Regulatory Overreach: Impacts on Access to Banking Products and Services

Availability of low-cost banking services and access to affordable credit remain critical to strengthening and maintaining the financial health of low-to-moderate-income individuals and financially vulnerable groups. Recent bank regulatory proposals, however, risk undermining the progress made in recent years by banks in expanding access to credit.

These regulations, which have had the stated aim of protecting consumers or promoting bank safety and soundness, arguably overreach because they fail to account for important tradeoffs and limitations. The resulting unintended consequences could reduce the availability of credit and other financial services to lower-income households and communities. This post reviews these regulatory developments and the potential harm they pose to households, small businesses and communities.

Capital Requirements and Their Disproportionate Impact

In 2023, U.S. prudential regulators introduced a major overhaul of capital rules-the U.S. implementation of the international agreement known as Basel III Endgame. While aimed at ensuring financial stability, the proposed changes would impose excessive capital requirements on mortgages and credit card lines. As described in previous BPI blog posts, these are not only potentially harmful to consumers, but also unwarranted based on analysis of historical loss data.^[1] The proposal has not been finalized, the Federal Reserve is currently developing a revised proposal and in a September 2024 speech, Vice Chair for Supervision Michael Barr indicated that these elements of the proposal would be eliminated or moderated.

For instance, the proposal had called for a substantial increase in the capital charge on residential mortgages with loan-to-value ratio (LTV) exceeding 80 percent by replacing the existing 50 percent risk weight with risk weights of 60 percent or higher depending on the LTV.^[2] The higher capital requirements, which exceed those specified in the international Basel agreement, would likely be passed on to homebuyers through higher mortgage rates. Lower-income and minority borrowers typically have higher loan-to-value ratios and would therefore be disproportionately affected by the increased borrowing costs.

For credit cards, the proposal had called for a new capital charge applied to the unused credit line amount. Although this is a component of the international Basel agreement, implementation in the U.S. could have a uniquely adverse effect given that about 80 percent of available credit among U.S. bank credit card lines are currently unused. Consumers across all income ranges would be vulnerable to significant credit line reductions, with adverse implications particularly for lower-income individuals that rely on spare credit lines to meet emergency expenses.

As noted, the Federal Reserve, having received comments concerning the potential harm to consumers, is poised to jettison or moderate these aspects of the Basel III Endgame proposal. This experience highlights the importance of weighing the implications for consumer access to credit when assessing the benefits of stricter capital regulations.

Debit Interchange Fee Cap: Revisiting Durbin's Legacy

In October 2023, the Federal Reserve Board proposed a major reduction to the maximum fee that debit card issuers can charge merchants for a debit interchange transaction. This regulatory cap, a component of Regulation II, implemented under a legislative mandate known as the Durbin Amendment, is applicable to banks with assets of $10 billion or more. ^[3] The cap had been unchanged since 2011 when it was first introduced.^[4] The regulatory revision is still pending.^[5]

The interchange fee cap was intended to ensure a more efficient allocation of the benefits of the interchange network, and more specifically, benefit consumers through merchant cost savings passed through in the form of lower prices. The Federal Reserve proposal was put forth without clear evidence to date that the existing cap has yielded such benefits and without any demonstration that these purposes will be served by the proposed reduction.

Potential Consumer Harm

Rather than such caps benefiting consumers, they often result in higher costs or reduced availability of services. Multiple studies have shown that banks and credit unions often have been compelled to offset at least part of their revenue losses by raising checking account fees or the minimum balance requirement to avoid fees, or with other restrictions on free checking accounts. The resulting decline in affordability of bank accounts may discourage bank account ownership among lower income households, possibly leading some to become unbanked. By some estimates, as many as 1 million consumers became unbanked because of the Reg II interchange fee cap.^[6]

It has been estimated that the proposed cap reduction will decrease interchange fee income by an average of 5.4 cents per covered transaction (based on the 2022 average transaction amount of $48.83). The ability of banks to offer free checking accounts consequently will further decline, and banks will have to increase the average minimum deposit requirements to avoid monthly fees for checking accounts. The reduced availability of free checking accounts and the imposition of higher minimum balance requirements would propel additional lower-income consumers to substitute services from less regulated nonbanks for bank accounts.

The economic theory of payment card networks and the role of interchange fees in this context is quite complex, but one aspect is that interchange fee income may fund activities that expand consumers' use of the debit payment network.^[7] Evidence presented in a recent study, albeit in the context of a credit card payment network, is consistent with this view. The study finds that that interchange fee income is an important driver of new card issuance, controlling for other relevant factors, and concludes that interchange fee caps "may result in fewer new credit cards being issued, particularly affecting lower-income and less creditworthy individuals."^[8]

Lastly, small businesses may not benefit from the fee cap. First, these businesses usually are checking account customers of the same banks to which they pay interchange fees and may pay various other fees for account-related services. As noted, these fees may increase to offset the reduced revenue resulting from an interchange fee cap. In addition, merchants who specialize in small-ticket transactions ($15 or less) encountered higher fees for these transactions. Most networks offered discounted debit interchange fees for small ticket transactions to encourage card acceptance by merchants for those transactions before the regulation, but the networks eliminated the small-ticket discounts and assessed the maximum amount set by the regulation on all transactions after the regulation. Thus, it is possible that the proposed further lowering of the caps on interchange fees will not yield net cost savings even for many small businesses that pay these fees.^[9]

CFPB's Final Rule on Overdraft Fees

A new rule promulgated in December 2024 by the Consumer Financial Protection Bureau (CFPB) governing overdraft services severely restricts larger banks from charging an overdraft fee exceeding $5. To do so, the bank must demonstrate that the fee represents a "breakeven" amount calculated under standards set forth in the rule, or else treat overdraft protection as a line of credit subject to the regulations and requirements that govern consumer lending.

These highly restrictive requirements, which were introduced without substantive consideration to potential adverse effects, are likely to reduce the banks' ability to provide overdraft services. One reason is the resulting compliance costs and regulatory burden for banks that choose to provide such services. Another is the likely inability of many consumers who currently rely on overdraft protection to qualify for the credit products banks would be required to offer in its place.^[10]

Potential Consumer Harm

Many consumers rely on overdraft protection when they face temporary cash flow shortfalls, lack access to a backup credit line such as credit cards, and have an immediate need to pay for necessities. Absent overdraft protection, many may turn to nonbank payday lenders or other high-cost credit alternatives from nonbanks, incur late payment penalties on bills that are due, or otherwise bear costly consequences.^[11]

A recent survey from the Financial Health Network found that, among those who overdrew on more than two occasions, most did so either intentionally or knowing they were risking an overdraft.^[12] Further, the Financial Health Network found that "the overwhelming majority of people who overdrafted intentionally (92%) indicated that they would prefer to incur the fee rather than have the most recent transaction that incurred an overdraft declined." A separate CFPB survey similarly found that most overdraft usage is not unexpected and is strongly associated with households that lack access to a credit card line.^[13] These surveys thus confirm the importance of overdraft protection to support the purchase of necessities for consumers facing cash shortfalls.

Moreover, large banks compete intensely for consumer deposits. It follows that they have limited ability to cross-subsidize low-balance depositors, who are also those most likely to incur overdrafts. To offset the loss of overdraft fee income under the new rule, large banks may need to increase other types of fees on low-balance accounts, raise the minimum balance required to avoid fees or impose restrictions on the services offered to low-balance depositors to mitigate costs.

Thus, for example, large banks may have to charge for basic account ownership or impose limitations on debit card usage, online bill payment, mobile banking services and ATM access. The new fees and restrictions in turn could lead to an increase in the unbanked population or increase reliance on nonbank providers of financial services.

Consistent with this concern, researchers at the New York Fed found that the OCC's 2001 decision to exempt national banks from state caps on overdraft fees had a favorable effect on financial inclusion.^[14]The analysis indicated that national banks exempted from these caps increased access to deposit accounts by lowering minimum-balance requirements by 30 percent or more relative to state banks. In addition, the share of low-income households with a checking account rose by 10 percent after the exemption. Thus, the findings highlight a "policy trade-off" whereby "the benefits of a fee limit come at the cost of more unbanked, low-income households."

A final factor to consider is that overdraft fees can have a disciplining effect on consumers who are prone to behavioral biases such as inattention or overspending, which studies have shown can lead to overdrafts.^[15] Capping the fees will weaken this deterrent effect, in which case such consumers may maintain lower average balances and incur overdrafts more frequently. This, in turn, can lead to suspension or closure of their deposit accounts.

CFPB's 2024 Final Rule on Credit Card Late Fees

In March 2024, The CFPB promulgated a final rule that dramatically reduced the "safe harbor" ceiling for credit card late fees originally established by Federal Reserve rulemaking in 2010. Within the regulatory "safe harbor" bounds, a late penalty is presumed to be reasonable and proportional to the customer's infraction as required by the 2009 Credit Card Accountability Responsibility and Disclosure Act of 2009 (the CARD Act). The CFPB reduced this ceiling to only $8, from its existing levels of $30 for a first violation, and $41 for a subsequent violation within the next six billing cycles.^[16]

The CFPB has claimed that restricting the safe harbor will save consumers at least $10 billion annually and mitigate financial strains posed by late fees, especially for lower-income consumers and those with below-prime credit scores, who most frequently incur these fees.^[17] However, in reaching this conclusion the agency overlooked multiple potential adverse effects of the mandated reduction in late fees.

As explained in prior BPI blog posts and research notes, when developing the new rule, the CFPB failed to adequately consider the efficiency roles of a late payment fee in the highly competitive U.S. credit card market. These include risk- and cost-based pricing, incentivizing borrower attention to on-time repayment, and deterring various behavioral biases that can lead to over indebtedness and jeopardize the consumer's financial health.^[18]

Potential Consumer Harm

The much reduced safe-harbor maximum undermines these purposes of a late fee. As a result, low- and moderate-income consumers and those with lower credit scores may face restricted access to credit, or other adverse consequences.

In their competitive market setting, U.S. credit card issuers price credit to cover operating expenses and risk of losses and obtain a reasonable return. With a strict cap on card late fees, issuers will be compelled to rely on other dimensions of pricing to achieve these objectives that are apt to harm expanded access to credit and be less efficient.

Banks may raise interest rates on card borrowing, thus shifting the cost and risk associated with consumers who pay late to all consumers with revolving balances. Not only is this a less efficient pricing outcome, but customers assessed as more likely to become delinquent (those with lower credit scores) would likely bear the brunt of such rate hikes.

Another possible response would be to raise the penalty interest rate for consumers that miss a payment due date.^[19] This is also less efficient, as the cost to the consumer is less transparent and predictable than a late fee. Such rate hikes would increase borrowing costs for the affected consumers, adversely affecting access to credit. Beyond that, increases in the penalty interest rate to make up for the lost revenue from late fees reduce the financial resources available for consumers with low incomes.

However, an issuer may find that raising penalty interest rates may not be an adequate response, as it may cause higher delinquency rates. In that case the issuer may find it preferable to reduce credit losses by restricting credit to higher risk segments, more directly harming access to credit. The consumers who lose credit access may turn to institutions outside the traditional banking sector and payday lenders, which charge much higher fees and interest rates.

In addition, the removal of late fees could incentivize missed payments-consumers may choose to prioritize more immediate perceived needs or extended convenience. This weakened deterrent aspect of late fees could prompt further rate increases and ultimately could lead to lower credit scores and associated harm to consumers' long-term financial health.

Conclusion

Some recent regulatory proposals risk reversing progress on expanding credit to low- and moderate-income households by driving up costs or limiting the availability of banking services or by driving low and moderate-income consumers toward higher-cost, less regulated alternatives outside the traditional banking sector. Regulators need to robustly assess how proposals affect low- and moderate-income and underserved consumers, with particular attention to the cumulative impact of multiple regulations.

Oversimplification of issues, such as overlooking that banking relationships often consist of bundled or interrelated products and services, can lead to suboptimal outcomes. Better understanding often can be attained through collaboration with banks to explore sustainable reforms that appropriately balance competing goals.

Regulators also should aim for regulatory parity: applying consistent regulatory standards to banks and nonbank financial service providers. This often will require enhanced oversight of nonbanks: expanding supervision to fintech companies, payday lenders and other nonbanks to mitigate consumer harm.

[1] See Paul Calem and Francisco Covas, "The Basel Proposal: What it Means for Mortgage Lending:" September 2023 (Link), and Paul Calem and Francisco Covas, "The Basel Proposal: What it Means for Retail Lending", November 2023 (Link), and Francisco Covas, Paul Calem, and Laura Suhr Plassman, "Potential Adverse Effects of the Basel III Capital Proposal on Consumer Credit Lines", June 2024 (Link).

[2] The proposal also includes an operational risk charge that BPI projects would add 5 percentage points to the risk weight, on average.

[3] A section of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 known as the Durbin Amendment required the Board to establish standards for assessing whether the amount of any interchange fee received by a debit card issuer is reasonable and proportional to the cost incurred by the issuer with respect to the debit card transaction.

[4] To be precise, under the current rule, each debit interchange fee received can be no more than the sum of (i) 21 cents (the "base component"), (ii) 5 basis points multiplied by the value of the transaction (the " ad valorem component"), and (iii) for a debit card issuer that meets certain fraud-prevention standards, a "fraud-prevention adjustment" of 1 cent per transaction. Together, the base component and ad valorem component comprise the "interchange fee standards"; the base component, ad valorem component, and fraud-prevention adjustment comprise the "interchange fee cap." Under the proposal, the base component would decrease from 21.0 cents to 14.4 cents, the ad valorem component would decrease from 5.0 basis points (multiplied by the value of the transaction) to 4.0 basis points (multiplied by the value of the transaction), and the fraud-prevention adjustment would increase from 1.0 cents to 1.3 cents.

[5] The Federal Reserve Board is currently defending the 2011 Regulation against challenges brought by retailers in North Dakota and Kentucky. See Corner Post, Inc. v. Board of Governors of the Federal Reserve System, Case No. 1:21-cv-95-DMT-CRH; Linney's Pizza, LLC, v. Board of Governors of the Federal Reserve System, Civil Action No. 3:22-CV-71-GFVT.

[6] Zywicki, Todd J., Geoffrey A. Manne, and Julian Morris. "Price controls on payment card interchange fees: The US experience." George Mason Law & Economics Research Paper 14-18, 2014. (Link).

[7] See Robert M. Hunt, "An Introduction to the Economics of Payment Card Networks", Working Paper no. 03-10, Federal Reserve Bank of Philadelphia, June 2003 (Link). There was no consensus when the caps were first introduced that they would yield net benefits. For instance, one academic expert concluded that "… there is no support in the economic literature for the proposition that welfare-enhancing regulation can be based only on cost data, a proposition the Board's proposal implicitly accepts … the Board's proposed interchange fee cap would likely reduce debit card interchange fees below the socially efficient level." See Emilio Calvano, "Note on the Economic Theory of Interchange", February 2011 (Link).

[8] See Chris A. Richardson, "Interchange Fees and Consumer Benefits in the Electronic Payments System (January 09, 2025). (Link).

[9] Thus, merchants selling mostly small items could have seen an increase in their per-transaction fees. -See Renee Haltom and Zhu Wang, "Did the Durbin Amendment Reduce Merchant Costs? Evidence from Survey Results." Federal Reserve Bank of Richmond Economic Brief, December 2015, page 2. (Link).

[10] See "BPI Comments on CFPB's Proposed Overdraft Rule",April 1, 2024. (Link). The Final Rule would require subject banks to instead offer a different product bearing resemblance to an overdraft credit line, such that the bank must first determine a consumer's "ability to pay" if the account is accessible via a debit card. That requirement would have widespread applicability, as 90% of consumers had a debit card in 2023.^[10] Under the rule, the bank would be required to underwrite the credit product according to the same assessment currently used for consumers applying for traditional methods of credit. Hence, consumers who are unlikely to qualify for approval of a credit card or line of credit also would be unlikely to qualify and have access to overdraft services.

[11] Evidence that overdraft protections and payday loans are substitute products is presented in Brian T. Melzer and Donald P. Morgan, "Competition in a consumer loan market: Payday loans and overdraft credit," Journal of Financial Intermediation 24 (1), January 2015, pages 25-44. Examining variation in payday lending restrictions over time and across states, the study demonstrates that banks and credit unions reduce overdraft credit limits and prices when payday credit is prohibited, in response to increased demand for smaller-sized overdrafts.

[12] Financial Health Network, "Overdraft Trends Amid Historic Policy Shifts", June 2023. (Link).

[13] Consumer Financial Protection Bureau, "Overdraft and Nonsufficient Fund Fees: Insights from the Making

Ends Meet Survey and Consumer Credit Panel", CFPB Office of Research Publication No. 2023-9, December 2023, p. 12. (Link).

[14] Jennifer L. Dlugosz, Brian T. Melzer & Donald P. Morgan, "Who Pays the Price? Overdraft Fee Ceilings

and the Unbanked", Federal Reserve Bank of New York Staff Report No. 973, pp. 7-8, June 2021 (revised July 2023). (Link).

[15] See, for instance, Andrej Gill, Florian Hett and Johannes Tischer, "Time Inconsistency and Overdraft Use: Evidence from Transaction Data and Behavioral Measurement Experiments." Gutenberg School of Management and Economics Discussion paper number 2205, March 21, 2022. (Link). Also see Daniel Ben-David, Ido Mintz, and Orly Sade, "Using AI and Behavioral Finance to Cope with Limited Attention and Reduce Overdraft Fees," February 11, 2024. (Link).

[16] Issuers would be allowed to exceed this threshold "so long as they can prove the higher fee is necessary to cover their actual collection costs." The rule also ends automatic inflation adjustments to the safe harbor maximum, and it applies to credit card issuers with more than 1 million open accounts.

[17] The agency estimates that one-fifth of credit card accounts belong to individuals with credit scores below 660, but they account for about two-fifths of total late fees. Moreover, accounts in lower credit tiers are significantly more likely to incur repeat late charges than accounts in higher tiers.

[18] Paul Calem and Paige Pidano Paridon, "Misunderstandings About Credit Card Late Fees", April 19, 2023. (Link).

[19] Credit card penalty interest rates, also known as penalty APRs, typically start 60 days after a payment becomes late. See White, Alexandria, "What is a penalty APR-and how to avoid it", January 16, 2025, (Link).