Federal regulations enacted under the to the Dodd-Frank Act are increasing competition among card networks and lowering merchant fees as intended, according to a report published in the Federal Reserve Bank of Kansas City's Economic Review covering the fourth quarter of 2012. The regulations limit debit interchange fees and require routing options for debit transactions.
However, the report, titled "The New Debit Card Regulations: Initial Effects on Networks and Banks," indicated that unintended consequences may come into play as networks seek to reclaim lost revenues via new merchant and consumer fees.
"Early signs suggest the interventions achieved some of their intended purpose, fostering increased competition in some areas of the industry," wrote report author Fumiko Hayashi, Senior Economist in the bank's Economic Research Department.
Hayashi found the legislation resulted in new incentives for exempt banks to offer lower banking fees; new competition among debit card networks; and separate fee schedules for banks with holdings of over $10 billion, which are regulated by the Durbin Amendment, and banks with holdings of less than $10 billion, which are exempt from said regulations.
Regarding potential consumer benefits, Hayashi said, "Whether the broader public reaps benefit in the long run will depend, in part, on the results of new revenue-generating strategies adopted by key players in the industry." The report cited Visa Inc. as impacted most by the regulations. "The decline of Visa's market share, especially in the PIN debit card market, is likely to be a sign of increased competition among the networks for merchants," the report stated.
In response to the regulations, Visa imposed on merchant acquirers a fixed acquirer network fee (FANF), which is being passed on to merchants. Visa said the FANF allows it to offset the revenue loss from the halving of debit transaction fees. "Given that the calculation of total network fee costs for debit card transactions must take into account the monthly FANF, merchants may face higher overall network fees for a debit card transaction with Visa than with other networks," Hayashi said.
However, since "the FANF is a sunk, fixed cost for the merchants, they do not take it into consideration when subsequently choosing which network to use for transaction routing," she added. "As long as the sum of the per-transaction network fee and the interchange fee is lower with Visa than with other networks, merchants are likely to route as many transactions as possible over the Visa network."
Hayashi said she believes fixed network fees could eventually cause merchants to limit the number of cards they accept to card companies with the largest market shares.
The report said banks regulated under the Durbin Amendment showed interchange fee revenue declines averaging 52 percent after the regulations went into effect in October 2011. Signature debit transactions fell an average of 59 percent (from 59 cents to 23 cents per transaction). PIN debit transaction revenues fell an average of 32 percent (from 34 cents to 23 cents per transaction).
"Each regulated bank's actual reduction in interchange fee revenue depended in large part on how its debit card transactions were distributed between signature and PIN debit," Hayashi said. The report found banks with "a significant proportion" of prepaid card transactions exempt from the regulations probably saw "only a relatively moderate reduction" in interchange fee revenue.
Hayashi said before enactment of the legislation, regulated banks promoted signature authorization over PIN authorization in debit transactions. Banks now have incentives to promote the more secure PIN debit.
"Whether the regulatory changes have increased competition among large, regulated banks is difficult to assess, but clearly the nature of competition among them has changed," Hayashi noted. "They now have an incentive to compete for customers by reducing or eliminating the fees associated with checking accounts and debit cards."
Exempt banks saw interchange fee revenue fall an average of 2 cents per transaction, from 45 cents to 43 cents after enactment of the Durbin regulations. Also, exempt banks benefited from promoting signature debit transactions over PIN debit transactions because of the much higher interchange fee revenues - an average of 20 cents per transaction - they receive from signature debit transactions.
A second article discussing the impact of the Durbin Amendment regulations on merchants and consumers will appear in the Fed's next Economic Review.
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