Here is one incontrovertible fact that will result from the interchange provision included in the Dodd-Frank Act: Every bank that issues debit cards will be harmed by it, regardless of asset size.
Yes, the Federal Reserve's proposed rule implementing the provision sets a maximum interchange rate of 12 cents for debit card transactions. And yes, this part of the rule theoretically "exempts" banks with assets of less than $10 billion. But the exemption is an illusion. It will not work and cannot be made to work. Every community bank in the country will feel the consequences.
The reason is simple. In any free-market economy, market forces naturally drive businesses to obtain the lowest possible price. In this case, the government has interfered in the market and artificially imposed a price cap on debit cards issued by large banks only — to the tune of 70-85% price reduction. Inevitably, all merchants will seek to drive as much business as possible to debit cards subject to the cap — i.e. to large banks.
So what happens to community banks? The resulting marketplace pressures will force them to seek lower interchange prices so they can remain competitive with larger banks and not lose their customers. In the end, small banks will be subject to the same price limitations as their larger competitors and will lose a significant amount of revenue that is currently used to support low-cost checking accounts, fight fraud and otherwise support lending in their local community.
A simple example can help illustrate the point: If a small retailer is selling candy bars for a dollar apiece and a large retailer right next store is selling the same candy bars for 12 cents because of government-imposed price caps, shoppers will be driven to the lower-cost option. In order to compete, the smaller retailer will have to lower the price of its candy bars or risk losing customers to the larger retailer.
Fed Chairman Bernanke himself recognized this economic reality when he said at a recent Senate hearing that "it is possible that that exemption will not be effective in the marketplace."
Furthermore, we don't think Congress can simply stick a Band-Aid on this and "fix" the problem. For example, placing limitations on the ability of merchants to steer customers to lower-cost debit cards will not be enough to reverse the laws of economics.
The billions and billions of dollars at play constitute a financial incentive that is far too great to ignore. It is naïve to think that retailers, particularly large retailers, will unflinchingly continue to accept small-bank cards without also trying to persuade customers to use options that cost as much as 85% less. The big-box retailers of the world will do everything they can to drive business to the lowest-cost option. Just ask any small retailer who has been driven out of business by a big-box competitor about the reality of the marketplace.
And now it's community banks that face this threat. Even if you believed that complete prohibitions on all forms of steering could somehow be established, they would be totally unenforceable. Steering can occur in countless ways and innumerable places. It does not have to be directly related to a particular transaction and is not limited to activities at the point of sale. Merchants can, and will, find many ways to encourage customers to use price-controlled cards. This means that community banks will see their customers — and their customers' checking and savings accounts, the bread and butter of community banks — fly out the door.
Price controls are bad public policy and they have real unintended consequences — in this case for every community bank in the country.
As much as Congress would like to, it can't overturn the laws of economics. A system of two separate prices for the same product is not sustainable, and the Fed's debit interchange rule should be stopped.
