[WASHINGTON, D.C.] – Assistant Senate Majority Leader Dick Durbin (D-IL) responded to criticisms of his new interchange law today, hours after Federal Reserve Chairman Ben Bernanke questioned the effectiveness of the new law’s small bank exemption at a hearing before the Senate Banking Committee.

In a letter to Chairman Bernanke Durbin wrote: “I was disappointed that your testimony about interchange fee reform today before the Senate Banking Committee echoed the financial industry’s talking points and failed to acknowledge several critical realities. 

The U.S. banking industry is a $13 trillion dollar industry… [and] has always fiercely opposed any reform to the current interchange fee system.  After years of considering the issue, Congress has recognized that reform of this system is necessary for the sake of America’s consumers, businesses and overall economy, and has passed bipartisan legislation to make this reform a reality. I urge you and the Federal Reserve to recognize these tactics for what they are, and to carry out the implementation of interchange reform as Congress intended - on the basis of facts and not the financial industry’s fictions. 

When you testified before Congress for your recent confirmation hearing, you said that the Federal Reserve’s policymaking “is informed not just by a Washington perspective, or a Wall Street perspective, but also a Main Street perspective.”  For the sake of Main Street American consumers and businesses, we need the Federal Reserve to understand and address the non-competitive practices of our largest financial institutions.”

A copy of the letter to Chairman Bernanke is pasted below.

Durbin also submitted written testimony to a House Financial Services Subcommittee hearing on the new interchange law. That testimony appears beneath the copy of the letter.

The Durbin-authored law directed the Federal Reserve to establish standards to ensure that debit interchange fees are “reasonable and proportional” to the real cost of processing a debit card transaction.  The new law was created by a bipartisan amendment Durbin included in the Dodd-Frank Wall Street Reform and Consumer Protection Act. Final regulations will be released in April.

February 17, 2011

The Honorable Ben S. Bernanke
Chairman
Board of Governors of the Federal Reserve System
20th Street and Constitution Avenue NW
Washington, DC 20551

Dear Chairman Bernanke:

I was disappointed that your testimony about interchange fee reform today before the Senate Banking Committee echoed the financial industry’s talking points and failed to acknowledge several critical realities. 

You expressed concern that the new interchange law’s exemption for issuers with assets under $10 billion would not be effective in the marketplace.  You said that whether the exemption will work depends on two things: 1) whether merchants might refuse to accept debit cards issued by small banks because those cards receive higher interchange fees, and 2) whether card networks might be unwilling to operate a “two-tier system” with different interchange rates for regulated large banks and for unregulated banks with assets under $10 billion. 

On the first point, as every merchant knows, debit card networks like Visa and MasterCard impose “honor-all-cards” contractual rules on all merchants that accept cards from those networks.  Merchants are subject to severe penalties if they decline to accept a network’s card on the basis of the card’s issuer.  These existing network penalties (which the new law leaves intact) provide a proven deterrent against discrimination, and the marketplace experience has confirmed that merchants do not violate this “honor-all-cards” rule.  Even before the new law was enacted, merchants have long been able to easily distinguish at the point of sale a network’s higher-interchange cards such as rewards cards and corporate cards - but merchants have not discriminated against those higher-interchange cards because of the significant contractual penalties that would result.  This reality will not change when the new law takes effect.

On the second point, I would like to bring to your attention a January 7 article in The American Banker titled “Visa Plans Two-Tiered Interchange Rates After Fed Rules.”  As the article points out, Visa, the largest debit network, has already announced that it would implement different interchange rate schedules for large regulated banks and for small unregulated banks. The article said the following:

Visa's move "makes total sense," said Eric Grover, the principal of the payments consulting firm Intrepid Ventures in Menlo Park, Calif.  Initially Visa executives said a dual schedule was impossible, he said. "That was simply intended to scare credit unions and small banks to keep them lobbying," Grover said.

Unfortunately, that “scare” tactic became part of your official testimony today.

The banking industry may argue that, in the words of the American Bankers Association, a two-tier system will fail because “marketplace pressures will force all banks to conform to the artificially lower government mandated rate restrictions to which large banks will be subject.”  But as you know, banks do not set the interchange rates that they receive – card networks fix those rates for their issuing banks, and networks have a clear financial incentive to keep interchange rates high for unregulated small banks in order to entice those banks to issue the networks’ cards.  As the January 7 article noted, analysts believe this dynamic “will put community banks and credit unions at an advantage over larger institutions” – exactly the opposite of your testimony.

The U.S. banking industry is a $13 trillion dollar industry, according to the American Bankers Association.  This industry has always fiercely opposed any reform to the current interchange fee system.  After years of considering the issue, Congress has recognized that reform of this system is necessary for the sake of America’s consumers, businesses and overall economy, and has passed bipartisan legislation to make this reform a reality.  Now the banks and card companies are devoting their enormous resources to spread misrepresentations and scare tactics in an effort to stop reform in its tracks.  I urge you and the Federal Reserve to recognize these tactics for what they are, and to carry out the implementation of interchange reform as Congress intended - on the basis of facts and not the financial industry’s fictions. 

When you testified before Congress for your recent confirmation hearing, you said that the Federal Reserve’s policymaking “is informed not just by a Washington perspective, or a Wall Street perspective, but also a Main Street perspective.”  For the sake of Main Street American consumers and businesses, we need the Federal Reserve to understand and address the non-competitive practices of our largest financial institutions.

Sincerely,
U.S. Senator Richard J. Durbin

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Statement of Senator Richard J. Durbin
Hearing before the House Financial Services Subcommittee on Financial Institutions & Consumer Credit on
“Understanding the Federal Reserve’s Proposed Rule on Interchange Fees: Implications and Consequences of the Durbin Amendment.”

February 17, 2011

Chairman Capito, Ranking Member Maloney, and members of the subcommittee, I appreciate the opportunity to submit this statement today.  

Last year, Congress passed landmark legislation to reform the interchange fee system in America.  This bipartisan effort came after years of Congressional hearings and Government Accountability Office studies that made clear that the interchange system was on an unsustainable course.  While many in the financial services industry have opposed interchange reform, it is clear that this reform is necessary for the sake of America’s consumers, businesses and overall economy.   

Debit and credit cards are rapidly replacing cash and checks in today’s economy.  Over half of all retail sales in America are now made with plastic, and that percentage is growing.  There are benefits that come from the increasing use of these cards, but there are also concerns that can no longer be ignored.

Visa and MasterCard are the dominant players in the card industry, and their cards are used in around 80% of debit and credit transactions.  Every time a sale is made with one of their cards, these card network companies take a cut out of the transaction amount and route it along to the bank that issued the card as an interchange fee.  These fees average between 1%- 3% of the transaction amount and have been steadily increasing.  Tens of billions of dollars in interchange fees are now collected each year from those who accept cards, including large and small businesses, charities, and government agencies. 

There is nothing wrong with card-issuing banks receiving fees for debit transactions as long as the fees are transparent and set in a competitive market environment.  But that is not the case with interchange fees.  For years card networks like Visa have fixed the interchange fee rates that each issuing bank receives when one of their debit cards is swiped.  In other words, each bank that issues Visa cards receives exactly the same network-established fee no matter how efficiently or inefficiently that bank processes transactions or prevents fraud.   

It’s easy to see why banks and card networks set up this interchange scheme. It is lucrative for the banks, who receive tens of billions per year in high fees that are not tempered by competitive market forces and that are not linked to any particular bank’s actual costs.  It benefits card networks, because they are paid each time a card is swiped and high interchange means banks will issue more cards.  But the system is unfair to consumers, who pay tens of billions per year in hidden fees passed on to them in the form of higher retail prices.  And it is unfair to merchants, who cannot negotiate interchange fees and who can no longer realistically refuse to accept the dominant card networks despite constant fee increases.  

Many merchants argue that interchange fees should be prohibited in the debit system as they are in the checking system.  The new reform law conceded that a network will be allowed to set an interchange rate that uniformly compensates issuers for the minimum costs necessary to authorize, clear and settle a debit transaction over that network’s wires.  But issuers should be incentivized to manage all other costs of operating a debit card system efficiently.  The old unregulated system encouraged networks to set rates at levels that subsidize inefficiency and that massively overcompensate banks at the expense of merchants and their customers.  This was simply unsustainable, and the new law corrects these incentives through reasonable regulation.    

What the Durbin Amendment Does

The Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act brings reasonable regulation to the $20 billion per year debit interchange fee system which had previously been unregulated.  The amendment will bring relief for small businesses, merchants, universities, charities, government agencies, and all others who accept cards for payment, and will help them achieve cost savings and pass those savings on to consumers through discounts and price competition.  

The amendment contains two main parts.  The first part directs the Federal Reserve to place reasonable constraints on the interchange price fixing that card-issuing banks permit networks like Visa and MasterCard to perform on their behalf.  The second part rescinds several anti-competitive restrictions imposed by card networks on other participants in the debit system.

The only fees regulated by the first part of the amendment are those fees that card networks fix on behalf of their issuing banks.  The amendment says that for transactions involving debit cards issued by banks with assets over $10 billion, any interchange fee established by a card network for the purpose of compensating the card issuer must be reasonable and proportional to the cost incurred by the issuer in processing the transaction.  The amendment permits card-issuing banks to receive debit interchange fee adjustments to cover reasonably necessary fraud prevention costs.   However, as opposed to the current system where banks receive a guaranteed level of interchange revenue no matter how effectively they deal with fraud, the amendment will require regulated banks to demonstrate that they have taken effective fraud-prevention steps in order to receive an issuer-specific interchange adjustment.

The second part of the amendment prohibits several anti-competitive card network restrictions.  The amendment prevents card networks from penalizing merchants who offer discounts for the use of cash, checks and debit cards as a method of payment, and it prevents networks from penalizing merchants who set a $10 minimum for credit card transactions.  The amendment also responds to efforts by dominant networks like Visa to sign banks to exclusive agreements under which Visa becomes the sole network upon which the bank’s debit transactions can be routed.   This growing trend toward network exclusivity will force smaller debit networks out of business, and the amendment preserves competition by directing the Fed to issue regulations ensuring that a card network cannot limit a debit card to only be allowed to run on one exclusive network.


Response to Financial Industry Arguments

I have heard many arguments against interchange reform presented by the financial services industry.  I will respond to those arguments below.

Consumer Impact

Banks and card companies argue that interchange reform will hurt consumers.  However, my amendment was supported by consumer groups and millions of individual consumers who signed petitions in support of swipe fee reform.  When banks and card networks advise Congress on what is best for consumers, I would urge my colleagues to take that advice with a grain of salt.   

Transparency, competition and choice are good for consumers, and the current interchange system is designed specifically to avoid those features.  Other nations that have regulated interchange fees have seen significant consumer benefits, and the same will be true here.  Note that the Fed met last October 13 with consumer groups about interchange reform, and according to the Fed’s public summary of that meeting the groups said they would prefer that debit interchange fees be either de minimis or zero.  

Small Banks and Credit Unions

Financial industry trade associations claim that interchange reform will harm community banks despite the amendment’s exemption for small banks and credit unions.  Neutral observers disagree with this claim.  For example, on February 4, an article in the American Banker titled “Durbin Amendment Winners and Losers” said that “[d]espite fear that has run rampant through under-$10-billion banks, we think they are winners” under the Durbin Amendment.  A January 7 American Banker article titled “Visa Plans Two-Tiered Interchange Rates After Fed Rules” said the following about Visa’s announcement that it would implement different interchange rate schedules for large and small banks: “[a]nalysts say the move will put community banks and credit unions at an advantage over larger institutions.”  

The financial industry argues that, in the words of the American Bankers Association, “marketplace pressures will force all banks to conform to the artificially lower government mandated rate restrictions to which large banks will be subject.”  But of course banks do not set their own interchange rates-- networks set them, and networks have a clear financial incentive to keep interchange rates high for unregulated small banks in order to entice those banks to issue the networks’ cards.

The argument that merchants will discriminate against small bank debit cards that carry higher interchange fees is also flawed for three reasons: (1) merchants are subject to severe contractual penalties if they refuse to honor all cards within a network; (2) merchants do not want to lose sales by telling customers to put their debit cards away; and (3) if merchants wanted to discriminate against cards that carry higher interchange fees, they could always easily do so by discriminating against rewards cards or corporate cards- but they do not because of the significant deterrent of contractual penalties and lost sales.

Threatened Consumer Fee Increases

Banks argue that if interchange reform is not stopped, they will be forced to raise fees on consumers.  But even a quick glance at past headlines reveals that banks have already been raising consumer fees long before Dodd-Frank was enacted last July.  I would note for example the following articles:

• October 27, 2008 - “Rising bank fees are setting records” – USA Today
• November 12, 2008 - “Banks Boost Customer Fees to Record Highs” - Wall Street Journal
• May 28, 2009 - “Banks Find Ways To Boost Fees; Checking Accounts Latest Target” - USA Today
• July 1, 2009 - “Bank Fees Rise as Lenders Try to Offset Losses” - New York Times
• July 19, 2009 - “Why Are Banks Raising Fees?  As Citigroup and Bank of America Post Huge Profits, Why Are Bank Fees Going Up?” – CBS News
• November 19, 2009 - “Checking Account Fees Are Making a Comeback” - SmartMoney
• January 4, 2010 - “Banks Eye New Fees, Revenue in 2010” - ConsumerAffairs.com
• May 18, 2010 - “Banks return to charging credit card, checking account fees” - USA Today
• June 22, 2010 -  “Wells Fargo to boost checking fees” - Business Journal   

Banks may have changed their justifications over the years for why they raise consumer fees -- from the financial crisis to loan losses to overdraft regulations to interchange reform-- but they have consistently increased consumer fees as far as the market will allow.   Reasonable regulation is needed to ensure competitive markets for the fees banks take from consumers as well as for the fees they take from merchants.  

I would further note that consumers are already paying for the debit interchange system in the form of higher retail prices – an estimated $427 per year for each American family according to one study.  Currently those fees are hidden and non-negotiable, but under my amendment they will be transparent and subject to competitive market forces.  Most retail sectors are highly competitive on price, which will ensure that interchange savings are passed on to consumers.

Preventing Fraud

The banking industry claims that network-established interchange fees are necessary in order to prevent fraud in the debit system.  This claim is misleading.  As the Fed pointed out in its draft rule, fraud rates are far lower for PIN debit than for signature debit transactions, but banks urge their customers to pay with signature debit since networks give higher interchange rates for signature than for PIN.  (See the April 21, 2010, American Banker article “Counterintuitive Pitch for Higher-Fee Debit Category” on JP Morgan Chase’s efforts to urge cardholders to stop using PIN.)  When fraud occurs on signature debit transactions, the Fed reports that 45 percent of those fraud losses are charged back to merchants.

In contrast to the current system in which all banks receive the same interchange fee rate regardless of how much fraud they allow and in which networks give banks higher interchange for fraud-prone signature debit than for PIN, my amendment will incentivize banks to reduce fraud by allowing higher interchange for those banks that take successful fraud prevention steps.  

Congressional Hearings

The financial industry claims that there were no Congressional hearings or informed consideration of interchange reform.  Actually, interchange fees have been the focus of two GAO reports and at least seven hearings in the past five years, including hearings before (1) the House Committee on Energy and Commerce, Subcommittee on Commerce, Trade and Consumer Protection, February 15, 2006; (2) the  Senate Judiciary Committee, July 19, 2006; (3) the House Judiciary Committee Antitrust Task Force, July 19, 2007; (4) the House Judiciary Committee Antitrust Task Force, May 15, 2008; (5) the House Financial Services Committee, October 8, 2009; (6) the House Judiciary Committee, April 28, 2010; and (7) the Senate Appropriations Committee, Subcommittee on Financial Services and General Government, June 16, 2010.  

Of course, previous Congressional hearings and GAO reports on the issue of interchange reform were hampered by the financial industry’s unwillingness to share key information about the interchange system.  As GAO noted on p. 23 of their November 2009 report, “We were not able to obtain data from the largest card issuers about their revenues, profits, or expenses to compare interchange fee revenues with expenses.”  The enactment of the Durbin Amendment and its requirement that industry provide key information to the Fed was necessary to bring this information to light, and this information has appropriately guided the Fed’s rulemaking process.
 
The Push for Delay or Repeal

Finally, I would note that many in the financial industry are pushing to stop or delay the Fed from implementing the interchange reform that Congress directed them to implement.  They are urging this action before the Fed has even crafted its final rules, and despite the fact that the amendment already provides ample timeframes for implementation between the issuance of the final rules and their effective date.  

The record shows that the financial industry has always fiercely opposed interchange reform efforts ever since the introduction of bipartisan reform legislation back in 2008.   However, after years of considering the issue, Congress has now recognized that interchange reform is necessary and has passed a reform law that should be given time to work.  


Thank you for the opportunity to provide this statement today.