Debit Card Fee Regulation Creates Excitement, Anxiety

From the June 2010 Payments newsletter: www.afponline.org/paymentsnewsletter

An amendment to tackle "swipe fees" recently passed the U.S. Senate. This amendment, sponsored by Sen. Dick Durbin (D-Ill.), focuses on how much Interchange fees issuing banks can charge merchants for accepting debit cards. Naturally, it has created a lot of excitement and anxiety in the merchant and banking communities.

The Durbin amendment proposes the following:

Debit fees must be "reasonable and proportional to the actual cost incurred" by the payment network or issuer for processing the transaction. The Federal Reserve will determine what counts as a "reasonable" fee, but it likely will be lower than the current rates that range from 1.03 percent + $0.15 to 1.90 percent + $0.25 for most merchants. (America has the highest credit and debit Interchange rates in the world.)

Merchants can offer discounts to customers who pay with cards that carry lower transaction fees. Currently, merchants must accept all cards on the same terms. So, for example, a merchant cannot offer a discount to a customer who pays with a debit card instead of a credit card. The Durbin amendment allows merchants to design incentives for customers who pay with less expensive tender types. So you could see retail and online merchants offering a 1 percent discount to customers who pay with a debit card instead of a credit card - a win-win for consumers and merchants because the effective cost of accepting credit card typically is north of 2 percent. The amendment carves out debit Interchange fees for the following reasons:

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 percent + $0.15 to 1.90 percent + $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 in the 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.

Debit swipe fees are unreasonably high and exist in an uncompetitive vacuum. The card networks (VISA and MasterCard), in collaboration 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 is not an option for most merchants.

Debit sales are growing. 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. And 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 several years, debit Interchange fees and network access fees also have been increasing. That does not seem logical in a competitive marketplace.

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

Anand Goel is managing partner of Optimized Payments Consulting http://www.optimizedpmts.com