As the issue of wealth inequality has surged to the forefront of the American political debate one rising area of interest is the large and growing number of Americans who are unbanked or underbanked, lacking access to mainstream financial services. According to a 2011 survey by the FDIC, some 10 million households are unbanked and increase of almost one million Americans from 2009) and over 20 percent of households are underbanked, meaning that they occasionally use alternative financial services providers, such as payday lenders or check cashers. Although precise figures are hard to come by, the number of unbanked may have increased still further since then, even as the banking system has stabilized and the economy has grudgingly recovered.
Why have so many Americans lost access to mainstream financial services in recent years? Surely, lingering effects of the financial crisis and perhaps the ongoing consolidation of the banking industry (spurred by Dodd-Frank’s regulatory onslaught) have played a role. But the bulk of the blame belongs to the unintended consequences of an often-ignored provision smuggled into Dodd-Frank’s last minute special interest feeding frenzy: the so-called “Durbin Amendment” to Dodd-Frank (after its primary sponsor, Illinois Senator Dick Durbin), which imposed price controls on the interchange fee (a portion of the merchant discount fee paid by the retailer when you use your card at the store) charged for debit cards issued by large banks (over $10 billion in assets).
Implementing the legislative mandate to set price controls at a rate “reasonable and proportional” the incremental cost of processing debit card payments (legislative language that the United States Court of Appeals for the DC Circuit described as “its language is confusing and its structure convoluted”), a subsequent rule-making by the Federal Reserve that went into effect on October 1, 2011, slashed the average interchange fee for debit cards issued by regulated banks more than half, from 44 cents to about 24 cents on the average-sized transaction of about $40.
What has been the Durbin Amendment’s effects? Two-and-a-half years after the Durbin Amendment’s implementation the evidence is in: According to a new study we authored for the International Center for Law and Economics, we found that consumers are paying more and getting less as a result of the Durbin Amendment, and that low-income consumers have suffered the most. Moreover, while big box retailers have seen billions in savings in lower interchange fees already, there is no evidence that they have passed-through any of their windfall to consumers, nor have small businesses benefited.
Bank consumers have borne the brunt of the Durbin Amendment, especially low-income consumers. Running a secure, instantaneous, globally-connected payment card system takes money and forcibly reducing the freight paid by merchants by an estimated $6.6 to $8.5 billion per year didn’t magically make the costs of the payment card system disappear. Instead, it simply transferred those costs to card issuers and, in turned, forced banks to reallocate those costs onto their customers. According to annual surveys by Bankrate.com, the percentage of bank accounts eligible for free checking plummeted from 76% in 2009 to 38% last year. The minimum average balance necessary to quality for free checking has doubled during that same period as has the monthly maintenance fees required for those who fail to meet the steeper eligibility requirements for free checking.
Moreover, because smaller banks were exempted from the regulation, they can provide a control group to isolate the effects of the Durbin Amendment from other factors that might explain these developments, such as lingering effects of the financial crisis and recession. According to a study by economist Richard J. Sullivan of the Kansas City Federal Reserve Bank, while access to free checking plunged at banks subjected to the Durbin Amendment, free checking actually increased at smaller banks below the $10 billion threshold. But since Sullivan also found that this growth in free checking at small banks predominantly occurred in higher-income neighborhoods, it offers little solace to poorer consumers. Moreover, to offset the loss of billions of dollars of lost interchange revenue, banks have also reduced costs (and value) by terminating debit card rewards programs and made other cost-cutting adjustments that reduced customer service, such as closing bank branches.
As debit cards have become more expensive and less-attractive, consumers have predictably switched to alternatives, notably credit cards and prepaid cards. Debit card usage flat-lined in the period following the effective date of the Durbin Amendment, arresting the double-digit annual growth rates of the previous decade. Meanwhile, credit card usage, which had actually declined in the wake of the financial crisis, has grown more rapidly than debit card use since the implementation of the Durbin Amendment. Even more revealing, while credit card usage is up, revolving balances on credit cards are down, indicating that a growing number of consumers are using credit cards as a substitute for debit cards. Meanwhile, newly unbanked consumers increasingly have turned to prepaid cards to meet their needs formerly met by (now unavailable) debit cards.
And what have Wal-Mart, Amazon, and ExxonMobil done with their windfall? Pocketed it. While retailers have saved billions of dollars a year in lower interchange fees, there is no evidence that consumers have seen lower prices at the pump or checkout counter. In an ironic twist, some megaretailers such as Redbox, 7-Eleven, and McDonald’s are actually paying more, as card networks have recouped costs by eliminating the rates discounts that they formerly provided to high-volume, small-ticket sellers. Small businesses have not seen any fee reduction, partly because the rates they pay are calculated differently from large merchants and partly because they lack the bargaining leverage of larger merchants to force lower fees. In turn, this absence of savings to smaller merchants has dampened competitive pressures on big box retailers to pass-through their savings to consumers. In fact, we estimate that because banks pass-through their increased costs to consumer faster and more completely than retailers do their cost savings, lower-income households will transfer roughly $1 to $3 billion per year to large retailers as a result of the Durbin Amendment.
Higher bank fees and lower quality for consumers and no savings to small businesses, all in return for empty promises of lower prices at the pump or check-out counter from big box retailers. And while wealthier consumers have largely avoided the pain of Senator Durbin’s price controls, low income consumers have once again borne the brunt. Want to increase access to mainstream financial services? Repeal the regulatory barriers that undermine the incentive of banks to offer financial services.
Todd Zywicki is GMU Foundation Professor of Law at George Mason University School of Law and a Senior Scholar of the International Center for Law and Economics.
Geoff Manne is Executive Director for the International Center for Law and Economics.
Julian Morris is Vice President of Research at Reason Foundation and Visiting Professor in the Department of International Studies at the University of Buckingham.
The referenced study is available for download at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2446080. ICLE, which funded this work, has received financial support from MasterCard.
