Interchange Fee Regulation in the US: A Case Study

Interchange fees are transaction costs merchants pay to banks for customers to pay for goods and services via card payments. Many merchants insist that lower interchange fees will reduce their overall costs and benefit customers, calling for regulation. Regulating interchange fees however, causes massive distortions in the payments system and does not lead to lower overall fees for merchant nor does it benefit customers. An in depth look at regulation implemented in the United States shows why.

The RBA says retailers and customers benefit from interchange fee regulation. Retailers have lower transaction costs which will lead to lower prices for customers, they argue. Although this may work in theory, the question is how this will happen in practice. Let’s take a look at the United States where interchange fees have become highly regulated since 2011.

The Durbin Amendment was the Federal Reserve’s response to growing complaints from merchants that interchange fees were too high. It prohibited large issuers worth over $10 billion in assets from charging more than:

-          The base fee

-          Potential fraud loss

-          Fraud prevention costs

While small issuers could charge as much they like, large issuers could no longer:

-          rely on interchange fees for a substantial portion of their revenue

-          charge according to diverse needs and requirements across the retail sector

 

So how did this regulation impact the American retails payments system?

 

  1. Merchants saw almost no reduction in transaction costs
  • Small issuers, responsible for 36% of all transaction costs, faced much less competition than previously. They charged the same, if not higher interchange fees than before
  • Large issuers, responsible for 64% of all transaction costs, removed all discounts on minor transactions. This meant small everyday transactions, which make up the majority of the retail sector, became more expensive than before

Verdict: Regulation of interchange fees meant that over 90% of merchants reported higher interchange fees than before

  1. Customers saw no reduction in prices
  • 90% of merchants paying higher transaction costs raised their prices accordingly
  • The 10% of merchants paying lower transaction costs did not lower their prices as a result

Verdict: Interchange fee regulation did not result in any price reduction for consumers

Regulating interchange fees in Australia will result in the same failures in the United States. Every exemption reduces interchange fee competition resulting in higher interchange fees than before. Every cap enforced on issuers results in the removal of previous discounts and lower prices elsewhere. Merchants do not have an incentive to lower their prices in the few cases where transaction costs are lower.

Interchange fee regulation is bad policy, and we should learn from the mistakes from overseas instead of repeating them.