Consumers rely on financial services for daily activities paying bills, buying groceries, or planning for retirement. Unfortunately, the ubiquitous nature of this industry makes it an easy target for consumer frustrations and well-meaning lawmakers. To make matters worse, many policy proposals aimed at promoting fairness or expanding access to low-income consumers result in restricting the use of financial products. When regulations attempt to police costs rather than support risk-based pricing, they reduce the supply of credit and reshape behavior in ways that often harm the consumers they aim to protect.
Price controls on interest rates and fees are a favorite policy of lawmakers looking to reduce costs. However, these policies undermine the logic of the entire financial system. Financial services companies rely on interest and fees to cover operating expenses and risk. When lawmakers place arbitrary caps, a company’s surest option to balance the equation is to reduce risk by restricting supply. These restrictions tend to disproportionately impact low-income individuals.
Despite this, price caps are still politically popular. After the 2008 financial crisis, the enactment of the Durbin Amendment under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), ushered in a new era of financial regulation, such as capping interchange fees, which was intended to reduce transaction costs and benefit the consumer.
The Durbin Amendment capped the price of interchange fees on debit cards at around $0.21. An interchange fee is a fee charged whenever a debit or credit card is used in a transaction and is used to fund card rewards and other costs to maintain the card. Instead of lowering costs for consumers, the Durbin Amendment disrupted consumer benefits like rewards causing a shift towards credit cards where the perks still remained. Since credit card interchange fees were not capped, these card networks were able to charge fees to fund marketing and rewards which enticed consumers.
Simultaneously, as a result of the Durbin Amendment, banks responded to the loss of interchange fees by reducing free banking while also reducing banking rewards. It significantly altered the credit market.
Despite these outcomes, further intervention in interchange fees is still politically popular. Senator Richard Durbin (D-IL), of which the amendment under Dodd-Frank is named, introduced similar legislation for credit cards under the Credit Card Competition Act.
This legislation would require large banks that issue credit cards to enable the cards to have a minimum of two payment networks by which to process the transaction so merchants could have a choice of network. Additionally, the card networks offered would have to be unaffiliated, meaning Visa and Mastercard cannot be the two offered; it must include another option such as Discover or Shazam. The intent is to create competition among networks, thus, lowering costs for merchants in hopes of further reducing costs for consumers. However, as evidenced in the aftermath of the Durbin Amendment, merchants rarely pass on savings to consumers. With reduced interchange fee revenue, people who rely on credit card rewards would likely see them reduced.
Furthermore, consumer interchange fees are based on risk and use type. This means that card security controls and even how a consumer is purchasing a product can determine the interchange fee. Consumers making a purchase in person versus online would have a cheaper interchange fee applied. The fee, in some effect, becomes commensurate with risk. Capping a fee without addressing the underlying driver, such as risk, often means that access is cut for low-income populations or fees are placed elsewhere in the system to cover the risk.
Credit card interest rate caps, also pose as consumer protection with similar results as interchange fee restrictions. Though not the first of its kind, this idea gained ground in January when the president asked Congress to cap rates. While that has failed to actualize at the federal level, a current Arizona bill seeks the same action to lower consumer costs at the state level.
Unfortunately, it would not have the desired result of reducing consumer expenses. Simply put, card companies charge interest based on risk characteristics: the higher the risk, the higher the interest rate. When card companies have the freedom to set interest rates, they can offer cards to greater numbers of people. But when regulations are in place to prevent risk-based pricing, fewer consumers are offered cards, forcing them to turn to alternative forms of credit that may not offer the same protection.
It is not just credit cards impacted by price controls. Buy Now Pay Later (BNPL) is a financial product that has gained popularity over the last several years. Predicated on the layaway plan, BNPL offers consumers the opportunity to pay in, typically, four installments per transaction. This credit product has allowed people with thin, or no, credit scores to access credit for products like groceries and has evolved to include paying rent and utilities on an installment plan.
BNPL has also been impacted by state interest rate caps. If paid on time, it is essentially a free service for consumers to use, however, if not paid on time, consumers are charged, fees and interest. For example, after taking effect in 2023, New Mexico’s cap on interest rates at 36 percent pushed several BNPL companies out of the state. The ability to institute risk-based pricing was limited by the cap resulting in decreased access to this service for state residents.
Despite a track record of failure, lawmakers continue to target the financial industry with price caps. These measures, intended for good, restrict access and reduce availability by preventing risk-based pricing measures—the foundation of the financial services industry.
Leah Locke is a Policy Analyst with the American Consumer Institute, a nonprofit education and research organization. Follow Leah on X @leahmlocke