Policy Documents

Research & Commentary: Interchange Fee Update

Matthew Glans –
June 9, 2010

In an effort to force a reduction of what consumer advocates call "swipe fees" and depository institutions call "interchange fees," many in Congress are proposing heavy regulation of these fees, which are charged for processing transactions through debit and credit cards.

A new amendment to the Restoring American Financial Stability Act of 2010, sponsored by Senator Dick Durbin (D-IL), would make substantial changes in how fees on debit card transactions and determined and imposed. Combining two of Senator Durbin’s previous amendments addressing interchange fees, the amendment would empower the Federal Reserve to regulate interchange fees and require those fees to be “reasonable and proportional to the costs of the issuer or the payment network.”

The amendment also gives merchants new flexibility in how they are able to manage the fees by changing merchant restraint rules for debit payments. The new rules would prohibit restrictions on both minimum and maximum transaction amounts for debit purchases, and would allow merchants to offer discounts designed to steer transactions towards other networks or to other forms of payment like cash or checking, which is currently disallowed by some networks.

Interchange fees are calculated as a percentage of the transaction amount using a formula incorporating several factors: account authorization costs, fraud and credit losses, and the average bank cost of funds. The fees change over time.

Retailers' groups say the fees are unfair and that the mandated reduction would be good for the economy. The Merchants Payments Coalition (MPC), for example, argues that the fees amount to a hidden tax of nearly 2 percent on just about every credit card transaction.

Credit providers say the fees are needed to cover the risk of nonpayment, the costs of processing transactions, and the expenses of maintaining the credit system infrastructure. They argue that the fees are justified and fairly reflect the cost of building and maintaining the debit and credit networks that make instant credit possible and beneficial for retailers, consumers, and issuing banks alike. They note that merchants have never contributed a penny to the cost of building the networks and that their participation in those networks is optional.

The following articles examine the debate over interchange fees, their effects on retailers and credit  providers, and the policies being devised to address the issue.

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The Interchange Fee Debate: Issues and Economics
http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=3235
This report from the Federal Reserve Bank of Minneapolis examines the interchange fee debate and the difficulties in reaching any agreement between banks and retailers.

Senate Amendments Could Be Major Setbacks for Credit Card Issuers
http://blogs.forbes.com/moneybuilder/2010/05/19/senate-amendments-could-be-major-setbacks-for-credit-card-issuers/
This article from Forbes examines the possible effects of the Durbin interchange amendments on credit card issuers and consumers.

CUNA Issues Summary: Interchange Fees
http://www.cuna.org/gov_affairs/legislative/issues/download/interchange_fees.pdf
The Credit Union National Association offers a credit union perspective on interchange fees and argues against the currently pending legislation.

Interchange Fees in Various Countries: Developments and Determinants
http://www.kansascityfed.org/Publicat/econrev/PDF/3Q06haya.pdf
This report from the Federal Reserve Bank of Kansas City studies the effects of interchange fee regulations in other countries worldwide.

"Swipe Fee" Reform--International Lessons
http://c0462491.cdn.cloudfiles.rackspacecloud.com/Swipe_Fee_Reform_-_International_Lessons.pdf
A release from the Merchants Payments Coalition examines the effects of interchange fees worldwide and recommends reforms.

Interchange Fees and Payment Card Networks: Economics, Industry Developments, and Policy Issues
http://www.federalreserve.gov/PUBS/FEDS/2009/200923/200923pap.pdf
This paper from the Federal Reserve describes the operation of a typical payment card system, presents a summary of the economic theory underlying interchange fees, and discusses various developments in the U.S. payment cards industry and legal and regulatory developments abroad.

The Economics of Payment Card Fee Structure: Policy Considerations of Payment Card Rewards
http://www.kc.frb.org/PUBLICAT/RESWKPAP/PDF/RWP08-08.pdf
This paper from the Kansas City Fed considers possible public policies for improving efficiency in the U.S. retail payments industry.

ABA Issue Update: Interchange Fees
http://www.aba.com/Issues/Issues_Interchange.htm
This issue update from the American Bankers Association discusses the position of many in the banking industry on interchange fees, which they argue should be set by the private market.

GAO Report: Rising Interchange Fees Have Increased Costs for Merchants, but Options for Reducing Fees Pose Challenges
http://www.gao.gov/new.items/d1045.pdf
This report from the Government Accountability Office examines the effect of interchange fees on merchants and the options for reducing fees, finding significant challenges for reform.

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Nothing in this document is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit The Heartland Institute's Web site at http://www.heartland.org and PolicyBot, Heartland's free online research database.

If you have any questions about this issue or The Heartland Institute, contact Heartland Legislative Specialist Matthew Glans at 312/377-4000 or mglans@heartland.org.