Why New Regulation Will Increase the Prices Banks Charge

We often hear the financial industry complaining about the new regulation that they are facing these days. They say that prices for their products and services will have to increase as a result of their costs rising due to new regulations. Some critics of the industry brush these claims off as banks wanting to avoid lower profits, but looking at some basic economics shows that their threat is a real one.

This common misconception was asserted Thursday morning on CNBC. There was a segment about banks facing higher costs due to regulation. Economics reporter Steve Liesman paraphrased Rep. Barney Frank (D-MA) as having said the following:

When did the banks become charitable institutions and were charging less than the market would bear fore these fees? If they could have charged more, they would have charged more. And the idea that they can charge more now would suggest that there is not really a competitive market out there.

The following isn't meant to criticize Frank, as this is a second-hand paraphrased quote said in passing, so I cannot be certain of its veracity. Perhaps it was taken out of context or Liesman misunderstood. But if Frank did mean this, then he should look to some very basic economics of supply and demand.

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Let's think about a product a bank offers that faces some new rules: how about credit cards. Banks will soon be forced to comply with stricter regulations on disclosing why a customer did not receive the lowest interest rate possible, which will result in the costs rising for its card issuance. Now, banks will have to mail out an additional disclosure form.

In the past, there was some demand for credit cards in the market, and there was some supply that a bank could offer, depending on its costs. As a result you could construct supply and demand curves. If microeconomics is correct, then the price banks sold these cards for was where these two curves intersected. After all, it's a competitive market, as hundreds of different banks are competing for those customers. 

Very early on in Economics 101, you learn that the supply curve of a good shifts to the left if the price of a resource used to produce that produce rises. That's the situation we're talking about here. In order to provide credit cards in the future, the bank will face higher costs. Here's how that looks:

supply shift wiki.png

The number values shown above are meaningless -- the chart is a generic one poached from Wikimedia Commons. But you can see here that the supply curve shifts left from S1 left to S2. Consequently, the price rises, and the quantity declines.

This is what will happen once new regulations take effect. You'll see bank products affected become more expensive for consumers. The number of those products sold will also decline a little, as some consumers will be priced out of the market.

So really, the paraphrased quote above misunderstands the situation. Because the market is competitive, banks aren't able to charge more or less than they do for their products and services. Only if the industry had a monopolistic advantage could banks charge a price that's higher than where market demand intersects supply.