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).

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).

Having won the debit interchange battle last year, although they still complain that the final resolution was deeply unfair to them, the nation’s retailers have now trained their guns on a much bigger prize: the credit card interchange fees. In fact, it has now come to light that U.S. merchants have been on the case in earnest even while they were still engaged on the debit front.

A huge antitrust case filed by some five million retailers and trade groups against Visa, MasterCard and thirteen of their member banks, including all of the largest U.S. banks, had somehow escaped everyone’s notice until last week when Forbes told us that a trial date was scheduled for Sept. 12 of this year. It is unclear precisely what the outcome will be, but it seems very likely that a settlement will be reached that will include at least a temporary cut in credit interchange fees. Such a cut could potentially be far more costly for issuers than its debit counterpart was.

And as we now know full well, and many of us predicted before the debit saga unfolded, any fall in interchange revenue will eventually be made up for in some way or other, so that when the dust settles the banks will not be a net loser, but it will be the consumer who will end up footing the bill.

The Case against Credit Interchange Fees

It is hard to believe that a case with such huge potential consequences could have gone unnoticed for so long, but so it happened. Still, since we first heard about it last Thursday, we’ve learned quite a few details.

It turns out that since 2005, merchants including Kroger, Payless ShoeSource and Safeway have filed more than 50 lawsuits accusing Visa, MasterCard and their member banks of price-fixing. These cases have now been consolidated and will be heard by Judge John Gleeson of the U.S. Eastern District of New York, who happens to be the same judge who approved the settlement of a 1996 class action suit led by Wal-Mart against Visa and MasterCard. Quite apart from a monetary settlement in the billions of dollars, that suit led to lower debit interchange fees, but Visa and MasterCard raised credit interchange to offset their debit losses, according to a Deutsche Bank report, cited by Forbes.

The merchants’ argument in the present case, as in the previous one, is that Visa and MasterCard have colluded with each other to charge much higher fees than an open market would have allowed. The plaintiffs seek to be compensated for these overcharges and to bar the defendants from violating the rules in the future.

What Can We Expect

Speculations rage about the possible outcome, but a credit interchange cut is widely expected, to go along with a monetary settlement that seems inevitable and that would be split 67 / 33 between Visa and MasterCard.

Dow Jones’ Andrew Johnson has read Visa’s regulatory filings and has found that the company has set aside $1.6 billion, in addition to $2.7 billion that have already been deposited into a “litigation escrow” account set up primarily for the purpose of resolving the merchant lawsuit. Jones cites an analyst who expects that the total cost for Visa and MasterCard of a potential settlement would be “$5 billion to $15 billion based on industry checks.”

But the brunt of any interchange cut will be borne not by Visa and MasterCard, but by the banks that issue the cards bearing their logos that actually collect the lion share of the interchange fees. These losses could be huge. A Deutsche Bank report, cited by Forbes, estimates that a 75 percent fee reduction would cost US Bancorp $1.2 billion of 2012 revenues, a loss four times bigger than the one caused by the Durbin Amendment. Under that scenario, JPMorgan Chase would lose $5.38 billion, five times the size of the bank’s debit loss and Bank of America’s loss would be $3.68 billion, nearly double the Durbin cost.

Does anyone believe that the issuers will quietly accept such huge losses? If they do not, as experience (not to mention common sense) tells us would be the case, what would be their response? The Durbin aftermath can be used as a blueprint for the potential course of action the banks will take, only this time the magnitude will be much larger.

The Takeaway

The Durbin Amendment to the Dodd-Frank financial overhaul legislation of 2010 led to a Federal Reserve decision last year to cut debit interchange fees to an average of $0.24 per transaction, which translates into a transfer of revenues of about $7 billion a year (estimates vary, but this one is ours) from card issuers to retailers. The banks’ response was fully predictable and was in fact predicted on this blog and elsewhere. As of today, free checking accounts have all but disappeared and various banking fees are either making their appearance or increasing. A Boston Fed paper told us a couple of months ago that young, less-educated and lower-income consumers were worst affected by the debit reform. The upshot of a credit interchange cut would be no different, only the scale would be much bigger.

Image credit: 24company.ru.

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).

The Financial Services Roundtable has published a fact sheet that lists the results of several studies into the impact on consumers of the Durbin Amendment that went into effect in the beginning of October.

While the FSR, a body representing 100 large financial services companies, clearly has a stake in the game, the numbers it is reporting are fairly uncontroversial and, unless you’ve been living under a rock in the past few months, you should have noticed that banks have been testing various strategies for making up for lost interchange revenues. While some of them have backfired and have been abandoned, most prominently the ill-conceived debit card fee tested by most large banks, other and less conspicuous fees have proved more resilient and are now here to stay.

Sen. Durbin and others may argue all they want that banks have no right to even try to recoup their interchange losses, but in reality they are trying just that and eventually will succeed in doing it. And it all started with the senator’s amendment.

How the Durbin Amendment Is Impacting Consumers

Here is what the FSR’s report says:

FACT: Most merchants will see substantial debit fee savings as a result of the Durbin Amendment. TSG Metrics Survey, October 14, 2011.

FACT: The average savings per merchant is $260.24 for every $100,000 of signature debit and credit card volume processed. Heartland Payment Systems Survey, October 28, 2011.

• Washington DC merchants received the highest average savings of $333.94.

FACT: There is no legal requirement for merchants to pass on savings from the Durbin Amendment to consumers.

FACT: In fact, 41% of merchants reported they do not intend to pass on lower debit card costs to consumers, when asked about the Durbin Amendment. DRF Survey, September 1, 2011.

• 56% of merchants in the survey reported they don’t know yet what they will do.

FACT: There is currently no published research showing that consumers have seen reduced fees at stores as a result of the Durbin Amendment.

FACT: Additionally, consumers are facing higher bank fees, according to the 2011 Bankrate Checking Survey. Bankrate Checking Survey, 2011.

• Just 45 percent of noninterest checking accounts are free of maintenance charges, down from 65 percent in 2010 and 76 percent in 2009.
• “The entire model of free checking has been turned upside down because of <Regulation E and the Durbin Amendment>,” said Ajay Nagarkatte, managing director of Chicago-based BAI Research, in the Bankrate survey.

There it is. It is clear (as it always has been to those who were paying attention) who is benefiting from the legislation and who isn’t.

How Banks Cope with the Durbin Amendment Effects

While the various debit card fees tested by Bank of America, Wells Fargo, Chase and other big banks have been getting the most attention, they are just one piece of the banks’ strategies for dealing with the Durbin Amendment’s revenue-slashing effects. These fees were eventually abandoned and the banks no doubt regret having ever decided to test them, but many other components of their strategies are very much alive.

Banking is still becoming more expensive, debit card fees or not. As the FSR study shows, free checking is quickly disappearing and other banking fees are creeping in, as the NYT recently reported.

At the same time banks are pushing hard to drive customers away from far less profitable debit cards and toward credit and prepaid cards, which were unaffected by the interchange reform. To that end, credit card offers are rapidly increasing in number, terms are improving and rewards programs are becoming ever more generous.

Prepaid cards were already the fastest-growing non-cash payment type in the U.S. even before the reform and now that bigger issuers are becoming more interested in them, their growth will accelerate further. American Express showed us what the future of prepaid will look like when it launched its fee-free card a few months ago.

The Takeaway

As we’ve been arguing on this blog all along, when it’s all said and done, the upshot of Sen. Durbin’s amendment will be that merchants will have increased their revenues, compared to the period before the reform took hold, banks will at worst be revenue-neutral and consumers’ cost of banking will have risen.

Yet, while on average consumers will be worse off, some will actually benefit from the better rewards programs and prepaid cards on offer. Unfortunately, the good rewards programs are only available to consumers with higher incomes and higher credit scores and prepaid cards are not yet, and are unlikely to ever be, nearly as widely used as needed to make a difference. So at the end those who will end up footing Sen. Durbin’s bill will be the ones who can least afford it.

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).