The U.S. Senate once again seems poised to attempt to impose a cap on credit card interchange fees by re-introducing the Credit Card Competition Act (CCCA). Legislatures in numerous other states have also put forth rate cap legislation. Supporters of these caps as well as other mandates in this realm have an overly simple view of our nation’s complex payment system, and many perceive--incorrectly--credit cards as being mere middlemen that deliver nothing of value. If that is true, they reason, then taking steps to reduce their revenue will save customers money.
However, an abundance of evidence--including my own research--shows that the main impact of these laws will be the diminution of credit available for middle- and low-income households by the threat of community banks and credit unions that millions of Americans depend on.
The CCCA ostensibly injects competition into the credit card payment ecosystem. It would mandate that large credit-card-issuing banks enable at least two networks to operate on their cards--but only for Mastercard and Visa. (The state legislation would cover all credit cards).
However, no one other than the largest merchants will benefit from this law by paying lower interchange fees without passing along those cost savings to customers. Smaller merchants find themselves at a competitive disadvantage without massive payment departments to negotiate lower rates, and less well-off customers risk losing access to credit altogether.
At the state level, several legislators want to reduce credit card costs by exempting taxes and tips from interchange fees. Once again, such a constraint would constitute a serious risk for smaller financial institutions, especially the community banks and credit card unions.
The experience of the 2010 Durbin Amendment should serve as a warning. That policy capped interchange fees on debit cards for banks over $10 billion in assets, with an exemption for smaller banks. Yet even exempt institutions suffered: data from the Federal Reserve clearly shows that interchange revenue fell for these entities as well. Lower revenue and relatively higher costs reduced the ability of smaller financial institutions to offer affordable banking services.
The reason smaller banks were hurt is that nearly all small banks and credit unions offer credit cards by partnering with those same large issuers, so they’re effectively covered by the law as well. These partnerships are essential in a market where the top 15 issuers control over 88 percent of outstanding credit card balances, according to data from the Nilson Report. Larger banks will pass on these costs to their smaller partners--or simply exit partnership agreements with smaller banks altogether, and either outcome leaves community institutions with fewer tools to serve their customers.
Both the federal and state legislation would reduce credit in rural and low-income areas, where big banks have little presence and community banks fill the gap. As interchange revenue declines, small banks may be forced to retrench, lay off staff, or raise interest rates. It will also accelerate bank consolidation, reducing competition and thus defeating the explicit goal of the legislation.
State laws like the Illinois Interchange Fee Prohibition Act compound the issue. Exempting taxes and tips from interchange calculations carve away at already thin margins, and I estimate that a nationwide version of these state bills could cost community banks and credit unions $1.6 billion annually--a quarter of their profits. Because only state-chartered banks would be subject to this legislation, these institutions--which tend to be much smaller than federally-chartered banks--would become even less competitive while large national banks often escape their reach.
Worse still, as consumer lending becomes unprofitable, small banks may shift further into riskier sectors like commercial real estate--where they already hold 70 percent of total loans--potentially introducing systemic risk into the country’s financial markets.
We should all want a competitive, fair, and innovative payments system, and the happy news here is that we already have it. The CCCA and its state-level cousins will not improve competition. Instead, these laws will shrink the ranks of community banks, reduce access to credit for everyday Americans, and hand even more power to the nation’s financial giants.
