A Case For Regulating Debit Card Fees

An amendment sponsored by Senator Dick Durbin to tackle “swipe fees” passed last Thursday in a 64-33 vote. This amendment focuses on how much Interchange fees issuing banks can charge merchants for accepting debit cards. Although this amendment still has to go through several hurdles (Senate must pass broader financial services regulatory reform legislation called the ” Restoring American Financial Stability Act of 2010″ –> reconcile reform bill with one previously passed by the house –> Senate and House reach agreement on “swipe fee” amendment and combine bills –> House and Senate vote on final bill –> send to President for signature), it has created a lot of excitement and anxiety in the merchant and banking communities, respectively.

It is anticipated that this financial overhaul along with the Durbin amendment will pass all the hurdles and become law. Read analysis from CNN and BusinessWeek. The Durbin amendment proposes the following limits on “swipe” or Interchange fees set by card networks.

  1. Bill requires that debit fees be “reasonable and proportional to the actual cost incurred” by the payment network or issuer for processing the transaction. The Federal Reserve will have authority to determine what counts as a “reasonable” fee, but it will likely be lower than the current rates that range from 1.03% + $0.15 to 1.90% + $0.25 for most merchants. The United States has the highest Visa and MasterCard credit and debit Interchange rates in world. For instance, in response to an antitrust probe, Visa Europe recently announced plans to cut its interchange rate to 0.20% on some debit-card purchases, following an earlier move by MasterCard. Rates in Australia are capped by regulators at 0.50%.

  2. Bill allows merchants to offer discounts to customers who pay with cards that carry lower transaction fees. Today, merchants are contractually obligated to accept all cards on the same terms. For instance, a merchant cannot offer a discount to a customer who pays with a debit card instead of a credit card. This bill would allow merchants to design incentives for customers who pay with less expensive tender types. For example, you could see retail and online merchants offering a 1.0% discount to customers who pay with a debit card instead of a credit card. This would be a win-win for consumers and merchants because the effective cost of accepting credit card typically is north of 2.0%.

Due to the political difficulty in addressing both credit and debit interchange fees in a comprehensive bill, this amendment smartly carves out debit interchange fees for the following reasons:

  1. Debit cards are simply plastic checks. Debit cards do provide guaranteed payment and some other incremental benefits to merchants than checks. However, these benefits are small compared the high cost of accepting these cards – typically 1.03% + $0.15 to 1.90% + $0.25 for most merchants. Merchants could add some of these debit cards features to check acceptance like electronic check conversion and check guaranteed service, but the total cost of these features would still be significantly less than the cost of processing debit cards.

    Now compare key bank costs associated with credit and debit cards…see table below. It is clear to see and to some degree justify the Interchange fees associated with credit cards. But it is much harder to justify current debit card fees given their true cost and the value they provide merchants.

    Bank Costs
    Credit CardsDebit Cards
    Cost of moneyBanks provide an interest free loan for about a month to card holders who payoff their balance in full each month.There is no cost here because the funds are immediately deducted from a checking or savings account.
    Cost of riskBanks have risk of non-payment by consumer, risk of fraudulent use of card, etc.Consumers cannot make purchases on debit cards beyond the funds available in their accounts. Banks do bear some risk with debit card but they are nominal when compared to credit cards.
    Cost of rewardsBanks offer frequent flyer miles, cash back, and other incentives to drive more charge volume. Experience shows that consumers spend more with credit cards…this is good for merchants.Some debit card have rewards tied to them but the reward value tends to be around 0.30% of the purchase value compared to 1.0% for credit cards.

  2. Debit “swipe fees” are unreasonably high and exist in an uncompetitive vacuum. The card networks (Visa and MasterCard) in collaborations with issuing banks have unchecked pricing power and set Interchange rates and fees to each other’s benefit. When the card networks introduce new fees or increase existing Interchange rates, the marketplace (processors, merchants, and consumers) has to accept the increases. There is no recourse or competitive forces to drive these fees lower. The only recourse a merchant has is to stop accepting credit/debit cards and that’s really not an option for most merchants. According to Robert Johnson, president of Consumers for Competitive Choice, despite advancements in technology that have lowered transaction processing costs, debit (and credit) swipe fees continue to go up each year.

  3. Debit sales are growing. Debit cards are becoming America’s plastic of choice. According to the Nilson Report, an industry trade publication, Consumers will charge an estimated $1.6 trillion on debit cards this year, nearly two-thirds more than in 2006. In 2009 debit transactions and total debit sales eclipsed credit card transaction and sales for the first time.

    So while debit transactions have been growing at double-digit rates over the past 6-7 years, debit interchange fees and network access fees have also been increasing. That doesn’t seem logical in a competitive marketplace. This dysfunctional market phenomenon has been exacerbated with Visa and MasterCard becoming public companies. As public companies, these networks show rising revenues and robust growth rates to Wall Street by consistently increasing fees to merchants. This is simply not fair.

In summary, the card networks provide a critical and needed service to the marketplace but their pricing, specifically debit card pricing, does not reflect the value provided to key stakeholders. Senator Durbin’s amendment provides much needed course correction in the payments industry.



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