Why debit fees should be low

By Felix Salmon
March 10, 2011
Antony Currie has a handy little FAQ on debit interchange. I agree with most of it, especially his final conclusion that the US should move to a secure chip-and-pin system. But I take issue with his idea that for the time being, the Durbin amendment is flawed and "needs a do-over".

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Antony Currie has a handy little FAQ on debit interchange. I agree with most of it, especially his final conclusion that the US should move to a secure chip-and-pin system. But I take issue with his idea that for the time being, the Durbin amendment is flawed and “needs a do-over.”

Indeed, Currie’s two conclusions are at odds with each other. The reason that interchange fees are so much higher in the US than they are elsewhere is precisely because they’re so profitable for the banks, which can use their fraud losses to justify some $16 billion in fees each year. If they moved to a safer, cheaper system, those profits would go away. If you allow banks to continue to wallow in a multi-billion-dollar revenue stream from debit interchange, they’ll have no incentive at all to move to a better system.

So what’s Currie’s reason to keep interchange fees high — or at least higher than they’re slated to go?

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.

Let me expand this a bit. Once upon a time, banks had to implement unpleasant things like minimum balance requirements and monthly fees and transaction fees, because checking accounts meant lots of cash and check transactions — both of which are labor-intensive things, for banks. Then, debit cards came along, and debit cards are much cheaper, for banks, than either cash or checks. As customers have moved to debit cards, banks have been able to get rid of some of those unpleasant fees. And at this point, debit cards are a significant profit center for banks, in stark contrast to cash and checks, which are both major loss centers.

The answer to this problem is not to continue the weird cross-subsidy of checks by debit. Instead, it’s to move away from checks, and towards a more European system where it’s easy to transfer money directly from any bank account to any other bank account. The less that people use cash and checks, the less cross-subsidy the banks will need from debt interchange and other fees, and the more efficient the whole system will be.

More generally, we have far too much opacity in banking as it is. Hidden fees are regressive: they generally hurt the poor and benefit the rich. (In the case of debit interchange, the rich tend to have those lovely rewards debit cards, while the poor have to pay higher prices at big-box merchants.) If banks want to charge fees, let them be transparent about it so that consumers can shop around. My guess is that for all the doom-mongering from the banks, most of them will somehow find a way of keeping hold of their customers, and keeping fees low. No bank ever likes to lose a customer, if only because today’s low-income, low-profit account can easily turn into tomorrow’s lucrative banking relationship once the customer starts getting rich.

12 comments

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“No bank ever likes to lose a customer, if only because today’s low-income, low-profit account can easily turn into tomorrow’s lucrative banking relationship once the customer starts getting rich.”

For exactly this reason 50% of the lost interchange revenue will simply not be recouped by any other means. Retail banking just got a bit less profitable.

That’s not the end of the world. In the tech sector PC’s became less profitable as they became a commodity. Great companies like AAPL and IBM focused on higher margin services… compare their stock prices to Dell and there you go…

The group most likely to lose will be low income middle aged workers banks deem unlikely to ever need a home loan (because they are renters) and will also never build any deposit balances of any value to the banks.

I remember when I use to have a “student” checking account when I was in college. When I graduated I asked what the difference was between the “student” account and a regular checking account… they waived the $5/month fee on the student account. I said well then I guess I’ll stick with the one I’ve got.

I can see crap like that comming back. If it does it will probably be good news for credit unions, good news for mutual community banks, and probably good news for the country.

Posted by y2kurtus | Report as abusive

the guy behind me today at the grocery store wrote a check. It kinda surprised me. People really still do that? I’m being serious here…

I ask the audience – do you write a check at the grocery store? if so, why? Why not credit/debit?

Posted by KidDynamite | Report as abusive

Perhaps the rich will have lower rewards on debit cards, but the poor will be hit with higher fees on cash and checks or go unbanked, often with even higher fees. I don’t see how they will benefit. The prudent will always prosper off the imprudent, that is the reason for interest.

Posted by MyLord | Report as abusive

While this is all true, debit interchange isn’t really the problem. While American fees are higher than in Europe, where the fees are regulated, they are lower than much of the world. America is actually middle-of-the-road on debit interchange fees, when compared to the world at large (according to data on the Visa website).

In credit card interchange, however, we are by far the highest. And even more alarming, the gap between those fees paid by large merchants (Wal-mart) and small merchants (your local bodega) is larger than any other country.

Posted by NerdWallet | Report as abusive

Yeah, Because if JP Morgan says it’s true, well then, it just has to be…

Posted by deaner66 | Report as abusive

Felix, thanks for cutting through the FUD. The consumer angle that the banks are pushing right now is ridiculous and is designed to manipulate us (http://feefighters.com/blog/consumers-a re-pawns-in-the-durbin-debate/).

This is a fight between retailers and banks and shouldn’t be clouded by a trumped-up fear of losing our free checking. It is good public policy because it increases transparency and regulates the behavior of an abusive monopoly.

Posted by seanh21 | Report as abusive

Dwolla.com are doing transactions at a 25 cent flat fee, and that’s why I’m an early adopter for both my web and brick n’ mortar stores.

With wider adoption of “smart” phones and the easy tools to code alternative payment pathways, the VISA/Mastercard monopoly could come tumbling down.

The rates they charge merchants are horrible. Rewards cards? That means taking an extra piece from the Merchant and handing it over to the customer.

Don’t even get me started on the AMEX big sucking hole of unnecessary fees.

Yeah. I’m hoping Dwolla.com, banksimple.com and (any other non-evil tech startup grounded in fairness and transparency) shake retail banking to it’s core.

Posted by bryanX | Report as abusive

Felix should stop writing about banks in general. It is funny that people (including some commenters) who appear to be so clueless about the economics of checking accounts write so self-assuredly on the subject.

The debit card is not a product. It is a service. An access point to the checking account. You cannot look at debit cards and checks in isolation. They are both access points to the same product, the checking account, as are ACH transfers.

Checking accounts are not costly because of check volume. Checking accounts are costly because they are highly transactional and because they are the tools that individuals use for personal financial management needs. This means that the bulk of channel (branches, call center, online and mobile banking, ATMs) interactions are tied to checking accounts. Operating channels is the most costly thing that banks do.

This is the second shoe to drop for free checking. Overdraft fee regulation was the first. You can make a very strong case that overdraft fees were/are highly regressive. The case for debit interchange is much more dubious. Citing debit rewards, as if they are on par with credit card rewards, is a joke. Debit rewards are not, by any means, ubiquitous. The rewards are quite limited and often dependent on having direct deposit and/or web bill pay at an institution.

If the 12-cent interchange rule goes through, checking accounts will be extremely unprofitable, to the point that they will be impossible to justify, even as loss leaders. Wishing away the reality or claiming that it is somehow the fault of evil bankers is foolish. The imposition of checking fees will be absolutely necessary.

Felix (based on this entry and the blog entry a few months ago about Chase) seems to feel that people are somehow entitled to have checking accounts with multiple expensive access points, a robust channels network and complete fraud protection and not have to pay for any of it. It is the typical sense of middle-class American entitlement, plan and simple.

Posted by Carl15 | Report as abusive

Very well put, Carl!

Maybe I’m a little different. All I ask for is:
* Transparency. I want to know how much I’m paying for a service.

* Appropriate matching of services and costs. If some forms of access are more expensive, then charge more for those — and I will modify my behavior to utilize the less-expensive forms of access.

* A competitive environment. Think we already have that.

Posted by TFF | Report as abusive

@ TFF

Once banks figure out product pricing in response to the regulation, the next “big thing” will be channel rationalization. Some banks are already playing with variations of “online only” accounts that entail fees for interacting with humans at the branch or on the phone. I don’t think you will see widespread branch fees (or the elimination of branches altogether) any time soon. But 20 years down the road branches will be a lot different. They will not be transactional (you will be able to do your transactions on your phone or via the ATM), they will be consultative. Think no teller lines and instead advisers sitting behind desks discussing personal financial management with clients.

With over 7,000 banks and 7,000 credit unions in the US, it is the most competitive market for banking in the world. There is literally nowhere in the US where consumer choice of bank is limited to one or two institutions.

That’s why claims that fees are unnecessary and banks can make money without them are so curious. If it were true, Citi could give everybody a free checking account with all the bells and whistles at no cost to the consumer and destroy the other large national banks. It is unrealistic to claim that “wallowing in interchange” is a form of pure greed. If this were true, somebody out there would stop “wallowing” and start dominating market share.

Posted by Carl15 | Report as abusive

“20 years down the road branches will be a lot different. They will not be transactional (you will be able to do your transactions on your phone or via the ATM), they will be consultative. Think no teller lines and instead advisers sitting behind desks discussing personal financial management with clients.”

Wow I’m flattered… we’ve converted 4 of our twenty branches to exactly that format. We’ll have the rest changed over by 2015. I guess my community savings bank is ahead of the curve!

Posted by y2kurtus | Report as abusive

no one wants FREE. That’s an overstatement.

People want non-obfuscated agreements: simplicity, transparency, appropriate fees.

But if lower fees are going to put bankers in the poor house, maybe we should all bite the bullet and accept with the current situation.

I wouldn’t want to send no bankers straight to the soup line.

Now excuse me while I make my deposit to Chase bank – i got a chance to get a DOUBLE DEPOSIT. I could WIN up to 5,000 dollars. I’m so excited

Posted by bryanX | Report as abusive