Debit Cards: Priceless?

When the banking industry talks, the U.S. Senate listens. And in the past the bankers have had little difficulty in brushing aside efforts by retailers to regulate fees on charge card transactions. But not this time around: If the House concurs, “interchange” fees on debit card transactions – at least those charged by all but the small-fry banks (under $10 billion in assets) – will be capped at a level the Federal Reserve decides is “reasonable and proportional.” What’s more, merchants who choose to accept debit cards will nonetheless have the discretion to offer discounts to customers who use cash.

The big retailers claim the provisions would save customers tens of billions annually. Mastercard, Visa and American Express say it would just shuffle the costs around, with card users bearing the charges in the form of higher annual fees, fewer perks, etc. We don’t know whether the banks would, in fact, be able to dodge the hit to their bottom lines. And if it turned out that they couldn’t, we don’t know whether merchants would share the bounty with customers, or swallow it all themselves. Indeed, we don’t think anybody knows – the research on who, in the end, bears the cost of interchange fees is inconclusive. What we do know is that, while one can conjure up a plausible economic case for interfering with market outcomes here, putting government bureaucrats in charge hardly guarantees a satisfactory fix.

Charge cards operate in a “two-sided” market, providing services to both merchants and card users in each transaction. And economic theory is of limited help in determining what proportion of the costs each side pays in a competitive environment. It is thus possible that lowering fees would increase economic efficiency by reducing the excessive use of plastic. Or maybe, lower fees would be a bad thing, slowing the transition to a paperless economy. So how does one decide?

While it is a stretch to claim that the free market drives interchange fees to efficient levels, letting the Fed decide (presumably with help from self-interested parties) seems even less likely to advance the cause of efficiency. Besides, it would be a shame to sully the Fed’s reputation for straight-shooting by putting it in charge of the sort of brute political task that reduced the now-defunct Civil Aeronautics Board and Interstate Commerce Commission to pigpens for lobbyists.

The other piece of the initiative – allowing merchants to offer discounts for cash – seems on balance to be a good idea because it would add a bit of competitive pressure on card fees. But then, if merchants are allowed to offer such cash discounts, why stop there? Indeed, why regulate these fees at all when the economic case is muddled at best?