Payments Intelligence Extract : The Durbin Amendment – it’s time for a regulatory reform10th March 2017
The election of Donald Trump as the 45th President of the United States has raised concerns among the merchant community that the Durbin amendment may be repealed. Here, we look at the performance of the Durbin amendment and the changes that need to be made to make it successful. The Durbin amendment was introduced in 2011 as part of the Dodd-Frank Wall Street Reform Act, with the core aim of protecting merchants against excessive interchange fees.
Calls to scrap the Durbin amendment, part of wider plans to remove some or all of the Dodd-Frank Act, have long circulated around the US payments space but have attracted only minority support. However, November’s US election result has significantly heightened this lobbying, as President Trump is believed to be a supporter of plans to withdraw Dodd-Frank. Meanwhile, retail associations such as NACS (National Association of Convenience Stores) have appealed to the government to retain Durbin amendment.
What has happened?
In June 2016, Congressman Randy Neugebauer (R-TX) ans House Financial Services Chairman Jeb Hensarling (R-TX), presented a bill called the Financial CHOICE Act to Congress that proposed changes to the Dodd-Frank, including plans to repeal the Durbin amendment. They believe that merchants have made substantial savings under the amendment, at the expense of consumers.
On September 13th 2016, the bill was approved by a House committee, by a vote of 30 to 26, with all but one Republican representative in favor of the bill. The next stage for the bill will be to move to debate within the House itself, and then to the Senate, the outcome of which is unclear.
Myth 1: Advocates of repealing Durbin argue that merchants have saved $36 billion in the five years since the regulation came into force, with no tangible evidence that these savings have been passed on to consumers. However, these figures ignore the $3-billion-plus annual increases in network fees and processor absorption of the savings. CMSpi estimates suggest that the net savings to merchants are less than half of the claimed $36 billion.
Myth 2: Many commentators have also argued that Durbin has benefited larger merchants at the expense of smaller merchants. However, this is not true; the Durbin amendment has in fact been detrimental to merchants with small average transaction values, rather than small merchants in general.
What are the issues with Durbin?
Six years after the Durbin amendment was introduced as a way to put an end to excessive debit card swipe fees, it is clear that the regulation has created little net gain for merchants, as acknowledged by the Federal Reserve:
“…the so-called Durbin Amendment of the Dodd-Frank Act aimed to lower merchants’ costs of accepting debit cards by capping debit interchange fees. New survey results suggest that the regulation has had limited and unequal effects on merchants.” […] “While issuers have lost billions in revenue, the costs of accepting debit cards have not gone down for many merchants in the survey; and for some merchants, the costs have even increased.”
Key issues with Durbin are:
1. Caps are too high – Despite the introduction of a cap and regulation, the debit card interchange fees seen in the US are far higher than in other major countries. Recent Federal Reserve data suggests that the fees are far in excess of underlying costs. It seems highly illogical that a country with the largest number of payment transactions, also has the highest fees.
2. Exemptions – The regulation did not include credit cards like in other jurisdictions where regulation of the card market has taken place, including Europe.
3. Processor absorption – With the introduction of the Durbin amendment, the processors began to absorb some of the prospective savings to merchants particularly small to medium enterprises who were on bundled pricing structures.
4. Loopholes – The rules did not prevent replacement network fees. This enabled Visa to introduce the FANF, which Visa has used to mitigate against the effects of the ‘no network exclusivity clause.
Beneficiaries of Durbin
While the Durbin amendment’s aim was to protect merchants by reducing excessive fees, the main beneficiaries of the Durbin regulation have actually been Visa and MasterCard.
Visa and MasterCard transitioned from not-for-profit entities, protecting the interest of their member banks, to listed companies that are among the largest companies in the world. This change in incentive has enabled the networks to capitalize on the aforementioned shortcomings of the Durbin amendment, as they have been able to benefit from rules deisgned to protect merchants.
Indeed, since Durbin was introduced in October 2011, Visa and MasterCard have seen profits increase year on year – mainly due to a business model that mixes high revenue growth with a largely fixed cost-base (see Fig. 1). In 2015, Visa recorded an operating profit margin of over 65%, while MasterCard was not far behind with 52.5%.
While issuers have had their revenues cut as part of the Durbin amendment, the caps do not apply to income received by the card networks. This regulatory oversight has meant that, over time, the two major card networks have managed to maintain their dominance over the debit despite a ‘no-network exclusivity’ clause which meant that Visa’s Interlink network initially lost a sizeable share of the PIN debit market.
While the ‘no-network-exclusivity’ clause within the Durbin amendment was created to increase competition between card networks, both Visa and MasterCard – and Visa in particular – have found ways to mitigate its impact. For example, 14 new or amended network fees were introduced after Durbin was brought in, including Visa’s FANF. In total, these new and amended fees have led to an increase for merchants of over $3 billion annually over the last five years, with little realistic prospect of them being withdrawn without regulatory intervention. The impact of this can be seen in Fig. 2, where an estimated $11.4 billion of annual savings for merchants was reduced to $6.1 billion as a result of the higher than expected caps and processor absorption, and is now just $3.1 billion as a result of the impact of network fees (based on 2013 volumes).
Figure 1: Visa and Mastercard revenue and operating profit margin from 2010 to 2015
Who would benefit from its abolition?
Repealing the Durbin amendment will likely benefit card networks again, as well as issuers. It is unlikely the new and increased network fees would be romoved. Instead, it is highly probable that the larger networks would attempt to re-introduce exclusivity arrangements and high interchange fees in order to win issuing contracts. The impact of these changes in the cost of accepting PIN debit transactions could be significant.
Repealing Durbin would likely restore interchange fees to their pre-Durbin levels and might also allow issuers to recoup a large portion of their interchange losses from 2011 to 2016. In Fig. 2 and Fig. 3, we can see that repealing Durbin would likely see a direct transfer of $6.1 billion annually from merchants to issuers, an equivalent of $0.13 per debit card transaction (2013 volumes). Overall, merchant fees would be $3.5 billion higher annually than pre-Durbin because, as we have discussed, the new network fees and processor absorption would be unlikely to be withdrawn. It is clear that neither retaining Durbin in its current form nor repealing it will deliver an optimal outcome. Instead, the only viable solution that we can see is to reform it.
Ultimately, reform could address the issues identified by the Federal Reserve by closing the loopholes that allow card networks and processors to circumvent the rules. The abolition of Durbin in its current state also has the capacity to address concerns made by the amendment’s critics that limited benefits have reached consumers during the time the regulation has been in place.
Reform would thus give merchants the opportunity to pass through any savings realized to consumers. If we again look at Fig. 2 and Fig. 3, we can see that a more sensible interchange cap and control over network fees would deliver as much as $8.1 billion in annual savings for merchants (2013 volumes).
Figure 2: Flow of money pre/post Durbin amendment (using 2013 volumes)
Figure 3: Interchange and network fee cost per transaction (2013 volumes)
How can these benefits be achieved?
Without hard action, vicious circles are created and problems continue. In our view, there are two ways in which merchants could realize benefits :
1. The aforementioned issues would be addressed if the Durbin amendment is reformed by introducing stricter caps for debit card interchange and extending the coverage of the regulation to credit card interchange and network fees.
2. Given that the incoming president is a supporter of free market approaches where possible, there may be a reluctance to regulate the card payments market. With this in mind, a second option would be to break up the card networks
The Durbin amendment was designed to protect merchants but has failed to do so and offers far greater benefit to card networks than merchants in its current form. Therefore, we do not agree that the Durbin regulation should be repealed but see little use in it continuing as it is.
We are calling for regulators to deliver large scale reform, particularly to the card networks. Mr Trump’s concerns about the behavior of firms in Silicon Valley should be extended to other industries with competition issues. In our opinion, addressing Visa and MasterCard would be a very good starting point.