U.S. $16 bln debit fee clampdown needs a do-over

March 9, 2011

By Antony Currie
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Washington’s plans to clamp down on the $16 billion U.S. financial institutions make each year from debit card fees needs a do-over. Sure, the interchange fees look high compared to those in other countries. But that’s in part because America’s system is less secure and less efficient. The Federal Reserve’s current proposal won’t change that. In fact, it only allows banks to charge merchants enough to break even — and that’s based on some simplistic cost assumptions. Worse still, smaller banks could be hit hardest. Even Fed chief Ben Bernanke and FDIC Chairman Sheila Bair are having second thoughts. Lost and confused already? Check out our Interchange FAQ below.

Remind me, what is this fight all about?
The Fed is preparing rules to comply with the so-called Durbin Amendment included in last year’s financial reform legislation. Named after Senator Dick Durbin, its intent is to reduce the levies that banks and networks like Visa, MasterCard and American Express charge merchants each time a customer pays with a debit card — these are known as interchange fees. Currently they account for $16.2 billion in revenue, or an average of 44 cents per swipe. The Fed wants to slash that to around 12 cents.

Durbin says they’re too high and the result of price-fixing. Compared to other countries, it certainly looks that way. Last year, for example, Visa Europe capped debit card interchange fees at 0.2 percent of the value of the transaction. U.S. rates currently average almost six times that, at 1.14 percent — though there are reasons for it being higher, which we’ll get to later. The argument is that reducing them would allow merchants to cut prices, benefiting consumers overall.

Isn’t that a good thing?
Not necessarily. There’s no guarantee merchants would pass on the savings to customers. That didn’t happen when Australia imposed similar limits, studies show. That’s why the financial industry argues the Durbin Amendment will simply take $16.2 billion of its revenue and gift it to merchants, particularly big-box retailers like Target, Wal-Mart and Home Depot.

Aren’t the banks overstating their case to keep their revenue?
They’re certainly guilty of being alarmist at times. For example, the American Bankers Association tried to pull a fast one by conflating revenue with capital. It claims that losing $10 billion or more of fees would eradicate the same amount of the capital and thereby lessen by up to $100 billion the industry’s lending capacity.

I hear a “but” coming
Well spotted. The Durbin Amendment stated banks can charge a fee that’s “reasonable and proportional to the cost incurred.” But the Fed’s proposed rule caps the fee at what it has determined are the industry’s costs of 12 cents a swipe. Worse, those are only the costs associated with authorizing, clearing and settling each transaction.

What’s wrong with that?
It ignores debit card interchange fees’ role in financing retail banking. The more that customers have used them over the past 15 years, the more banks have been able to remove minimum balance requirements and transaction fees they used to charge to fund all the cash and checking transactions. These forms of payment cost 70 cents or more a pop, according to JPMorgan — at least 60 percent more than the average debit card fee.

Unsurprisingly, the Fed’s interpretation of the Durbin Amendment has led many banks to ax free checking and their debit card rewards programs and to dust off their old pricing strategies. Some, like JPMorgan, are even warning that 5 percent of customers could become too unprofitable to bank.

And you’re sure that’s not just bank posturing?

They’re not the only ones complaining. Left-leaning consumer group the National Community Reinvestment Coalition is, too. Fed chief Ben Bernanke isn’t happy with it. FDIC Chairman Sheila Bair has warned of the unintended consequences of the rule. Even Congressman Barney Frank, co-sponsor of the legislation that created the Durbin Amendment, reckons it needs a re-write.

Those last two aren’t fans of big banks.
Precisely. But the big banks aren’t the ones at most risk. With more scale and more products to sell, they’ll just suffer a knock to profits — Bank of America reckons its retail unit can make at least a 25 percent return, for example.

Isn’t there some protection for smaller banks?
Yes, those with fewer than $10 billion in assets won’t have to cut their fees. There’s some fear merchants might refuse to take their cards — Bernanke is worried about it — although that would apparently violate the contracts they have with processors like Visa and Mastercard. But slighter larger banks — just below the megabanks — would certainly suffer.

So what’s the solution?
First, the Fed needs to be more flexible, on both costs and allowing the banks to make a profit on debit cards. That may require some help from Congress. But Washington is also missing a larger trick: one reason U.S. fees are so high is because Americans still sign for the majority of debit card transactions rather than using a pin code.

That increases the chance of fraud as well as processing costs — so-called signature debit costs merchants twice as much, yet only 18 percent of them are set up to take payments with pin codes, according to the Fed’s own data. Europe, on the other hand, has all but abolished swipe-and-sign in favor of chip and pin cards. It’s a safer and more efficient process for banks, customers and merchants. That’s hard for any side to argue against. Moving the U.S. financial system in that direction should be the ultimate outcome of the current debate.

One comment

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Did you just come from a lobbyist briefing session? You should have talked with some merchants to get their perspectives as well.

How is the Visa and MasterCard networks and debit transactions occuring on them in the U.S. “less efficient” than elsewhere? REALLY? They are the same networks. A U.S. signature debit transaction in Minnesota goes through the same steps as one in Australia or South Africa.

Then you write “one reason U.S. fees are so high is because Americans still sign for the majority of debit card transactions rather than using a pin code.”

Whose fault is that? Visa, MasterCard and the banks have worked for 20 years to strangle PIN services to death, Visa owns the largest U.S. PIN network, Interlink with 40% of market share, and has driven the interchange rates up several hundred percent since 1990 to cripple merchant incentives to steer customers to PIN. Add on top of that the network’s merchant operating rules that for years inhibited or prevented merchant’s ability top steer customers to PIN. PIN debit is now distorted in the U.S. because that is what Visa, MC, and the large banks wanted to have happen.

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