Payments 3.0: The Fed’s Dubious Debit Proposal

The latest round in the fight over interchange fees began Oct. 25. That’s when the Federal Reserve released its latest proposal on debit interchange.

To recap, the Fed’s proposed rule would reduce the interchange that banks with more than $10 billion in assets would receive when their customers pay with a debit card. The current cap—21 cents, plus 5 basis points of the cost of the transaction and a one-cent fraud-prevention adjustment—would drop to a base of 14.4 cents, plus 4 basis points of the cost of the transaction, and a slight increase to 1.3 cents for
fraud prevention.

The proposal also establishes a review of the interchange cap every other year as data comes in from bank surveys on transaction costs. (This is the first time the board has revisited the fee cap since it was first put in place in 2011.)

But the big question is, who benefits? The Durbin Amendment in the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act requires that the Fed set a cap on fees charged by issuers with more than $10 billion in assets, and it mandates that the Fed revisit the cap from time to time. So, while there is a legislative reason to revisit the cap, it’s not clear how the average American benefits.

The National Retail Federation suggested, in a press release published a week before the Fed’s meeting, that shoppers would benefit.

“Debit and credit card swipe fees have doubled over the past decade and totaled $160.7 billion in 2022, according to the Nilson Report,” said the release. “The fees are among most merchants’ highest operating costs and drive up prices paid by consumers by more than $1,000 a year for the average family. Debit card swipe fees account for $34.4 billion of the total.”

But, large-issuer debit interchange has been capped for more than a decade, so it is not likely that debit fees drove that increase. And, while debit cards are popular, the Federal Reserve Bank of San Francisco’s 2023 “Findings from the Diary of Consumer Payment Choice” found they made up only 29% of all payments.

So, it is not clear that debit interchange caps will save the average shopper any money. When the Fed Governors asked the staff about changes to consumer prices, they responded that research shows merchants pass card-processing costs onto shoppers, but it isn’t clear that caps reduce prices.

“Empirically, I think the question of merchant-cost pass-through is one of those that is well-recognized to be very difficult. Partly because prices are well-known to be sticky, especially when the underlying cost changes are relatively small,” said Kriss Wozniak, section chief of the Payment System Studies Section at the Federal Reserve.

In a speech at the 2023 Ohio Bankers League “Main Event,” Fed Governor, Michelle Bowman—who asked the question about the benefits to consumers—expressed skepticism about the proposal. She noted interchange fees help banks offer low-cost and no-cost products to customers.

“If finalized as proposed, this revision may force banks to discontinue their lowest-margin products, including options designed to increase financial inclusion and access for [low or moderate-income] individuals and families,” she said.

The Federal Reserve says on its Web site that it exists “to promote the effective operation of the U.S. economy and, more generally, the public interest.”

If prices are sticky, merchants’ bottom lines will increase, but household bottom lines will stay the same. Low- and moderate-income people could end up with fewer payment options. It’s not clear, then, how this proposal promotes effective economic operation or the public interest.

—Ben Jackson bjackson@ipa.org