OBSERVATIONS FROM THE FINTECH SNARK TANK
Proposed government regulations would change how credit card payments are processed, impacting how much financial institutions can charge merchants for payment transactions.
The Credit Card Competition Act of 2023—nicknamed “Durbin 2.0” after its co-sponsor, Sen. Dick Durbin, who enacted debit card regulations following the passage of the Dodd-Frank Act in 2010—would require every credit card transaction to have two networks—one of them not Visa or Mastercard—enabled to route transactions.
Today, credit card payments are routed through payment networks, with Visa and Mastercard dominating the market. Under the proposed regulation, merchants would have the option to route transactions to other lower-cost networks (lower-cost to the merchants, that is).
Proponents of the bill argue that it will be a boon for Americans because—allegedly—“excessive” credit-card processing fees push up the cost of consumer goods.
Durbin 1.0: Making The Rich Even Richer
Durbin’s first amendment to the Dodd-Frank Act (Durbin 1.0) reduced the amount of interchange fees banks could charge merchants. It was sold to the American people as a benefit to them because merchants were expected to pass along the savings.
But that didn’t happen.
Numerous studies, including some from the Federal Reserve Bank, found that merchants—in particular, Amazon, Target, and Walmart—used the savings from Durbin Amendment to pad their profits, enabling billionaires like Bezos and the Walton family to get even richer.
Consumers, meanwhile, saw their debit card rewards and free checking accounts go down the drain.
What Does Not Kill Me Makes Me Stronger (Or Bigger)
The proposed bill—as described by its sponsors—would increase competition by enabling merchants to select payment networks other than Visa and Mastercard. The real impact, however, would be just the opposite.
The government is creating a game of whack-a-mole: Increased competition in one sector will lead to diminished competition in another. As Todd Zywicki, professor at George Mason University’s Antonin Scalia Law School, recently wrote:
“By artificially pushing down interchange fees on credit cards, the bill would curb an important revenue stream for banks. Larger banks, which have gotten even bigger since Dodd-Frank was enacted, could offset such losses by selling investment advice, mortgages and other products—or by imposing new fees as they did in response to the original Durbin amendment. Small banks lack these revenue streams and would have to raise fees, curtail services or merge, fueling industry consolidation.”
It’s ironic that proposed financial regulations from sponsors who want to see large financial firms broken up will actually make them larger.
Consumers Are Big Losers Under the New Regulations
Consumers are the big losers under the proposed regulations. According to Zywicki:
“Consumers, who already face rising bank fees and reduced rewards from the first Durbin amendment, could see the return of more fees and higher interest rates. Experts warn that Durbin-Vance would put an end to popular frequent-flier and other card reward programs. Pushing the use of lesser-known card networks also might compromise consumer data security.”
The importance of—and the impact of the proposed regulations—on data security and fraud prevention should not be overlooked or minimized.
In a Cornerstone Advisors report titled The True Impact of Interchange Regulation: How Government Price Controls Increase Consumer Costs and Reduce Security, author Glenn Grossman points to studies that show that 79% of consumers choose credit cards as a payment option because of their data security and explains:
“Visa and MasterCard offer consumers zero liability when a transaction on their branded card is processed on their network. The advantages offered when all credit cards come down one pipe is a single view of the transactional fraud landscape. A change to this format would provide a fragmented fraud landscape. The guarantee of zero liability will be questionable because customers will never know if their card brand processed the transaction or it was sent through an alternate network.”
A more fragmented fraud landscape will likely result in increased fraud operating costs for payment networks and issuers as utilizing multiple payment networks will force the detection of fraud to the endpoints of the payment process—merchant acquirers and the issuing bank—adding risk and cost.
Merchants and Retailers Will Be Negatively Impacted
If Durbin 2.0 passes, the negative impacts of regulatory whack-a-mole will be felt not just by consumers and banks, but by merchants—large and small—as well.
A higher rate of declined authorizations due to increased fraud rates will frustrate cardholders and ultimately negatively impact merchant revenue.
In addition, Cornerstone Advisors‘ Glenn Grossman opines that merchants could be negatively impacted as consumers spend less as they lose access to rewards and have to pay more in annual fees as card issuers look to recoup their revenue shortfalls.
The Law of Unintended Consequences
It’s hard to believe that proponents of the new regulations—on both sides of the aisle—can’t see second order effects (i.e., unintended consequences) of the proposed rules:
- Credit crisis. Issuers will need to find revenue replacement and will increase fees and possibly tighten underwriting and credit standards. As margins recede, banks and credit unions offering credit programs wlll tighten credit, reducing the availability of credit to even more Americans.
- Shadow banking. Higher fees could push more Americans outside of the financial system and into higher-cost alternatives such as payday lending and high interest rate loans from non-bank lenders.
- New financial behemoths. In fact, higher fees could push more Americans to obtain more financial services from the mega-retailers like Amazon and Walmart who already offer a range of financial products todays. If Chase and Bank of America are too big to provide financial services, why aren’t Walmart and Amazon?
- Fraud explosion. The requirement to offer multiple payment networks will result in an increase in card-not-present transactions which already have higher rates of fraud than other types of card payments.
- Tax shortfalls. Reduced consumer spend will result in lower sales tax revenues causing state and local government to raise other taxes to compensate for the decline.
Sadly, even before the second-order negative effects hit, the promised first-order benefits—lower prices for consumers—won’t be realized. With rampant “greedflation” and “wageflation” throughout the economy, merchants will have a myriad of reasons why their savings from Durbin 2.0 won’t be passed on.
As George Mason University’s Zywicki said:
“Durbin’s anti-bank and pro-competition rhetoric might have swayed Sen. Vance and other Republicans. But when shoppers choose certain market alternatives over others, that isn’t a failure of competition. The bill would give big banks and big retailers an advantage at the expense of small banks and consumers—and that is anything but pro-competition.”
For a complimentary copy of the Cornerstone Advisors report The True Impact of Interchange Regulation: How Government Price Controls Increase Consumer Costs and Reduce Security, click here.
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