Economic Analysis: Durbin Amendment

As part of the Dodd- Frank financial regulatory overhaul passed in 2010, the Durbin Amendment was designed to “reduce costs for merchants that accept debit cards” (Sidel, R. December 8, 2011. PP. 1) by imposing a ceiling on the interchange fees which the banking service industry could charge their clients. As with most government intervention into economic activity, there is well intention to ameliorate perceived market failures, protect consumers, or more strongly regulate business. Yet, the how externalities arise from beneficent government activity. In this case many small to medium size merchants, and consequently their customers are experiencing higher costs not lower.

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The Durbin Amendment’s ostensible goal is to protect merchants from the confiscatory pricing on debit card interchange fees charged by the banking industry. The legislation empowered the Federal Reserve to set interchange prices, “capping merchant customer debit card fees at 21 cents per transaction- down from an average 44 cents” (Zywicki, T. September 29, 2011. PP. 1). The banking industry is now “faced with a dramatic cut in revenues (estimated to be 6.6 billion by Javelin Strategy & Research)” (Zywicki, T. September 29, 2011. PP. 1), and is looking to recoup this loss through multiple avenues, including increases in interchange fees for small to medium size merchants which conduct “transactions that are less than $10” (Sidel, R. December 8, 2011. PP. 1). Prior to Durbin, banks and financials which “used to give merchants discounts on on small transactions, have responded by eliminating the discounts” (Sidel, R. December 8, 2011. PP. 1). Additionally, banking institutions have made significant changes to “imposing new monthly maintenance fees-usually from $36 to $60 per year-on standard checking and , as well as new or higher fees on particular bank services” (Zywicki, T. September 29, 2011. PP. 1).

Economic Concepts

The Durbin Amendment highlights multiple economic tenets; namely how price controls distort economic activity by artificially manipulating the supply and demand equilibrium, the incidence v. burden of taxes and fees, and supply-side drag due to reductions in innovation. Further explication of these concepts is warranted to illustrate the externalities of government intervention.

The interchange fee is fundamentally a price control, with a ceiling placed on the debit card transaction fee of 21 cents. A price ceiling in this case is placed below the market rate for interchange fees of 44 cents, and causes merchants to at the lower price, but equivocally witnesses banking institutions decreasing quantity supplied. As with all price ceilings, shortages result as the equilibrium price and quantity are distorted. In this case the shortages appear not only in transactions, as “consumers are encouraged to shift from debit cards to more profitable alternatives such as credit cards” (Zywicki, T. September 29, 2011. PP. 2), but also with banks recouping lost revenue through higher fees on other bank services.

As just noted, the impact of the price control is the change in behavior of buyers and sellers in what was an equilibrium market, but in typical fashion the effect is harmful to those the regulation meant to protect. Here the idea is that the incidence of a tax, fee, or price control is far different from the burden i.e. those who ultimately pay its cost. In the attempt to help merchants, the Durbin Amendment has in fact increased interchange fees for the small business owners. “Overnight, the variable costs of a transaction have tripledmy