The Federal Reserve recently issued its final ruling on interchange, or swipe fees, that will deeply impact banks, merchants and anyone who holds a debit card. But what is the Durbin Amendment, which required the Fed to take action? Why do both supporters and opponents claim that the other side supports big industry at the expense of everyday Americans? And how much do a few cents matter anyway?
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The Era of Visa and MasterCard
An interchange fee is the charge assessed on a merchant every time you swipe your debit or credit card. The fee varies widely, depending on the card and the merchant, and is levied to offset the cost of fraud prevention and processing the transaction. Fraudulent charges on a debit card are relatively small, so they command lower swipe fees; signature cards have the largest swipe fees, since they often have the highest credit limits. Larger merchants that have more bargaining power can negotiate lower swipe fees, but smaller ones are forced to accept higher charges.
The two major card networks, Visa and MasterCard, have a virtual duopoly on debit card transactions and can dictate the interchange fees they charge. Part of the fee goes back to the network, while part remains with the issuing bank. Swipe fees have risen substantially in the past decade, and now amount to nearly $48 billion a year, with $17 billion coming from debit cards.
July 21, 2010: The Dodd-Frank Act is signed into law
About this time last year, Congress passed and President Obama signed a sweeping legislation to reform the financial industry. The bill, hotly contested and passed along party lines, contained a last-minute addition from Senator Dick Durbin of Illinois. The so-called Durbin Amendment required the Federal Reserve to cap swipe fees at a reasonable level. The Fed would determine the true cost of fraud prevention, and limit interchange fees accordingly. The Durbin Amendment stipulated, though, that institutions with less than $10 billion in assets would be exempt from the cap.
December 16, 2010: The Fed’s first proposal
At the end of 2010, Chairman Ben Bernanke proposed a 12-cent cap on debit swipe fees and a requirement that debit cards be processed on at least two independent networks (for example, Visa-owned PLUS and MasterCard’s Maestro). He opened the proposal for comment, and promised to announce the final rules in April of 2011.
March 29, 2011: Fed announces they’ll miss a key deadline
The Fed’s initial proposal garnered over 11,000 comments, and Bernanke announced that he would need more time to finalize the regulation. He reaffirmed his commitment to a July 21st implementation date, though banks and card networks were heartened by the delay.
March 15, 2011: Bill introduced to delay Durbin’s implementation
Democratic Senator Jon Tester of Montana, along with Republican Bob Corker of Tennessee, introduced a bill that would defer interchange regulation for a year while the Fed studied possible effects on small banks and credit unions. Unusually, the bill drew supporters and detractors from both sides of the aisle, with those in favor of regulation accusing Tester of cozying up to big banks and those against arguing that a cap would cripple the small community banks and credit unions that are the lifeblood of sparsely populated states. Financial institutions flooded Tester’s campaign with donations after he introduced the bill, eroding his popularity among Montanans.
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June 8, 2011: Tester’s bill falls short
In a down-to-the-wire vote that split the Democratic leadership, Tester’s bill gained a majority vote in the Senate but fell short of the 60 votes needed to avoid a filibuster. That the bill reached the Senate floor at all reflected a remarkable turnaround: 63 senators voted for the Durbin Amendment in 2010, but 54 voted to delay it in 2011.
June 29, 2011: Fed (finally) issues the regulations
Into the maelstrom of lobbying and rhetoric, Ben Bernanke announced the Fed’s final regulations on the Durbin Amendment. The charges would be capped at 21 cents per swipe, plus 0.05 percent of the transaction, with the possibility of an additional cent if banks comply with fraud prevention procedures. His decision was far more favorable to banks than expected: the average transaction of $38 would garner a swipe fee of 24 cents, double the initial proposal.
The ruling pleased no one. Banks and credit unions fought the mere existence of the Durbin Amendment, while retailers and merchants accused the Fed of caving in to pressure from the financial industry. Bernanke acknowledged that banks had increased the fees on checking accounts, but said that retailers in competitive markets would pass the savings on swipe fees onto their customers. All in all, he was “unsure” if the Durbin Amendment would be a net gain for consumers.
October 1, 2011 and April 1, 2013: The rules go into effect
The Fed also moved back the implementation date from July 21st to October 1st. On that date, card networks (like Visa) must honor the 21-cent cap and allow debit cards to be processed on at least two independent networks. Issuers had until April 1st of 2013, a year and a half from now, to comply with the two-network rule.
What does this mean for consumers?
Higher banking costs? Certainly. Banks have already factored in the loss of interchange revenue, and are levying new fees on checking accounts, raising minimum balance requirements, and ending debit rewards programs. After financial reform, debit cards are significantly less lucrative for banks: not only do customers have to opt in to overdraft fees, but interchange revenue will fall by an estimated 40 percent. Banks are finding new ways to monetize checking accounts, such as maintenance fees, higher out-of-network ATM fees, and selling data to retailers.
They’ll also try to push customers toward credit cards and prepaid debit cards, which escaped interchange fee regulation. Bank of America and Chase threatened to cap debit transactions at $50 to $100, rendering them useless for many everyday purchases. Issuers are offering unprecedented incentives to switch from debit, from low interest credit cards to juicy rewards bonuses. American Express recently launched a prepaid debit card with vastly simpler and fewer fees, expecting to earn money through interchange revenue rather than charges on the cardholders themselves. With carrots and sticks, consumers are nudged away from debit cards.
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Lower prices? Perhaps. As Fed Chairman Ben Bernanke said himself, it’s far from certain that consumers will see lower prices as a result of swipe fee reform. He expects that retailers in competitive, low-margin sectors will drive down prices, but those in less competitive sectors will pocket their savings. What’s more, debit interchange fees are only one segment, and a small segment, of merchants’ interchange costs. Credit card swipe fees account for 65 percent of the total interchange costs, so the savings from debit swipe fees are unlikely to be noticeable for consumers.
The poor will hurt the most. To sum up the probable consequences of the Durbin Amendment, banks will try to entice customers towards credit cards with rewards bonuses and away from debit with higher fees, while merchants may or may not reduce prices. These effects are a wash or even a benefit for the wealthy and those with excellent credit, who can take advantage of unprecedented rewards bonuses as well as potentially lower prices.
Those who cannot qualify for, or want to avoid, credit cards will be forced to pay more for checking accounts or resort to high-fee prepaid debit cards. Even assuming that merchants pass on all of the savings from lower debit interchange fees onto their customers, those who rely on checking accounts will have difficulty recouping their losses. The effect will be strongest for those who struggle to make minimum balance requirements on their checking accounts. While the effect on consumers as a whole is uncertain, it is likely that the poor will bear the brunt of the Durbin Amendment’s ill effects.
Tim Chen is founder and CEO of NerdWallet.com, a site dedicated to educating consumers about credit cards.