Post image for Getting Real About Durbin

I’ve been amazed by what I’ve been reading of late from the “analyst” firms commenting on the Durbin Amendment. A lot of what I’ve seen makes me wonder whether these folks should turn in their analyst licenses and simply register as paid lobbyists for their big bank clientele. (The Durbin amendment, for those not in our industry, is an amendment to the financial regulation bill that has passed the Senate and is awaiting its fate in the reconciliation committees. The amendment would give the Fed, and possibly the consumer regulatory agency, the power to regulate debit card interchange. Most likely, this would reduce a key source of retail bank revenue.)

Now, don’t mistake me as a supporter of the Durbin approach. I’d like to see the courts deal with the legality of the present interchange arrangement and hopefully guide us toward a more market-based approach to setting prices, but for a moment, let’s deal with the world as it is, rather than as we wish it to be.

The Amendment could be modified, watered down, and limited, but the strong probability is that it will pass in some form that will result in lower rates of interchange on most debit card transactions. There, I said it.  So now let’s talk realistically about what could ensue.

I think the possible competitive actions and reactions by banks and card networks make for a fascinating and complicated chessboard, but I seem to be in the minority. Most of the commentators are unusually happy to make to confident predictions about the outcomes. For example, writing on last Friday, David Evans went so far as to say, “The consequences of the Durbin amendment are pretty easy to forecast, sadly enough.” Yet most of the predictions on his list make little sense to me as a former retail banker and payments consultant. Below are my reactions to Evans’ major predictions (quoted in bold).

“There is no evidence that I know of that it is a massive generator of profits for anyone so price caps aren’t going to come out of profits.” Then what is everyone so upset about? Why is my in box stuffed with promotions and rewards offers tied to use of my debit card? Why is a major bank running national ads that depict two brothers racing to swipe debit cards for each other’s purchases? I was in charge of an “ATM card program” when signature debit was introduced. At the time, PIN debit was at best a break-even proposition, which we largely ignored; signature debit interchange was dropped on us like manna from heaven and powerfully transformed DDA economics as it grew over the years. Free checking was nearly unheard of before debit interchange.

“At least in the near term the retailers will pocket a good portion of that money in the form of extra profits. Consumers shouldn’t expect to see price reductions.” If you are merchant reading this, you must giddy to learn that you have so much pricing power and that the laws of economics no longer apply to you. Debit interchange is an input cost to merchants and if that cost goes down it means the industry supply curve shifts down. When the price of a barrel of oil falls on a futures market, a day or so later, the price of gasoline responds. Why don’t the extractors, refiners and dealers just pocket the money? Because in a competitive market, they can’t.

Now, you shouldn’t look for a penny-for-penny change in prices. Debit isn’t 100% of the payment volume, and it is just one small component of the cost of most goods sold at retail. But in any market where price is set at the intersection of supply and demand, there will be at least subtle downward pressure on prices.

Frankly, we are already seeing a less subtle impact on pricing that is encouraged by the Durbin provisions that allow merchants to promote some forms of payment over others. If you’ve been to a gas station lately, you know that cash purchases are already priced about 3% lower than card purchases. Shell recently introduced a private label decoupled card that clears via ACH debit and offers discounts to users of that card. Ikea has already also been offering vouchers for discounts on future purchases to customers who pay with debit. And last week came the news that Target will now offer instant 5% discounts to users of its proprietary and co-branded cards. I’ve been waiting a couple of years to see retailers begin tying their discount and loyalty cards to specific, less-costly forms of payment and I sense now that the genie is slowly oozing out of the bottle. Keep a watch on other high frequency retailers (supermarkets, drug chains, discounters, gas stations) for evidence of similar programs. Interchange is a meaningful expense and retailers will invest money to avoid or reduce it.

“Banks are going to have to figure out how to recover the costs of offering debit cards and it is inevitable consumers will face higher banking fees in one form or another.” Can’t argue this one, but so what? Where is it written that merchants must underwrite “free checking”? If consumers value their checking accounts and debit cards, they’ll pay for them; if they don’t, they’ll pay some other way. When signature debit first came out, I was criticized for offering it for free to the bank’s customers while banks elsewhere in the country were readily commanding annual fees of $12-18 for the convenience these cards were bringing to customers. I decided to remove the barriers to activation and focus on usage, reasoning that we would make more money over time that way. After a while, most every other bank in the country reached the same conclusion. Times change, and I suppose if interchange is reduced sharply enough, we could see annual fees come back to debit cards (anyone remember when other banks’ ATM didn’t charge you a convenience fee?). My bet is that retail banks will find some other element of the DDA to reprice.

“It is also likely that banks will be less enthusiastic about debit cards and regain for love (sic) for the plain old paper check.” Likely? Having spent the last 15 years selling consumers on the convenience of debit cards and online bill payment, will the retail banking industry simply turn 180 degrees en masse and encourage their customers to start writing checks again? Will the consumer accept that? Will merchants happily accept an increase in checks? Can the economics of the zero-interchange, fraud-prone check really be better for the banks than the regulated debit card? That approach could provide interesting openings for card players like American Express and Discover who do not currently participate in the volume and growth of the debit market.

*  *  *

So, there will be effects from the regulation as historical cross-subsidies are disrupted. Transaction accounts may become more expensive for some consumers, and debit reward programs will probably be diluted. At the same time, consumers could benefit as retailers provide incentives for certain forms of payment.

But we need to be careful about overdramatizing the possible outcomes in the heat of the current political debate. Consumers are not going to suddenly abandon the convenience of their debit cards in order to write more checks. Debit card interchange was significantly reduced by the settlement of the Wal-Mart lawsuit and debit cards not only survived but became much more popular in the years after. In fact, debit cards exist and are quite popular in markets with minimal or no interchange – just ask a friend in Canada. In fact, maybe a change in the regulatory regime could drive the industry away from the highly contentious, zero-sum game that interchange has become in recent years and towards some innovative – and mutually profitable – partnerships between banks and retailers.

What do you think?
Let us know in the comments…

5 Responses to “Getting Real About Durbin”

  1. Terry says:

    Bryan – the impact will be significant on prepaid card programs that rely significantly on interchange, such as government benefits, employee benefits and programs for unbanked or underbanked consumers (such as the FDIC templates for LMI consumers).

    On government benefits cards, the cards are typically provided to the government entities at no charge, and the cardholders pay little or nothing for use of the cards. Interchange is the primary source of revenue to the issuing bank, along with some float on funds held (but they are earning little or nothing on float right now). If Durbin passes, either the states have to pay for the cards or go back to using checks.

    Same for employee benefits cards. Employers will have to pick up the cost of offering the cards, as the employees cannot be charged.

    LMI conusmers using prepaid are the worst off. If they pay a “surcharge” to a merchant for using their card (I know it is a discount for cash, but it really is a surcharge for using the card), they will be driven to get cash out of the ATM and carrying cash around in order to make their purchases in order to get the discounts. If they get charged higher cardholder fees, they do not take the prepaid card. It defeats one of the primary purposes for using a prepaid card, safety and security of funds.

  2. Bryan,

    I’m not sure which “analysts” you’ve been reading, but this one is far from convinced that the Durbin Amendment will do much of anything. I’ve spelled out the arguments here: Before we get into heated arguments about the impacts, we should be certain that there are actually going to be any impacts.

    In any case, you make the case in your own blog that merchants are finding ways to discourage signature debit card usage without any help from the government. So why is this amendment necessary? While I think some of your criticisms of Evans are valid – the idea that banks are going to swing back to paper checks seems absurd to me – I agree with his view that this is a colossal mistake that is only going to lead to a more dysfunctional payment system and further regulation down the road. This is what happens when an industry fails to resolve its own problems; the government comes in and imposes a solution that everyone hates.

    • Terry says:

      Aaron – what do you make of the concern of the smaller banks about the definition of issuer? It includes “agents.” Most smaller banks and credit unions do not issue directly – they enter into agent bank agreements with corporate credit unions, banker’s banks, or larger issuing banks to issue their cards. If all the “agents” assets are lumped together with an issuing bank to determine an issuer’s size, many would exceed the $10 billion floor.

  3. Bryan Derman says:

    Thanks for these thoughtful replies.

    Terry is right to highlight the strong potential impact on prepaid programs. But again, I would ask why it is the responsibility of retailers or consumers who pay cash to subsidize the cost of financial services for others, whether that is through a big bank, a prepaid card program manager, or the Social Security Administration. I would also point out that card economics can be compelling in their own right; one of the first government benefit programs that migrated to cards was SNAP (food stamps), which clears at par (no interchange). In fact, many states go so far as to provide a free terminal to merchants who want to accept EBT cards.

    In the payroll area, employers always assumed the cost of issuing paper payroll checks. Why would they not also be responsible for the cost of payroll cards? This could be one area where we will see a move back toward checks. Finally, if interchange is reduced sufficiently, retailers might well offer cash-type discounts to prepaid and debit cardholders, benefiting LMI consumers.

    I agree with Aaron that price regulation is a difficult and messy path; as I said, I am no advocate for the Durbin approach. But I also question the implicit suggestion that interchange rates are just fine as they are. Signature debit cards used to earn the same rate of interchange as credit cards until the “Walmart Suit” was settled; was that right? Are the current rates better? At a minimum, I cannot see why merchants should not have the right to price payment products differently if they have different costs.

    The truth is that it is probably a risky proposition to base business models entirely or largely on interchange: It is an opaque factor that masks the true cost of a product to its customers; it changes twice a year in ways that are sometimes hard to predict; and, as we now know, it is subject to sudden regulation (though as Aaron notes, people who are shocked by this development haven’t been paying attention; Durbin may have been a surprise, but dozens of merchant lawsuits have been pending in the courts for the past several years). A few years ago, lots of prepaid business models were based on breakage and you never see that anymore.

  4. FactChecker says:

    As far as a “subsidy” is concerned, I believe that is false since it assumes that cash has a zero cost unless you are tax evading and that companies and retailers can benefits from electronic payments and consumers benefits.

    The issue of why consumers should “subsidize” bank programs who pay in cash is misleading, subsidizing happens all the time from paying to maintain roads, from paying for someone else’s milk and the coffee shop, etc, but that’s a bit different.

    If someone pays in cash merchants may have to hire many more armed security cards, tellers, losses may occur slightly if exact change is not given, etc, many airports and a few places in new york city have stopped taking cash , so why should debit and credit card users subsidize cash users then?

    It’s true that you should not depend entirely on interchange fees and a retail bank partnership should develop, however to the merchants who decry fees they have their own branded cards in partnership with the banks. Of course lawsuits have been going on for years, one reason signature debit was now accepted is not just because of the lawsuit but because PIN debit interchange is narrowing with signature. Furthermore, signature has benefits including the ability to reverse charges if a mistake is made either by the consumer or the merchant.

    Companies such as perkstreet financial are trying to build businesses models around debit interchange fees, and are giving 1-2% debit cash back cards. Is that model sustainable even though they aren’t yet affected by durbin? In the case of the government programs would it be better for them to just give cash or pay retailers money, I’m not sure. Businesses also have credit cards too, so the national retail’s consumer pays fees is partially false.

    This is interesting about decoupling and companies such as perkstreet financial. There is a move back to checks with certain colleges and universities as well as government agencies charging 2.5% by credit or signature debit, but not charging anything for a paper or regular electronic transfer or cash even though its not free (the move to debit was to save money on cash), this credit users are subsidizing those folks, and if you are low to middle income you may use a credit card until your next pay check comes are if you don’t have the funds, by contrast if you are wealthy you may not care or care , if your a multimillionaire probably not, but even the wealthy are cutting back and if they can save 2.5% and have the funds, then its it could become subsidizing of the wealthy too.

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