Back in December, in a move praised by retailers and bemoaned by financial institutions, the Federal Reserve announced limits to the fees banks can charge merchants each time a debit card is used to make a purchase at a retail location. The limits, which will cap debit card interchange fees at 12 cents per transaction when they take effect on July 21, are intended to ease the financial burden on merchants and, in turn, help consumers through a sort of trickledown economics. However, since they are also projected to cost major banks about $13 billion in annual revenue, these fee caps have also sparked a fury of political and financial maneuvering that stands to significantly alter the ultimate effect of the regulatory power originally granted to the Fed by the so called Durbin Amendment.
As expected, many major banks have already announced plans to counteract the revenue they will lose as a result of interchange fee limits. However, these contingencies might ultimately not be needed thanks to a bill proposed on March 15 by a bipartisan group of U.S. senators. If passed, the Debit Interchange Fee Study Act would postpone interchange fee caps for two years and call for a study on their effects. If it doesn’t pass, a major restructuring of the payment landscape is likely. Since we’re unsure as of yet what exactly will happen, why don’t we take a look at both scenarios?
Scenario 1: Debit Interchange Fee Study Act does NOT pass
In the event this legislative injunction does not pass, major banks will likely continue with plans to recoup lost interchange fee revenue elsewhere. Banks will react to debit card interchange fee caps by first cutting the rewards tied to their debit cards. In fact, they have already begun doing so. JP Morgan Chase, for example, mailed letters to their customers informing them that debit card rewards would no longer be offered as of July 19. This shouldn’t be surprising, however, because it only seems natural that offers for these products become less attractive as they become less lucrative.
This disappearance of debit card rewards should also result in consumers increasingly using rewards credit cards. In addition, banks will position prepaid cards as cost-effective replacements for checking accounts because they provide the same functionality, minus the ability to write paper checks, and their interchange fees are not restricted by the new regulations.
The Durbin Amendment will therefore ultimately result in reward-less debit card offers with higher fees as well as increased credit and prepaid card use. Since the interchange fees for credit cards, prepaid cards and even debit cards from small banks (which were excluded from regulations) are not limited, merchant costs should not decline much, if at all, in the long term, and banks will still make their money, albeit from different sources.
Scenario 2: Debit Interchange Fee Study Act PASSES
If the legislation does pass, banks will be given a two-year reprieve, during which studies will be undertaken to gauge the effects of interchange fee limits. My hope is that what results from these studies is an understanding that price-fixing does not lead to a truly competitive payment landscape.
What’s needed instead is for merchants to be given the ability to provide discounts and assess surcharges based on both payment type (e.g. credit card, debit card, cash, etc.) and payment network (e.g. Visa, MasterCard, etc.). In other words, if a retailer is able to offer a discount to a customer paying for a given item with a Visa credit card, apply a surcharge to someone paying for the same item with a MasterCard credit card and leave the price unaltered for someone paying with a debit card, then there will be incentive for networks and card issuers alike to compete for merchant favor. The end result: lower merchant costs, lower prices for goods and more money in your pocket.
Ultimately, we don’t know exactly how things are going to turn out, but the implications of the different options before us are fairly clear. No matter which scenario comes to fruition, there is no doubt that changes must be made in order to instill greater competition within the payment landscape.
This is a guest post from Odysseas Papadimitriou, CEO of CardHub.com, a credit card comparison website that helps consumers find credit card deals.