Credit Card Processing Blog

A new study by Javelin Strategy & Research, a consultancy specializing in the financial services and payments industries, examining the effects of the recently enacted Durbin Amendment on consumer payment behavior attempts to answer this question, among others. To do that, the company relies on the results of a survey of 3,000 Americans, conducted by the way in October of last year, when the country was still in the grips of the huge backlash caused by Bank of America’s ill-conceived introduction, and eventual abandonment, of a $5 debit card fee.

So the survey’s results should be looked at through the prism of the debit fee uproar and anyway, what people tell researchers does not always match their actions. Still, we do get an insight into the recent evolution of the American consumer’s sentiment towards the use of bank cards and other payment methods. And we also learn about some widespread delusions along the way. Let’s see what we can make of the data.

70% of Americans Would Switch to another Payment Method

That’s what Javelin’s survey tells us Americans would do if their bank started charging them a debit card-related fee. What would they start using instead? Here is the breakdown:

• 32 percent would switch to cash.
• 25 percent – credit cards.
• 13 percent – checks.

Just over a quarter of the respondents (26 percent) said they would counter a debit fee by switching banks, presumably giving their business to ones that do not charge such a fee.

It has to be said right here that, even though banks eventually decided against charging a debit fee, the aggregate volume of debit card transactions in the U.S. has been growing at an ever decreasing rate, while the exact opposite is true for credit cards. The chart to the right is showing you these dynamics, using the latest available data.

That, by the way, is precisely the type of a trend that U.S. banks have wanted to establish ever since it became certain that debit card interchange fees would be cut. So you might say that, although they lost the debit-card-fee fight, they may still win the war. Which brings me to the delusion point.

Who Benefits from the Durbin Amendment?

Perhaps the most unexpected piece of statistics to come out of Javelin’s survey is that 70 percent of the respondents told the researchers that they thought that the banks were the ones benefiting from the new limits on the debit interchange fees. This response again reminded me of the fact that the survey was taken at the height of the anti-bank backlash, but that notion is nevertheless very, very wrong.

The Durbin Amendment did exactly the opposite of what so many Americans have told Javelin. By limiting the debit interchange fees – the fees issuers charge to merchants for processing transactions involving debit cards – the Durbin Amendment slashed bank revenues by about $7 billion a year (that is our estimate, Javelin’s is $12.2 billion). As these billions, whatever the exact amount, are for the most part to be collected by the merchants, the Durbin Amendment is in effect redistributing revenues from the financial industry to the retail one.

Now, you may say that this is all good, because banks are finally getting exactly what they deserve. Well, the problem is that the card issuers could not just stand by and calmly accept their comeuppance. What they did instead was that they started looking around for ways to make up for the lost revenues. And as many of us predicted even before the debit reform took place, finding such new revenue sources could not leave consumers unharmed. That is exactly what happened. Debit card related fees may have been abandoned, but free checking is virtually gone, overdraft fees are up to $35, which is as high as the CARD Act would allow them to go and banking has overall become more expensive. And yes, consumers are worse off than before the Durbin Amendment was enacted.

The Takeaway

The data show that Americans have been turning away from debit card use long before banks began tinkering with debit fees. Credit cards have picked up most of the slack, although prepaid card use is also on the rise.

So, much to the chagrin of many consumers, their payment preferences are shifting precisely in the direction that is most favorable to the card issuers, whose credit card interchange revenues were left untouched by the Durbin Amendment. Of course that may soon change too, thanks to a huge anti-trust case filed by millions of retailers aiming to push credit interchange fees down. We’ll have to wait and see.

Image credit: NYDailyNews.com.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

Prepaid cards have been in the news quite a bit lately and not least thanks to the controversy surrounding Suze Orman’s prepaid card. This latest dust-up confirmed my belief that the vast majority of consumers are very poorly informed about this type of payment product, a fact which unfortunately Orman tried to exploit.

So when this morning I read yet another news headline praising prepaid cards as a “Safe, Secure and Cost Effective Way to Manage” personal finances, I instinctively prepared myself to be underwhelmed by what followed. I was proved correct. The author was citing some dubious statistics, attempting to convince us that prepaid cards are a much cheaper alternative to a low-balance checking account, but the numbers simply didn’t add up.

The Case for Prepaid

By the way, I should first say that I’m referring to a press release issued by the Network Branded Prepaid Card Association (NBPCA), so of course we should be expecting them to be praising the virtues of prepaid cards and that’s perfectly fine. Yet, that doesn’t give them a carte blanche to say anything they please.

Anyway, here is NBPCA’s argument:

Stacked up against low-balance checking accounts, the yearly cost of using a prepaid debit card is less.

Then they bring up a study from a consulting company – Bretton Woods – to back up their claim. So here are the cost-comparison numbers that are supposed to convince us:

Furthermore, we are told that “[t]he reloadable prepaid card costs would decrease after the first year by the amount of the activation fee.”

As soon as I read these numbers, I knew that this just couldn’t be right. This report is covering 2009 and 2010 and is taking its checking account numbers from just four banks: Bank of America, Citibank, JP Morgan Chase, and Wells Fargo, which for the most part were offering free checking back then. So how is it possible then that a checking account with these banks would have cost users a minimum of $218.35 in 2010?

The Numbers Are What You Make of Them

Well, the Breton Woods researchers tell us that the $218.35 2010 checking account usage cost is calculated for a “usage profile” that is “relevant for a consumer to meet their basic transactions needs.” A cardholder fitting this profile would participate into the following transactions:

• 3 ATM withdrawals.
• 3 bill payments (rent, utilities and phone).
• 8 point of sale purchases (groceries and meals once a week).
• 4 balance inquiries.
• 2 deposits/loads.

Well, but these things were and still are free for account holders at the four banks under examination. So the question remains: where does the $218.35 number come from?

Eventually we discover the culprit and it’s a familiar one: overdraft fees. We learn that “active household users of overdrafts incur more than four overdrafts per month, or 51 per year.” So, for good measure, the researchers “include five overdrafts per year” in their usage profiles.

You just can’t do that. I’m not sure exactly what their definition of “active household users of overdrafts” is, but whatever it is, it does not encompass the entire group of checking account users, far from it. So, if anything, the usage profile should be the victim of fewer overdrafts than an “active household user,” not more.

I wasn’t able to find another source of checking account fees in the report, so it all seems to come down to overdraft.

And as far as the numbers for prepaid costs are concerned, it is very difficult to verify them. It is possible that the lowest annual usage cost will be $76.35, but the average will certainly be much, much higher. Just take a look at the pricing disclosures for each of the prepaid cards under examination here – AccountNow, Green Dot Visa/MasterCard, NetSpend Visa, ReadyCard, RUSHCARD and Walmart MoneyCard Visa – and you’ll see what I mean.

The Takeaway

Prepaid cards definitely have a place in our financial system and it is true that their quality has been improving, as issuers have been trying hard to steer their customers away from debit cards, which in the wake of the Durbin Amendment have become a poor source of revenue for them. However, even today’s high-quality prepaid cards are loaded with fees that would be triggered if the cardholder does or fails to do something. This is why Suze Orman tells us that her card would cost users “[o]nly $3.00 a month if you use it how I tell you to.” The problem is that the “unbanked,” who make up the vast majority of prepaid users, have been cut out of the system precisely because they weren’t doing what they were told.

So prepaid is still the best card only if no other option is available to you. Checking accounts and the debit cards linked to them are still a much better alternative for consumers with access to the financial system, even if they have to pay a monthly fee for it.

Image credit: LeaveDebtBehind.com.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

WSJ’s Robin Sidel has a piece about the effect of the Durbin Amendment on the debit card interchange fees charged by credit unions and small banks. Or rather, the lack of a direct effect, as financial institutions with assets of less than $10 billion were unaffected by the regulation.

That is an interesting topic for a number of reasons and not least because when the exclusion of smaller financial institutions from the Durbin Amendment’s scope was first proposed, we heard quite a few uneasy voices from the under-$10 billion financial world. See, the small-bank concern was that, by allowing them to charge substantially higher debit card transaction fees than their bigger competitors, the Durbin Amendment would make them very unpopular with retailers and may prompt them to take retaliatory actions.

Now Sidel is reporting signs of a retailer backlash against this special treatment. But what actually prompted me to comment on her story was the fact that she has made some misleading statements about the structure of payment processing fees. This is important and is something many non-industry observers don’t seem to understand. Let me explain.

What Did the Durbin Amendment Do?

In order to understand what is wrong with the WSJ piece, you first need to understand what the Durbin Amendment did and what it didn’t do. So the Durbin Amendment mandated that the Federal Reserve ensure that debit card interchange fees are “reasonable and proportional.” The Fed responded by placing an upper limit of about $0.24 (0.05% + $0.21 + $0.01 per transaction), on average, on these fees, which is 45 percent lower than the pre-reform average of $0.44.

Now, what are interchange fees? These are the fees collected by issuers every time one of their cards is used for payment. These fees make up only a portion (which can and does vary greatly in relative size from one merchant to another) of the total amount paid by merchants for the processing of each card transaction.

The other portion of the card processing fees is charged by the payment processor, which is an entity that is separate from the card issuer and which has entered into an exclusive agreement with the merchant to enable it to accept bank cards for payment. The Durbin Amendment did not touch this part of the processing fees. Moreover, the processor-charged fees are the same for all debit cards, irrespective of whether they are issued by a large or a small bank. There are no reliable data on the average size of these fees, but what is known is that they can cover an enormous range and typically the very large merchants can squeeze them almost to the point of oblivion.

Who Collects Your Debit Card Fees?

Now that you know what the reform did and didn’t do, we can proceed to Sidel’s story. Here is the passage that caught my attention:

[S]mall banks and the middlemen that process their debit-card transactions will collect fees that are often three times the size of those imposed on cards issued by big banks. For example, a $100 sweater purchase made with a debit card would incur a fee of 95 cents on a card issued by a smaller bank, more than triple the 26 cents for debit cards issued by big banks.

Let’s break this down.

In the first sentence we are told that the total processing fees charged by a small bank can be “often three times the size of those” charged by a large bank. While it is true that small-bank debit interchange varies, while large-bank interchange no longer does, this is a misleading statement. You now know that, on average, the interchange fees charged by smaller banks will be less than twice as large as the ones charged by the bigger ones ($0.44 vs. $0.24). You also know that the processor’s fee is precisely the same for all debit cards, which additionally minimizes the difference.

But the second sentence is even more misleading. It is not that the example given by Sidel is necessarily unrealistic. On the contrary, it may, and probably is, a real-world one. In fact, we can find examples of even bigger discrepancies in favor of the small banks. But we can also give the following real-life example (using the $0.02 per-transaction processor fee that Sidel is using in her calculations):

A $3 latte purchase made with a debit card would incur a fee of 24 cents ($3 x 0.05% + $0.22) on a card issued by a big bank, almost triple the 9 cents (calculated using the 1.55% + $0.04 Visa CPS / Small Ticket, Debit interchange rate) for debit cards issued by small banks.

So we can also find substantial differences in favor of the large banks. Our calculations show that under the new pricing structure big issuers will be making more money from debit transactions in amounts of up to $11 or so than they were under the old one. This is why it is important to look at the averages when making such general statements.

The Takeaway

So the Durbin Amendment’s impact on processing fees is much more subtle than Sidel and many other commentators realize. And the biggest thing non-industry observers don’t seem to understand is that for a very large number of merchants the Durbin Amendment’s impact will be precisely non-existent. The reason is that the most prevalent pricing model out there – the tiered one – which comes in many different shapes and forms, does not pass any interchange savings (or dissavings, for that matter) on to the merchant. Instead, these differences, either positive or negative, are absorbed by the processor. But this is a topic for another post.

Image credit: WinonaDailyNews.com.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

Payment card industry rules prohibit merchants from charging consumers a fee for making a payment with a bank card. Compliance with this requirement ensures that both the cards and their users are not discriminated against at the checkout. However, there are loopholes, some of which are easier to define than others. For example, merchants can offer discounts to customers using other (non-card) payment methods (e.g. cash), which is straightforward enough.

But then we have an allowance made for a “convenience fee,” which is not nearly as clear-cut. It does constitute a clear surcharge to payments made with bank cards and yet, industry rules permit it. Why? Well, credit card companies and associations don’t have much of a choice. Let me explain.

What Is a Convenience Fee?

Industry rules state that merchants that offer an “alternate” payment channel (mail, telephone and e-commerce have been given as examples of such channels) are allowed to add a convenience fee to the transaction amount. If that definition sounds nebulous to you, that is because it is nebulous. Still, let’s see if we can decipher it.

If we are to make any sense of the convenience fee, we should begin by asking who, in practice, is charging it. Think about it for a moment. The most prominent examples are the federal and local governments (charging it for things like taxes and parking tickets) and huge utility companies (adding it to your gas or electricity bill, if you want to pay by credit card). In fact, I can’t really think of any other examples, although I’m sure there must be.

What does that tell us? I don’t think it would be a stretch to infer that the convenience fee has been more or less imposed on the Visas and MasterCards of the world. I mean, could they really have told the federal government that it was not allowed to add a convenience fee to a tax payment made by a credit card? After all, by law the Internal Revenue Service is required to collect the full amount of any tax owed, which precludes the deduction from it of a processing fee. Utilities, on the other hand, are monopolies, so they can (and many still do) opt to only accept non-card payment forms, if the card companies insist on collecting a piece of the payment amount. They own their customers who cannot go anywhere else.

Convenience Fee Rules

So faced with the inevitable, the card companies have chosen to make the best out of an unwinnable situation and have allowed convenience fees to be charged under certain circumstances. These rules state that convenience fees must be:

• Charged for a bona fide convenience in the form of an alternative payment channel outside of the merchant’s customary payment channels.
• Disclosed to the customer as a charge for using the alternative payment channel.
• Disclosed before the transaction is completed and the customer is given the opportunity to cancel it.
• Added only to a card-not-present transaction.
• A flat or fixed amount, regardless of the transaction amount. A percentage-based fee may only be charged for consumer tax payments.
• Included as a part of the total transaction amount.
• Applicable to all forms of payment accepted in the alternative payment channel.

Visa and MasterCard attempted to dissuade utilities from charging a convenience fee by introducing a special merchant category code (MCC) that offered preferential interchange rates (it’s funny that there isn’t a special MCC for the government). Only utilities that agreed to not charge convenience fees could qualify for this special treatment. I don’t know how many have signed up for the program, but anecdotal evidence suggests that it has not been hugely successful.

The Takeaway

If the distinction between a convenience fee and a surcharge that runs against the rules is still fuzzy to you, well, all I can say is that it seems to have been meant that way. The bottom line is that it would be close to impossible for ordinary businesses to legitimately charge such a fee. But more importantly, would you want to do it, even if you could? I can think of few things that could be more annoying to an e-commerce shopper than an unexpected fee that pops up at the last moment when she’s ready to check out. There must be a reason why only monopolies and the government would want to do it, right?

Image credit: R3views.com.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

It seems like almost every day someone will “discover” yet another unintended consequence of the limit that the Federal Reserve placed on debit card transaction fees, which took effect in October. The latest such discovery that I’ve come across is made by WSJ’s Robin Sidel who is writing about the “nasty side effect” the debit cap is having on retailers selling small-ticket goods.

The thing about all these side effects is that they were all both predictable and described in some detail on this blog and elsewhere before the limit was enforced. No one who was paying attention and had bothered to look into the numbers should be surprised. This whole situation is strikingly similar to, though not quite as potentially apocalyptic as, the euro crisis in that in both cases politicians and pundits were gleefully ignoring early warnings from experts only to later declare, when those experts were proved right, that everyone was surprised with the way events were unfolding. But let’s confine our attention for the moment to the side effects the WSJ piece is focusing on.

What the Durbin Amendment Did

The Durbin Amendment to the Dodd-Frank financial overhaul legislation charged the Federal Reserve with the task of ensuring that the fees issuers charge merchants accepting their debit cards – the interchange fees – were “reasonable and proportional.” The Fed responded by placing an upper limit of about $0.24 per debit transaction, which is 45 percent lower than the pre-Durbin average of $0.44.

The Fed’s decision ensured, among other things, that all debit transactions would be processed right at the limit. Now, though for most debit sales the cap meant a reduction in the cost of payment processing, for a significant proportion of the transactions it actually translated into a fee increase.

There are two reasons for that. The first one is that the way the Fed set its limit discriminates against merchants selling low-cost goods. The second is that Visa and MasterCard are no longer willing to give preferential treatment to merchants processing small-ticket transactions. To understand why, you will need to look at the numbers. Let’s do it.

Why Merchants Pay Higher Fees for Small-Ticket Transactions

Well, as it happens, we’ve already done that, which makes my job is a little easier. Before I do some copying and pasting, however, you will need to understand how the new debit interchange structure differs from the one it replaced.

Under the new rules, issuers can charge up to $0.21 per debit transaction plus 0.05% of the sale’s amount and an additional $0.01 can be tacked on for fraud prevention measures implemented by the bank. The per-transaction portion of the new interchange rate is substantially higher than the corresponding part of the old one. For example, the old interchange rate for small-ticket Visa debit transactions – the Visa CPS / Small Ticket, Debit – was 1.55% + $0.04. Here is how the two rate structures compare for transactions in amounts of $5, $10, $15, $20 and $25:

As you see, and as small-ticket merchants are now discovering, the old structure was much more beneficial for sellers of low-cost goods, with the difference growing exponentially with the lowering of the transaction amount. When you go into coffee shop territory – an owner of one is the protagonist of Sidel’s story – that difference can be as high as 100 percent (reached at a hair under $5) or greater. And if you think that such small-ticket transactions are exceptional, here is another piece of statistics for you. In 2009, U.S. merchants processed a total of 4.9 billion debit transactions in amounts lower than $5, according to Federal Reserve data.

The Takeaway

So we knew what the consequences of the new interchange structure would be on small-ticket transactions and warned about it, as did others. This is not difficult stuff, it only takes you a few minutes looking at the numbers to figure it out.

Yet, the amazing thing is that people just refuse to see the obvious. We keep being told in comments and emails that the banks should be made to accept the losses and move on without making much fuss. Now, whether that is the right thing to do in a free and open economy is an important question on which we may agree or disagree, but it is also an irrelevant one.

The point is that, whether anyone likes it or not, the issuers cannot and will not accept the losses and move on. Instead, they will look for and find ways to make up for lost interchange revenues. Someone will always be paying for this revenue-generating exercise. In this case, it is the small-ticket merchant. In most cases it will be the consumer. At the end, when it’s all said and done, the Durbin Amendment will have hugely benefited big-box retailers, the issuers will not be worse off than before the reform and consumers will end up footing most of the bill.

Image credit: Daily Trojan.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).