interest-bearing checking accounts rose by 20 and 17 percent respectively. Minimum balance requirements to avoid monthly fees increased by 50 percent and 55 percent for noninterest and interest-bearing checking accounts respectively as well. Other studies later found these effects placed a disproportionate amount of burden on lower-income households.
Researchers at Georgetown and Yale found that the Durbin Amendment had unsavory distributional effects on consumers. Because of lost interchange fee revenue and the resulting increases in fees and minimum balance requirements, low-income consumers were “disproportionately subject to these higher fees.” Some consumers “closed their checking accounts because of the increase in monthly fees and became unbanked”. They found that between 2010 and 2015 “there was a notable increase in the proportion of the unbanked population that cited high account fees as the primary reason for not having a bank account”. Unsurprisingly, wealthier households tend to have higher account balances, meaning an estimated 3 percent of accounts belonging to those in the top 10 percent of households by income sit below minimum account balance thresholds compared to 70 percent of those in the bottom 20 percent.
Claims that the payments market is uncompetitive rest on a flawed assumption: the number of firms in a market can be equated to the intensity of competition within it. Many industries are concentrated for entirely benign reasons: they face high barriers to entry in the form of large, fixed costs, and steep economies of scale that require long time horizons to generate profitability. In these cases, a small number of marketplace actors is a consequence of market economics, not evidence of market failure. Empirical evidence lends credence to this theory: a study conducted at the University of Miami found that “the net profit per dollar of purchases for the transaction part of the credit card network is negative, -0.5 cents per dollar.” The study goes on to say that “the only reasonable explanation of negative returns for the payment network from transactions is that there is already fierce competition in the market and a likelihood of additional competition in the transaction processing market”.
The evidence is clear: government-mandated price controls on interchange fees worsen consumer welfare.
When retailers save on costs through government intervention, they have no real incentive to pass those savings onto consumers. And consumers pay for the revenue shortfall through higher costs elsewhere. Retailers essentially passed the costs of the Durbin Amendment on to their own customers.
it’s no surprise then that even democrat lawmakers, such as Jared Polis (D-Co.), are wary of the unintended consequences of interchange fee regulation. In his letter explaining the rationale for his veto of SB 26-134, Colorado’s interchange fee regulation bill, Polis cited concerns surrounding how the bill “could create chaos for [Colorado’s] business environment…, tourism-dependent economy, and consumers that want to make purchases easily and efficiently.”
Colorado’s veto of interchange regulation, combined with the OCC’s and NCUA’s preemption order against Illinois’ law, reinforce the narrative that price controls on interchange fees pose considerable risks to consumers and lie largely beyond the reach of state legislatures to mitigate the fallout risks of interchange fee controls.
Lawmakers should abandon efforts to legislate interchange carve-outs at the state or federal level and let market forces continue setting prices in the payments space.
