The debit-card interchange scam

By Felix Salmon
January 7, 2010
Mike Konczal has a detailed response to Tyler Cowen on the subject of debit-card fees, but before disappearing any further down this rabbit hole, I think it's worth clearing up one misconception which Tyler might have, given that he seems to think that his experience shows that maybe "things aren't so bad after all".

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Mike Konczal has a detailed response to Tyler Cowen on the subject of debit-card fees, but before disappearing any further down this rabbit hole, I think it’s worth clearing up one misconception which Tyler might have, given that he seems to think that his experience shows that maybe “things aren’t so bad after all”.

Tyler is absolutely right that there are lots of good reasons for people to use credit cards rather than debit cards. I do the same thing, for much the same reasons — mainly the miles and the insurance. But the thing which I found so outrageous about Andrew Martin’s NYT article had nothing to do with credit cards at all — rather, it was the rising interchange fees on debt cards.

Tyler makes a case — which Mike then tries to undermine — that it’s reasonable for people with credit cards to effectively team up with Visa against retailers. But in the case of debit cards, Visa and the issuing banks get all the benefit, and the individuals making the purchases get none: no miles, no insurance, nothing. (A few “premium” debit cards are beginning to appear, but they’re still pretty rare, and I daresay they carry credit-card-style interchange fees.)

Visa has a monopoly here, and is raising its debit-card fees with impunity, safe in the knowledge that there’s nothing anybody can do about it. Retailers get hurt a lot, consumers see no benefit at all, and the excess profits accrue to Visa and to the issuing banks. The question of incentives to use credit cards rather than debit cards is an interesting one, but it is a fundamentally separate issue, so long as credit-card interchange fees remain even a tiny bit higher than their debit-card counterparts.

Debit cards shouldn’t really carry an interchange fee at all, since the banks would much rather process a retailer’s debit-card transactions than have to deal with large amounts of cash. Indeed, when debit cards were first introduced, some of them did carry negative interchange fees. The rise in those fees is a hidden windfall for banks, and an unnecessary burden for retailers both large and small.

If you use a credit card to pay for a $100 item, then you can maybe consider that by dint of the miles and the insurance, a buck or two comes back to you in one way or another. If you use a debt card to pay for that item, then none of that money comes back to you at all. So there’s really no reason for consumers like Tyler to think that rising debit-card fees are anything but a bad thing.

Comments
8 comments so far

How else are banks supposed to make money? If you don’t allow them to tax everything they have no purpose.

Posted by mushr00m | Report as abusive

Can someone explain why people use debit cards at all, when credit cards offer a no-cost 10 to 30 day float (debit cards debit your bank account instantly), free miles, 3% cash rebates on Amazon, or an extra discount on a General Motors car without a clunker to trade. Maybe it’s the cash withdrawal feature (but, why not use an ATM card)? Or maybe you don’t qualify for a credit card? (But until recently, who did that apply to?) Or maybe you don’t trust yourself with credit? Or is it simply that Visa pushes them so hard?

Posted by maynardGkeynes | Report as abusive

I used debit cards because they were sent to me in connection with checking accounts without my applying and they were sometimes easier to use than checks. But now that I have a credit card I never use them.

Posted by JamesBShearer | Report as abusive

Retailers do have an option here, they can offer discounts for purchases with a preferred method of payment. A convenience store I frequent offers a 2% discount on certain items purchased with cash or debit. If debit interchange fees continue to rise, I imagine this store will offer the discount for cash purchases only.

Posted by Kosta0101 | Report as abusive

felix – all i hear in this post are reasons for consumers to avoid debit cards. if Visa wants to charge a 10% interchange fee on debit cards – so what? no one needs to use debit cards – they are not a human right. neither are credit cards, for that matter. if you don’t like the fee, don’t use the product.

ahhh – but what is interesting about this case is that these fees are essentially spread amongst ALL consumers, not just the ones using the products – because the consumer doesn’t pay an explicit interchange fee – the merchant does… so we all get hosed for the actions of a few…

Posted by KidDynamite | Report as abusive

Kosta0101 said:
“A convenience store I frequent offers a 2% discount on certain items purchased with cash or debit. If debit interchange fees continue to rise, I imagine this store will offer the discount for cash purchases only.”

Actually, in their agreement with the merchant bank they agree to never offer such discounts, otherwise they can have their account revoked. It is a breach of their contract. I live in Delaware and people are really sensitive about it here (as it is our cottage industry to rent seek on the national payments processing platforms via regulatory capture and oligopolies). They do it, but at risk of being cut off and/or sued.

KidDynamite touches on a larger point – the impacts of the interchange fees are paid by all and I think a good arguemnt could be made that they disproportionately impact those with less money to spend. The fees are absorbed by everyone. On ‘Signature’ and ‘World Points’ cards the interchange is even higher, and based on the amount of spend in a year a ‘upgrade’ may occur that allows even higher rates to be charged (to pay for richer rewards).

Merchants have no way to know who is who and have to accept all the transactions (literally not knowing what the interchange rate they will be charged is). We all pay for this. The people who spend the most generate additional interchange fees not only because of the volume but a higher interchange rate – this expnse get spread across all

Also, businesses that have smaller average ‘ticket’ pay a higher percentage of interchange once the per transaction charges get baked in. If you are paying a flat fee of $.05 per transaction and 2.15% in interchange fees and someone buys a coffee with a chip card at 7-11 for $1.00 then you have effectively increased the interchange rate to 7.15%. This is a rough example, but it illustrates the motivation behind 7-11 having petitions on their counters last year asking for support for regulation on the industry – but then again, if there were ever a business that would prefer not to amass large amounts of cash overnight it would be a convenience store. What is not being as much of a target worth?

Posted by KidA | Report as abusive

Maybe I’m a twit, but I only use debit cards. I generally forget to pay my credit card bill once a year. When this happens my finance charges comfortably cover the ‘loss’ I make using a debit card. I’m almost certainly a twit, but I am a twit that knows I forget to pay sometimes, and when I do, it hurts.

Also, isn’t there subtle privacy difference involved here? E.g. your purchase history is “fair game” for a credit card, but not so for a debit card? Since in the latter case the actual details of the item purchased are irrelevant – it’s a cash transaction? Or am I missing something?

Posted by nicfulton | Report as abusive

@KidA: merchants can absolutely offer different prices for cash and credit – they just have to phrase it in a specific way. also, i don’t think they can offer different prices for credit and debit.

Posted by KidDynamite | Report as abusive
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