Editor’s note: Piotr Brzezinski, a friend who has thought very deeply about financial reform, has kindly greed to share his thoughts on the Durbin Amendment, a measure designed to curb interchange fees. I have mixed feelings about this effort, and in the past I’ve begrudgingly suggested that regulation might be appropriate given the strength of the market position of Visa and Mastercard. But Piot’s analysis has convinced me that the unintended consequences outweigh the benefits.
Leafing through JP Morgan’s annual Investor Day presentations, I was struck by a couple charts:
As a result of recent regulations JP Morgan’s poorest customers (or, technically, those with the smallest deposits and investments) have become 35% less profitable but the wealthiest have only become 5% less profitable.
This makes sense: Dodd-Frank and related regulations clamped down on bank fees. Banks make money from fees and from investing customers’ deposits. Poorer customers make fewer deposits; fees, therefore, play a more important role in enabling banks to serve poor customers profitably.
Even after Dodd-Frank regulations, fees contribute over 50% of bank revenues from the poorest two segments but less than 5% for the wealthiest segment.
The effect of targeting such fees, unfortunately, is to deter banks from serving the poor. Almost one out of ten American households go unbanked, paying up to $1,200 a year in alternative service fees (e.g. payday loans) on a $20,000 income. Faced with such shocking costs — typically falling on the most vulnerable in society — you’d think that financial-sector reforms like Dodd-Frank would seek to get poor customers into the system; instead it makes serving such customers unprofitable.
Of course, it’s hard to argue with new regulations insofar as they make it harder for banks to bamboozle customers with hidden fees; a market that’s only profitable because of corporate trickery is no market at all. But many Dodd-Frank regulations go well beyond the laudable aim of improving market transparency.
The Durbin Amendment, in particular, looks spectacularly misconceived. By capping the amount banks can charge merchants for debit transactions, Durbin undermined the economics of providing bank accounts to poor customers; although debit interchange fees were unseemly — high profits; low marginal costs — they made it profitable to serve customers who wouldn’t otherwise warrant the cost of attracting their deposits. It’s no surprise, therefore, that we’ve seen the proportion of banks offering free checking accounts with no minimum balance (the kind that low income households are most likely to use) fall from 76% to 39% since the passage of Dodd-Frank.
Felix Salmon and others have inveighed against interchange fees because they raise merchants’ prices, disproportionately harming customers who pay in cash or debit rather than with a generous rewards card. But debit fees don’t particularly benefit cushy Starwood Rewards–style card owners; the cross-subsidy from merchants to banks benefits all card users and especially those whose accounts only become profitable as a result of such fees (i.e., the poor). Unbanked cash users do lose out—since they pay higher prices and don’t benefit from an account — but it’s not a simple rich vs. poor narrative; other low-income customers benefit from a bank account they would not have otherwise had.
Ultimately, banks exist to make profit. The problem with the Durbin Amendment and related regulations is that, if you make a given set of customers less profitable, banks will shift their service provision away from those customers. In JP Morgan’s oblique language, the bank will “align our service models toward the highest potential customers.” Given the costs of going unbanked, this harms precisely the people that the financial reformers are seeking to protect.