Debit card price controls miss their intended targets

In 2011, the Federal Reserve adopted rules implementing fee caps on debit card transactions, pursuant to the Dodd-Frank Act of 2010. These rules have led to diminished access to credit products for consumers and have failed in their promise to lower consumer debit fees. The last eight years have shown this to be a failed experiment. 

Merchants had long complained about the fees they paid on debit card transactions, though they appreciated the convenience those cards offered them and their customers.

Rather than renegotiating their contractual agreements, they instead lobbied Congress to get out of them. That effort culminated in the Dodd-Frank Act’s Durbin interchange amendment. 

{mosads}The amendment’s direct price control has gotten most of the attention and well-deserved criticism, having resulted in the same consequences as all price controls. Every college student taking Economics 101 learns that keeping prices at an artificially low level results in an undersupply of vital goods or services.

Just as rent control results in a shortage of housing, the Durbin amendment’s price controls have led to decreased access to bank services and higher fees on checking accounts.

The Durbin price controls have a companion provision that has also taken vital financial services out of the hands of consumers and has destroyed the property rights of payment system innovators: a mandate that card transactions offer multiple networks for routing the payment that underlies the transaction.

Think of it like Coke being forced to sell Pepsi products in Coke-owned vending machines.

Before the Dodd-Frank Act, these businesses could enter into exclusive arrangements with retailers. Exclusive dealing arrangements are useful when businesses make large investments that are specific to the needs of their commercial partner, and they serve as a common and legitimate business practice in many industries.

In this case, exclusive dealing arrangements helped debit card providers to make the necessary investments in infrastructure to prevent fraud. It also further encouraged innovation in authorization methods, which is now under-incentivized given the mandate. 

Indeed, the pace of innovation in the fintech space holds the promise of solving many of the core problems in payment systems, including fraud prevention, reliable execution and efficient authorization.

Unfortunately the mandate to process payments through multiple networks creates a “free-rider problem” in which innovators don’t reap the benefits of their own innovations because competitors can enjoy them as well. Knowing this, innovators will invest less in new consumer- and merchant-friendly ideas.

Prior to Dodd-Frank, a federal judge upheld exclusive network arrangements for debit cards as a legal and appropriate contract as part of a settlement approval of litigation between retailers and card providers. The retailers then switched tactics and lobbied for legislation to get them out of their contractual obligations. 

Supporters of the Durbin amendment’s price controls and exclusivity ban argued that the provision would pass cost savings on to consumers.

That alone was not a legitimate argument in the first place, as it would merely reflect use of government power to take property rights from innovators and redistribute them to politically sympathetic beneficiaries. Even if one were willing to accept that as a legitimate policy goal, the fact is it didn’t happen. 

Studies by the Federal Reserve Bank of Richmond demonstrate that the Durbin amendment didn’t even fulfill its intended purpose. Retailers simply kept the cost savings. Thus, the Durbin Act merely reflected a very successful act of lobbying by retailers. 

While the Federal Reserve waits on appropriate legislation to repeal this harmful provision, it could revisit some of the provisions it adopted. The Fed chose a broad definition of “debit” under the act and thus it could limit the reach of an overregulation by narrowing that definition. 

The Fed could also further revisit the level of the price cap it adopted and raise it to a more appropriate level and better tailor the rule to limit the harmful effects of its network sharing requirements.

That will have to suffice until someone addresses this power grab by retailers, which ultimately harms the consumers the rule was ostensibly designed to protect.

J.W. Verret is an associate professor of law at George Mason University Antonin Scalia Law School.