Sen. Richard Durbin (D-Ill.) recently introduced legislation to regulate how credit-card transactions are routed that, if passed, would hinder competition between credit-card issuers, reduce benefits for consumers, and impede fraud detection and prevention.
Co-sponsored by Sens. Peter Welch (D-Vt.), J.D. Vance (R-Ohio) and Roger Marshall (R-Kan.), the Credit Card Competition Act would require banks with more than $100 billion in assets to offer merchants the choice of at least two routing networks on credit cards they issue, one of them being a smaller competitor to Visa and Mastercard. The legislation, which would cover most existing cards, intends to address merchants' concerns about requirements to route transactions over the payment network branded on the card.
But current routing requirements are a feature, not a bug. They ensure adherence to security and fraud-prevention protocols established by the networks. They also enable networks to set interchange fees that maximize the value for both cardholders and merchants, the two sides of the payments market.
Any two-sided market requires sufficient participation on both sides. A payment network with either too few merchants or too few cardholders would fail. Participation in such markets is often broadest when one side subsidizes the other. Take newspapers, for example: advertisers subsidize readers by paying for part or all the costs of producing, marketing and distributing the newspaper, thereby increasing the total number of readers who will see their ads.
In credit-card networks, merchants subsidize cardholders through the interchange fees paid by acquiring banks to issuing banks. Revenue from interchange fees enables issuing banks to provide various card benefits, which can include up to 45 days of free credit, insurance and rewards. These motivate consumers to use their cards, leading to increased spending. Cards co-branded with merchants also foster loyalty and increased spending. Card networks have developed a range of interchange-fee rates for different types of cards, as well as for different kinds of merchants, including lower interchange fees for merchants with low-ticket sales, and caps on fees for sales of gasoline.
These and other innovations have been driven by fierce competition among the payment networks. Merchants have benefitted enormously from increased spending, faster transactions, and reduced counterparty risk. Nonetheless, larger merchants have regularly complained about high interchange fees, asserting that they are the result of a lack of competition. In response, legislators and regulators in many countries have introduced price controls and other interventions that have, unfortunately, led issuers to reduce rewards and other benefits, and to increase card fees, harming consumers.
In 2010, Sen. Durbin introduced an amendment to the Dodd-Frank Act that required the Federal Reserve to cap debit-card interchange fees for banks with assets of more than $10 billion. One study found the effects of this rule was to reduce revenue at covered banks by about $5.5 billion per year. For their part, banks recouped about 42% of that lost revenue by raising monthly fees on checking accounts and increasing minimum deposits required for “free” checking. But merchants passed through very little of the savings.
The result was that lower-income consumers ended up paying much higher bank fees but received little in return. Citing these effects, a report published last year by the U.S. Government Accountability Office concluded that the Durbin amendment is one of the main factors inhibiting access to banking among low-income households.
The Credit Card Competition Act would exacerbate these negative effects. Merchants would route transactions through networks that offer lower interchange fees, compelling larger networks to lower their fees in order to compete. We can predict that, in response, card benefits like rewards programs will be scaled back or eliminated. Co-branded cards would likely vanish. Annual fees would increase, and fee-free cards would be reserved for individuals with high credit scores.
Merchants would also suffer, as spending would likely fall. Smaller merchants selling low-ticket items would be particularly affected, with little if any reduction in fees to match the decline in business. Furthermore, diminished rewards and higher fees may drive consumers toward less-secure payment methods like cash.
If lower-cost networks capture a significant share of transactions, it would also likely compromise card security. Fraud-detection systems rely on extensive user-spending data, which would be fragmented if traffic is diverted from the primary card networks. Additionally, certain security features—such as temporarily halting transactions on a lost card—may not function correctly if data is not routed over the main network.
Durbin obviously never intended his original amendment to harm poorer consumers, but that is what happened. If enacted, his bill would amplify the adverse effects, resulting in heightened security risks, increased costs for consumers, reduced spending, and negative implications for small-ticket merchants.
