The Federal Reserve provided a considerable amount of effort and monetary largesse to stimulate the economy with the rollout of Quantitative Easing II. Also known as "the last resort," this effort is wholly dependent on the action of U.S. banks: QE cannot succeed unless banks make business and consumer loans ... lots of them.
The positive, short-term effects of the increased money supply generally means lower borrowing interest rates, increased wages or more employees, a higher level of output and increased spending. This creates a positive environment for businesses, particularly small businesses that have been very vocal about limited access to loans.
QE II will come to a close at the end of June. While the economy is seeing signs of recovery, the full effect of increasing the money supply through loans has not yet been realized.
The Durbin Amendment will take effect in late July, which is truly spectacularly bad timing. It coincides with QE II's lag time and could negate its positive effects. This in and of itself may be a compelling reason to delay the amendment.
So, what do small businesses really want? Inexpensive loans or lower interchange fees? One thing is for sure, they won't get both.
If banks are expected to be part of the economic recovery via QE, there needs to be a good environment for them to loan out their money. Currently, there are fewer loans going bad, which means banks are able to use some of the money set aside to cover loan losses. In addition, there has been a modest increase in demand for auto and business loans, indicating consumers and businesses are ready to spend again.
Contrary to this positive lending environment, the Durbin Amendment is estimated to impact U.S. banks' annual revenues anywhere from $4.5 billion to $12 billion. (Lower estimate projected by S&P, upper estimate cited by the consulting firm Oliver Wyman and others.) In practice, the larger banks will get hit the hardest. The $600 billion spent in QE II may not cover the losses from the cap on interchange fees for every bank.
Simply put, banks' increase in liquid assets will not fully offset the anticipated loss of revenue from the Durbin Amendment. The extra liquid assets each bank acquired from QE are going to have to replace the rainy day funds (usually set aside from revenue). It's a simple business decision: a loss in revenue means a loss in working capital, a loss in employment and, most importantly to the banking industry, a loss in cheap loans available to businesses and consumers.
We need to ask several important questions to determine if we really need the cap on interchange fees:
- Will merchants actually pass on the savings to consumers, particularly in light of the anticipated inflation from QE?
- Does this create an environment for consumers to spend more?
- Do government officials really want to sacrifice our "last resort" to economic recovery to support an understudied interchange fee?
- Is there sufficient evidence to prove that the interchange fee was at the wrong amount before?
Policy makers have attempted to answer these questions when deciding to delay or possibly nix the Durbin Amendment. To date, there has been no resolution. In fact, there have been multiple, contradictory speculations. Before deciding on a cap of the debit card interchange fees, it is imperative that these questions be answered, especially when it could have a detrimental effect not only to the financial service sector but, more importantly, to the nation's economic recovery.
Why not let merchants choose which type of payment method they will accept for any given purchase amount and let the market price of the interchange fee and revenue shift to the most efficient level? This would allow the payment method market to be more competitive and result in lower prices, which was the intended goal of the interchange fee cap in the first place. Merchants could decide what payment method makes the most business sense for them. And, it would motivate banks to lower the interchange fees on their own to ensure that merchants would use their customers' debit cards. This solution would take the liability off of the government and the Federal Reserve, if the predicted 12 cent cap is the wrong level to charge.
Shayna Stewart is an associate in financial services research at Market Strategies International.