The credit unions’ fight against interchange regulation

By Felix Salmon
June 10, 2010
enormous lobbying effort from the credit union industry; John Magill, the chief lobbyist for the Credit Union National Association, told me that there were over 400,000 "contacts" with Congress this week. He was on the phone with Harriet May, the CEO of a big El Paso credit union, GECU, and the chairman of the CUNA board. She was trying hard to persuade me that credit unions are implacably opposed to regulating interchange fees, which she was prone to characterize as "government price fixing".

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Yesterday saw an enormous lobbying effort from the credit union industry; John Magill, the chief lobbyist for the Credit Union National Association, told me that there were over 400,000 “contacts” with Congress this week. He was on the phone with Harriet May, the CEO of a big El Paso credit union, GECU, and the chairman of the CUNA board. She was trying hard to persuade me that credit unions are implacably opposed to regulating interchange fees, which she was prone to characterize as “government price fixing”.

I’m a fan of credit unions in general, but I’m suspicious of this lobbying effort. I’m on the board of directors of my local credit union, and I don’t think any of us are opposed to the Durbin amendment. May told me that some credit unions don’t care about this issue because they don’t issue cards — but we do, both credit and debit.

In any case, May’s main argument was that debit cards are expensive for credit unions, and that interchange fees help to offset that expense. “My debit card losses are high,” she said, “but they’re offset by the interchange”.

The problem was that she refused to say just how high her debit card losses were, beyond saying that she had to replace over 1,000 cards in the wake of the Heartland affair. Similarly, the official factsheet sent out by CUNA asserts baldly that “for most credit unions debit interchange currently covers somewhat more than the direct costs of providing debit services but is not disproportinate given their expenses and potential costs such as those relating to fraud”, without actually quantifying those costs.

When I asked whether the sensible response to fraud would be better security, through things like chip cards, rather than higher interchange fees to cover the ex post expenses associated with fraud, she said that she would welcome chip cards, and that she suspected that interchange fees would be lower if chip cards were introduced.

At the same time, however, she was at pains to point out that she wasn’t setting interchange fees, and that she wasn’t entirely clear on how Visa and Mastercard did set them: I would have to talk to Visa and Mastercard, she said, or to the Electronic Payments Coalition, to get a clear bead on how exactly interchange fees are set. As a result, she couldn’t or wouldn’t answer my simple question: since banks have proved themselves able to increase their revenues by raising interchange fees, what’s to stop them continuing to raise those interchange fees regardless of whether their costs are rising?

The fact is that the banks have worked out, over the past five years or so, that raising interchange fees is a great way of making money, more or less invisibly. As financial regulatory reform curtails their ability to make money in other ways, they’re going to look to interchange fees as a method of making up for revenue lost elsewhere — unless the Durbin amendment, or something like it, passes.

May’s stated reason for believing that U.S. interchange fees — which are already the highest in the world — won’t continue to rise indefinitely is that “merchants can work together with the card associations and we can work through it”. But the fact is that this is a game where the card associations very much have the upper hand: merchants aren’t allowed to group together in a negotiating bloc, and most of the time just have take-it-or-leave-it offers from the Visa/Mastercard duopoly.

What’s more, Senator Durbin himself has written forcefully to the CEOs of Visa and Mastercard, telling them in no uncertain terms not to disadvantage credit unions or other small issuers — who are specifically excluded from Durbin’s amendment.

So unless and until banks or credit unions can plausibly demonstrate that their debit-card losses are high and rising, I’m not going to have much sympathy with them. And I’m going to continue to believe that interchange rates are too high; that they should come down; and that absent any regulation, they’re going to continue to go up instead.

Comments
7 comments so far

Felix, I work for NAFCU, another trade association that represents credit unions. Losses are only one part of the equation, in my humble opinion. When a member wants to dispute a debit or credit card transaction, who do they contact? Not the merchant, although they may. They’ll contact their financial institution. Regulation E, which governs part debit card transactions, indicates that all a consumer needs to do to challenge a debit card transaction is to indicate that it was “unauthorized.” The financial institution then must do an investigation. In each credit union and bank that offers plastic, you’ll find “card services” employees that do nothing other than process these claims. And if the investigation turns up the fact that the transaction is unauthorized, even due to a member’s negligence with their debit card, the credit union is on the hook. The member gets their money back within certain limits. This is a huge cost involved with the card payment system that no one wants to discuss. There are other issues, but I think one rambling issue per comments should suffice.

Posted by Ademanaonge | Report as abusive

Even if they can demonstrate that losses are high and rising, making up for it via an instrument like this is going to be disastrous in the long run. There are other (better) ways to fund cards — this one’s only appealing because the customer pays for it in a bizarrely indirect manner, with some of that cost presumably tossed onto cash customers and merchants.

The duopoly is a problem only inasmuch as it makes structural change unlikely (i.e. the possibility that an entrant or player will achieve a significant foothold by pursuing a different business model / revenue structure). Even if there were more players, the merchants would have lousy market power. High interchange fees are in fact a result of strong competition — competing for banks means raising interchange fees. I can imagine this getting worse, not better, with more firms.

Posted by absinthe | Report as abusive

Ademanaonge — May made pretty much the same point. To which I respond with exactly the same thing I said in response to the fraud point: show me the numbers. And, explain what’s so special about the US that it requires its interchange fees to be higher than anywhere else in the world, and rising, despite the fact that its banking system is actually quite efficient by global standards.

Posted by FelixSalmon | Report as abusive

Bruce Schneier makes the excellent point that banking security often doesn’t improve unless financial institutions have incentive to do so, something which is often not the case.

Because of inflated interchange fees, banks have very little incentive to reduce debit fraud. Vantage CU has a misleading chart on their website which states that the CU is responsible for “100% of fraud losses”, while the merchant is only responsible for a “2% interchange fee.” What they don’t state is that that 2% entirely covers their losses many times over.

I’ve heard that a good rule of thumb is that debit fraud losses are ~5% of interchange revenue. It’s true that doesn’t take other costs into account (people to adjudicate the Reg E process, etc), but it puts things into perspective.

Also, it’s certainly not true that every CU has a group of dedicated card services employees. As anyone who has worked in a CU knows, you often wear multiple hats.

And the Reg E investigations? Often they’re perfunctory and not too involved. (Was a member double-charged at a restaurant? Write it off and move on. )

Posted by oasisbob | Report as abusive

The Office of Fair Trading in the UK has been investigating interchange fees for some time (I could go into the history if you want, but it’s pretty tedious). They put out a report a couple of years back which describes in detail the then policies of Mastercard and Visa and how they set the fees. No doubt there are some differences with how they operate in the US (particularly for debit cards, I would imagine), but it might give some insight.

Posted by GingerYellow | Report as abusive

Hi Felix,

I’m from the Texas Credit Union League. I’m a little surprised that, as a board member of a credit union, you are unfamiliar with the role that interchange plays in your credit union.

Many mid size credit unions (under 500 million in assets) have card programs that break even under the current interchange rate. Certainly the bigger your card program, the more you can tolerate in terms of losses. But what happens for those mid size credit unions? They will end up having to charge for debit cards (while large banks don’t) or potentially stop offering cards.

As you can imagine the future for a credit union without debit cards for members will be grim – people simply expect this as a service.

Does your credit union offer free checking? Does it offer free debit cards? How does it manage to do that? I’d hazard to guess that interchange plays a role.

But there is another issue – shouldn’t there be a cost associated with a guarantee of payment? Consumers pay either interest or overdraft fees, credit unions pay for the cost of issuance, merchants (who used to eat BILLIONS in hot checks) pay for a guarantee. As for the saving being passed on to the consumer, I trust a not for profit like my credit union to do that (and they do – with a 10 cent rebate on any transaction).

Also, interchange RATES have not risen. What has risen is the % of transactions using interchange.

There’s a great story in the Houston Chronicle on this issue, perhaps one that will give you a broader view.
http://www.chron.com/disp/story.mpl/busi ness/steffy/7046970.html

The bottom line is that interchange is complex and shouldn’t be tossed into the financial reform effort – at the 11th hour, without hearings, without debate, and with a lie (that credit unions are “carved out”).

Posted by wprosapio | Report as abusive

@wprosapiao, I share Felix’s sense of frustration about people talking past each other on this issue, I think your claim that “interchange RATES have not risen” is a great example.

Felix has even covered this in a past post, it’s simply inaccurate to claim that interchange fees haven’t risen: http://blogs.reuters.com/felix-salmon/20 10/01/05/the-interchange-fee-rip-off/

As much as people like to paint the interchange issue as being primarily about BIG business, or BIG banks, it’s about anyone (big or small) who issues cards or accepts them. This is a systemic issue that affects us all, and I’d argue it’s entirely appropriate to tackle it with financial reform.

In comparison to everything else being covered in the reform bill, are interchange fees really that complex?

Posted by oasisbob | Report as abusive
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