Will the US Durbin Foster Financial Inclusion?

In 2010, the Durbin Amendment (or Amendment II) was passed in the United States, effectively putting a cap on Interchange fees for debit card transactions. Now, further caps on debit Interchange fees are being proposed, and a potential cap on credit card transactions is being discussed. Large banks and Credit Unions are alarmed.

The Durbin Amendment is meant to make digital payment products, particularly the ‘entry’ product of debit, be less costly for the consumer, and potentially make them use it more. But this doesn’t work because the cost savings are not actually passed on to the consumer. Instead, it makes the largest issuers with the most potential reach ignore their debit products, thus putting up more barriers to entry for underserved and unbanked populations in the US given that debit is an ‘entry product’.

But what and why is Durbin?

Let’s take a step back. Every time you use your payment card, the bank that issued you that card gets a fee called ‘Interchange’. Typically, each bank sets their fees based on different factors e.g., using your card to buy something on the Internet is riskier than using it physically, so Interchange for that virtual use is higher. The Interchange is taken off of the merchant/store you made your purchase. It’s generally expected that the store factors this cost into their operations or markups for such payments.

The 2010 Durbin Amendment in the US, however, put a cap on how much Interchange your bank can charge when you use your debit card. (This doesn’t apply to smaller card issuers with less than $10 billion in assets). This has meant that merchants have benefited a huge deal in cost savings. This has been especially great for large merchants who deal in so many transactions. Their savings have been exponential, the banks and other players have lost money, and the consumers have seen no difference.

Now the government wants to do it all over again.

Presumably, Durbin 1.0 happened in 2010 to make it easier for cardholders to actually use their cards, thus reducing the barrier to entry for the debit card. The government is intending to lower this barrier even further by making it cheaper to use the card. Given that true financial inclusion cannot happen unless the products are used, this is truly a notable aspiration. The deposit account, and the associated debit card that usually comes with it, is typically one of the first financial products people get when they are coming into the formal financial system - whether they’re turning of age, are newcomers in the country, or getting an account for the first time because they’ve just started earning enough. The Federal Reserve shared that 93% of American adults had a debit card in 2021, compared to 82% of adults holding a credit card. Getting to 100% of adults will likely be a debit play.

Another potential reason might be to tackle the growing plague of debt in the American society - for the first time, credit card debt surpassed $1 trillion in 2023. Staggering!

Why the New Amendment Might Not Work

Because the old Amendment didn’t work.

The intention was to significantly reduce the barriers that fees might cause for the general public, and thus encourage them to use their cards to pay. But these consumers saw no change in fees because merchants didn’t pass it on.

In fact, they faced new challenges of higher fees on their actual deposit (checking) account as banks started to increase these fees to recoup their lost revenues. This Interchange cap might also have been one of the defining reasons for many card-issuing banks to largely neglect their debit card business and focus on the more profitable and competitive credit card. Richer rewards and perks were poured into credit cards, while investments in debit cards were kept to a minimum.

Even more stringent regulations as being proposed would make this situation worse - more fees on checking accounts, higher minimum deposit requirements, and more quiet abandonment of debit card portfolios by affected card-issuing banks. All of these potentially means a regression for financial inclusion.

Research into the effects of Durbin 1.0 showed that the availability of free checking accounts were reduced, making a number of people abandon their checking account and become unbanked. Furthermore, issuers focused on promoting credit cards instead, despite the fact that Americans should not be accumulating more debt.

It’s worth noting though, that overall, permanent fee caps hardly ever have the intended effects because they ultimately stifle competition and make investments in the focus product tremendously unattractive for businesses.

What Might Work?

High fees have never quite been a top reason why people don’t use their debit cards; availability of funds is. Several research shows that lower-income households especially use debit cards more than other income segments. And while it’s intuitive to believe that they would be concerned about fees, it’s not front and centre when they use their cards because the fees are largely invisible - embedded in their purchase. Another top reason people prefer their debit cards is because it helps them budget better since they’re not tempted to run free with a credit line.

It stands to reason that boosting economic and digital activity should be built on the foundation of increasing income and improving financial resilience for the public. Plus, rather than limiting fees further, attention could be on giving card issuers the space to create value-adding features that help cardholders better budget and track their spend.

There might also be an opportunity for smaller card issuers who are not yet subject to the Durbin Amendment. Given that debit cards might be more profitable for them, they can be more imaginative and creative with this product than larger card-issuing banks. They are particularly in a better position to provide unique solutions to unique population segments anyway…as long as merchants/stores don’t restrict the use of their cards.

In Conclusion…

Fee caps have traditionally not been the most effective way to boost usage of financial products. And so, increasing the debit interchange cap will do nothing to boost economic activity and financial inclusion because card players will be less motivated to push the product and potentially even add on unnecessary fees on linked deposit products. Better to leave this alone and instead, allow innovation to thrive according to market forces.

References: The Federal Reserve, Freshbooks, Greenberg Traurig, CNet, SPGlobal, Protect Interchange