December 8, 2023

Economix: Small Banks and Debit-Card Reform

Today's Economist

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

It’s not hard to understand why large banks oppose any attempt to overhaul the financial arrangements currently surrounding credit cards and debit cards. In the duopoly run through Visa and MasterCard, big banks earn fees that far exceed their costs.

The excess profit for debit cards would be substantially reduced by a proposed Federal Reserve regulation now on the table that would implement the Durbin Amendment from the Dodd-Frank 2010 financial reform act. That amendment, sponsored by Senator Dick Durbin, a Democrat from Illinois, required the Fed to place a cap on the fees that banks may charge on debit-card transactions.

Senator Jon Tester, a Democrat from Montana, has proposed legislation that would delay and effectively derail implementation of the Durbin Amendment, and the big banks are very much in his camp.

Senator Dick Durban, Democrat of Illionois, has proposed that the Federal Reserve require banks to lower debit-card fees to a level closer to the actual cost of transactions. Philip Scott Andrews/The New York TimesSenator Dick Durban, a Democrat from Illinois, has proposed that the Federal Reserve require banks to lower debit-card fees to a level closer to the actual cost of transactions. 

It’s much harder to understand why Independent Community Bankers of America, the trade group for small banks, is pushing so hard for the Tester bill (and effectively shielding big banks from political pressure), because community banks are explicitly exempted from having to lower their fees, and individual executives from at least some small banks publicly support the Durbin Amendment (see, for example, Senator Durbin’s letter to the I.C.B.A. last year).

The most plausible explanation is that I.C.B.A. is one of the country’s largest issuers of credit cards and debit cards — so the representatives from small banks actually have, in this regard, the incentives of a big bank. Although all of its members may be exempt from the debit-card fee provision, the association perhaps is not. To an outsider, this looks like a serious conflict of interest that is undermining the interests of community bankers and distorting the political process.

The I.C.B.A. needs to provide the details of this potential conflict in a transparent manner, including how much money the organization makes from its card business. It also needs to publish the full details of a “survey” that it uses to claim that most community bankers are against the Durbin Amendment. And it probably should also step back from its involvement in the Durbin-Tester debate.

The open secret of the American financial system is that while you and your friends might like to rail against banks over dinner, when the time comes to pay (at the grocery store or in the restaurant), you are likely to offer the merchant some form of plastic card.

While this transaction may seem free to you, the merchant is charged a fee by the bank that issued the card — administered through a card network run by Visa or MasterCard (or American Express or Discover). Specifically, the merchant’s bank (known as the “acquirer”) has to pay “interchange fees” to the card-issuing bank.

For debit cards, which draw directly from your checking account, these fees averaged 44 cents for each transaction in 2009 (which was 1.14 percent of the relevant average retail transaction, according to the Fed, adding up to $15.7 billion economy-wide).

The actual cost of these operations varies, mostly depending on economies of scale in the bank’s processing operation (which is why the Durbin exemption for small banks makes sense). But over our current systems, the cost is very low; on average it is 4 cents for a transaction, according to the Fed. (For the most detailed publicly available study on the effect of lower interchange fees, look at this report on what happened in the Australian debit-card payment system.)

The Durbin Amendment charged the Federal Reserve with lowering the debit-card fees to a reasonable level that will cover costs, and the Fed is proposing to set this rate at not more than 12 cents for a transaction. But this rate would apply only to larger banks. By design, the Durbin Amendment does not apply to banks with less than $10 billion in total assets, and the Fed has confirmed that this exemption can be implemented (see this statement by Ben S. Bernanke, the chairman of the Fed).

Global megabanks are now regarded as “too big to fail” by policy makers, and these companies benefit from huge implicit government guarantees. When you talk with community bankers, they understand and are seriously upset by this arrangement.

But the lobbyists for these community bankers have been unwilling or unable to take on the big banks in any part of the political arena. The Durbin Amendment is a determined attempt to give the small banks an advantage. But the I.C.B.A. is not interested.

It argues that the “carve out” for small banks will not work — through moves by merchants and the card networks, these banks will be squeezed out of the payments system. This is not the view of the Federal Reserve staff, which has studied this closely.

And Senator Durbin is firm on this:

My amendment does not allow discrimination by merchants against issuers of debit cards. As is the case today, under my amendment a merchant who accepts Visa debit cards from large banks would be required to accept Visa debit cards from small banks and credit unions as well. They would also be prohibited from offering discounts for large bank cards and not providing the same discount for small bank cards from the same network.

Perhaps there are legitimate reasons for the I.C.B.A.’s views, but it is also the case that the I.C.B.A. Bancard is a significant player. This is ironic, because the card’s stated purpose is admirable — to help small banks compete:

Today, I.C.B.A. Bancard also serves as an advocate for independent community banks in national policy discussions about payment systems. Part of our mission is to educate community banks about the need to actively offer payment services in order to retain their best customers, earn profitable returns, and be respected as full-fledged participants in the marketplace.

By some rankings, the I.C.B.A. Bancard is among the top 25 debit cards and credit cards in the country.

The I.C.B.A’s main justification for its position is a “survey” of independent community bankers that shows they are opposed to the Durbin Amendment — that is, lowering the debit fees of banks with which they compete. This result is odd, particularly given that a simple online poll by American Banker showed that 60 percent of its readers thought that small banks would gain from the amendment — and this result came after the I.C.B.A. tweeted that it wanted votes against the Durbin plan.

The I.C.B.A.’s Web site does not disclose details of who was surveyed or by whom, or what questions were asked. Its staff members were friendly but confirmed to me that they would not disclose these details. (My impression is that the survey asked banks how they would respond if their debit interchange fees were greatly reduced — not whether the Durbin Amendment would actually reduce these fees).

It’s time for the I.C.B.A. to disclose those details. Is this a real survey or another instance of lobbying posing as research? The I.C.B.A. should share this information both with its membership and with the public.

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