Legal Commentary

CardHub Study on the Effects of the Durbin Amendment Debit Price Controls

By Todd Zywicki

CardHub has a new study that assesses the effects of the Durbin Amendment and its likely unintended consequences:

Given that only banks and not networks are subject to these restrictions, banks will be collecting less in fees while paying unrestricted fees to the networks. It is unlikely that major banks will allow their revenue to decrease significantly, so we predict that they will make up for lost revenue by increasing monthly fees and minimum balance requirements, and making debit card reward programs less appealing.

Since prepaid cards are exempt from these regulations, it is also likely that major banks will begin to introduce these offers and encourage customers to switch from checking accounts to prepaid cards, especially given the constant convergence of these two products. As an example, Capital One, the eighth largest U.S. bank, has already introduced a prepaid card.

Small banks? exclusion from this legislation makes it likely that their interchange fees will rise overtime, thus allowing them to have more competitive products than bigger banks. These banks currently hold a relatively small market share of 15 percent, which will allow the gradual increase of their interchange fees to go unnoticed. As the fees continue to rise, so will the appeal of their offers, and in turn their market share is likely to grow. As the use of small bank debit cards increases, the benefit of this legislation to merchants will be significantly diminished.

I would also add that because debit cards will now be relatively more expensive for consumers relative to credit cards (which will continue to have unregulated interchange fees) there almost certainly will be a substantial substitution from use of debit cards to a greater use of transactional use of credit cards.

CardHub runs the numbers on the expected losses to regulated card issuers as a result of price controls, but only runs it up to a 50% cut in interchange fees.  At this point it is unclear how the price-control commissars at the Fed will calculate the allowable interchange fee, but most observers seem to believe that the cut in interchange fees will be much larger than 50%, which would of course, increase the revenue losses to card issuers and increase the substitution effects to other fees and other products (such as prepaid cards and the cards issued by unregulated banks).

A final issue to consider is that the Durbin Amendment seems to contemplate a single permissible price for debit cards and a single permissible fraud allowance.  In reality, however, different businesses have different fraud risks associated with them.  Nobody seems to know exactly how the Fed is going to carry out this mission with which it has been charged, but if it does interpret its charge to create one price for all debit cards, this seems like it would logically mean that merchants with higher than average fraud risk would be even more of a money-loser than others.  I would expect that in general those with higher fraud losses would be small businesses or certain types of businesses.  If so, one possible consequence might be that debit issuers might no longer permit their cards to be accepted at businesses with higher fraud losses, especially if they are small businesses where issuers could afford to do that without undue alienation of customers.

Full post as published by The Volokh Conspiracy on November 05, 2010 (boomark / email).