New Interchange Proposals Debut From the Federal Reserve

The Federal Reserve has put out its proposal for interchange reform and they are very promising.

Under Alternative 1, issuers with costs in excess of the safe harbor would be permitted to recover their average variable costs for authorization, clearance, and settlement up to a cap. The proposed standard sets a cap of 12 cents per transaction, which corresponds to approximately the 80th percentile of allowable costs across issuers that responded to the survey.

The financial sector does two things: it provides a medium of exchange for buyers and sellers (cash, checks, credit cards, money orders, etc.) and a matcher for borrowers and lenders. It is wholly appropriate that interchange fees, fees that are some of the highest in the world and increasing, be subject to regulation, as this medium of exchange function drives all the other parts of the economy. In the same way that checks are regulated by the Federal Reserve, debit cards, the 21st century equivalent of checks, should have the same regulation to encourage them to trade at par.

Money is an object that acts as a store of value for payments of debts, goods or services. Is it necessary that a private corporation collects 2%+ of value in order to move this object from place A to place B?  The breakdown in the merchant rules that prevent businesses from discriminating between debit and credit cards, because they go to the payment system that provides the infrastructure for our markets, distort all kinds of outcomes.

It generates inequality through the very act of consumption, where the poorest people paying cash pay extra to buy frequent flyer miles for the richest.  It gives price advantages for large businesses and discriminates against and blocks out small businesses. Competition seems to increase interchange rates, as banks have to soak merchants more to get another card into your wallet at the margin, and merchants can’t price discriminate.

So Dodd-Frank allow for the discrimination of debit and credit cards and then has the Federal Reserve set a limit on the debit card rate. This creates a market between the two where there wasn’t before.

As Felix Salmon notes: “This is a victory for Dodd-Frank, a victory for consumers, and above all a victory for merchants over the financial-services industry. Assuming, that is, that the banks don’t find some way of killing, avoiding, or repealing it. Well done, Fed.” Agreed.

These rules now will move to a comment period through February.  It’ll be interesting to see what the financial sector responds with, and how it plays out with a likely GOP and Hard Money Right war against the Federal Reserve next year.