Ever read one of those scary articles about how a new particle accelerator might cause the end of the world?
Well, when the Federal Reserve moved last week to slash debit card interchange fees, the reaction from large banks, small banks, credit unions, and various folks of the libertarian persuasion was apocalyptic: Don’t touch that button! You might break everything and throw consumers into a black hole! Meanwhile, retailers are thrilled because (irony alert) they are looking forward to offering you lower prices.
The bad news
First, a refresher on interchange fees (aka “swipe fees”), which are somewhat less complicated than particle physics. When you swipe your card (debit or credit) at the checkstand, a portion of your payment goes to the bank that issued the card. The fee varies depending on the type of card (debit or credit, reward card or plain vanilla) and how you use it (PIN or signature). For debit cards, the fee is typically about 1% of the transaction, up to about 2% for some reward cards. The Federal Reserve proposes to cut that fee to 12 cents. This would apply only to debit cards (whether you use the PIN or sign), not credit cards.
That’s a big haircut, about 75% off the top of the average charge, and bigger than the market expected, which is why Mastercard and Visa saw their stock slump on Friday.
Banks are freaking out because they make big money off interchange fees. Dennis Moroney, who covers the card industry for TowerGroup, studied mid-sized banks earlier this year and found that they average 8.5 percent of their revenue from debit card fees. The Fed proposes to replace this revenue stream—which funds popular products like reward debit cards—with the equivalent of a jar full of pennies. “The reward programs are going to be curtailed,” says Moroney.
The bankers argue ominously that 12 cents isn’t enough to cover what merchants and cardholders expect from debit cards. “They don’t fully appreciate some of the benefits they get today in terms of payments when they accept cards,” says Viveca Ware of Independent Community Bankers of America. That means fraud prevention and protection from customers with insufficient funds.
Furthermore, the bankers warn, retailers who pay less for debit cards aren’t going to pass on their savings to the customer; they’re going to keep the profit for themselves and cackle while they roll around in money. “Let me put it this way,” says Greg McBride, senior analyst for Bankrate. “Would merchants have spent millions of dollars lobbying for this change if they were just going to pass it all on to the consumer anyway? No. The notion that this is going to yield some big windfall for consumers in terms of lower prices is halfway to fantasyland.”
The good news
At this point—and I’m not saying this purely for narrative effect—I started getting nervous. I don’t carry a reward debit card, but I do have a checking account (Schwab) which waives all international and ATM fees. Those perks are probably funded by swipe fees. I don’t want to give up the good stuff just so Walmart can enhance its bottom line.
So I did just what you do when you’re feeling down: I called an economist. Greg Ip is an editor at The Economist and author of The Little Book of Economics. He reminded me:
Capitalism isn’t dead yet. Retailers in a competitive market would love to keep big sacks of extra profits, but they can’t—not unless they want to go out of business. “Think of a retailer that sells children’s clothing,” says Ip. “As a result of this ruling, perhaps the retailer’s profit margin goes up by 50 cents. Now, if he was the only retailer who benefited from that, he would be able to keep that 50 cents. But down the hall is another retailer who sells children’s clothing who just caught the same benefit. And they’re going to keep an eye on each other.” No market is perfectly competitive, Ip cautioned, but we’re talking about American retail here.
But is this just government price-fixing? I like cookies, but I don’t want Uncle Sam to set the price of chocolate chips.
No, Congress intervened because of market failure. “The premise of doing is this is that the provider of the retailer interchange fees enjoys a quasi-monopoly or oligopoly,” says Ip, “and that’s the argument for why there should be government involvement.” (To be clear, Ip didn’t say he was in favor of government involvement, just that this was the argument being made by proponents.) Banks compete with each other to offer more feature-rich cards, which drives up the price of interchange. But retailers can’t band together to negotiate lower fees, because that would be illegal collusion. All they can do is lobby Congress (check) or sue (a class-action antitrust suit by retailers against Visa and Mastercard has been pending for years).
Finally, other countries have been down this road before. The European Union regulates interchange fees. Canada has a unique arrangement between issuers that sets the debit fee at around (drum roll) 12 cents. Australia’s central bank has been regulating interchange fees since 2003. All of these countries have functioning credit and debit card systems, albeit with less in the way of incomprehensible reward card regimes. In other words, in Australia, card users pay more of the costs of credit card processing. Is this really a bad thing?
What about credit cards, which are completely untouched by the Fed’s regulation? “Who knows, candidly, if there might be enough momentum to go after interchange for credit cards?” says Moroney. “If this plays out well, why wouldn’t they?” Cue the doomsday music.