Bits of Cents

Yesterday under the direction of the Durbin Amendment, the Federal Reserve unveiled its proposed debit card interchange fee cap and pegged it at $0.12, a 70% decrease over the current average of $0.44.  For the uninitiated who think interchange is some sort of superpower, it’s the amount the card networks (Visa, MasterCard) charge merchants (Target, Wal-Mart, your local restaurant) for the service of settling transactions electronically.  You don’t see the fee as a consumer but a $100 shopping spree at Amazon paid with your Bank of America Visa debit card actually costs the retailer something closer to $102.  In this example, the proposed change would bring Amazon’s price for using the Visa network on a $100 purchase down from $1.75 to $0.12.

Reading into the (always cloudy) Witheiler crystal ball, there are a number of implications of this change.

What will happen:

• RIP debit loyalty programs – If you enjoyed the cash back, airline miles or point rewards on your debit card, you can kiss those perks goodbye.  The money to pay for those programs was funded out of interchange.  Reduce interchange by 70% and you can forget about that free trip to Hawaii.
• Fees will move elsewhere – Interchange fees are estimated to generate $8B in revenue to the top 6 issuing banks (who get a cut of the fees that Visa and MasterCard charge) and are a large revenue driver for these banks.  Expect the entire bank ecosystem to react in a manner that replaces lost interchange revenue.  Possible places the dollars will shift include further fees for checking accounts (adding to those already piled on to make up for lost overdraft revenues) and higher fees on the ACH network (the network used to wire money into bank accounts, for instance when your employer direct deposits your paycheck).
• Startup banks will be impacted – There have been a number of startups targeting the banking industry as of late – BankSimple and PerkStreet come to top of mind.  Like the big banks, these startups rely in part on interchange revenue to drive profits.  A $0.12 fee cap materially impacts this revenue stream and makes it harder to build a new business here.
• Merchant funded rewards increase – The other side to debit card loyalty programs are merchant funded rewards, where the merchant provides funds to consumers to build loyalty.  You’ve probably experienced this first hand when you shop at one of the bank malls, like Bank of America’s WorldPoints Mall or the Chase’s Ultimate Rewards Mall.  Expect more dollars to flow into this category given the fact that merchants are now making more money off of you.

What will not happen:

• Lower prices – Merchants lobbied congress to pass the Durbin amendment under the premise that interchange raises prices for consumers.  If you think that the price savings from lower interchange will be passed to consumers, you’re crazy.  There is a zero percent chance that retailers will use they money they are saving to decrease prices of goods.  It’s not that merchants are “greedy” and are looking to make more money (although they may be), it’s the fact that debit is only one form of payment.  While interchange on debit transactions may be capped to $0.12, interchange on credit thus far remain unchanged.  To realistically be able to lower the prices of goods, merchants would have to have different prices depending on how you pay – imagine a pack of gum with a $1 price tag if paid in cash, a $1.12 price tag if paid with a debit card and a $1.25 price tag if paid with a credit card.  It’s insane to think that merchants will have three price tags on goods and that consumers will understand the differences – after all, to most people, Visa is Visa regardless if it’s a debit or credit card.  Until there is consistency and parity across payment forms (likely never), expect merchants to pocket the savings off reduced interchange.

The interchange regulations are currently in draft form and are out for comment until April 21st.  The draft legislation can be found here and comments can be made here.