Amidst a rush of new rulemakings by federal regulators is a recent proposal by the Board of Governors of the Federal Reserve System (Fed) to amend Regulation II (Reg. II), which sets rules for debit card interchange fees. However, the Fed’s proposed changes are arbitrary, unnecessary, and certain to lead to unintended consequences for financial institutions and their customers. The Fed would be wise to withdraw its proposal.
The proposal seeks automatic biennial adjustments to debit card interchange fee caps for financial institutions with consolidated assets of $10 billion or more, starting with an initial reduction in the fee cap base sum from 21.0 cents to 14.4 cents. The proposal would also reduce the ad valorem component (multiplied by the value of the transaction) from 5 to 4 basis points, and marginally increase the fraud-prevention adjustment (for qualified card issuers) from 1 to 1.3 cents. The Fed argues regular updates to debit card fee caps are necessary to prevent card issuers from charging unnecessarily high transaction fees and to keep pace with changes in survey data that’s collected biennially from those card issuers.
However, the law already provides such protection. For instance, in the aftermath of the 2007-09 financial crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 1075 of this act—also known as the Durbin Amendment—stipulates that debit card transaction fees must be “reasonable and proportional to the cost incurred by the issuer with respect to the transaction.” The act directed the Fed to write new regulations to make this a reality, which it did by establishing the current debit card price cap of 21 cents per transaction.
Strangely, years later, the Fed has now decided that this price cap is inadequate and should be arbitrarily adjusted downward to 14.4 cents, after which it should be updated biennially. But the Fed provides no good reason for why such a change is necessary, nor does it provide a careful analysis to justify its position. Indeed, regarding consumer costs and compliance costs, the Fed states that it does not know “whether the potential benefits of the proposal to consumers exceed the possible costs imposed on consumers and financial institutions.” Yet, it has sought to move forward with the proposal anyway, going so far as to admit that future changes to the interchange fee cap will be made without “inviting public comment,” since it believes changes to the fee cap’s methodology (incorporating biennial card issuer survey data) is sufficient. This makes no sense and is inconsistent with the Administrative Procedures Act (APA), which guards against arbitrary rules by requiring federal agencies to seek public comment on proposals.
Perhaps even more concerning, the Fed acknowledges that government intervention could make “covered issuers’ checking account and debit card programs less attractive to consumers.” That is an alarming admission considering that is exactly what happened after the Durbin Amendment was enacted. The amendment denied financial institutions the flexibility to determine interchange fees and therefore the ability to achieve full cost recovery. As a result, these institutions were forced to reduce the availability of free checking accounts, raise minimum balance requirements, and eliminate popular debit card rewards programs. The Fed’s current proposal is certain to produce similar results.
Lower profitability means banks and credit unions may be forced to downsize, scale back operations, or reduce investment in important services like fraud protection and remaining rewards programs. This has important ramifications for consumers who, in addition to experiencing cuts to such services, are unlikely to receive any of the cost savings the Fed says are possible under its proposal.
Merchants famously failed to pass along cost savings to consumers the first time the government-imposed regulations on debit card transaction fees. A Federal Reserve Bank of Richmond study, published after the Durbin Amendment’s passage, found that just two percent of merchants reported lowering their prices, 75 percent kept them the same, and 23 percent increased them. There is no reason to think things would be any different this time.
The Fed’s proposal would be more of the same. It would strengthen existing government-mandated price controls that, historical evidence has repeatedly demonstrated, drive up the price of services for consumers. For instance, a 2020 Government Accountability Office (GAO) study noted research that had found that large financial institutions may have increased their checking account fees to offset caps on debit card transaction fees. Worse, the Fed’s proposal may harm low-income Americans most, since they are disproportionately unbanked or underbanked, and could struggle to pay higher service charges on services like checking accounts.
The only logical step is for the Fed to reevaluate its proposal, which, as written, is certain to produce unintended consequences for the debit card market that will inevitably harm consumers.
Nate Scherer is the Director of Finance Regulation with the American Consumer Institute, a nonprofit education and research organization. For more information about the Institute, visit us at www.TheAmericanConsumer.Org or follow us on X @ConsumerPal