Who Bears The Costs? The Challenges To Durbin’s Credit Card Bill

September 20, 2022
Since US Senator Richard Durbin introduced the Credit Card Competition Act in August, banks, credit unions and other market players have reacted against the proposed legislation. VIXIO takes a look at some of the issues driving the debate.

Since US Senator Richard Durbin introduced the Credit Card Competition Act in August, banks, credit unions and other market players have reacted against the proposed legislation. VIXIO takes a look at some of the issues driving the debate.

The Credit Card Competition Act, which largely mirrors US debit card legislation also authored by Durbin, requires that the largest credit card issuers allow merchants to choose from at least two unaffiliated networks when they process a credit card transaction.

The bill does not establish an interchange cap but it is believed that by opening up competition in credit card transaction routing, the costs to merchants, and eventually to that of consumers, would decrease.

Banks and credit unions, the beneficiaries of those fees, have unsurprisingly rallied to oppose the bill, arguing that it could harm consumers and would only favour the country’s largest retailers.

Consumers could lose out

Banks justify the level of the interchange fees by the fact that they are, in part, used to offer consumers rewards and loyalty programmes that encourage them to spend at merchants.

According to Forbes, on average 60 percent of the interchange gets back to the consumers this way. Considering that merchants were estimated to pay $105.23bn in total fees for credit card transactions in 2021, this suggests around $60bn could be used to promote consumer spending via rewards.

A drop in interchange revenue could consequently have a negative impact on these rewards, some critics speculate.

Recently, Vasant Prabhu, vice chairman and CFO of Visa, argued that “[t]he biggest loser here potentially is the consumer because presumably the only reason this is being done is to reduce interchange. And if that's the case then consumer loyalty programmes will most likely go away.”

But even if banks continue to offer rewards, the Durbin bill would take away the ability from the consumer to choose the processing network, which again could have a negative impact on their loyalty points.

“[I]f you have two networks and let's say you have a United miles card with Visa and the merchant chooses another network on that card, do you lose your rewards?” Prabhu posed the question.

Nonetheless, merchants, who would be the direct beneficiaries of the credit card legislation, argue that the potential interchange revenue loss, resulting from better competition, would not necessitate the elimination of rewards.

“The banking industry consistently has the highest profit margins of any industry in the United States — more than 32.5 percent,” Doug Kantor, executive committee member of the Merchants Payments Coalition (MPC), told VIXIO.

“Yet retailers and others routinely offer generous rewards programmes to their loyal customers to bring in more business — and operate with profit margins around 2.5 percent. If this comment were at all accurate, no business in the nation other than a bank would have loyalty rewards,” he stressed.

“If credit card-issuing banks want customers to be loyal, they will continue to offer rewards.”

It should also be noted that rewards are returned only to credit card users, who are typically higher-income consumers, according to Josh Pynn, insights consultant at CMSPI. Merchants, on the other hand, charge everyone higher prices, regardless of their payment method, due to high card fees.

“Rewards, therefore, are largely subsidised by working-class Americans,” Pynn pointed out.

According to MPC estimates, swipe fees drove up consumer prices by about $900 for the average household last year.

“The relevant consideration is: would the amount consumers miss out on via lower rewards exceed the amount consumers would benefit from lower pricing? Our analysis suggests the answer to this question is a resounding no,” Pynn said.

As previous experience shows, such regulation may also prompt banks to introduce new products that may benefit consumers in a different way even if rewards cease or reduce significantly.

This was the case in Australia, which regulated interchange fees back in 2003. Shortly after the regulatory intervention, several banks switched their focus from rewards-based cards to low-interest no-frills products.

Despite the absence of rewards, credit cards continued to show strong growth in the years that followed, before slowing down during the financial crisis.

Devil's in the detail

Critics of the bill have also raised concerns that there are a lot of unknowns about the specifics that could affect the feasibility of the proposed measures.

For example, although debit cards always had multiple networks, even before Durbin’s debit card legislation, credit cards never had that, according to the Visa CFO.

“[T]he entire infrastructure in credit is set up for a single network, you've got a massive amount of work to be done to figure out how you set up the credit infrastructure for multiple networks all the way from what happens at the point of sale to what happens to your card,” Prabhu said.

Although Prabhu raised that this process would probably involve a massive reissuance of cards, it is unlikely to have a significant negative impact on credit card users.

According to Kantor, routing happens as a back-office process with the banks sharing information regarding the enabled networks with processors. There will also be some software changes to the acquiring infrastructure, but these will be relatively minor, he added.

Even if the law would require changes to the existing infrastructure, there are things that can be done to minimise any one-off costs, for example, through flexible reissuance of cards, Pynn pointed out.

“There will likely be some stakeholder investment required to enable credit card routing, but we think this will be insignificant compared to the huge net societal benefit of the proposed legislation,” Pynn added.

Conflict of interest

Banks and credit unions have consistently opposed any changes to curb card fees or open up routing for competition.

Even before the credit card bill, the Credit Union National Association wrote to Congress that the Durbin Amendment, which introduced debit card regulations in 2010, is the “purest example” of failed government policy.

They argued that the result of the Durbin Amendment “has been additional compliance burdens and related business costs to credit unions and banks, a reduction in interchange revenue from debit card transactions and a massive transfer of money to the largest retailers”.

Banks and credit unions claim that despite the proposed legislation’s intention, merchants tend to pass on to consumers the interchange costs but they often keep for themselves any savings when those fees are reduced.

For example, as a result of a legal settlement in 2013, US merchants cannot surcharge credit card transactions more than what their own card processing costs are for that specific transaction.

In addition, ten US states, including California, New York, Florida and Texas, explicitly ban any surcharges on credit cards.

Banks also argue that the proposed law favours large retailers only because, unlike smaller shops, they have the market power to negotiate better prices with the card processor.

For instance, Forbes pointed out that Amazon could save a large sum on passing the bill.

Last year, the e-commerce giant had $340bn in sales, with around two-thirds of it being conducted via credit cards, roughly amounting to $225bn. Even if Amazon paid a low 1 percent credit card fee, it meant that the bigtech firm paid $2.2bn in fees.

Cutting these fees as a result of the legislative reform could save Amazon at least $1bn in extra revenue, according to Forbes.

Nonetheless, the fact that large retailers have a lot to gain from the proposed legislation does not necessarily mean that small businesses could not benefit from it.

Last week, more than 200 merchant trade associations and close to 1,700 businesses signed letters urging Congress to pass the bill. Signatories included Main Street small businesses and national chains alike.

“As members of the retail community and champions of the free market we typically do not support government intervention except in cases where a market is not functioning. That is the case with the credit card marketplace in the United States,” the merchants’ letter said.

Meanwhile, in a separate letter, the trade associations emphasised: “While this legislation would benefit all merchants, it is small retailers who are calling for swipe fee reform more than any segment of our industry. Small retailers have the narrowest profit margins and fewest resources and are hit hardest by continuing unjustified increases in swipe fees.”

Following the letters, on September 19, Representatives Peter Welch (D-VT), and Lance Gooden (R-TX) introduced a companion bill in the House. Both bills have been filed with bipartisan support and merchants believe the introduction in the House shows the bill is rapidly gaining momentum in Congress.

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