Superstitious individuals consider the number 13 to be a sign of misfortune or simple bad luck and avoid its occurrence wherever possible in life. But when it comes to the Federal Reserve’s Regulation II, which sets price caps on debit card transactions, there is no superstition at work—only genuine misery that consumers, taxpayers, and the American economy have endured for 13 years. Worse, a proposed “update” to Regulation II now under consideration at the Fed would, if finalized, portend even more suffering ahead.
Section 1075 of the Wall Street Reform and Consumer Protection Act of 2010 (a.k.a. the Dodd-Frank law) directed the Federal Reserve to prescribe standards for whether the “interchange fees” that debit card issuers must charge retailers are “reasonable and proportional” for recovering costs to run payment networks.
Those costs are considerable, given constantly-evolving security challenges in online finance, rising transaction volumes as fewer consumers pay in cash, and merchants’ needs for faster, more convenient processing and clearing services. Such trends were plainly visible in 2011 when the Federal Reserve followed through with Regulation II, which imposed a price control on major card issuers of a 21-cent base rate (plus a small value-assessed component and 1-cent network security fee) on each debit transaction. In the fall of last year, the Federal Reserve proposed an even more draconian level—just 14.4 cents, with a smaller ad valorem fee and a security fee of 1.4 cents. Apparently that 0.4-cent boost for security is the Fed’s way of telling card issuers to give thanks for small favors.
Perhaps most concerning, the Fed is also proposing a new methodology based on its own collected data that would adjust the interchange fee cap biennially with no opportunity for public comment. As our friends at Americans for Tax Reform observed, “Such a measure would be tantamount to granting the Fed price-fixing authority in what should be a free market space.”
NTU warned back in 2011 that the Fed’s regulation would, like price controls enacted on most any good or service throughout history, turn out poorly. In February of that year, our comments to the Federal Reserve noted:
Companies must invest time and resources toward their services, which are then priced accordingly. When government steps in and arbitrarily rules that the product price must be fixed at some point other than where supply meets demand, distortions (such as shortages) result. The consumer debit card industry is no different; competing networks have invested large sums in creating electronic payment processing systems that many Americans utilize every day. Deprived of the ability to fund these systems with market-priced fees, the networks – and eventually consumers and retailers – suffer.
NTU likewise cited already-accumulating evidence of severe economic fallout from Section 1075’s destructive mandate. Then-CEO of NerdWallet Tim Chen opined that “. . . [I]ssuers aren’t waiting around to see how it’s going to turn out . . . [B]anks all over the country have already started adding new fees to services that most of us have long taken for granted as free.” Others’ observations were truly prophetic. Glen Trudel of Connolly, Bove, Lodge, & Hutz wrote:
A further widely held belief is that, notwithstanding that the debit interchange regulation portion of the Dodd-Frank Act was touted at the time of its passage to be pro-consumer, in fact consumers will be very unlikely to see any real cost savings from what is often perceived as a shift of profit revenue from the issuers of the covered debit cards to the merchants who will benefit from the reduction in the interchange fees charged to such merchants.
Subsequent events went downhill from there, proving what opponents of Fed interchange regulation had been asserting:
- According an excellent review of research from the International Center for Law and Economics, various account fees “have replaced between 40% and 90% of the reduction in revenue from debit-interchange fees.” In the two years following adoption of Regulation II, the share of covered banks offering free checking accounts dropped from 76 percent to just 38 percent; that share has yet to fully recover. Required minimum balances for non-interest-bearing free checking accounts rose by over $400.
- A study from the Richmond Federal Reserve concluded that only 1.2 percent of retailers passed along “savings” from Regulation II’s price controls to consumers.
- Consumers in a variety of nations with interchange price controls, including Australia and Spain, have experienced similar hardships.
Based on these dismal findings from the original Regulation II and other countries’ experiences, it should not be surprising that more mayhem would be on the way from proposed revisions. An analysis for the Consumer Bankers Association conducted by former Pew Charitable Trusts Director of Consumer Finance Nick Bourke determined that the Fed’s updated Regulation II could cost consumers between $1.3 billion and $2 billion annually in higher bank account fees. These are effectively shifted costs that card providers would have to recoup because marked-based interchange fees would be further undermined by new price caps.
Even though the original Regulation II purported to exempt certain smaller institutions from its dictates, the collateral damage could not be avoided. According to an op-ed from Vance Ginn, former chief economist at the Office of Management and Budget:
The Federal Reserve isn’t oblivious to the politics here. It knew it would be controversial, therefore, it only applied Regulation II to institutions with over $10 billion in assets. That way, it wouldn’t also have to justify the changes to frustrated community banks and credit unions. Yet, the regulation had unintended consequences[,] hitting even these exempt institutions. Between 2011 and 2021, debit card interchange revenue for exempt issuers fell by 13% for single-message network transactions, a clear sign that the ripple effects of price controls extend far beyond their intended targets.
Ginn also predicts the ruination will be even greater if the current plan to tinker with interchange becomes reality:
Moreover, the proposed regulation’s stricter routing requirements could further strain smaller banks by limiting their flexibility in negotiating better terms with networks. This could reduce their ability to offer competitive pricing and services to consumers, stifling innovation and increasing operational costs. In 2014, a survey found that 73.3% of exempt banks reported that the policy hurt their earnings, indicating that even institutions not directly subjected to the cap suffer from these market distortions.
Though created by Congress, the Federal Reserve System exists outside the government. Yet, whether intentional or not, the Fed seems to be mimicking some of the worst policy initiatives underway at government entities such as the Consumer Financial Protection Bureau (CFPB), the Federal Deposit Insurance Corporation (FDIC), and the Federal Trade Commission, all of which have issued poorly-informed regulations and requests for information driven by the White House’s hyper-politicized crusade against what it calls “junk fees.”
Conspicuously absent from these—as well as the Fed’s—proposals are solid cost-benefit analyses that account for holistic economic impacts, as well as the impacts of past taxes and regulations on current circumstances. There is, after all, research to show that Regulation II forced financial providers to recover their unavoidable expenses on debit cards by raising account fees and overdue payment charges, as well as by curtailing popular rewards programs (see above). Now, CFPB is complaining about and exploring caps on . . . wait for it . . . account fees and overdue payment charges. CFPB also requested comments on how “junk fees” associated with home loan closing should be addressed, ignoring credible analysis that points to taxes as the often-single largest component in a homeowner’s settlement costs.
Taxpayers have an interest in both the Fed’s and government agencies’ dubious efforts to micromanage markets, which is why NTU is involved in the first place. These power grabs boost regulatory and enforcement budgets that put taxpayers on the hook, all while interfering with private sector innovation in financial services that can make government purchasing more efficient and resilient to fraud. Worse, they give momentum to even more ambitious schemes such as postal banking, heavier subsidies for credit, and expansions in the $10 trillion-plus portfolio of taxpayer-backed loans.
Meanwhile, in the opinion of many prominent economists, Biden (and Trump)-era legislation that dramatically boosted federal spending did not help to slow, and may have even accelerated, price hikes. This is the very inflation that the Fed is charged with taming, even as its latest interchange proposal would simply squeeze the inflation bubble that retailers are experiencing into consumer financial services instead. Smart retailers recognize that such a shift benefits no one in the long run, and that the far more extant threat to their businesses comes from excessive taxes and regulations.
Given all of these problems associated with Regulation II, why would the Fed even consider tightening its existing price caps by one-third? Why indeed.
Unlike many other regulatory morasses, there is a readily apparent exit strategy for the Fed to pursue: stop making matters worse. Section 1075 of Dodd-Frank may have given the Federal Reserve a mandate to meddle with debit transaction pricing, but the statute does not specify a timetable for how or when the Fed must make subsequent adjustments.
Any internal Fed “deadline” for finalizing the update to Regulation II is an artificial one, for which there would be no consequences in statute if it were delayed to conduct further desperately needed study or shelved entirely. Even the Fed admitted in the text of its rulemaking that it is unable to “determine at this time whether the potential benefits of the proposal to consumers exceed the possible costs imposed on consumers and financial institutions.” It is therefore all the more shocking that the Fed would claim the power to go through this rate-setting exercise automatically every two years, let alone now.
The flaws of such an approach are especially true given the yellow light the U.S. Supreme Court signaled in the recent Loper Bright decision that ended courts’ reflexive deference to regulators in how the statutory instructions from Congress are carried out.
A prudent decision by the Fed to scrap this rule could likewise reduce the threat of a multi-front war on cardholders, who are already facing a blitz from Members of Congress to pile debit-card interchange price controls on credit cards too. Not content with the wreckage caused by Dodd-Frank and Regulation II, Senators Durbin (D-IL) and Marshall (R-KS) have sought openings throughout this Congress to attach such a plan to must-pass legislation.
And just this week, Transportation Secretary Buttigieg dutifully announced that, at the behest of Senators Durbin and Marshall, he had “initiated a review to examine the fairness, transparency, and predictability, and competitiveness of airlines’ reward programs” that are tied to credit cards. Buttigieg’s ploy rivals that of CFPB’s for its attempt to deflect from the real source of consumers’ hardship—government itself. As NTU has long pointed out, the typical traveler pays a higher effective rate of taxes and other government charges on an airline ticket than he does on a 1040 income tax return.
Another hopeful outcome from the scrapping or postponing of the rule is that, perhaps, states too would be a little less enthusiastic to rush in where the Fed fears to tread. As my colleagues Jessica Ward and Mattias Gugel have written in op-eds and communications to state lawmakers, legislation to establish state “study commissions” on interchange are transparent preludes to full-blown (and unconstitutional) regulation at their levels.
Here’s hoping the Fed will put its own agenda on ice, and cool the ardor of other federal and state officials a bit at the same time. Otherwise, year 14 of Regulation II—and every year thereafter—will prove as unlucky for American consumers and taxpayers as the past 13.