The (Non-)Impact Of The Interchange Amendment

Well, I didn’t think it would happen, but what do I know about Washington. They managed to pass an amendment regulating interchange fees.

A shining example of how low the financial literacy rate is in DC, the amendment instructs the Federal Reserve to regulate interchange fees and requires that the fees be reasonable and proportional to the costs of the issuer or the payment network.

To prove what a slippery political slope this amendment was, most senators uncharacteristically gave up their right to be heard on the amendment before its vote, leaving only Dick Durbin to tout it on the Senate floor.

But it passed, and that has led some observers to comment on what the impact of the amendment will be. A recent post on Mint.com’s blog listed five potential impact points. Here’s the list with my take on them:

1. Happy shopkeepers. The blog post claims that both small and large retailers feel gouged by card issuers and networks and are happy about the amendment.

My take: The amendment means potentially happy shopkeepers. Potentially, because, in the short term there’s no guarantee of a rate decrease. Remember, the amendment instructs the Fed to establish a rate that is “reasonable and proportional to the costs of the issuer or payment network.” Do you know what those costs are? Neither do I. And I bet that the issuers and networks don’t know what those costs are either. The interchange rate is a fee for a bundle of services that the issuers and networks provide. Unwinding those costs will be messy, and it will be a while before new rates are established, unless all parties simply agree to bow to political pressures and compromise (or more accurately, capitulate).

2. Lower prices. According to the Mint blog “when flour gets cheaper, bread gets cheaper.”

My take: Ain’t gonna happen. Retailer profitability has been in the dumps, and they’re desperate to show increased profitability. If they really wanted to lower prices, they could find other ways to reduce their cost structure. The retailers decided to fight the interchange war, and scored a victory in one battle.  But this misses the even more important point on why prices ain’t coming down: As I said in the previous point, the fee represents a bundle of services — services like fraud detection/protection, risk management, money movement, etc. If the issuers/networks don’t get compensated for these services, they will stop providing them. And retailers/merchants will have to pay separate charges for those services. And those charges might turn out to exceed the current level of fees.  Consumer prices aren’t coming down, folks.

3. More cash-only transactions. One of the things the amendment does is allow merchants to establish minimum charge amounts on card transactions, so they don’t end up paying outrageously priced fees for 50-cent transactions. Mint’s thinking is that retailers will jump on this, and set up minimum charge amounts (retailers who do this today violate their Visa/Mastercard agreements).

My take: Ain’t gonna happen. Two reasons driving my thinking here. First, retailers are loathe to force customers into payment options. Retailers know that customers have choices, and would rather pay a fee on a transaction than lose the transaction altogether. The other reason is that younger Gen Yers have no clue what cash is.

4. Fewer rewards. Mint’s logic on this is: “debit card reward programs, financed by interchange fees, have traditionally been less generous than those offered by credit cards, because banks collect lower interchange fees on debit transactions. If the Durbin amendment stays on the bill once it becomes law, these programs will probably be toast.”

My take: Sorry, I disagree again. Mint’s logic misses some critical points: That competition for checking relationships still goes on, and banks will compete for new accounts using rewards programs as a competitive lever. Why? Because consumers are conditioned to expect something in return for their business. And because even if the interchange fee ends up being lower, with the restrictions on overdraft fees, banks will turn to the interchange fee as a driver of revenue on checking accounts. In a shining example of strange bedfellows, it will actually end up being the merchants themselves who will end up providing much of the funding for rewards programs.

5. The end of the world.

My take: And you think I’m cranky?

4 thoughts on “The (Non-)Impact Of The Interchange Amendment

  1. Hey, Ron, thanks for taking the time to rebut me point by point. I see you didn’t take on #5, so I win the point. (Kidding!)

    1. Sure, maybe the Fed will study debit interchange rates and say, “Hey, turns out they were about right. Maybe even too low!” Does this seem a likely outcome to you–not just on the merits, but given the political winds?

    2. What the issuing banks are arguing, absurdly, is that if interchange goes down, retailers will “pocket the profit.” Uhh, which world are we living in, exactly? The one where price competition doesn’t exist? Just checking.

    Yes, the banks are also making the point you’re making, and that’s a trickier one. I think the analogy with checks is specious: sure, checks have no interchange fee, but they’re expensive in other ways. What supporters of the Durbin amendment are arguing–and I don’t know whether they’re right–is that debit interchange fees don’t reflect–what’s the term?–underlying fundamentals. That they’re not set by a competitive market, but by a price-fixing oligopoly. Having talked to a jillion people on this issue, I’m sympathetic to this argument.

    3. Retailers already set minimums all over the place, even though they’re not supposed to. As a card-carrying (get it?) member of the plastic generation, I hate this. Right now, retailers have two incentives not to set a minimum: Visa will bust them, and it bugs customers. If we get rid of one of those roadblocks, we’ll see more minimums.

    That said, I wonder whether the prevalence of minimums has been changing over time. I’ve noticed, anecdotally, that they seem less common in my neighborhood than they used to. Do you know of a study?

    4. “In a shining example of strange bedfellows, it will actually end up being the merchants themselves who will end up providing much of the funding for rewards programs.” That’s how it already works! If debit interchange fees are reduced due to Fed intervention and merchant-imposed minimums, there will be less revenue to fund rewards.

    The banks are screaming about this in a way they didn’t about the CARD Act. If it’s a non-impact, what are they so afraid of?

    Best,
    Matthew

  2. You make a lot of good points, with perfectly logical reasoning, as usual. There is really only one sentence of your post that I want to share some thoughts about.

    RE: The amendment instructs the Fed to establish a rate that is “reasonable and proportional to the costs of the issuer or payment network.”

    My understanding is that the amendment restricts what “costs” the Fed is allowed to use in making its calculation.

    Ed Yingling, the president and CEO of the American Banker Association, explained it like this: “It limits the factors that can be considered by the Fed when setting interchange rates to the cost of individual transactions only, specifically precluding consideration of various other costs such as infrastructure expenses, account management expenses, and fraud protection expenses. These are very real and significant costs that banks incur in making debit cards available to their customers. In effect, it’s like saying airlines can only price tickets based on the cost of fuel and have to ignore the cost of paying their pilots, the cost of buying and servicing their planes, the cost of air traffic control, and whole host of other expenses that are necessary to make air travel possible.”

    I haven’t studied the amendment closely myself. But if he is right, it might not be so far-fetched to think that the amendment could result in debit interchange fees being lower than they are now.

    In effect, the Fed is not free to arrive at a “reasonable” rate all on its own. It must do so within tight parameters that banks and credit unions argue are unreasonable in and of themselves.

    I do agree that there is a difference between assumptions and facts. In this case, lower interchange fees are an assumption, as you point out.

    But people on both sides of this amendment — the retailers who favor it and the banks and credit unions who oppose it — all seem to think that this is a reasonable assumption. When people of both sides of such a divisive argument agree on something, it makes for a stronger case that they could be right.

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  4. Matthew: Thanks for taking the time to reply, and apologies for the slow response back to you. Couple of points back at you:

    4. Your logic is inconsistent here. If merchants pass the cost of interchange back to the consumer, then merchants are NOT already funding rewards.

    The key point I want to argue, though, is whether or not a decrease in interchange will produce lower consumer prices. Here’s the primary reason why I’m so confident that it won’t happen: Because prices aren’t set based solely on the costs of providing a product or service.

    You live in Seattle, right? Would it be a good assumption on my part that you’ve been in a Starbucks before? If so, let me ask you something. What does Starbucks charge for a venti mocha latte (or whatever they call it)? Like $3.85, right? How is that price established? Do you think Starbucks allocates the costs of the building, the labor, the ingredients to each drink, and then determine that the price should be $3.75 — and then tack on $.10 for the interchange? Not how it happens.

    The price reflects supply and demand. As long as people are willing to pay $3.85, Starbucks will charge $3.85. If they thought they could make more profits through the additional volume that a $.10 reduction would provide, they would have done it long ago.

    So when the interchange rate comes down, Starbucks’ prices are staying where they are.

    Let’s take another example: a camera at Best Buy. Let’s say that camera costs $360 today. And let’s say the average interchange rate is reduced from 3% to 2.5%. If a retailer like Best Buy WERE to pass along the savings, they couldn’t simply reduce all prices by the .5%. Why? Because not all sales of the product is paid for with a credit or debit card. So let’s assume that even three-quarters of sales are paid for w/ credit or debit. Best Buy will only reduce the price of the product by 75% of .5% or .375%. You’ll be saving $1.35. Not even enough to buy that latte at Starbucks.

    What WILL happen here, Matthew, is that, as a result of a decrease in interchange, card issuers will have to raise interest rates. This will depress demand for those HDTVs. By winning the interchange battle, the merchants will have lost the profitability war.

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