Final Rules for Debit Card Fees Released - Effects on Checking Accounts?

Today the Federal Reserve Board approved the final rules for the debit card interchange fee regulation. For banks it was a significant improvement over the preliminary proposals from last December. The debit card interchange fee cap was raised from 12 cents to 21 cents with an extra 0.05% of transaction price to cover fraud prevention costs. The higher cap is intended to ensure all reasonable costs are covered.

Another win for banks is that the final rule delayed the implementation date of the new cap. Instead of July 21st, the effective date will now be October 1, 2011.

You can read the draft of the final rules at this Federal Reserve page. The Staff Memo to the Board contains a summary of the rule, and the full details are contained in the Federal Register Notice. This CNNMoney.com article has a good overview of the final rule.

Small Bank Exemption

The cap on debit card interchange fees is based on the Durbin Amendment that was part of last year's financial reform. It required the Federal Reserve to implement caps on debit card interchange fees. The Durbin Amendment exempts small institutions with less than $10 billion in assets. However, there were widespread concerns that this exemption would not protect the small institutions. That led to Senator Tester's attempt to delay this regulation, but that failed to pass the Senate earlier this month.

The draft report of the final rule has a good explanation of how small banks could be affected. Here's an excerpt from that explanation:

Many issuers expressed concern that this exemption will not be effective because networks would not institute, or could not sustain, a two-tier fee structure. If two-tier fee structures are implemented, these issuers believed that merchants would discriminate against cards of small issuers in favor of cards with lower interchange fees. Moreover, several issuers contended that even if networks institute a two-tier fee structure, merchant routing choice and steering would put downward pressure on interchange fees over time, thereby eroding the ability of small issuers to recover their full costs through interchange transaction fees and ultimately reducing any difference in interchange fees for small issuers.

The Durbin Amendment didn't include provisions to allow the Fed to make rules to protect the small banks from these concerns. For example, they can't require the networks to maintain a two-tier fee structure and they can't exempt small banks from the portions of the rule dealing with network exclusivity. However, the Fed did include some provisions in the final rule that may help a little.

Changes at Large Banks

The higher caps in the final rule may encourage the large banks to refrain from an all-out elimination of free checking. We'll have to continue to keep an eye out for new fees. Higher minimum balances and more activity requirements will probably be added to checking accounts at many large banks.

We will probably see the termination of many debit card reward programs from the large banks. One example might be Bank of America's Keep the Change program. With these new caps, there will be little incentive to encourage customers to use their debit cards. Most of these programs were never that great of a deal for depositors. So I'm not too worried about losing these.

Credit card perks should continue, and in fact, we may see the large banks place more emphasis on credit cards instead of debit cards since these interchange fee caps do not affect credit cards.

Changes at Small Banks and Credit Unions

What worries me the most is the effect on credit unions and small banks which offer high-interest reward checking accounts. The vast majority of reward checking accounts come from small banks and credit unions. The debit card interchange fees help pay for a sizable portion of the higher interest rates.

If the above concerns prove real and interchange revenue for small banks and credit unions does decline, then interest rates on reward checking will likely fall. However, it seems that this decline of interchange revenue should be slow. First the new cap won't take effect until October 1st, and the network exclusivity rules won't completely take effect until April 1, 2012. Once these take effect, the conditions described above would take time to erode the interchange fees.

One of my concerns is that the banks may see this new regulation as a good excuse to make cuts to their reward checking programs. If the reward checking wasn't as profitable as they had first anticipated, the publicity of this regulation provides for a convenient time to announce changes.