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Financial Reform: How Regulating Debit Cards Helps Retailers and Consumers

By Alain Sherter

Updated on: June 22, 2010 / 2:07 PM EDT / MoneyWatch

If banks are unhappy with something, that's often a good sign for everyone else. And the American Banking Association is mightily displeased with the agreement reached yesterday on regulating debit card fees. Says the industry's main lobbying group:

The harm is real â€"- consumers will see higher costs, basic banking accounts in low-income communities will either be eliminated or involve higher prices, and government programs will cost taxpayers more money, all for the purpose of increasing merchant profits.

It's SOP for the ABA to attack efforts to restrain banks by saying it will hurt consumers and business owners. But the compromise over Sen. Richard Durbin's interchange amendment is a good one precisely because it stands to help both these parties.

For retailers, particularly small merchants, the proposal offers relief from the soaring fees banks Visa (V) and MasterCard (MA) charge to process debit transactions. According to government estimates, the value of swipe fees paid on Visa and MasterCard credit and debit cards has risen from about $20 billion in 2002 to as much as $45 billion in 2007 (see chart below).

Durbin's measure requires the card issuers to make these "swipe" rates "reasonable and proportional" to processing costs. The compromise with House negotiators overseeing financial reform assigns the Federal Reserve -- not the proposed Consumer Financial Protection Agency, as directed under the Senate reform bill -- to regulate Visa and MasterCard.

Retailers can cut their costs by encouraging consumers to make purchases with debit cards rather than credit cards, which are more expensive for businesses to process. Debit cards are even cheaper to handle than cash. Says financial wonk Mike Konczal, noting that swipe fees for credit cards average 2.19 percent and 1.75 percent for debit cards:

As a merchant you can now put incentives out there for consumers to use the lower cost option, whereas right now the system encourages extra credit consumption.

Stricter debit network regulation should also level the playing field between small businesses and large retailers. Visa and MasterCard charge lower interchange rates to giants like Walmart (WMT). The Durbin plan would help merchants compete by enabling them to pass along cost savings to consumers who pay with a debit card, Konczal says.

Banks will continue to fight the proposal. But significant support for the measure on both sides of the aisle make it highly likely to survive the conference committee.

Following, courtesy of Durbin's office, is a summary of some of the changes to the debit card measure under the House-Senate compromise:

Discounting between card networks. The Senate-passed amendment provided that card networks could no longer prevent merchants from offering customers a discount to use one card network versus another (eg, a discount to use Visa vs. MasterCard), and that this discount would apply in both the credit card and debit card contexts.This provision has been removed from the amendment. In its place, the compromise includes a provision directing the Fed to issue rules preventing card networks from requiring that their debit cards can only be used on one debit card network (thereby ensuring that merchants will have the choice of at least two networks upon which to run debit transactions). This provision allows merchants to choose the debit network with the lowest cost â€"- the opposite of the current system where merchants are forced to use a specific network with fixed prices.
Authority of the Federal Reserve Board versus the Consumer Financial Protection Agency/Bureau. The Senate-passed amendment provided for regulatory authority under the amendment to migrate to the Consumer Financial Protection Agency/Bureau after the CFPA/B is established.The compromise provides that regulatory authority under the amendment shall remain with the Fed.
Definition of interchange transaction fee. The Senate-passed amendment defined "interchange transaction fee" to include debit card fees that are established by a payment card network (eg,, Visa and MasterCard) and that accrue to either the card-issuing bank or to the network itself.The compromise provides that the Fed cannot regulate network fees (ie, the fees that Visa and MasterCard charge and that accrue to themselves) except to ensure that the fees are not used to circumvent interchange fee regulation. These changes are a different way of accomplishing the same goal of protecting consumers from loopholes which would allow banks to raise fees to cover any loss in interchange revenue.
Reloadable prepaid cards. The Senate-passed amendment would regulate the interchange fees associated with reloadable prepaid debit cards, which are in common use by consumers who lack bank accounts.The compromise exempts these cards from interchange regulation, provided that after a two-year grace period the issuing bank must not charge cardholders any overdraft fees or fees for the first monthly in-network ATM withdrawal. The compromise is an attempt to protect the unbanked from being driven to payday lenders and other non-bank entities for their financial needs. It further ensures that fees won't be charged on those who can least afford them.
Fraud prevention costs. The Senate-passed amendment did not permit consideration of fraud prevention costs in the calculation of reasonable and proportional interchange rates.The compromise provides that the Fed can adjust the interchange fee rate received by a particular card-issuing bank if the bank demonstrates that the adjustment is reasonably necessary to cover fraud prevention costs incurred by the bank. Banks will be incentivized to efficiently and effectively prevent fraud while competing to provide the best protection for the lowest cost.
Discounting between forms of payment. The Senate-passed amendment provided that card networks cannot prevent merchants from offering a discount for one form of payment vs. another (cash vs. check vs. credit versus debit).The compromise clarifies that these discounts cannot be offered if the discounts differentiate between card issuers or card networks. The agreement further clarifies that the discount must be offered to all prospective buyers and disclosed clearly and conspicuously to the extent required by federal and applicable state law, though a network would not be permitted to penalize a merchant for a discount that is provided in compliance with federal and state law.
Setting of maximum/minimum transaction thresholds for use of a credit card. The Senate-passed amendment provided that card networks could not prevent merchants from setting a minimum or maximum dollar amount for payment by credit card.The compromise provides that such a minimum may not exceed $10, with authority given to the Fed to increase that dollar amount. The agreement also limits the ability to set maximums for payment by credit card to the federal government and colleges and universities.
Non-discrimination between cards issued by different banks. The Senate-passed amendment did not change the existing prohibition in the operating rules of Visa and MasterCard against card issuer discrimination. The compromise amendment contains a rule of construction affirmatively stating that nothing shall be construed to authorize any person to discriminate between debit cards or between credit cards on the basis of the issuer who issued the card.

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Image from Flickr user Walter G. Arce