Three Points about Interchange Reform: Pass Through, Australia, Low-Income Groups.

Let’s say you are a careful business news reader, and the following story just broke:  Saudi Arabia is going to double the amount of oil it produces.   Would you think the following:  “This will be a major windfall for oil companies, as consumers are unlikely to see any decline in prices.  The oil companies will simply not pass any savings along to consumers.”

Or use a different industry.   Let’s say there’s been a breakthrough where computer manufactures can make the same exact microchip at half the cost.    Would you think the following:  “This will be a major windfall for computer manufactures, as consumers are unlikely to see any decline in prices.  Computer manufactures will simply not pass any savings along to consumers.”

That’s why its a little bit frustrating to see this so much in the interchange debate. The level of bank lobbying over this topic is intense.   Their messaging to customers is so one-sided Annie Lowrey wrote a parody letter poking fun at it.   But to get to the passing savings part of it, for example, here is Antony Currie at Reuters, explaining the banking line:

The argument is that reducing them would allow merchants to cut prices, benefiting consumers overall.

Isn’t that a good thing?
Not necessarily. There’s no guarantee merchants would pass on the savings to customers. That didn’t happen when Australia imposed similar limits, studies show. That’s why the financial industry argues the Durbin Amendment will simply take $16.2 billion of its revenue and gift it to merchants, particularly big-box retailers like Target, Wal-Mart and Home Depot.

A few things.

1. Pass-Through

It’s fun watching bank lobbyists become super-duper high hysterical New Keynesians, where menu costs keep any possible savings from passing through to consumers and informational and macroeconomic frictions and monopolistic competition everywhere give giant windfalls to big-box retailers.  (Welcome to the club, but where were you guys when we needed a second round of stimulus?)  Even if this is the case, businesses compete on all kinds of things other than price, and if the cost of using money goes down for business even if that isn’t transferred through price mechanisms there are other ways it’ll get transferred.  It may go to wages, it may go to hours, it may go to quality of products, etc.  But it’ll go somewhere.

(And even if it is just used as working capital for expansion at the firm level, I think more growth and investment done through business-level implementation is going to be better than at the level of the six largest banks.   Not that all that rotting housing stock in abandoned exurbs and gigantic valuations for dilapidated shacks in urban cores wasn’t the best use of our resources in the past decade or anything, but maybe Wall Street can slow down a bit and firm owners can drive the car for a while.)

It will pass through in sectors that are more competitive than other sectors.   And what do we think is more competitive – the retail market, with its brutally thin margins?   Or the banking sectors, where you can look up the latest 11+ figure bonus pool numbers yourself?

2. Australia

“That didn’t happen when Australia imposed similar limits, studies show.”  There’s been no study on Australia that argues that.

If this is referring to the Mastercard funded Charles River Associates study on the impact of interchange reform in Australia, there are some problems.  Adam Levitin:

There’s a MasterCard-funded study which found (surprise, surprise) that interchange regulation hurt consumers. But the study reaches this conclusion by looking at annual fees and levels of rewards, which are just two pieces of a much larger picture. Selective metrics can’t tell us about overall consumer welfare (or the distribution thereof). To do so would require a detailed analysis of, at the very least, Australian consumer prices (including rate of inflation) and Australian credit card products (including interest rates and other fees, not just annual fees and rewards). The data for such a study doesn’t exist. No one can take an empirically-founded stance one way or another. What this means is that statements from MC/Visa and their defenders that consumers in Australia haven’t benefited from interchange regulation are simply nonsense.

For one, they don’t look at the actual credit card products outside annual fees. It is likely that interest rates plummet as cards become competitive on rates, not fees. We don’t know about Australian consumer prices, including rates of inflation.  Joshua Gans, who has studied Australia in depth, found “It was found that the capping of the interchange fee likely did have an impact on retail prices and that the net effect was no redistribution of wealth from consumers to merchants. Zywicki argues that, in Australia, the reforms harmed access to credit. But that is clearly not the case.”

If Australia is the worst case example, it’s not a worst case.  It’s not even a case.

3.  Low-Income Groups

Another line I’m hearing lately is that interchange reform will impact access to banking services for low-income groups.  I don’t see any evidence that this will impact access to low-income banking customers as low-income groups aren’t profitable at the margins through interchange.

Let’s pull some data on overdraft from FDIC’s Study of Bank Overdraft Programs, November 2008 (we discuss this at length here). NSF stands for Non-sufficient funds, which is an overdraft.  This is one of many fees you can get charged.  On average across all counties that the following study was carried out on, the upper bound for low income bracket is $29,263, medium is $46,821, middle is $70,231 and upper is above that.

First question: How much money does a low income bracket user have in their checking account over the course of a year?  Table IX-10:

Over 55% of low income users have, on average, less than $100 in their banking account.   80% have less than $2,000.   Interchange is a percent of how much money you spend, and if all you have is $100 in your checking account chances are you aren’t profitable to the bank because you are churning through your balance and paying it off each and every month.

Why are low-income groups profitable?  Table IX-13:

Low income people pay, on average, more in overdraft fees (see the All column) than any other income group.   They pay about the same per overdraft, they are just more likely to have overdraft transactions.   Interchange reform, as far as I can tell, is unlikely to change this dynamic.