What the Debit Card Interchange Rules Mean For Consumers

The Federal Reserve Board announced final rules that will limit debit card swipe fees, as mandated by the "Durbin Amendment" under the Dodd-Frank Wall Street Reform and Consumer Protection Act. It backed away from a proposal to cap debit interchange fees at 12 cents per transaction, and instead the Board voted on a final proposal that includes a cap of 21 cents per transaction, plus 5 basis points on the amount of the transaction for fraud costs, plus 1 cent for fraud prevention costs (the penny could change). Financial institutions with $10 billion or less in assets, governmental benefit cards, and certain prepaid cards are exempt. The cap is better than many banks had hoped, though higher than retailers may have expected given the previous proposal.At stake is an estimated $14-19 billion a year in revenue issuers collect from merchants when consumers use their debit cards to make purchases. Merchants currently pay an average of about 44-47 cents per transaction, which is divvied up among the merchant's financial institution and the bank or credit union that issued the card. (Visa and MasterCard also get paid, though not directly.) Under the new rules finalized today, issuer revenues will be cut, but not as dramatically as initially expected.

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"It backed away from a proposal to cap debit interchange fees at 12 cents per transaction, and instead the Board voted on a final proposal that includes a cap of 21 cents per transaction, plus 5 basis points on the amount of the transaction for fraud costs, plus 1 cent for fraud prevention costs (the penny could change). "

More consumers now have debit cards than credit cards, and consumers use debit cards more often than cash, credit cards, or checks individually, according to the the 2008 Survey of Consumer Payment Choice. If you're among those consumers who rely on debit cards, is that about to change?

If you have listened to the arguments on both sides of the issue (or all four sides, if you include small issuers, large issuers, retailers and consumers) you'd think the sky is falling. But this may just be a bit like an industry-created Y2K, with fear-mongering and uncertainty cultivated from both sides. Big money has been at stake.

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With today's announcement, we can confidently say that debit cards are not going away. Even if the interchange limit were stricter, financial institutions have invested far too much time and money persuading consumers to move away from cash and checks to abandon them now. Many consumers don't have, or don't want to use, credit cards. Do most merchants really want to risk losing sales by discouraging these "plastic checks" and the additional sales they bring?

Restrictions on interchange fees will be effective October 1, 2011. The rules that related to the networks over which transactions are processed and competition among networks take effect October 1, 2011 and April 1, 2012.

The impact of this rule will play out over the next couple of years, and at least one Federal Reserve Board member said there is no evidence of what the impact will be on consumers. Here are some scenarios, however, and what I think is likely to happen:

Lower prices at the cash register? Don't hold your breath. Retailers insist they are going to be able to bring prices down as debit swipe fees go down. The Federal Reserve Board said, though, that looking at other countries, the evidence is weak that lower interchange leads to lower prices for shoppers. So don't hold off on making major purchases until October 1st, hoping to get a better bargain.

Fewer debit card rewards? Likely.

Debit card rewards are not nearly as rich as credit card rewards, because credit cards can be so much more profitable. Still, the reason debit card rewards exist is because these transactions (especially signature-based debit) have been profitable. Now there's been a double whammy on those revenues—reduced debit overdraft income as the result of earlier regulation, and now swipe fee income. Combined, it means there is a good chance some issuers will reduce their debit rewards programs—if they keep them at all. Wells Fargo, Chase and SunTrust are among the issuers who have curtailed or ended their debit rewards programs in the wake of the original proposal. Whether they will revive more limited programs remains to be seen.

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Fewer free checking accounts? Don't panic yet.

There's been a lot of talk that this rule will spell the end of free checking. While it does diminish one major source of revenue, it doesn't mean that free checking is a thing of the past. As one industry consultant points out, financial institutions "that do away with free checking will be sending customers to competitors." Still, there is a legitimate concern that it may be harder for lower income customers to find free checking accounts. In fact, it is one of the reasons Federal Reserve Board Member Elizabeth Duke cited in voting against the proposed rule. She explained that earlier in her career she studied the demise, and subsequent revival of free checking accounts, largely due to debit interchange revenue.

Fewer debit card programs and more prepaid cards? Maybe.

After mobile payments, prepaid is the buzzword in the payments industry. American Express recently entered the foray with their new prepaid card, and it's likely that other issuers are also looking at prepaid since these programs may be designed to avoid the Durbin swipe fee restrictions. Prepaid cards were mentioned by several board members with no clear conclusions about the effect of the final rule on their issuance. Still, it's important to remember that when you're looking at migrating millions of consumers from a payment method to which they have become accustomed, that wouldn't be a smooth—or guaranteed—transition.

Fees for debit cards or debit transactions? Be on the alert.

Although less likely under the current cap than under the previous proposal, it's still very possible that some issuers will start charging debit card fees, at least on less profitable accounts. As with ATM fees, they'll start small, test the waters, and if successful, slowly raise them. Just as we've become accustomed to ever increasing ATM fees, we may adjust to the idea of debit card fees as well. And just as some financial institutions waive ATM fees for their best customers, the same is likely to happen with debit cards as well. (Merchants may offer discounts for preferred payment methods, but under card company rules they cannot charge surcharges. That has not changed.)

Incentives/perks that favor one payment method over another? Why not?

Under part of the Durbin amendment that has already gone into effect, merchants are allowed to impose a $10 minimum on credit card purchases (though not debit cards). They are also allowed to encourage consumers to use preferred payment methods as long as they don't encourage one specific card issuer or brand over another. So you might see special deals—free shipping or gift wrapping, for say, a debit card purchase over a credit card purchase.

Opponents of the amendment warned that the new limits could stifle innovation in the industry, but the Fed argued that the final rule should have a positive effect on innovation. In the end, the best thing that could come out of this multi-million dollar battle would be greater competition in both payment and fraud prevention technologies. Despite all the Doomsday warnings, the Fed's final rules appear to be reasonable and with new products being developed for the payment industry, it may not be long before this whole brouhaha—along with the debit cards we use today—will seem so yesterday.