By Patti Murphy
Editor's Note: This article was published March 1, 2011, by Inside Microfinance at www.insidemicrofinance.com; reprinted with permission. © 2011 Inside Microfinance. All rights reserved.
It was bound to happen. In their rush to complete a comprehensive financial reform package last year, Democrats in the U.S. House of Representatives caved in to a poorly conceived plan to help out Main Street and stick it to Wall Street by effectively redistributing costs and revenues associated with debit card payments.
Now, as reality sets in, there's a growing sense that the so-called Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act, does anything but protect consumers - that it might actually push more Americans away from the financial mainstream and swell the ranks of unbanked.
At issue is a long-standing feud over the costs incurred (implicitly and explicitly) in processing credit and debit card payments and the fees banks assess merchants for accepting card payments.
Banks that issue credit and debit cards are paid a fee each time those cards get used at a merchant's checkout. This fee, known as interchange, can vary, but typically works out to between 1.1 percent and 4 percent of the ticket total. Interchange gets assessed by the card companies and is factored into the overall price a merchant's bank charges for card processing (sometimes known as the merchant discount).
Retailers have complained about interchange for years. In 2003, led by the retailing giant Wal-Mart Stores Inc., retailers secured a multibillion-dollar out-of-court settlement with Visa Inc. and MasterCard Worldwide over claims the card companies had been overcharging on interchange.
Over the past few years, retailers managed to win over public sentiment and congressional leaders with a massive public relations campaign against what they dubbed "swipe fees." Equating interchange with a tax, retailers argued that interchange relief would result in lower prices to consumers.
However, generally they have been unable to provide any tangible evidence backing those claims. I recall a treasury exec from a major retailing chain being asked to do just that during a 2009 symposium at the Chicago Fed. His response went something like this: it's not something we can say with any certainty ... it might work out only to be like 99 cents instead of $1 for a can of soda.
Now some folks are suggesting that Congress was hoodwinked by merchants and that many small merchants were hoodwinked, too, by the big-box stores. And there's a movement afoot in Washington to delay or revise the Durbin Amendment, which instructs the Federal Reserve to regulate interchange assessed on debit card transactions to ensure these fees are "reasonable and proportional" to the costs banks incur issuing debit cards and processing payments made using the cards. (Prepaid debit cards are exempt from the statute.)
A proposal the Fed put out for comment in late 2010 would cap interchange at a maximum of 12-cents per transaction, which by the Fed's own reckoning represents a 70 percent price cut, vis-â„¢-vis 2010, when debit interchange averaged 44 cents a transaction.
In anticipation of a huge drop in revenues (financial institutions collected about $12 billion in interchange last year, according to several sources), executives at financial institutions are looking for new revenue opportunities. The conclusion most have reached is that they'll need to start re-pricing checking account and debit card services. And that, in turn, is apt to chase low-balance and cost-conscious consumers out of the banking system.
The Credit Union National Association said all of its members will be hit hard by interchange price caps and may be forced to start charging their members for debit cards, checks and other previously free services. Credit unions are cooperatives, owned by member-depositors, and as such are considered consumer-friendly institutions. The Chief Executive Officer at JPMorgan Chase & Co. said he expects upward of 5 percent of checking account customers will leave the bank once it does away with free checking and debit cards.
A group of respected economists, collaborating on an economic analysis of the pending Fed proposal, predicted that as many as 1 million Americans will join the ranks of the unbanked if banks and credit unions try to compensate for lost interchange revenues with new accountholder fees. These are folks who generally maintain small balances; many simply don't have enough income to support new monthly bank charges.
The three - David S. Evans of the University of Chicago Law School, Robert E. Litan of the Brookings Institute and Richard Schmalensee of the MIT School of Management - suggest the interchange capping plan the Fed has proposed could wind up costing consumers and small businesses more than $33 billion over the course of the first 24 months of implementation.
They further predict in their newly released report, Economic Analysis of the Effects of the Federal Reserve Board's Proposed Debit Card Interchange Fee Regulations on Consumers and Small Businesses, that the largest retailers will divvy up a windfall of upward of $20 billion in interchange savings during that same period.
Free checking predates debit cards by decades. In fact, one rationale banks first saw in debit cards was perpetuation of the myth of free checking. And for some banks - especially the large national brands - it was a great move, generating a huge revenue windfall.
But among small community banks and credit unions debit cards became a necessity as budget-conscious and tech-savvy consumers demanded the immediacy of electronic access to their deposits. I, like any business owner who has ever tried to understand a credit card processing statement, know how frustrating it can be to try to make sense of the pricing formulas the banks and card companies concoct. It's an antiquated system that has outlasted several generations of processing networks and is in need of change.
This isn't something that Congress can or should fix, however. And frankly, the timing of this change couldn't be worse. Debit cards are the most popular method of payment among U.S. consumers, outside of cash. At 35 percent of noncash payments in 2009, debit card usage far exceeded credit card payments (20 percent), and even checks (22 percent).
So, why would Congress, or more importantly the Fed, want to risk dampening consumer spending at this fragile stage of an economic recovery with ill-conceived price controls?
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