Let’s say you’re buying a latte at a coffee shop. You dig into your purse but discover you’re out of cash. So you pluck a debit card from your wallet, wave it in the air and ask the barista, “Can I use this?”
To you this seems like a tiny, unimportant moment of your day. But to the coffee shop, it could mean the difference between making a profit, or selling the latte at a loss. And to the nation’s largest merchants and banks, this little decision, repeated millions of times every day across the country, lies at the very heart of a titanic and expensive battle in Congress between retailers on one side, banks and credit card networks on the other.
The winning side will see an annual windfall of at least $24 billion.
“It’s huge right now,” says Ed Mierzwinski, director of the consumer program at the U.S. Public Interest Research Group (PIRG) in Washington, D.C. “Probably every lobbying firm in the city is getting paid because of this.”
The fight is over the dry-sounding Durbin Amendment, scheduled to go into effect April 21, and the even drier-sounding issue of “interchange fees.” Under rules proposed by the Federal Reserve, the fees that banks charge merchants for processing debit card transactions would be cut 84%, and capped at a maximum of 12 cents (the current average is around 44 cents).
Banks are fighting the change, and the outcome of the battle could change the way we buy everything from gas to groceries.
“Why should consumers care?” says Trish Wexler, spokeswoman for the Electronic Payments Coalition, which represents banks and the credit card networks in this fight. “Because the debit card as they know and live it today is about to change.”
That is, unless Wexler and her coalition can stop it.
Interchange Made Easy
OK, let’s start with the basics. What’s an interchange fee? It’s the fee the merchant pays every time you swipe your debit card. If you swipe your card to spend $100 at the grocery store, you probably assume the store gets to keep the full $100.
They don’t. They only get $98.30, because an average of $1.70 covers the interchange fee, according to a report by the Federal Reserve. That money is divided between your bank, the grocery store’s bank, and the network that supplies the card swipe machine. Visa and MasterCard run the dominant networks, with American Express and Discover running a distant third and fourth respectively.
That $1.70 average fee charged for every $100 spent applies only to debit card transactions that the customer authorizes with a signature. These transactions occur over the major credit card networks. They cost retailers slightly less than the cost of processing credit card transactions. Alternatively, the customer can swipe the same debit card, but enter a PIN number instead of a signature. This type of transaction occurs electronically and immediately. These transactions are processed over different networks (such as Pulse, Star, or NYCE as well as MasterCard’s Maestro and Visa’s Interlink). This type of transaction costs retailers a lot less, usually around 15 cents.
Two different payment methods using the same card fosters plenty of jockeying between banks and retailers. Because PIN-based transactions cost retailers significantly less money, they try to encourage those purchases, often by automatically prompting customers to enter a PIN on the terminal where they swipe their cards. Meanwhile, banks offer rewards for signature-based transactions, and a few charge their customers a fee for every PIN transaction.
Either way, a debit purchase is like using a digital check, only it’s faster for consumers, merchants and banks.
That convenience may explain why Americans’ debit card purchases surged from $210 billion in 2000 to $637 billion in 2006, according to the Fed study. And most consumers have no idea the fee is there, buried in the price of items they buy every day.
“I think that a lot of us, particularly in younger generations, have started to use debit as cash for the convenience and security,” Wexler says.
OK, So Who Should Pay?
So the question becomes: Who should pay for that convenience? Retailers have a surprising answer: Nobody. For decades, retailers paid small fees to process paper checks. Now they pay significantly more money—$1 billion a month collectively, according to the National Retail Federation—for a system that should cost less than paper checks.
That doesn’t make much sense, merchants say.
“A debit card is not a product. It’s just a withdraw device, like a paper check,” says Mallory Duncan, chief attorney for the federation. “And since debit cards cost less to process than checks, they should cost less to use.”
But instead of going down, interchange fees are going up. The Federal Reserve estimates that interchange fees cost consumers $24 billion in 2006; the Merchant Payments Coalition reported that the amount in 2010 was closer to $50 billion. Either way, the total amount spent with debit cards is growing by 20% a year, the Fed found.
As the networks expand and become more efficient thanks to higher sales volumes and faster technology, one might expect Visa and MasterCard to compete with each other by lowering the prices they charge retailers. That hasn’t happened. Interchange fees have stayed roughly stable over time, and fees on premium cards continue to grow, according to the Fed.
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How is that possible? Visa and MasterCard control 70% of all debit transactions. They use that dominant market power to dictate prices to merchants, the retailers say, keeping interchange fees (and retail prices) unnaturally high.
“They don’t want to compete,” Duncan says. “They want a cartel. They want monopoly pricing, because that’s what they have now and it’s very profitable.”
Consumer advocates agree.
“It’s pretty obvious that this is a broken market,” says Mierzwinski. “You have a duopoly of Visa and Mastercard controlling the entire payment market, and I think everybody pays more at the store and more at the pump because of it.”
Retailers have repeatedly sued Visa and Mastercard for running a de facto monopoly, and they lost every time, Wexler points out. “Just because you have large players does not equal a duopoly,” she says.
The real issue, according to Wexler, is that debit card networks provide retailers a valuable service, one that brings them more customers, encourages those consumers to spend more money per transaction, and lowers retailers’ labour and banking costs.
And now the retailers are trying to weasel their way out of paying for it, Wexler says.
“The retailers don’t want to pay their fair share of this system,” says Wexler. “They want us, the consumer, to pay for it. And that’s not fair.”
Not All Consumers Are Treated The Same
Arguably, consumers already pay for the debit card swipe system, since retailers pass on the fees in the form of higher prices on food, gasoline and other goods. This forces people who don’t have bank accounts or debit cards to subsidise people who do, according to a report by the Boston branch of the Federal Reserve.
About a quarter of Americans don’t have bank accounts, according to U.S. PIRG. These people tend to be from low- to moderate-income families. Currently they pay higher prices for milk, gas and most everything else they purchase, helping to support a payment system they don’t use.
“Cash buyers are subsidizing card buyers, who generally are more affluent,” Mierzwinski says. “That doesn’t make much sense.”
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Meanwhile, banks use revenue from interchange fees to pay for rewards programs and free checking offers, according to the Boston Fed. The best rewards programs often are targeted at the most valuable banking customers, usually those with higher incomes.
“Free checking is the primary mechanism banks use to steal customers from their competitors,” says Travis Plunkett, lobbyist for the Consumer Federation of America.
The result, the Boston Fed found, is that the average low-income family earning $20,000 or less pays an extra $21 a year in interchange fee-related costs at the checkout counter. Meanwhile, the highest-income families, who make $150,000 or more annually, receive $750 a year in rewards bonuses and waived checking fees thanks to the current system.
Lower-income people “are subsidizing this anti-competitive system. That’s simply unjust,” says Plunkett.
Even if the system is changed, there’s no guarantee that retailers will pass the savings onto consumers, low-income or otherwise, Wexler says. She points out that Home Depot’s report to investors in the fourth quarter of 2010 estimated the company would receive an extra $35 million a year if interchange fee costs are shifted from retailers to banks.
“Well that doesn’t sound to me like they’re planning on passing that along,” says Wexler. “I don’t buy for a second that giant retailers have spent a decade and millions and millions of dollars lobbying so they can take their winnings and pass it on in the form of lower prices.”
Unlike the interchange fee market, however, retail sales are highly competitive, with profit margins of between 2 and 3.5%, according to the Michigan Retailers Association. Even if retailers pocket some of the windfall from transforming interchange fees, consumers still would benefit, advocates say.
“I think consumers should care because the interchange market is broken, and it’s forcing retailers to raise their prices,” Mierzwinski says.
The Fallout on Banks
The lobbying battle in Congress over interchange fees has focused largely on the effect of changing the interchange rules on small banks and their customers. In a survey by the Independent Community Bankers of America, a trade association, 93% of small banks said they will have to get rid of services like free checking if interchange fees go down.
“I am appalled that our members will shoulder tremendous financial burden and still be on the hook for fraud loss while large retailers receive a giant windfall at the hands of the government,” John P. Buckley Jr., president of Gerber Federal Credit Union in Fremont, Mich., testified before the House Financial Services Committee.
Supporters of the change say the small banks issue is a red herring. The Durbin amendment doesn’t apply to any bank with assets below $10 billion, and Visa already has announced its system for allowing small banks to charge higher interchange fees than big banks.
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Also, the Durbin amendment only applies to debit cards in which Visa, Mastercard and any other network dictate the prices. If Visa, MasterCard and their issuing banks negotiated the transaction price for each debit card, they could avoid the Durbin amendment altogether. Duncan, the attorney for the National Retail Federation, argues that in a truly competitive market, banks should be able to negotiate with the networks to determine fees. That would allow small banks to raise enough money in fees to cover their expenses, and let Visa and Mastercard charge more than the 7- to 12-cent cap per transaction allowed under the Durbin amendment.
“That’s what they’re not telling people,” Duncan says. “They can get around the Durbin amendment tomorrow if they want. They just have to compete, and they don’t want to do that.”
The card companies say that’s not competition. That’s chaos.
“By the same token, 7-Eleven should let every customer who comes into their stores negotiate the price of a Slurpee,” says Wexler of the Electronic Payments Coalition. “But of course they don’t do that. Businesses have to set prices. This is how businesses work.”
Down to the Wire
The Durbin amendment, passed last summer as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, is scheduled to take effect April 21. However, after banks and credit unions pushed to have the implementation deadline extended, legislators in the Senate and House responded with recent bills that would delay the rule’s enforcement by either two years or one, respectively, thus buying the banking industry time to renew debate on the issue.
“This is one of the most important issues on Capitol Hill right now that’s being considered,” Wexler says.
Republicans, who control the House of Representatives, mostly agree with the banks and card networks.
“If we don’t get it right, that credit union or community bank in your town isn’t going to be there and you will be left with larger institutions,” Rep. Spender Bachus (R – Ala), chairman of the House Financial Services Committee, said in a recent speech.
Democrats have been more divided. Some agree the rules should be changed or postponed.
“I believe the Fed was given too narrow of set of rules,” said Rep. Barney Frank (D – Mass), told The New York Times.
Either way, this hidden little fee that consumers pay every day will remain at the centre of an expensive lobbying battle for weeks, if not months, to come.
“Now there is genuine political pressure to do something,” Frank says. “It’s very much in play.”
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