How Fed Debit Card Regs Could Drive Debanking

Aaron Klein is Miriam K. Carliner Chair and senior fellow in Economic Studies at the Brookings Institution.

Adam Rust is the director of financial services for the Consumer Federation of America. Formerly, we was a senior policy advisor for the National Community Reinvestment Coalition. He served two terms on the Board of Directors of the US Faster Payments Council.

Debanking, the removal or refusal of banks to offer accounts to customers, is a hot topic in Washington, with Federal Reserve Chairman Powell pledging to examine the issue. One of us testified before Congress that the high cost of basic banking causes people to be debanked. Today, 5.6 million households in America – and approximately one in ten Black, Hispanic, and Native American households – lack a bank account. 

While debanking has garnered headlines, fewer may be aware of the Fed’s plans to lower swipe fees charged on debit cards. We believe this proposal is a mistake that could exacerbate debanking. Instead of moving forward with a rule that will make the problem worse, the Fed should address how overdraft fees cause people to leave the banking system. 

Why would a regulation on debit card swipe fees cause people to become unbanked? People who live paycheck to paycheck typically pay with debit and, by definition, do not maintain deposit balances high enough to generate meaningful interest margins for their banks. For these accounts, debit swipe fees are a significant source of revenue for banks. And importantly for consumers, these fees are vital to the economics of banks offering basic accounts, and an alternative to another bank economic model – high-cost overdraft fees – that is substantially worse for consumers.

A better path for the Fed is to step up its lax regulation of banks and overdraft practices. While the Fed has done nothing to reign in abusive overdraft practices among the banks it regulates, some, including many big banks, voluntarily reformed their overdraft practices, and the CFPB finalized a new rule to further rein in overdraft fees. We hope Congress resists the proposal to reverse the CFPB’s sensible rule. Congress should see the connection between not being able to afford bank account overdraft fees and deciding not to have a bank account. Further, they should understand that when 40% of American households have less than $400 in liquid funds, many will opt out of banking if their savings are endangered by surprise overdraft fees. Lowering debit swipe fees and green-lighting overdraft fees is a two-stroke engine that could debank millions. For different reasons, banks and consumers will make dollars-and-cents decisions, and the impacts will be to the detriment of our economy.  

Whether Congress keeps or eliminates the CFPB’s overdraft rule, a problem remains: The rule will not apply to small banks or credit unions. A similar carve-out permits those banks and credit unions to charge more for debit swipes. Thus, the Fed’s debit proposal will further widen small banks' advantage in achieving profitability from lower-wealth customers. This would result in small banks that can still charge $35 for an overdraft having an even greater economic advantage in serving those living paycheck to paycheck for whom the new overdraft regulation is targeted. Sadly, a handful of small banks and credit unions rely on overdraft fees for a majority (and in some cases a totality) of their profit, a practice the Fed and other bank regulators have refused to rein in. Why should the banks that can still charge high overdraft fees also get to charge higher swipe fees? 

The Fed’s proposal would also exacerbate a different loophole favoring small banks that partner with online fintech companies. When Congress exempted small banks from debit card swipe fee caps under the Durbin Amendment to the Dodd-Frank Act of 2010 it led to an unexpected outcome: a wave of partnerships between small banks and fintech companies because the smaller banks have more interchange revenue to share. Fintechs deserve credit for popularizing no-overdraft accounts and pressuring others to follow. On the other hand, their business model cuts costs by eliminating bank branches, which limits access for those without digital access. Moreover, gaps in the regulation and supervision of fintechs can leave people vulnerable, even for the money they thought was fully government-insured, and efforts to undermine the CFPB only make matters worse. For example, look to the fintech Synapse debacle. Why should the Fed further advantage the fintech business model with higher swipe fees? 

A third potential problem looms: the merger of Capital One and Discover. Discover owns a payment system, exempting it from the Fed’s proposal. Should these banks merge, they would have a strong competitive advantage, enjoying higher interchange fees and the economies of scale that come from being a mega-bank. Why should the Fed allow one mega-bank to charge higher swipe fees, further distorting the market?

For years, the Fed has directly ignored instances when banks play gimmicks like reordering transactions to drive up overdraft fees. The Fed has had no problems with banks they regulate relying on overdraft fees for the majority their profits. While some banks have made efforts to reduce or eliminate overdraft fees, the gutting of the Consumer Financial Protection Bureau (CFPB) endangers the progress.

To address our top priority – access to high-quality banking for people of moderate means – the Fed could exempt non-overdraft basic accounts (aka “Bank On” accounts) from lower interchange rates. This would reward larger banks for offering safer bank accounts. This single proposal would lower the cost of living for millions of  working people.

The Fed is at a crossroads. We urge it to make a U-turn and follow signposts on swipe fee reform to help the millions of Americans struggling to make ends meet in this economy.

The opinions shared in this article are the author’s own and do not reflect the views of any organization they are affiliated with.

Open Banker curates and shares policy perspectives in the evolving landscape of financial services for free.

If an idea matters, you’ll find it here. If you find an idea here, it matters. 

Interested in contributing to Open Banker? Send us an email at [email protected].

Like Open Banker? Check out Capitol Account, a daily newsletter on financial regulation. Capitol Account is written by veteran financial journalists and has become essential reading for top policy makers, advocates, and executives. Click here for more information.