ICLE White Paper Explores Adverse Consequences of Payment-Routing Rules

PORTLAND, Ore. (Aug. 19, 2022) – Proposals before Congress and the Federal Reserve to control how credit- and debit-card transactions are routed threaten harms to consumers and smaller merchants, and could render co-branded cards a thing of the past, a new white paper from the International Center for Law & Economics (ICLE) concludes.

Written by ICLE Senior Scholar Julian Morris and Academic Affiliate Todd Zywicki, the George Mason University Foundation Professor of Law at Antonin Scalia Law School, the paper follows earlier ICLE research on the so-called “reverse Robin Hood” effect and the effects of price controls on payment-card interchange fees, as well as payment-card regulations in Brazil and Costa Rica.

The Federal Reserve already requires all debit cards to include at least two unaffiliated networks on their cards, as specified in Regulation II, the 2011 rule that implemented the Dodd-Frank Act’s so-called “Durbin Amendment.” The Fed currently is considering whether to interpret that requirement much more expansively, such that issuers would be required to enable two networks to process debit transactions on card-not-present transactions, including online transactions, and “for every geographic area, specific merchant, particular type of merchant, and particular type of transaction for which the issuer’s debit card can be used to process an electronic debit transaction.”

The authors identify several harms that would be expected if the Fed moves forward with the proposed changes, which will prompt more merchants to route transactions on the lowest-cost network, rather than the one primarily tied to the issuer.

“First, by splitting transactions over two or more networks, the cardholder’s payment patterns will be obfuscated, making it more difficult for machine-learning algorithms to detect unusual spending patterns and thus flag potential fraud,” Morris and Zywicki write.

“Second, to the extent that cardholder benefits are tied to a particular network—including, but not limited to, fraud-prevention tools such as card blocks—these may not be available to consumers if the merchant chooses not to route over that network,” the authors add.

In addition to the proposed changes to Regulation II, Sen. Richard Durbin (D-Ill.)—author of the original Durbin Amendment—has introduced the Credit Card Competition Act, which would impose similar routing requirements on credit cards. Morris and Zywicki note the bill “is specifically intended to reduce the volume of credit-card payments routed over Visa and Mastercard’s rails.”

“If enacted, it would likely achieve that effect, with the result that interchange fees received by issuing banks would be much reduced,” the authors write. “Issuers would then respond by raising fees and reducing rewards on credit cards, just as they did in Australia and elsewhere when credit-card interchange fees were forcibly reduced.”

“The only unambiguous beneficiaries of the proposed routing changes will be the shareholders of very large retailers and service providers that have their own machine-learning-based profiling and fraud-prevention tools, enabling them to use cheaper, less secure routing without a significant in-crease in fraud and other losses,” Morris and Zywicki conclude.

The full white paper is here. Journalists interested in interviewing ICLE scholars about the law & economics of payments networks should contact ICLE Editor-in-Chief R.J. Lehmann at [email protected] or 908-265-5272.