'Wakeup Call' on Debit Swipe Fees

Richmond Fed study reveals effect of interchange reforms on merchants

Federal Reserve Bank of Richmond

WASHINGTON -- A new study by the Richmond Federal Reserve shows the Fed made mistakes when it tried to implement reforms to make the market for debit-card interchange fees competitive.

The Richmond Fed’s new Economic Quarterly features a report on a survey of merchants to learn about the impact of a regulation on debit-card swipe fees that was part of the Durbin Amendment to the Dodd-Frank Act.

Based on a survey conducted two years after the regulation went into effect in 2011, Richmond Fed economist Zhu Wang and his co-authors Scarlett Schwartz and Neil Mitchell investigated the impact of the regulation on the costs to merchants of accepting debit cards. They also examined merchant reactions to the regulation in terms of changing prices and debit-card restrictions.

The survey results suggested that the regulation has had limited and unequal impact on merchants' debit-acceptance costs.

The Durbin Amendment directs the Fed to regulate debit-card swipe fees so that they are "reasonable and proportional to the cost incurred by the issuer with respect to the transaction." The Debit Card Interchange Fees & Routing regulation took effect on Oct. 1, 2011.

The regulation establishes a cap on the debit interchange fees that financial institutions with more than $10 billion in assets can charge to merchants through merchant acquirers. The permissible fees were set based on an evaluation of issuer's costs associated with debit-card processing, clearance and settlement. The resulting interchange cap included a base fee of 21 cents per transaction to cover the issuer's processing costs, a 0.05% charge of the transaction value to cover potential fraud losses, and an additional one cent per transaction to cover fraud prevention costs if the issuer is eligible. This cap applies to both signature and PIN debit cards.

Most of the merchants in the survey sample (about two-thirds) reported no change or did not know the change of debit costs post-regulation. Some merchants (about a quarter) reported an increase of debit costs, especially for small-ticket transactions. The remaining less than 10% of merchants reported a decrease of debit costs.

The impact varies substantially across different merchant sectors, the report said.

"We also find asymmetric merchant reactions in terms of changing prices and debit restrictions," the authors said. "A sizable fraction of merchants are found to raise prices or debit restrictions as their costs of accepting debit cards increase; however, few merchants are found to reduce prices or debit restrictions as debit costs decrease."

The preliminary study showed that 90% of merchants had not seen any savings, did not know whether the reforms affected their costs or saw their costs rise--the opposite effect Congress envisioned when it passed debit reform five years ago, the Merchants Payments Coalition (MPC) said in an analysis of the Richmond Fed survey.

“The Richmond Fed report should be a wakeup call for the Federal Reserve,” said Lyle Beckwith, senior vice president of government relations for the National Association of Convenience Stores (NACS), a member of the MPC. “Ninety percent of merchants having their fees stay the same or go up makes no sense when Congress recognized that the price-fixed fees were too high already.”

Under the Durbin Amendment to the Dodd-Frank financial reform bill, Congress required the Fed to impose rules to make this market more competitive and exorbitant fees more reasonable.

But according to the MPC, the Fed bowed to heavy pressure from the big banks and introduced only half-measures. For instance, it doubled its own original estimate of a fair fee on a debit transaction. For some small transactions, the fees went up, too.

According to figures the banks themselves report to the Fed, they still earn a 500% profit on these fees, which they charge merchants every time a customer swipes a debit card to pay for something, said the MPC.

These fees--set by MasterCard and Visa for their member banks so the banks don’t have to compete--raise prices for consumers, hurt small retailers and slow the entire economy, MPC said.

Concluded MPC: "The Fed’s rules have failed to create the result Congress intended: A fair, competitive market that looks like the rest of the free-market system."

Click here to view the complete Richmond Fed study, including merchant sector analysis.