Why Interchange Reform Is Necessary
Last year, Congress passed landmark legislation to reform the interchange fee system in America. This bipartisan effort came after years of congressional hearings and Government Accountability Office studies that made clear that the interchange system was on an unsustainable course. While I know that many in the financial services industry have vigorously opposed this reform, I want to explain why a bipartisan majority of Congress supported this reform and what it will mean for credit unions.
Debit and credit cards are rapidly replacing cash and checks in today’s economy. Over half of all retail sales in America are now made with plastic, and that percentage is growing. There are benefits that come from the increasing use of these cards, but there are also concerns that can no longer be ignored.
Visa and MasterCard are the dominant players in the card industry, and their cards are used in about 80% of debit and credit transactions. Every time a sale is made with one of their cards, these card network companies take a cut out of the transaction amount. Some of this cut they keep, but most of it is routed along to the bank or credit union that issued the card as an interchange fee. Tens of billions of dollars are collected in interchange fees each year from those who accept cards, including large and small businesses, charities and government agencies.
There is nothing wrong with fees that are transparent and set in a competitive market environment. But that is not the case with interchange fees. Interchange rates are centrally fixed by the dominant card networks across all issuers in their network. Each bank or credit union that issues Visa debit cards receives exactly the same network-established fee no matter how efficiently or inefficiently that issuer processes transactions or prevents fraud.
Unregulated network price-fixing in the current interchange system has proved lucrative for issuers, who receive high fees that are not tempered by competitive market forces. It also benefits card networks, because they are paid each time a card is swiped and high interchange means issuers will issue more cards. But the system is unfair to consumers, who pay tens of billions per year in fees passed on to them in the form of higher retail prices. And it is unfair to merchants, who cannot negotiate interchange fees and who can no longer refuse to accept the dominant card networks.
Many have argued that interchange fees should be prohibited on debit transactions as they are on checking transactions. Congress did not go that far, instead conceding that a network should be allowed to set an interchange rate that uniformly compensates issuers for the reasonable and proportional costs necessary to authorize, clear and settle a debit transaction over that network’s wires. But Congress agreed that issuers should be incentivized to manage other costs of operating a debit card system efficiently. That is what the new law will do by placing reasonable constraints on network price-fixing.
In crafting this necessary reform of the interchange system, Congress took careful steps to protect the ability of small banks and credit unions to compete in the debit card market. We exempted all financial institutions with assets under $10 billion dollars from fee regulation. That means that only the largest 100 or so banks–and only three credit unions–will be regulated under this law.
Neutral analysts agree that the law’s small issuer exemption will give those issuers competitive advantages over their regulated competitors, because networks will continue to compete for the business of unregulated small issuers by keeping their interchange rates high. Some have argued that merchants will discriminate against small issuer cards if they carry higher interchange fees, but the reality is that merchants have long been able to discriminate against higher fee cards like rewards or corporate cards yet they have not done so. Existing contractual penalties and lost sales provide a significant deterrent against such discrimination, and nothing in the new law will change that reality.
Given the enormous amount of money involved in the interchange system, it is not surprising that reform has prompted much discussion. I am happy to continue discussing this issue with all stakeholders, including the credit unions whose interests I have worked hard to protect throughout this necessary reform effort.
Sen. Dick Durbin, a Democrat, is the senior senator from Illinois.
Contact 202-224-2152 or durbin.senate.gov