Bank Profitability and Debit Card Interchange … · Debit Card Interchange Regulation: Bank Responses to the Durbin ... Constant -0.00156 0.00102 0.00278 0.00825 (0 ... Bank Profitability

Introduction Summary Results Data Testing Concluding Remarks

Bank Profitability andDebit Card Interchange Regulation:

Bank Responses to the Durbin Amendment

Cindy M. Vojtech*joint with

Benjamin Kay** and Mark D. Manuszak*

* Federal Reserve Board**Treasury, Office of Financial Research

April 4, 2014The views and opinions expressed in this paper are solely the

responsibility of the authors and should not be interpreted as reflectingofficial policy of the Treasury Dept. nor of the Federal Reserve System.

Kay, Manuszak, & Vojtech (FRB and UST) Durbin Amend.–Debit Card Interchange 4/4/2014 1 / 14


Introduction—Durbin Amendment Background

Durbin Amendment of Dodd–Frank instructed the Board to1 Establish “standards for assessing” whether any interchange fee for a

debit card transaction is “reasonable and proportional to the costincurred by the issuer with respect to the transaction.”

2 Prohibit network exclusivity arrangements for debit cards and routingrestrictions on merchants.

This paper analyzes some effects of Regulation II (“Reg II”)implementing 1.

Identification is possible becauseI Law created a somewhat arbitrary size cut-off for exemption: $10 B in

consolidated assets.I Little to no incentive to adopt early or change behavior in anticipation

of the regulation.

Timeline



Effect on Debit Card Interchange Fees for Treated Firms

$32 billion interchange fees collected by banks in 2009. Debit cardsalone estimated at $16 billion (Board 2011).

Before the law, the interchange fee was on average $0.44 for anaverage $38.00 transaction

After the law was in effect (2011 Q4), for a treated firm (>$10B),that $38.00 transaction provides a $0.24 interchange fee

I 21 cents/transaction + 5 bps + 1 cent fraud-prevention adjustmentI 45% fall in interchange fee

Transaction



Summary of Potential Outcomes of Reg II

Outcomes Examples AddressedPrice increases on related finan-cial services

* Charge account maintenance fees forchecking accounts

In scope

* Establish higher minimum balances* Reduce account interest rates* Eliminate reward programs

Bank profitability harmed * Reduce noninterest income In scopeReduced quality of related finan-cial services

* Close bank branches In scope

Customers shifting to alternativeproducts

* Move debit card customers to creditcards

Not in scope

Pass-through of reduced inter-change fees

* Lower prices for consumer goods Not in scope

Merchant profitability helped * Lower costs for merchant expenses Not in scope



Testing Strategy & Summary Results

Difference-in-differences: Exploit law’s $10 B thresholdI First difference: Change over time for treated and not-treated banksI Second difference: Differential change between treated and not-treated

banks following Reg II’s effective dateI Advantages and disadvantages of diffs-in-diffs approach

Summary resultsI Interchange income falls: Treated banks did not disproportionately

increase debit card volumes or switch customers to credit cardsInterchange income graph

I Deposit fees increase: Evidence of partial mitigation by treated banksDeposit fee levels graph Deposit fee growth graph

I Broader income measures fall: Consistent with incomplete mitigationby treated banks

I No significant evidence of lowered quality: Lowering expenses,decreasing operations, or changing size to avoid treatment



Data

“Bank” data: Bank holding company (FR Y-9C) and commercialbank (Call Report)

I Regulatory financial statements filed quarterlyI For BHCs with >$500 million in assets, standalone banks from Call

Report restricted to >$500 million

Exemption status: Based on commercial bank lists published by theBoard in 2011, 2012, and 2013 aggregated to BHC level

Regressions on two families of panels1 Consistent Panel—688 firms; for all nine primary variables, a

year-over-year log difference can be calculated for at least four quartersbetween 2011 and 2012.

2 [Variable Name] Panel—firms that report given variable such that ayear-over-year log difference can be calculated for at least four quartersbetween 2011 and 2012.

F Panels range in size 700–1,047 firms



Table of Means—Consistent Panel

Levels (000) Log Differences

Not-Treated Firms Treated Firms(407 Firms) (47 Firms) Not-Treated Treated Difference-

Pre-Law Post-Law Pre-Law Post-Law Firms Firms In-Difference

2010:Q4 2011:Q4 2010:Q4 2011:Q4 2011:Q4 2011:Q41 2 3 4 5 6 7

Interchange Income 629 681 115,131 91,717 0.126 -0.261 -0.387(1,277) (1,307) (302,461) (238,621) (0.390) (0.496)

Deposit Fees 1,535 1,503 119,741 126,249 -0.043 0.018 0.061(3,695) (3,712) (279,819) (297,238) (0.191) (0.153)

Core Other Noninterest 984 1,065 141,271 117,339 0.085 -0.121 -0.205Income (1,677) (1,631) (345,791) (283,689) (0.299) (0.430)

Core Total Noninterest 3,870 3,850 693,809 591,803 -0.001 -0.072 -0.071Income (6,551) (6,476) (2,023,087) (1,692,371) (0.214) (0.192)

Core Revenue 17,581 17,908 1,916,518 1,806,469 0.014 0.037 0.023(18,344) (18,793) (4,926,321) (4,420,012) (0.094) (0.190)

Standard deviations are in parentheses.Limited to panel members with all primary variables in 2010:Q4 and 2011:Q4.



Testing Equation

Difference-in-differences methodology

∆yi ,t = [gi ] + λt + τ · ∆Treati ,t + ∆ui ,t ,

where

∆yi ,t = (ln yit − ln yit−4)

λt is a common date-specific effect

∆Treati ,t = 1 if firm i is subject to the regulation at time t and notin t − 4 (an interaction of treated time with treated firm)

∆ui ,t is the error term

τ is the effect of the policy on a firm

gi is a firm-specific growth trend (making it a fixed effect estimate)



Interchange Income

Consistent Interchange Inc. Consistent Interchange Inc.Variables 1 2 3 4

Durbin×Treat -0.412*** -0.420*** -0.405*** -0.409***(0.0492) (0.0541) (0.0490) (0.0508)

Constant 0.142*** 0.141*** 0.149*** 0.149***(0.0274) (0.0272) (0.0264) (0.0263)

Fixed Effects? No No Yes Yes

Observations 10,169 10,330 10,169 10,330Firms 688 700 688 700R-squared 0.023 0.024 0.215 0.218Adj. R-squared 0.021 0.023 0.157 0.160

Robust standard errors in parentheses are clustered at the firm level.Year-quarter dummies are suppressed.*** p<0.01, ** p<0.05, * p<0.10

Relative sizes



Deposit Fees

Consistent Deposit Fees Consistent Deposit FeesVariables 1 2 3 4

Durbin×Treat 0.0401** 0.0334* 0.0262 0.0469*(0.0177) (0.0198) (0.0192) (0.0253)

Constant -0.00156 0.00102 0.00278 0.00825(0.00800) (0.00879) (0.00767) (0.00884)

Fixed Effects? No No Yes Yes

Observations 11,425 16,630 11,425 16,630Firms 688 1,019 688 1,019R-squared 0.028 0.017 0.245 0.229Adj. R-squared 0.027 0.016 0.195 0.178


Relative sizes



Broader Measures of Income—Core Income

Core Other Core Total CoreNoninterest Income Noninterest Income Revenue

Core Other Core Total CoreConsistent Nonint Inc Consistent Nonint Inc Consistent Revenue

Variables 1 2 3 4 5 6

Durbin×Treat -0.240*** -0.245*** -0.0722*** -0.0646*** -0.00268 -0.0127(0.0407) (0.0432) (0.0207) (0.0193) (0.0175) (0.0150)

Constant 0.167*** 0.137*** 0.0160 0.00880 0.0301*** 0.0247***(0.0217) (0.0197) (0.0113) (0.0104) (0.00659) (0.00690)

Observations 11,100 15,225 11,400 16,928 11,435 17,060Firms 688 976 688 1,043 688 1,047R-squared 0.021 0.011 0.007 0.004 0.012 0.012Adj. R-squared 0.019 0.010 0.005 0.003 0.011 0.011


Relative sizes



Robustness Testing

We perform a number of related tests and robustness checks includingtesting

Firms with asset sizes closer to $10 B threshold Figure

For selection into treatment—balance sheet reaction Table

Expense reductions such as salaries and premises Table

For operational changes—number of branches and FTEs Table

For loss of customers—number of deposit accounts Table

For reporting issues—use annual income (year-to-date) Table

Alternative measures of interchange income and noninterest income



Concluding Remarks

Bank managers predicted being able to mitigate 30-50% of revenueloss

I Often described as a multi-product approach

We have a multi-pronged mitigation approach that wouldinclude such actions as reducing the cost associated withdebt card offers, changes and eliminations to rewards,selected fees, incorporation of debit usage in the bundleddeposit product offerings, and the implementation of newproducts. We are consulting with our customers about theirpreferences for our services and how they pay for thoseservices.

—Fifth Third CFO

I Implementation was likely mixed across banks but no general evidenceof cutting costs

Source of quote: FactSet CallStreet through SNL Financial. The conference call was on January 20, 2012.



Concluding Remarks

Treated banks experienced a loss of income following implementationof Reg II

I Interchange income fallsI Mitigation from deposit fees offsets roughly 30 percent of income loss

—suggests that large banks have pricing powerI Results are robust with sub-samples around $10 B thresholdI No evidence of banks changing size to avoid treatment


Supplemental Information

Timeline of Dodd-Frank and Reg II Implementation

Back to Intro



Example of Debit Card Transaction

Note: Numbers are illustrative of the types of fees that would be charged in a transaction andtheir relative magnitudes.

Back to Interchange effect



Interchange Fees: Notable Features

Set by payment card network

Do not vary by issuer

Typically ad valorem + fixed component, sometimes with a cap

Vary by merchant type (large retailer vs. market vs. gas station)

Transaction fee rate comparisons historicallyI credit card > debitI signature debit > PIN debit

Pre-Reg II examplesI Visa signature, standard debit: 1.90% + $0.25I MasterCard signature, standard debit: 1.90% + $0.25I Vis PIN, qualitifed supermarket, performance threshold I: $0.20I NYCE PIN, standard debit: 0.75% + $0.15I STAR PIN, standard debit: 0.75% + $0.16 ($0.66 cap)

Back to Interchange effect



Interchange Income for Consistent Panel

Source: FR Y-9C and Call Report (09:Q1-13:Q2).The Consistent Panel includes the 688 firms that report required values for all nine primaryincome and expense variables. For each variable, a year-over-year log difference (growth rate)can be calculated for at least four quarters between 2011 and 2012.

Back to Summary results



Deposit Fees for Consistent Panel





Deposit Fee Growth for Consistent Panel





Relationship Between Income Items

Consistent Panel (2010)

Deposit Fees as a % of: Interchange as a % of: Interchange as a % of:Core Total Core Core Other Core Total Core Other Total

Interchange Nonint Inc Revenue Nonint Inc Nonint Inc Revenue Nonint Inc Nonint Inc Revenue

Treated FirmsMean 279 36 9 71 20 5 37 15 4St dev. (234) (15) (4) (21) (15) (4) (35) (12) (3)

Not-Treated FirmsMean 733 46 8 58 16 3 36 15 3St dev. (2,513) (48) (6) (62) (11) (3) (23) (29) (3)

All FirmsMean 694 45 8 59 17 3 36 15 3St dev. (2,407) (46) (6) (59) (12) (3) (25) (28) (3)

Interchange income Deposit fees Core income



Coefficient Sensitivity to Changing Sample, Near $10 B

Back to Robustness checks



Broad Measures of Expense

Other TotalSalaries Premises Noninterest Exp Noninterest Exp

Other TotalConsistent Salaries Consistent Premises Consistent Nonint Exp Consistent Nonint Exp

Variables 1 2 3 4 5 6 7 8

Durbin×Treat 0.0168 0.00941 0.0299 0.0118 0.0417* 0.00445 0.0308* 0.0161(0.0127) (0.0102) (0.0183) (0.0153) (0.0242) (0.0244) (0.0174) (0.0155)

Constant 0.0176*** 0.0110** 0.0543*** 0.0494*** 0.178*** 0.181*** 0.0859*** 0.0841***(0.00656) (0.00520) (0.00697) (0.00603) (0.00901) (0.00823) (0.00970) (0.00785)

Observations 11,434 17,080 11,434 17,071 11,424 17,040 11,432 17,080Firms 688 1,048 688 1,048 688 1,047 688 1,048R-squared 0.013 0.011 0.008 0.004 0.098 0.074 0.017 0.016Adj. R-squared 0.012 0.010 0.006 0.003 0.097 0.073 0.015 0.015





Probability of Nominal Assets >$10 B at Year-End

Range of Nominal Asset Values atPrevious Year-End ($ in Billions)

<5 [5,10) [10,15) ≥15Year 1 2 3 4

2009 Prob ≥ 10B 0.000 0.083 1.000 1.000N 505 36 12 36

2010 Prob ≥ 10B 0.000 0.057 0.800 1.000N 536 35 15 37

2011 Prob ≥ 10B 0.000 0.053 0.923 1.000N 576 38 13 39

2012 Prob ≥ 10B 0.000 0.054 1.000 1.000N 574 37 13 40




Year-to-Date Regressions

Interchange Deposit Core Other Core Total CoreIncome Fees Noninterest Income Noninterest Income Revenue

Deposit Core Oth Core Tot CoreConsistent Interchange Consistent Fees Consistent Nonint Inc Consistent Nonint Inc Consistent Revenue

Variables 1 2 3 4 5 6 7 8 9 10

Treat×y2011 -0.185*** -0.168*** -0.0100 -0.0183 -0.111** -0.0970** -0.0568** -0.0598* -0.0155 -0.00296(0.0468) (0.0496) (0.0203) (0.0226) (0.0465) (0.0449) (0.0262) (0.0355) (0.0251) (0.0271)

Treat×y2012 -0.103*** -0.105*** 0.00865 0.00629 -0.0648*** -0.0704*** -0.0132** -0.0103** 0.00235 -0.0207(0.0139) (0.0151) (0.00542) (0.00476) (0.00991) (0.0127) (0.00554) (0.00520) (0.00340) (0.0215)

Constant 0.141*** 0.144*** 0.00524 0.00688 0.123*** 0.121*** 0.0151* 0.0248*** 0.0359*** 0.0414***(0.0204) (0.0203) (0.00747) (0.00761) (0.0153) (0.0142) (0.00915) (0.00909) (0.00515) (0.00591)

Observations 2,225 2,261 2,361 3,523 2,334 3,303 2,361 3,600 2,361 3,615Firms 616 626 616 930 616 887 616 953 616 956R-squared 0.031 0.031 0.023 0.008 0.036 0.015 0.004 0.002 0.009 0.010Adj. R-squared 0.029 0.029 0.021 0.006 0.034 0.014 0.002 0.000 0.007 0.009

Robust standard errors in parentheses are clustered at the firm level.Year dummies are suppressed.*** p<0.01, ** p<0.05, * p<0.10




Branch Count and FTE Regressions

Branches FTEsVariables 1 2 3 4

Durbin×Treat 0.0165 0.0114 0.0472 0.0322(0.0194) (0.0241) (0.0316) (0.0257)

Constant 0.0331*** 0.0369*** 0.0121** 0.0157***(0.00417) (0.00430) (0.00504) (0.00468)

Fixed Effects? No Yes No Yes

Observations 3,998 3,998 9,548 9,548Firms 852 852 571 571R-squared 0.004 0.286 0.009 0.312Adj. R-squared 0.003 0.092 0.007 0.267

Robust standard errors in parentheses are clustered at the firm level.Year dummies are suppressed for branch regressions, andyear-quarter dummies are suppressed for FTE regressions.*** p<0.01, ** p<0.05, * p<0.10




Number of Accounts Regressions

Total Small Large Total Small LargeAccounts Accounts Accounts Accounts Accounts Accounts

Variables 1 2 3 4 5 6

Durbin×Treat 0.0308* 0.0297* 0.116 0.0220 0.0224 0.0823(0.0178) (0.0179) (0.0915) (0.0252) (0.0253) (0.0793)

Constant -0.0107 -0.0110 0.0499*** -0.00959 -0.00989 0.0523***(0.00808) (0.00822) (0.0131) (0.00770) (0.00788) (0.0123)

Fixed Effects? No No No Yes Yes Yes

Observations 5,480 5,480 5,479 5,480 5,480 5,479Firms 569 569 569 569 569 569R-squared 0.002 0.002 0.019 0.269 0.267 0.414Adj. R-squared 0.000 0.000 0.017 0.183 0.181 0.345




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Bank Profitability and Debit Card Interchange … · Debit Card Interchange Regulation: Bank Responses to the Durbin ... Constant -0.00156 0.00102 0.00278 0.00825 (0 ... Bank Profitability