DODD-FRANK AND THE DURBIN AMENDMENT IS IT WORKING AS INTENDED?

DODD-FRANK AND THE DURBIN AMENDMENT IS IT WORKING AS INTENDED? CAPSTONE STRATEGIC PROJECT FOR THE AMERICAN BANKERS ASSOCIATION STONIER GRADUATE SCHOOL OF BANKING SCOTT D. STROCKOZ DEPUTY REGIONAL DIRECTOR FEDERAL DEPOSIT INSURANCE CORPORATION

TABLE OF CONTENTS EXECUTIVE SUMMARY..i STATEMENT OF PROBLEM 1 RESEARCH METHODOLOGY, DATA SOURCES, AND ANALYSIS.5 FINDINGS AND CONCLUSIONS 7 Merchant Impact..7 Bank Reaction 11 Consumer Impact...16 RECOMMENDATIONS...19 BIBILIOGRAPHY 22

EXECUTIVE SUMMARY The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 contained a provision commonly know as the Durbin Amendment. The Amendment was drafted by Senator Dick Durbin who wanted to bring fairness, transparency, and competition to the debit card transaction system. The Durbin Amendment limits the amount certain banks can charge in debit card interchange fees in the hope that merchants who should be paying less in fees will pass those savings onto consumers in the form of lower prices; however, debit card payment transactions are complex and involve several entities and consumers are generally not seeing any cost savings. To date, the Durbin Amendment is not working as intended. Prior to the Durbin Amendment, banks generated a significant amount of income from debit card interchange fees, approximately $20 billion in 2009. 1 With the loss of that income, banks are looking at other ways to recoup that revenue, including through charging new fees for previously free services or by charging fees that are higher than they were prior to Durbin. Banks are also trying to push customers from debit card use to other unregulated payment transaction options, such as credit cards or prepaid cards. These actions have potential compliance and reputational risks for the banks. Banks are increasing fees at a time when the country is still experiencing economic uncertainty and many customers either won t be able to or can t afford to pay fees for services previously free. Further, federal regulatory agencies will want to ensure that the fees are fair and transparent and may issue guidance or take other legislative action to ensure consumers are not being harmed. 1 Dirk Lammers, Judge Rejects Injunction in SD Debit Fee Lawsuit, ABC News, April 5, 2011. http://abcnews.go.com/business/wirestory?id=13296091 (accessed 2-17-12). i

Merchants, through lower interchange fees, should be seeing higher profits; however, due to the complexities of the payments system and the outstanding contractual agreements many merchants have with their payment processors, some are actually paying more in interchange fees after the Durbin Amendment. Merchants who sell lower cost items are paying more in fees due to actions by both Visa and MasterCard while merchants who sell higher cost items are seeing a reduction in those fees. In other instances, the payment processor for the merchant is not contractually required to pass along the interchange savings so they are keeping it for themselves. Consumers were supposed to see lower retail prices due to the implementation of the Durbin Amendment. In many cases, consumers are seeing higher prices for low cost items or no savings at all. Further, banks are increasing or implementing fees on traditional bank products and services thereby increasing consumer cost. Consumers either have to pay the fees, find a new bank that doesn t charge those fees, or end their banking relationship and use an alternative financial service provider for their banking needs. In certain instances, these providers charge more in fees than a traditional bank but they do not adequately disclose these fees in advance so the consumer ends up paying more to a check casher or a payday lender than they would to their bank. It is unlikely consumers will see any tangible benefits from the Durbin Amendment. The bank regulatory agencies should monitor the effectiveness and the impact of the Durbin Amendment and take action as necessary to ensure there are no safety and ii

soundness implications for banks and to ensure that consumers are being treated fairly. The FDIC should work with the other federal bank regulators to issue guidance to the industry regarding the consumer protection risks of issuing prepaid cards and in using third-party providers to oversee the program. Examiners should also incorporate trends in reported noninterest fee income to determine if there is elevated risk and accelerate onsite supervisory activity, if warranted. Further, the FDIC should incorporate the impact of the Durbin Amendment into its outreach efforts for both banks and consumers and the FDIC s ComE-IN committee should seek to identify the impact the Durbin Amendment has had on low-income individuals, as well as the underbanked population. iii

Statement of Problem In 2008, the country experienced the greatest financial crisis since the Great Depression. It resulted in a significant downturn for both our national economy and for the banking industry. As of December 31, 2011, 414 banks failed since 2008. As a comparison, in the years 2004 through 2007, there were a total of 7 bank failures. 2 Poor asset quality was the primary driver in the reduction of industry profits. The industry had been experiencing record profitability prior to the crisis. In 2006, banks reported a record $145.2 billion in net income; that declined in 2008 to $4.5 billion then dropped further with banks reporting a net loss of $10.6 billion in 2009. Industry profitability has begun to rebound and in 2010, banks reported net income totaling $85.7 billion. In the years leading up to the crisis and as profitability declined due to the poor performance of its interest earning assets, many banks made a conscious decision to focus on increasing noninterest fee income. This led to an increase in credit card fees, overdraft fees, and other consumer charges. The regulatory response was to modify existing regulations, issue clarifying guidance, or create new regulations to ensure that consumers were not being financially harmed and were aware of the fees and service charges they were required to pay. Significant regulatory changes include the Credit Card Act of 2009, revisions to the Federal Reserve s Regulation E requiring consumers to opt-in to the bank s overdraft service before fees may be assessed, and the FDIC s supervisory guidance on overdraft payment programs. The result of these regulatory actions was a drop in the income 2 FDIC, Quarterly Banking Profile. Fourth Quarter 2010: 5. 1

derived from fee-based deposit and card products. In fact, in 2010, service charge income on deposit accounts was $2.1 billion, or 20.7%, lower than a year earlier. 3 The primary driver for this decrease was the revision to Regulation E noted above that became effective on July 1, 2010. In addition to these regulatory changes, the financial crisis and the increasing support for greater consumer protection within the financial sector led to the implementation of sweeping legislation known as the Dodd-Frank Act. President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) on July 21, 2010. The Dodd-Frank Act has had a profound impact on the banking industry and on consumer protection. Specific to this paper, a provision included in the Dodd-Frank Act known as the Durbin Amendment will be discussed in detail. The Durbin Amendment (Durbin) is a provision included in the legislation that targets debit card interchange fees and seeks to increase competition in the payment processing arena. An interchange fee is the charge assessed by the issuing bank on a merchant every time a consumer swipes their debit or credit card. Prior to Durbin, the interchange fee varied widely, depending on the card and the merchant, and was levied to offset the cost of fraud prevention and processing the transaction. Interchange fees generated significant income to the banks who issued the debit cards. In 2009, $1.21 trillion in purchases were paid for by debit cards and processed through Visa and MasterCard networks, and generated $19.7 billion in fees paid by merchants to debit card issuing banks. 4 The Durbin Amendment capped these fees for banks over $10 billion in assets and regulated the control that banks and networks have over debit card transactions. The Dodd-Frank 3 FDIC, 2. 4 Lammers. 2

Act required the Federal Reserve to determine the true cost of fraud prevention and then limit interchange fees accordingly. In December 2010, Federal Reserve Chairman Ben Bernanke proposed a 12-cent cap on debit card interchange fees and a requirement that debit cards be processed on at least two independent networks (for example, Visa-owned PLUS and MasterCard s Maestro). Prior to Durbin, the average transaction of $38 would generate 44 cents in interchange fees, significantly higher than the proposed 12 cent cap. The proposal received over 11,000 comments with retailers generally saying that 12 cents was still too high while the banking industry saying the cap was too low and would lead to increased fees on other bank products to account for the lost income. In June 2011, the Federal Reserve issued the final rule, which capped the interchange fee at 21 cents per transaction, plus 0.05 percent of the transaction, with the possibility of an additional cent if banks comply with fraud prevention procedures. 5 For the average transaction of $38, a fee of 24 cents would be charged, double the initial proposal but less than the previous average of 44 cents. Capping the fees at 24 cents would cost the banking industry approximately $9.4 billion annually in lost fee income. 6 As noted above, the restriction on interchange fees does not apply to issuers that, together with affiliates, have assets of less than $10 billion. Although smaller institutions are exempt from the interchange restrictions, over time it is likely that these smaller institutions will be forced to lower their interchange fees due to free market pressures. Durbin now allows merchants to offer lower or reduced prices to consumers who pay using debit cards issued by large banks with set rates. The differential in interchange fees 5 Federal Reserve Board, Final Rule on Debit Card Interchange Fees and Routing and Interim Final Rule on Fraud Prevention Adjustment, June 22, 2011. 6 CardHub, Interchange Fee Study Durbin Amendment. June 30, 2011, http://www.cardhub.com/edu/interchange-fee-study-2010/ (accessed 2-8-12). 3

between banks over $10 billion and small-sized banks is significant enough to provide strong motivation for merchants to steer consumers away from using their community bank or credit union debit cards. Further, large merchants have been successful in incorporating technology into their point-of-sale systems to steer consumers into using less costly PIN-based debit transactions as opposed to signature-based transactions; these systems could easily be engineered to identify cards from more expensive small issuers and to prompt consumers to use another payment option at checkout. 7 The Durbin Amendment has the potential to have a significant impact on the banking industry, the way consumers shop, and on the relationship between a customer and their bank. This paper will research the risks associated with capping interchange fees at this new level and the impact it has had on consumer behavior. The paper will also make recommendations regarding the effectiveness of the provision and on any necessary changes to the FDIC s examination program or economic inclusion initiatives. For example, the FDIC established The Advisory Committee on Economic Inclusion (ComE- IN) in November 2006. The Committee is comprised of individuals representing the federal government, the banking industry, state regulatory authorities, community-based groups, and consumer advocacy groups and provides the FDIC with advice and recommendations on important initiatives focused on expanding access to banking services by underserved populations. 8 This includes reviewing basic retail financial services such as check cashing, money orders, remittances, stored value cards, short-term loans, savings accounts, and other services that promote asset accumulation by 7 Richard Misasi, Ken Patterson, Tim Sloane, Patricia Hewitt, David Fish, The Durbin Amendment: Impact Analysis, Mercatur Advisory Group, June 7, 2010, http://voiceofpayments.org/uploads/sites/174/is8.pdf (accessed 2-8-12). 8 FDIC, Charter of the FDIC Advisory Committee on Economic Inclusion, November 29, 2006. 4

individuals and financial stability. The impact that Durbin may have on currently banked low-income consumers is a concern that will be researched and will be available for the ComE-IN group to review. Further, industry reaction has been to attempt to increase fee income through other sources such as checking account maintenance fees, raising minimum balance requirements, and fees for using your debit card. These fees make it difficult for consumers, specifically low-income individuals, to maintain their bank account. This paper will research the risks associated with increasing these fees from both a bank and a regulatory perspective. Those risks include reputational risk, legal risk, and compliance risk. RESEARCH METHODOLOGY, DATA SOURCES, AND ANALYSIS Information cited in this paper and used for analysis and in determining the final recommendations was obtained from internal and external sources. The Internet was a primary source of information. There are numerous publications, blogs, and other summary documents that focus, both positively and negatively, on the potential impact of Dodd-Frank, the Durbin Amendment, and fee-generating bank products and services. There was conflicting and potentially erroneous information on several of these sites so cross-checking facts was an essential part of the research process. The Federal Reserve was charged with amending the Electronic Funds Transfer Act (Regulation E) to ensure that the amount of any interchange fee shall be reasonable and 5

proportional to the cost incurred by the issuer with respect to the transaction. The Federal Reserve s website was an excellent source of information regarding the proposed rule, the final rule, speeches and testimony by Chairman Bernanke, and various other comments regarding the Durbin Amendment. Further, regulatory guidance and other publicly available governmental and banking information was researched and studied to obtain information, add support, and draw conclusions. Internal FDIC information such as examination procedures and guidelines, ComE-IN policies and minutes, and Community Affairs outreach initiatives were also valuable sources of information. A research limitation for this paper is the short time period that Durbin has been effective. Many of the expected or predicted outcomes have not had time to fully develop. For example, even though Durbin does not cap the interchange fees for those banks under $10 billion in assets, because of market forces it is widely expected that the smaller institutions will have to lower their fees in order to remain competitive with the larger institutions. Additionally, with an effective date of October 1, 2011, there was only one quarter of Call Report data available to determine the actual financial impact of Durbin. 6

FINDINGS AND CONCLUSIONS The Durbin Amendment does not appear to be fully working as intended. Its purpose was to promote competition among payment processors, lower the fees retailers are charged and in turn pass those savings on in part to retail customers. My research indicates that banks are recording less interchange fee income; although the retail industry as a whole is seeing lower overall debit card transaction charges, many small retailers are paying more debit card related fees than they did prior to the regulation change; and, consumers are generally not paying lower prices as a result. In fact, many low-income consumers are paying more for basic banking services post-durbin and for smaller retail items. Durbin attempted to regulate the debit card transaction process; however, by only limiting interchange fees at the issuing bank level, which is just one part of a complex process, the desired outcomes have generally not been realized. To date, merchants, banks, and consumers have all been impacted by Durbin, and in many instances that outcome has been negative. Merchant Impact Debit Card Transaction Process To date, many merchants are not realizing the savings that Durbin intended. In its simplest form, the Durbin Amendment sought to lower the interchange fees paid by merchants to issuing banks and have those savings passed onto the consumer in the form 7

of lower prices. To accomplish this goal, Durbin focused on lowering the interchange fee; however, in a typical debit transaction there are several entities involved and there are other fees that a merchant has to pay. A typical debit transaction involves at least four parties including a cardholder, a card-issuing bank, a merchant, and a merchant bank. The cardholder provides the debit card information to the merchant. The merchant sends the card information to its bank, which passes it along to the card-issuing bank. Card networks, such as Visa or MasterCard generally provide the link between merchant banks and card-issuing banks to allow for the flow of this information. The network routes information first to authorize and then to settle the payment. Prior to settlement, the card-issuing bank retains a portion of the funds as an interchange fee. The merchant bank also charges the merchant a processing fee. Additionally, companies known as merchant acquirers often act as intermediaries between merchants and the merchant bank by processing transaction information for the merchant. These companies also receive a fee. Interchange remains the highest fee paid by a merchant in a debit card transaction; however, even with that specific fee lowered, the merchant continues to pay additional unregulated fees. Further complicating and mitigating the impact on merchants is the pricing structure used by the merchant s payment processor. The two main types of merchant account pricing are tiered and interchange plus. At the time Durbin became effective, the vast majority of merchant accounts operated on a tiered rate structure. All tiered merchant accounts have a base rate called the qualified rate and anywhere from one to several additional tiers that carry a surcharge that is added to the qualified rate to arrive upon the final rate for that 8

tier. 9 Interchange plus is a relatively new pricing structure and is more transparent and usually less expensive than tiered pricing. On an interchange plus pricing structure, the merchant pays the exact interchange fee in addition to a fixed markup to their merchant service provider. Durbin lowers the interchange fee so those savings are passed on directly to the merchant under the interchange plus pricing structure. Under the tiered pricing model, there is no specific interchange fee line item; the fees are spread among various tiers and included with numerous other processing fees. Durbin only capped the interchange fee rate at the bank issuer level and not at the merchant service provider level, so merchants using the tiered pricing structure may still be paying the same amount in interchange and not realizing any savings. Merchant service providers that specialize in interchange plus pricing models are promoting their services and benefits aggressively; expect merchants currently using a tiered pricing structure to switch to the less costly interchange plus pricing structure as their payment processor contracts expire. Visa and MasterCard Challenges There is another significant obstacle that interferes with the intentions of the Durbin Amendment. The two major card networks, Visa and MasterCard, have a virtual duopoly on debit card transactions as they account for 80% of the debit processing market. 10 The networks recently implemented two policies that will cause merchants who specialize in smaller dollar amount transactions to actually pay more in fees than they did prior to Durbin. First, both networks have committed to charging retailers the maximum allowed 9 Merchant Council, Interchange Plus Pricing VS Tiered Merchant Account Pricing, April 2009, http://www.merchantcouncil.org/merchant-account/rates-fees/interchange-tiered-pricing-structure.php (accessed 2-4-12). 10 Anisha, Visa, MasterCard Slip Through Durbin Loopholes, NerdWallet, October 10, 2011, http://www.nerdwallet.com/blog/2011/durbin-amendment-two-weeks-in-falling-short (accessed 2-4-12). 9

swipe fee for small-ticket debit transactions. Before the Durbin Amendment, the networks used a lower variable rate based on the dollar amount of the transaction so a neighborhood coffee shop would pay a 7-cent fee on a $2 cup of coffee and a 35-cent fee on a $20 group order. 11 Durbin hoped to cap the latter fee at 24 cents, and leave the first unaffected. Instead, that $2 coffee now comes with a 24-cent interchange fee, an increase of over 200%. Visa and MasterCard s actions ensure that small merchants will face higher costs than before. In fact, debit card interchange fees have increased by 12% for merchants on an average retail sale under $10. In contrast, those retailers with transactions averaging over $200 have seen a decrease in their interchange fees by 64%. 12 The second action involves a section of the Durbin Amendment that bans arrangements that networks such as Visa had with banks under which it exclusively processed their debit card transactions. Durbin will require banks to allow their debit cards to be processed by at least two networks that are not affiliated with each other. The intent was to introduce competition to a market dominated by Visa and MasterCard, thereby bringing prices down to a more reasonable level. In response, Visa lowered an existing variable fee that merchants pay on each card transaction. To compensate for that fee decrease, they simultaneously introduced a network participation fee, which is a flat charge levied on retailers who accept Visa cards. 13 Merchants have little recourse in this situation - if they don t pay the fee they 11 Anisha. 12 Jeff Zimmerman, Durbin has major Impact on Debit Interchange, http://www.clearent.com/blogiso/industry-news/durbin-has-major-impact-on-debit-interchange (accessed 2-10-12). 13 Anisha. 10

would have to deny any card carried on the Visa network, which is the most popular network at the point-of-sale. 14 In addition, once the network participation fee is paid, the merchant has little incentive to process on another network as they will receive a per transaction fee decrease to continue using Visa s network. This is an example of how Visa and MasterCard can use their market dominance to determine rates and fees for merchants outside of the legislative arena. Merchant Conclusion The Durbin Amendment was intended to lower prices for retailers, particularly small merchants, and to introduce competition into a market dominated by the two largest networks. However, both Visa and MasterCard immediately raised fees on small retailers, treating the amendment s ceiling as a floor, and introduced an additional fee that may preclude merchants from processing transactions on other networks. Smaller merchants are not realizing any cost savings and in certain instances are paying more in interchange fees. Larger merchants are generally seeing decreases in interchange fees paid; however, they are not required to pass those savings on to the consumer. Bank Reaction Debit card usage has grown rapidly and passed credit card usage in 2008 to become the most common noncash payment method in the United States. 15 Along with the increase 14 Anisha. 15 Kathy Chu, Rewards programs grow with debit use USA Today, August 31, 2009, http://www.usatoday.com/money/perfi/credit/2009-08-31-debit-card-rewards_n.htm (accessed 2-15-12). 11

in debit card use came an increase in the interchange fee income derived from these transactions. For comparison purposes, the following table, which includes all networks (not just Visa and MasterCard), reflects interchange fees paid by merchants to all banks annually from 2006 2010. Source: CardHub.com Year Interchange Fees Paid by Merchants to Banks 2010 $27.7 billion 2009 $24.2 billion 2008 $22.5 billion 2007 $19.9 billion 2006 $16.8 billion The expected loss due to the interchange fee caps for the non-exempt banks is expected to be $9.4 billion. Banks have acted swiftly, but not always successfully, in their attempts to recoup this lost income. Fee-Replacement Initiatives Initially, many banks attempted to tie new fees directly to the customer s use of their debit card. Wells Fargo and J.P. Morgan Chase piloted a $3 monthly fee for debit card use. Bank of America announced that they would begin charging a $5 monthly fee for making debit card purchases and SunTrust implemented the same $5 fee. Public reaction to these fees was vocal and negative. In the end, each bank reversed course and indicated that they would not be charging their customers for using their debit cards. 12

Based on the negative reaction to those fees, banks are turning to the products where fees are expected or are already in place. The number of free checking accounts continues to drop. In 2011, only 45% of noninterest checking accounts are free of maintenance charges, down from 65% in 2010, and down from its peak of 76% in 2009. 16 Banks are also increasing the monthly maintenance fees for its checking accounts. The average account maintenance fee rose from $2.49 in 2010 to $4.37 in 2011, an increase of 85%. 17 Many banks give account holders the ability to avoid these fees by holding a certain minimum average balance; even this number is increasing as the average minimum balance required to avoid the monthly fee rose from $249 in 2010 to $585 in 2011, an increase of nearly 135%. 18 Other fees seeing increases include ATM withdraw surcharges, replacing a lost debit or ATM card, or requesting paper statements. Banks have also begun trying to move customers back to using credit cards as opposed to debit cards. Although Durbin caps the interchange fees paid to the issuing bank for debit, credit card interchange fees remain unregulated. In 2011, in preparation for the effective date of Durbin, banks began an intense push to have their customers choose credit cards over debit. The tactics appear to be working as credit card purchases climbed 10.6 percent in the 3 rd quarter of 2011, after an 8.6 percent jump and a 9 percent increase in the first and second quarters of 2011, respectively. 19 Over the same three quarters, growth in debit card usage dropped from 9.5 percent to 8.3 percent and then to 5.9 16 Claes Bell, 7 Ways Checking Accounts Cost You More. Bankrate.com. September 26, 2011, http://www.bankrate.com/finance/checking/7-ways-checking-accounts-cost-you-more-1.aspx (accessed 2-8-12). 17 Bell. 18 Bell. 19 Blake Ellis, Credit card use is on the rise, CNN Money. December 5, 2011, http://money.cnn.com/2011/12/05/pf/credit_card_use/index.htm (accessed 2-10-12). 13

percent. 20 Overall, this represents a 27.8 percent increase in credit card purchases, and a 23.7 percent decrease in debit card purchases in 2011. One way that banks have made debit cards less attractive when compared to credit cards is to reduce or eliminate the rewards programs for debit. In 2011, the availability of debit card rewards programs declined by 30 percent. 21 At the same time, credit card reward programs are becoming increasingly generous with banks paying more cash back and eliminating annual fees and expiration dates for reward usage. 22 Prepaid Card Alternatives Banks are also looking to prepaid cards as a way to increase fee income. Prepaid cards are cards which are not tied to a traditional, individual bank account; rather, the cards are funded directly by the cardholder. These cards are basically checking accounts without the paper checks and allow for direct deposit as well as online bill pay and can generally be used to make purchases anywhere Visa or MasterCard is accepted. Prepaid card interchange fees are not regulated by the Durbin Amendment so banks are looking to expand into this market as a way to replace fee income. Prior to Durbin, the prepaid card industry was growing rapidly; in 2010 prepaid card use expanded by 35 percent and had over 1 billion transactions. 23 With the implementation of Durbin, these numbers should continue to increase. Prepaid cards have historically 20 Ellis. 21 Samuel Weigley, Credit Card Rewards Grow as Debit Rewards Dwindle, IBTimes, February 13, 2012, http://www.ibtimes.com/articles/297786/20120213/credit-card-rewards-debit-cash-back-points.htm (accessed 2-17-12). 22 Weigley. 23 Dawn Kopecki, AmEx Targets Big Banks, Dodges Debit Caps With Prepaid Card, Bloomberg, June 14, 2011, http://www.bloomberg.com/news/2011-06-14/amex-targets-biggest-banks-ducks-debit-capswith-prepaid-cards.html (accessed 2-3-12). 14

been associated with high fees that are not clearly disclosed and can quickly erode a cardholder s balance. However, the prepaid card arena is becoming very competitive as banks impacted by Durbin have begun offering these cards with less costly fees than traditional cards. American Express began offering a lower-cost prepaid card in 2011 primarily in response to the Durbin Amendment. The bank has chosen to forgo many of the traditional fees such as those for monthly maintenance, activation, balance inquiries, or replacement cards. Part of the reason American Express, and other banks, will be able to offer these lower cost prepaid alternatives, is that they will derive income through the unregulated interchange fees. Regulatory Concerns Banks charging new fees as well as increasing existing ones on customer accounts, and the increasing popularity of prepaid cards has drawn the attention of the bank regulators. Regulators will want to ensure that all fees being charged are clearly disclosed to the customer and that they have not been misled or deceived in any manner. Reaction from Bank of America s proposed $5 monthly debit card fee included negative comments from Senator Durbin and President Obama. In an interview with ABC News, President Obama stated the fee is exactly why we need somebody whose sole job is to prevent this kind of stuff from happening. The somebody he was referring to was the Consumer Financial Protection Bureau (CFPB), a new regulatory agency created through the Dodd-Frank Act. The CFPB is responsible for enforcing federal consumer financial laws at banks with assets over $10 billion to ensure that all consumers have access to financial products and that the market for consumer financial products and services are fair, transparent, and 15

competitive. The CFPB also has the authority to promulgate regulations applicable to banks of all sizes with respect to numerous consumer financial laws. New laws and guidance may be issued by the CFPB or other federal regulatory agencies in direct response to the financial industry s reaction to the loss of interchange fee income due to the implementation of the Durbin Amendment. Banks will need to ensure that all fees, new or otherwise, are disclosed in a clear and conspicuous manner and that the customer understands the changes. Consumer Impact Merchant Response The Durbin Amendment hoped to lower retail prices by capping the fees paid by merchants; however, although most merchants are paying lower interchange fees, meaningful price reductions on consumer goods has not occurred. In fact, 41 percent of merchants indicated that they do not plan on passing lower debit card costs onto consumers while 56 percent indicated that they are unsure if they will do so. 24 Further, since the interchange fees for smaller dollar items (under $10) have risen since the Durbin Amendment, consumers may be paying more for low cost items they buy on a recurring basis such as coffee, soda, snacks, and sandwiches. 24 Digital Transactions, Consumers May Not See Much Durbin Benefit from Card-Not-Present Merchants, September 1, 2011, http://digitaltransactions.net/news/story/3188 (accessed 1-31-12). 16

Higher Bank Fees In addition to not receiving pass-thru savings from merchants, consumers may be paying more to hold onto their checking accounts as banks have increased the fees required to maintain these accounts. Banks have been increasing deposit account fees to make up for lost interchange income. Banks have also eliminated many debit card reward programs. These reward programs used to provide customers with cash back, gift cards, or other rewards based on debit card usage. In addition to making debit cards less attractive, banks are increasing credit card incentives to entice customers to use credit rather than debit. For customers, credit card spending can lead to increasing debt levels at high interest rates. Many customers prefer using their debit card since those transactions are funded directly through their checking account and can promote more responsible spending. Impact on Low-Income Consumers There is no current empirical evidence that shows the early impact of Durbin on consumers as an overall group; however, the evidence we do have shows that low-income consumers are most likely to be affected negatively through higher costs and less choice of banking products. As free checking declines and banks raise fees tied to deposit accounts, low-income individuals are least able to afford these changes. To avoid many of these account fees, banks require a minimum monthly balance; that minimum has increased 135 percent in 2011 and will be too high for many low-income individuals. The number of unbanked or 17

underbanked in 2009 was 25.6 percent of U.S. households; 25 however, that number could rise as low-income individuals look to alternative financial service providers to meet their needs. The push to entice customers to use credit cards will also have a negative impact as many low-income individuals will not qualify for these cards and will then be forced to pay higher fees to maintain their bank account or replace their bank account by using prepaid cards. A significant majority of prepaid cards charge high fees for many card activities. The disclosure of these fees is not always clear or transparent and consumers could be unwittingly choosing a financial product that ends up being more costly than traditional debit cards. Additionally, although consumers may feel that bank fees are high and no longer want to deal with a bank or feel they cannot afford to, they will end up paying more for financial services by using check cashers or payday lenders. Conclusion Durbin was meant to help consumers by lowering prices to date, retail prices have remained steady or have risen as in the case of small dollar items; and, consumers are paying more to maintain their bank account or they have joined the ranks of the underbanked and unbanked and are paying more for those financial services. Consumers have not benefited as intended from the Durbin Amendment. 25 FDIC, National Survey of Unbanked and Underbanked Households. December 2009. 18

Unless the Durbin Amendment is modified to account for many of the challenges and reactions brought on by its implementation, consumers, banks, and merchants will continue to be unfavorably impacted. RECOMMENDATIONS The Durbin Amendment is the latest legislative change that has decreased a bank s ability to generate noninterest fee income and these institutions continue to look for other ways to replace lost debit card interchange fee income. In many instances, fee generating bank products and services have an element of risk, including those related to compliance risk, reputation risk, and legal risk. Bank regulatory agencies should monitor the effectiveness and the impact of the Durbin Amendment and take action as necessary to ensure there are no safety and soundness implications for banks and to ensure that consumers are being treated fairly and continue to have access to banking products and services. In consideration of these risks and the potential changes in a consumer s banking behavior, regulatory agencies, and specifically the FDIC, should consider the following recommendations. Issue prepaid card guidance to the industry to make banks aware of the risks associated with these cards and to ensure that consumers are knowledgeable of the product. The guidance should be issued in tandem with the Office of the Comptroller of the Currency (OCC), the CFPB, and with the Federal Reserve. 19

The guidance should remind financial institutions boards of directors and management of their need to ensure that the prepaid card program offered by the institution complies with all consumer protection laws, including clear and meaningful disclosures regarding the program, fees, and other features and options. Further, the guidance should include a reminder that institutions using a third-party provider for their prepaid card program must exercise careful oversight, as discussed in the FDIC s 2008 Guidance for Managing Third-Party Risk. The FDIC s Division of Depositor and Consumer Protection (DCP) uses off-site analytics to assist in identifying red flag activities, which may indicate the need for an accelerated on-site activity, such as an examination or visitation. DCP should incorporate the Call Report item Non-Interest Income - Service Charges on Deposit Accounts into the off-site quarterly analysis. A bank s reported income in this line item should be evaluated for trends on both a quarter-over-quarter and year-over-year basis. A spike in this area may indicate that an institution has raised fees on current products or has implemented a new fee-based product and should be evaluated to determine if further supervisory action should be taken. The FDIC s DCP should incorporate current and future findings related to Durbin into its banker outreach efforts. The FDIC s banker outreach is designed to make banks aware of emerging issues and risks and to provide them with the 20

knowledge and training to ensure compliance with applicable consumer protection laws. Outreach should include reminders of the risks involved in certain fee generating products, including practices that may be deemed unfair or deceptive in violation of Section 5 of the Federal Trade Commission Act. The FDIC s ComE-IN Advisory Committee should follow the impact that the Durbin Amendment is having on consumers, specifically underbanked lowincome persons. Banks reaction to Durbin and the corresponding impact on consumers is directly related to the mission of this committee, which includes expanding access to banking services for underserved populations. The FDIC should consider including the impact of Durbin in its consumer protection outreach program, specifically in its free quarterly Consumer News publication. The FDIC Consumer News provides practical guidance on how to become a smarter, safer user of financial services. Information included in the publication should discuss the differences and risks when using credit, debit, and prepaid cards, as well as the trend of increasing bank fees. 21

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Merchant Council. Interchange Plus Pricing VS Tiered Merchant Account Pricing. April 2009. http://www.merchantcouncil.org/merchant-account/ratesfees/interchange-tiered-pricing-structure.php (accessed 2-4-12). Misasi, Richard, Ken Patterson, Tim Sloane, Patricia Hewitt, David Fish. The Durbin Amendment: Impact Analysis. Mercatur Advisory Group, June 7, 2010. http://voiceofpayments.org/uploads/sites/174/is8.pdf (accessed 2-8-12). Weigley, Samuel. Credit Card Rewards Grow as Debit Rewards Dwindle. IBTimes, February 13, 2012. http://www.ibtimes.com/articles/297786/20120213/creditcard-rewards-debit-cash-back-points.htm (accessed 2-17-12). Zimmerman, Jeff. Durbin has major Impact on Debit Interchange. http://www.clearent.com/blog-iso/industry-news/durbin-has-major-impact-ondebit-interchange (accessed 2-10-12). 23