Nearly 15 years ago, Congress and the Federal Reserve capped the fees that merchants pay to processors and debit-card-issuing banks when customers use debit cards for their purchases. This regulation of “interchange fees” is now back in the spotlight. Two federal appellate courts have issued conflicting rulings on whether the Fed exceeded its authority, so the Fed, Congress and the Supreme Court may have to revisit the issue. As they do, they should carefully consider the extensive studies that establish the promised consumer benefits did not materialize.
The U.S. economy runs on electronic payments, mainly debit and credit cards. In 2022, Americans used debit cards 98 billion times for payments totaling $4.3 trillion and credit cards 55 billion times for transactions totaling $5.4 trillion. Each time, merchants pay a fee that ultimately goes to the networks processing the transactions and the banks that issue the cards.
Under an amendment to the 2010 Dodd-Frank law by Sen. Richard Durbin, D-Ill., the Federal Reserve issued Regulation II, a formula to cap the interchange fee for every debit card transaction. Durbin and the Fed expected the cap would meaningfully lower merchants’ costs and that merchants would pass their savings along in lower prices for their customers.
My new research for the Progressive Policy Institute documents that it hasn’t worked out that way at all. The formula for the cap ultimately increased merchants’ costs for small transactions. The regulation also didn’t cover cards issued by smaller banks. And because the regulation didn’t cap fees for credit card transactions, the covered banks offered new rewards and other inducements to use their credit cards instead of debit cards and also raised fees for their debit-card account holders.
In 2012, the first year Regulation II was in effect, credit cards accounted for 30% of electronic payments by value, and debit cards accounted for 36%. By 2024, the share of credit cards had increased to 49%, while the share of debit cards had fallen to 33%. In an age of electronic payments, the share paid by cash plummeted from 16% to 6%.
My analysis found that in 2022, the cap saved merchants $37 billion in debit transaction costs. But the shift from debit cards and cash to credit cards, with unregulated fees, cost merchants $25 billion. Moreover, studies have found “little” or “negligible” evidence of any consumer benefits from any net cost savings and that 99% of retailers did not pass along any savings.
And the lion’s share of those net savings went not to neighborhood merchants but to large corporations. Retailers with more than $100 million in annual revenue account for 72% of all retail revenues, and 54% of revenues go to retailers with more than $2.5 billion in sales.
Beyond those direct effects, numerous analyses have found that card-issuing banks moved to offset their reduced revenues from debit card interchange fees, raising costs for millions of people. Federal Reserve economists reported that banks covered by the regulation reduced customers’ access to free accounts by 42% and increased minimum balance requirements by 30%. Academic economists similarly found that among covered banks, the share of free checking accounts fell from 58% to 28%; average monthly fees for checking accounts rose from $4.30 to $6.65, or 55%; and monthly minimum balances to avoid those fees rose from $1,049 to $1,339, or 33%. By one calculation, these measures offset 42% of banks’ foregone revenues from the cap.
The burden of these changes also falls disproportionately on low- and moderate-income Americans, who are least likely to qualify for credit cards and most reliant on debit cards. The higher fees affected 70% of account holders in the lowest income quartile, and 81% of unbanked households cite high bank fees as a reason for not maintaining a bank account.
It has been 14 years since Congress and the Fed imposed the cap. Yet instead of reassessing its impact, some policymakers are considering additional measures, such as the Credit Card Competition Act, to impose new regulations on credit card interchange transactions. Our experience with Regulation II should teach us that the results will likely be equally disappointing and risk harming American consumers by limiting access to credit, raising costs and diminishing the value people derive from credit cards.
The Durbin amendment was well-intentioned, but it simply didn’t work as expected. In the coming months, as Regulation II works its way through the courts and may require regulatory or legislative changes, policymakers should heed the reality of what has happened under its regulatory regime.