If President Donald Trump gets his way, Congress will repeal the Dodd-Frank Act and do away with the Durbin Amendment that caps fees charged by banks to process retail debt card transactions. Repealing the Durbin Amendment could cause retailers to increase their prices, and it may be a boon to banks, so let's learn more about what's at stake.
First, some background
After the banking industry brought the nation to the brink of a depression in 2008, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. The act includes wide-ranging regulations on banks, requiring significant reporting and oversight of their financial condition in a bid to prevent too-big-to-fail bank bailouts in the future.
The Act is the most comprehensive banking reform since the 1930s, but it's widely been panned for limiting borrowers access to capital, increasing costs, and reducing the industry's ability to return money to shareholders.
The Durbin Amendment is a provision in the Dodd-Frank Act that grants the Federal Reserve the authority to cap interchange fees that are charged to retailers by banks and transaction processors, including Visa (NYSE:V) and Mastercard (NYSE:MA).
Historically, interchange fees were negotiated between retailers and banking institutions, and as such, large retailers often paid lower interchange fees than small retailers. Overall, the average interchange fee charged to retailers prior to the Durbin Amendment was $0.44 per transaction. While retailers may have absorbed some of that fee, it's likely that most of it was spread out across consumers in the form of higher prices on goods and services.
The Durbin Amendment tasks the Federal Reserve with determining how much banks can charge retailers on debit card transactions, and that rate is supposed to only take into consideration the true costs that are associated with those transactions.
Initially, the Federal Reserve recommended a cap of $0.12 on interchange fees, however, aggressive lobbying by the banking industry resulted in a final cap of $0.21, plus 0.05% of the transaction amount. Banks that took certain fraud protection measures could collect an additional $0.01 per transaction.
While the individual cost of these transactions is measured in pennies, the cumulative amount of revenue that's generated from them is anything but small. According to NerdWallet, the banking industry collected roughly $17 billion in interchange fees on debit cards prior to the Durbin Amendment's passage. After the limit was put in place, interchange revenue at banks declined by about $6 billion per year.
Retailers argued that those billions in cumulative savings would allow it to lower prices on goods and services, however, it's unclear if that's happened. Some of their savings may have helped them limit price increases, but it's equally likely those savings were simply a windfall to retailers profit growth.
Adding insult to injury, the capping of interchange debit card fees resulted in unintended consequences for bank customers. In the face of losing billions of dollars in swipe fee revenue, banks increased other costs, such as overdraft fees on checking accounts. Because banks boosted charges elsewhere, the capping of interchange fees simply shifted transaction costs from retailers to bank customers.
Breaking free of regulation
In part, Trump won the presidency on promises to deregulate businesses. Trump has already passed an executive order mandating that no new regulations can be enacted without removing two existing regulations, and GOP members of Congress are already working on rolling back much -- if not all -- of Dodd-Frank.
Assuming Dodd-Frank's repeal includes a jettisoning of the Durbin Amendment, banks and retailers will have to negotiate interchange fees again, and it's difficult for me to believe that interchange fees won't rise back to their pre-Durbin Amendment levels over time. If so, banks may offer perks to boost debit card use, but those perks may not offset other costs.
Retailers may increase prices on goods and services to protect their profit, and banks may not fully roll-back the increases they made to fees following the passage of the Durbin Amendment. For this reason, it's consumers who could end up being the losers in this particular case of deregulation, not retailers or banks.
Todd Campbell owns shares of Mastercard. His clients may have positions in the companies mentioned. The Motley Fool owns shares of and recommends Mastercard and Visa. The Motley Fool has a disclosure policy.