Quick thoughts and speculations on proposed Durbin interchange decrease and (indirect) connection with 1033 rulemaking
Two rules have recently been proposed that, when finalized, will likely take effect relatively near each other. In a vacuum, both rules will cost banks money without means via the implementing rule to offset the cost. I’m discussing the FRB’s proposed revisions to Durbin (Durbin 2.0) and the CFPB’s 1033 rulemaking. This short post is solely about the decrease in interchange, and how its impact may be affected by any 1033 rulemaking;1 in a later post, I’ll address some of my thoughts on the CFPB’s proposed 1033 rulemaking.
TL/DR - If 1033 rulemaking is successful in facilitating consumer account switching, the FRB may be discounting the potential harm to covered financial institutions by decreasing the debit interchange so significantly.
The FRB’s proposed rulemaking seeks to lower the authorized interchange under Durbin from $0.21 per transaction + 5 basis points x value of transaction + $0.01 fraud prevention to $0.144 per transaction + 4 basis points x value of transaction + $0.013 fraud prevention.2 That’s a pretty significant decrease (and yes, I’m exceedingly skeptical retailers will pass the savings onto customers).3 So, how does this decrease relate to the proposed 1033 rulemaking?
First, the easy connection between the two proposed rules is the decreased revenue from Durbin 2.0 for financial institutions whose assets are above $10 billion will occur near in time when 1033 may impose increased costs on all financial institutions.4 Taken together, entities impacted by both rules will face increased costs and decreased revenue. What do entities do when faced with that situation? Cut costs, raise prices, or both.
The FRB acknowledges that consumers will face increased costs and does not believe that increased costs will cause consumers to shift institutions. The FRB stated in response to this concern the following:
Furthermore, the continued growth in debit card popularity since the adoption of Regulation II, and the lack of a pronounced shift by consumers from covered issuers’ to exempt issuers’ debit card programs, suggest that such fee increases and other adjustments to checking accounts and debit card programs offered by covered issuers did not make them substantially less attractive to consumers.
Basically, the FRB is taking the approach that past performance likely equals future performance - “Research suggests that competition between smaller and larger depository institutions is weaker than competition between large depository institutions or competition between small depository institutions, likely because these institutions serve different customer bases.” The CFPB begins its 1033 rulemaking with the following: “When a consumer can switch with less friction, this will create incentives for superior customer service and more favorable terms.”
One of these viewpoints will be wrong. Either financial institutions will lose customers—and fully admit that some financial institutions may be relieved if customers whose costs outstrip their revenue leave—or customers will stay and likely incur higher costs without an increase in services.
Second, the FRB stated the following: per-transaction interchange fees for exempt issuers have remained substantially higher than for covered issuers, with “average per-transaction interchange fees for exempt issuers increas[ing] in 2020 and 2021.” Combining this with increased usage of debit cards, will we see exempt issuers when the 1033 rulemaking takes effect—likely through fintechs—use the supposed ease for account switching to again offer benefits such as rewards for debit card usage? Or some other perks that induce switching? It’s possible that fintechs driving revenue through interchange may see a renaissance. And if the FRB is right—or remains right—that competition is more between similarly sized institutions rather than large versus small, then smaller banks above the $10B threshold may be those that lose the most.
Again, these are some quick thoughts and speculations, after reading both proposed rules so close in time. Further thoughts on 1033 are incoming.
Before I begin, just to be crystal clear - different agencies proposed each rule; while the agencies discussed their respective rules with the other agency, there is no public indication of feedback received, much less whether the areas I identified were part of any discussion.
Note: This article is not an analysis of whether the FRB is right in how it determined to calculate the maximum interchange fee cap. I have not read the underlying materials provided by the FRB that it used to reach its decision, and while my math skills are adequate, they are not sufficient to assess whether the methods the FRB used are appropriate. Instead, I’m challenging some of the bases the FRB relied on in choosing to publish this rule, especially as those bases indirectly relate to the 1033 rulemaking.
Note that a pending lawsuit in front of the Supreme Court may have been an impetus for the FRB to propose this rule; this is just speculation on my part, however. While the Supreme Court is hearing the case based on when a right of action first accrues under the APA to challenge a final rule, the underlying case involves retailers suing the FRB seeking to invalidate the FRB’s standard in Regulation II for setting “a fee that is reasonable and proportional to the cost of a debit-card transaction.” See Corner Post, Inc. v. Board of Governors of the Federal Reserve System.
Proposed 1033 is staggered, so financial institutions between $850M and $50B in assets have about 2.5 years from the effective date to comply (assuming it remains as proposed). It is possible that the FRB will have cut interchange further when such institutions are required to comply with 1033, which may magnify my thoughts for such institutions.