Academic journal article Economic Review - Federal Reserve Bank of Kansas City

The New Debit Card Regulations: Initial Effects on Networks and Banks

Academic journal article Economic Review - Federal Reserve Bank of Kansas City

The New Debit Card Regulations: Initial Effects on Networks and Banks

Article excerpt

A merican consumers are using debit cards more than ever before, affecting how banks and merchants do business and triggering key changes in the payment card industry. At the same time, the growing fees levied on merchants by the payment card industry for processing debit purchases have stirred controversy. Congress and the Justice Department have intervened in the last two years, seeking to advance consumer welfare by promoting competition within the payment card industry. The new rules cap certain fees and give merchants the freedom to choose among rival card networks.

Proponents of these interventions argue they help bring fairness, transparency, and competition to the payment card market. According to this view, a lack of competition among debit card networks had led to unduly high fees for merchants. Part of the burden of the outsized fees ultimately fell on consumers, as merchants passed on the cost by raising prices for their goods and services.

Others argue, however, that the debit card market was already marked by intense competition, aimed not at winning merchants to a given card network but at attracting consumers to a given bank's debit cards. The growing fees charged to merchants enabled card-issuing banks to use some of the fee revenue to offer debit card rewards to consumers and allow debit card use without charge. According to this view, the interventions by Congress and the Department of Justice might make consumers worse off. Consumers could see rewards programs vanish and may face higher banking fees as their banks try to offset lost revenue. These changes in turn could lead consumers to switch away from debit cards to other payment methods.

As new proposals emerge for encouraging competition and promoting consumer welfare, it is important for policymakers to review the early evidence of how the regulatory changes so far have affected debit card networks, banks, merchants, and consumers. This article, the first in a series of two, examines the regulations' initial effects on card networks and banks. The second article, appearing in the next issue of the Economic Review, will consider the regulations' effects on merchants and consumers.

A detailed review of how the new rules have affected card networks and banks-and how they have begun to respond-shows that fee structures have adjusted, incentives within the industry have shifted, and the market shares of the top card networks have changed. Early signs suggest the interventions achieved some of their intended purpose, fostering increased competition in some areas of the industry. But whether the broader public reaps benefit in the long run will depend, in part, on the results of new revenue-generating strategies adopted by key players in the industry.

Section I of this article provides background on the structure of the U.S. debit card industry and the regulatory and legal changes enacted in the last two years. Section II describes how the changes have affected card networks and what strategies the networks have adopted in reaction. Section III evaluates the impact on banks and reviews the banks' initial responses. Section IV summarizes the impact that these changes may have on the level of competition within the industry, now and in the future.

The second article in this two-part series-forthcoming in the First Quarter 2013 issue of the Economic Review-will examine the ripple effects of the regulatory and legal changes on merchants' business practices and costs and, ultimately, on the bottom line for consumers.

I. INDUSTRY STRUCTURE AND THE NEW REGULATIONS

The debit card market consists of a complex array of institutions, fees, and types of transactions, all affected by the new regulations and legal settlement that took effect in mid-2011. This section first provides an overview of the industry's rapid growth in recent years; its key institutions and their market shares; and the industry's complex fee structure, which has changed significantly over the last 15 years. …

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