Given the critical importance of pending rules on interchange fees, FedFin has looked at new Federal Reserve research that will affect the rulemakings here. Importantly, at least one study from inside the Fed now argues for rulemaking based on reversing income inequality.
A recent study by the Federal Reserve Bank of Boston pertaining to interchange fees and credit card rewards programs found that lower-income borrowers—who use cash, checks, or debit cards more than higher-income households—subsidize the costs of credit card rewards programs for wealthier consumers. While the study did not allege that credit card companies or banks have designed the credit card market intentionally to produce a regressive transfer from low-income to high-income households, the conclusions do provide an interesting argument for regulating credit cards by stating that, “income inequality” is sufficient justification for policy intervention in the credit card market.
The Dodd-Frank Act gives the Federal Reserve responsibility for regulating interchange fees associated with debit cards—but not credit cards, except to ensure that the credit card interchange payments are “reasonable and proportional” to the cost incurred by the issuer. The main argument in favor of regulating interchange fees during negotiations in Congress was unfairness to cash users who bore retailer mark-ups imposed to cover what merchants and consumer advocates argued were unduly higher interchange fees. Now, discounts may be provided and retailers have considerably more right to shop among card providers, although the pending FRB rules – which must then be finalized and implemented by the Consumer Financial Protection Bureau – will be the principal force in redefining the retail-payment market. Reflecting this, banks like Wells Fargo have already announced major changes – downward – in their earnings forecasts.
The study defines lowest income households as those earning $20,000 or less annually, with the highest-income household earning more than $150,000. On average, accounting for rewards paid to households by banks, the lowest-income household pays $23 in increased costs and the highest-income household receives a $756 subsidy every year. The study concluded that because higher-income households benefit disproportionately through rewards programs, reducing card rewards and merchant fees “would likely increase consumer welfare.”
It will be interesting to see the study’s effect on interchange fees going forward—Dodd-Frank has already been signed into law of course, but the Federal Reserve does have considerable discretion over the regulation of interchange fees. So the Fed may decide to heed the policy prescriptions from the Boston study, given that the differences between the lower-income and higher income consumers regarding interchange fee costs are indeed so pronounced. However, if the Fed does not act swiftly to ensure that the fees are “reasonable and proportional,” it could signal the beginning of a long debate with the newly-launched CFPB over the authority to set fees on cards. Finally, with respect to card rewards, credit card companies may also scale them back anyway in order to trim costs during a time of diminished consumer spending. Nonetheless, the Boston Fed’s research sheds light on two important issues that consumers, payment card companies, and merchants alike are all justifiably concerned about.