Banks Push Prepaid, Credit Cards to Make up for Lost Debit Revenue

All big U.S. issuers have now abandoned their plans to charge debit card-related fees. The huge popular backlash against them, coupled with threats for legislative actions from politicians, forced the bankers to back down from their initial plans.

Yet, the issuers still have a huge revenue shortfall to make up for and they have every intention to find a way to do it. The Durbin Amendment to the Dodd-Frank financial reform act of last year, which just took effect this past October, cut the amount of fees issuers can charge merchants for processing debit card transactions — the so-called “interchange fees” — by 45 percent. As a result, banks now stand to lose about $7 billion in annual revenues. That’s the hole they are so desperate to find ways to fill in.

Do Issuers Have the Right to Try to Make up for Interchange Losses?

In letters to two of the nation’s biggest debit card issuers, Sen. Durbin, the author of the eponymous amendment, told the bankers that that they had no right to attempt to recoup their losses, because these revenues did not belong to them in the first place. Moreover, the senator declared, even under the new rules the banks would still be making enormous profits. Here is, for example, what he wrote to Wells Fargo:

Wells Fargo will make at least an estimated $1.22 billion in annual debit interchange revenue after swipe fee reform. This amount far exceeds any reasonable measure of the cost to Wells Fargo of conducting debit transactions. Instead of making up costs, your new consumer fee appears to be a plain attempt to increase your profits — even though your bank just reported third quarter profits that hit a record high.

We’ve written previously on Sen. Durbin’s issue with profit-making, so there is no need to do it again here, but his point is nevertheless a reasonable one and needs to be addressed. The senator’s calculations are based on Wells Fargo’s financial reports from last year and he is correct that the bank would still have collected substantial interchange revenues if the new rules had been in place back then. The fact still remains, though, that these revenues would have been 45 percent lower than the ones collected in the real-world scenario.

It seems to me, however, that this whole dispute is a moot one. See, whatever Sen. Durbin thinks of the right of banks to create new revenue sources to replace ones that no longer exist, the fact is that they will do it. They have no other choice. After all, who would invest in a business that happily accepts a revenue shortfall, whatever the reasons?

So, with that in mind, let’s take a quick look at the banks’ top alternative revenue-generating sources.

Banks to Push Prepaid, Credit Cards

Prepaid cards are already the fastest-growing non-cash payment method in the U.S., according to the Federal Reserve. Here is what the Fed’s study found:

*CAGR is compound annual growth rate.

So prepaid cards were growing much faster than any other non-cash payment method even in the pre-Durbin world, when only smallish, largely unknown issuers were interested in them. That has now changed, because prepaid cards are unaffected by the new interchange limit. American Express recently launched a prepaid card that is practically fee-free, something unheard of for a product that typically comes loaded with fees for activation, purchases, balance inquiries and monthly maintenance, among others. Other big issuers are also said to be considering their prepaid options.

Credit cards, on the other hand, have been declining in popularity, as the Fed’s data show. Issuers will surely now do their best to reverse that trend. They have already started to push credit cards much more aggressively than at any time since before the financial crisis began and will no doubt try to make credit a more attractive payment option than debit.

The Takeaway

The bottom line is that issuers will find ways to make up for lost interchange revenues. Sen. Durbin may not like the idea, but it is going to happen all the same. It seems to me that the only relevant questions are how the issuers will do it and what it will mean for consumers.

The top contenders to make inroads into debit territory — prepaid and credit cards — are payment products that are very different from one another and have historically appealed to very different types of consumers. Typically, prepaid has been the domain of the “unbanked,” consumers with no access to regular bank services. Credit cards, on the other hand, have been available to a much wider range of consumers, but the best credit terms and rewards programs have been reserved for the ones with the highest credit scores. Now issuers are devising plans to extend the appeal of both types of products to a wider consumer range and make debit unattractive in the process.

Well, if the end result of all this turmoil is that my credit card rewards program becomes more generous, I’m all for it, as I think most other credit card users would be.

Image credit: Wisegeek.com.