The Durbin Amendment: a costly price control experiment

Most Americans would be surprised to learn that the federal government is still in the business of setting the prices that one industry can charge another for its services.  That kind of economic micromanagement seems archaic and outmoded in 2016.  But a retro regulation is exactly how one sector is protecting its profit margins – and it’s time to make it history.

Buried deep in federal law is the “Durbin Amendment,” an obscure provision that instructed the Federal Reserve to study the complex and fast-changing electronic payments market and then divine the correct price that retailers should be charged for accepting debit cards.

When a consumer uses a debit card, the bank or credit union who issued the card receives a fee from the merchant to offset the cost of running the debit card system.  Known as “interchange,” this fee is invested in ensuring that the debit card system (comprised of hundreds of millions of participants) operates efficiently, safely, and keeps up with consumer needs.Before the Durbin Amendment, the market set the price of accepting debit cards.  Retailers eagerly signed up as debit cards became a popular substitute for cash and checks.  Since retailers had exited the resource-intensive payment card business years before debit cards took off, stores relied on financial institutions to issue debit cards, build the system to process them, and to open and maintain the underlying deposit account attached to the card.  In exchange for a turnkey payment solution which assured payment for valid transactions (and cut down on costly check and cash processing), merchants agreed to interchange as a cost of doing good business.

But the Durbin Amendment represented a major government intervention by making the Fed the arbiter of debit interchange, a task they did not request.  The debit price control law was hastily assembled and tacked onto the virtually unrelated Dodd-Frank Act at the 11th hour.  It passed with little notice and without hearings or robust debate, handing one industry a victory without considering the unintended consequences of government second-guessing the market.

For one, the Fed wrote a regulation which differed from what retail lobbyists anticipated.  They sued for a better deal and lost.  Their arguments did not impress economists or judges when put under strict scrutiny, and yet the litigants ensured that all three branches of government were drawn into the minute mechanics of market forces.

Ironically, this price control had the effect of raising the cost of accepting debit cards for many small businesses who lost access to flexible market rates when the one-size-fits all Durbin rate cap was enacted.  Small businesses now live under a law written at the behest of the largest players in the retail industry, which might give Main Street pause.  And community banks, even those that were supposedly “exempted” from the Durbin Amendment, have faced increased compliance costs related to the law’s other provisions.  State bankers associations representing thousands of local banks recently wrote to Congress to support repealing Durbin, which hampers their ability to serve their communities and small business customers.

But the worst unintended consequences of the Durbin Amendment were reserved for consumers.  Under market pricing, debit interchange supported consumer benefits such as low-cost checking accounts and debit card rewards.  Once the interchange funding that supported these benefits was diverted to retailers, consumers noticed new minimum balance requirements, higher fees, and fewer rewards programs.  Though not the goal of retail lobbyists, the Durbin Amendment has made it harder to obtain low-cost mainstream banking services, especially the protections of a debit card-linked checking account.  Retailers had promised to offset these consequences by passing their savings onto consumers through lower prices – which has not happened.

Like the many other price controls which have proven themselves counterproductive, the Durbin Amendment is a misguided attempt to “help” very able businesspeople.  In the 1970s, our friends in the convenience store industry saw first-hand how price controls led to gas lines.   For many small shops, the Durbin Amendment has also backfired.  There is little need for this anachronistic, market-distorting law. National retailers routinely use their scale to negotiate with suppliers on the cost of everything from paintbrushes to electricity.  They would instantly recognize the absurdity of Washington regulators deciding the “fair” price for a box of cereal on their shelves.

House Financial Institutions Subcommittee Chairman Randy Neugebauerhas introduced legislation (H.R. 5465) to fix this case of over-eager regulation and return market pricing to the debit card market.  We support this legislation and appreciate House Financial Services Committee Chairman Jeb Hensarling including this proposal in his financial reform framework.  There is longstanding support on both sides of the aisle for reform in this area.  Price controls have faded away for a reason, and the Durbin Amendment is one more example of an idea whose time has gone.


Author: Rob Nichols

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