To comply or to defy

Original Reporting | By James Lardner |

March 23, 2011 — In its first major effort to roll back part of last year’s Dodd-Frank financial-reform law, the banking industry is going after that statute’s attempt to sharply reduce the so-called interchange or “swipe” fees that banks collect with every debit-card purchase.

The swipe-fee provision, originally an amendment championed by Senator (and majority whip) Richard Durbin (D-IL), ended up as one of the few provisions of Dodd-Frank actually to threaten an important banking-industry revenue stream. Swipe fees, which now average 44 cents per transaction, would be capped at 12 cents under a draft rule developed by the Federal Reserve to carry out the law’s requirement that fees be “reasonable and proportional to the cost incurred by the issuer with respect to the transaction.” The final rule is expected next month.

“The government shouldn’t be in the business of setting prices, and they especially shouldn’t be in the business of setting prices between two businesses,” Charles Kim, the chief financial officer of Commerce Bank of Missouri told Remapping Debate, echoing the view of many of his industry peers.

If the Fed sticks with its proposed cap (and if the Durbin amendment stands), banks could lose some $11 billion of the estimated $16 billion in swipe fees that they currently receive from America’s retailers, according to The Nilson Report, a trade journal that covers the industry. (JP MorganChase alone could see its fees cut by roughly $1 billion a year.)

Last week, eight senators launched an effort to impose a two-year freeze on implementing  the amendment. The Senators, like the banks, paint a picture of growing remorse  — of policymakers and others belatedly waking up to the perils of a measure that was “hastily enacted” without due consideration of “the complexity of the entire system and how it’s all woven in together,” as Nessa Feddis, senior counsel of the American Bankers Association, said in a phone interview. Introducing the freeze proposal last week, Sen. Jon Tester (D-MT) issued a statement stressing the need for more time to study the “impact on consumers, credit unions, community banks, and the small businesses and jobs they sustain.”

Most of the objections being raised now, however, are the same ones aired when the amendment was unexpectedly approved by the Senate last May. And the firepower for the resistance is coming mainly from the banking industry, which has taken a hard line all along.

Durbin and the retailer and consumer groups supporting his amendment had hoped to prod the industry into some fundamental rethinking of its debit-card practices; in particular, they were trying to convince the banks and card companies to deemphasize types of cards and transactions associated with higher rates of fraud. Rather than use the intervening months to make major changes, however, banks have largely declined to move away from riskier “signature” (as opposed to PIN) debit transactions, and they have continued not only to dispute evidence of anti-competitive pricing, but to insist that there is no way for them to adapt to a world of lower fees except at a heavy cost to their own interests and those of some of their customers.


Shot across the bow

Defending the fairness of the current fees, the banks portray them as an inseparable part of the way they finance a broad range of account services, so that, as Feddis put it, if “you push down one place, it comes out somewhere else.” To compensate for the lost revenue, Feddis and others warn, banks will have no choice but to raise customer charges, reduce services, or both — especially for the non-affluent account-holders whose balances don’t generate enough income to cover the banks’ costs.

In what could be seen as a shot across the bow of political and public opinion, Chase last week floated the idea of a $50 cap on debit transactions, while experimentally hiking ATM withdrawal fees for non-customers to $4 in Texas and $5 in Illinois. “The banks are clearly using scare tactics, painting a worst-case scenario, “ said Ed Mierzwinski, consumer program director of the Public Interest Research Group, which supports the Durbin amendment.


Card-company takeover

Debit cards arose in the early 1980s as a spinoff of the ATM technology that banks had deployed in order to cut down on customer waiting time and teller and back-office expenses. The first cards were issued directly by banks, with cooperating retailers paying little or nothing for the ability to accept them. Interchange fees entered the picture only when Visa and MasterCard (then organized as non-profit bank consortiums, now as profit-making companies in their own right) moved in with nationwide debit-transaction clearance networks that piggy-backed on their credit-card infrastructure, know-how, and brand-name credibility.

Pin versus “signature” debits

There are two ways to make a debit-card purchase: by entering a personal identification number (or PIN) or by signing a receipt as you do with a credit card. The latter type of transaction, known as “signature debit,” is possible only with cards that carry the Visa or MasterCard logo, as do most cards nowadays. Signature transactions are also known in the trade as “offline,” because the retailer does not immediately verify them with your bank. That process, which can take up to 48 hours (depending on the retailers’ habits) is part of what makes them riskier.

PIN debit transactions have been significantly safer up to now. That is because, in the first place, they call for a piece of information that (unlike a signature or the security code often used in e-commerce) cannot be found on the card itself. PIN transactions are known as “online” transactions, because verification occurs right away, which also cuts down on the risk. (The terms “offline” and “online” have nothing to do with the Internet. Europe has developed PIN systems for e-commerce; the U.S. is just beginning to do so.)

Some U.S. banks promote debit cards that are signature-only. A small fraction of debit cards, which don’t carry the Visa or MasterCard logo, are PIN-only.

PIN transactions generally involve a smaller swipe fee than do signature transactions; and the swipe fee for a signature debit purchase is lower than for a credit-card purchase.

It is the card companies that set the fees on the banks’ behalf; and it was the card companies that came up with the idea of signature debit as a way to appeal to businesses that had grown accustomed to credit cards but were initially reluctant to pay for PIN-reading machines. Today, while PIN-debit predominates across Europe, U.S. banks remain committed to — and, in many cases, actively promote — the signature alternative, which makes a lost or stolen card far easier to use but generates higher swipe fees, besides being more likely to trigger overdraft charges because of the delay between purchase and bank verification (see sidebar).


Other ways to do business?

With the deadline for a final Fed rule looming, the banks say the Fed’s tentative fee cap makes no allowance for the need to invest in debit-card innovation. But retailers and consumer groups assert that Visa and MasterCard, having achieved market dominance through what Mierzwinski calls “anti-competitive practices,” aren’t properly motivated to innovate. “They’re complaining about [fraud], but they never fixed the problem.”

The amendment creates “tremendous potential for innovation” — higher fees are “just one way the banks could respond,” Mierzwinski said in a phone interview.  If banks were thinking seriously about how to comply, he went on, they would seize the opportunity to follow Europe’s lead by discouraging the signature transactions responsible for much of the fraud that the banks cite as a core argument for keeping fees at or near their current levels.

The banks reject that claim, which Feddis called “shortsighted.” Fraud is “always changing,” she said. If the industry committed itself to a more PIN-centric system, which it has not yet done, “the fraudsters [would] have a heads-up.” They would know that “this is where you need to focus.” Nevertheless, Feddis did acknowledge that, so far, PIN-debit has been less susceptible to fraud.

“Let’s step back for a second,” said David Balto, a Washington antitrust lawyer and former policy director for the Federal Trade Commission. At least a dozen countries in addition to the twenty-seven that comprise the European Union have decided to regulate interchange fees, “and what you see is… greater innovation abroad than there is the United States,” Balto said. A number of countries, he added, “have no interchange fees at all.” They include New Zealand, Iceland, Finland, Norway, Denmark, the Netherlands, and Canada, which make up “seven of the eight nations [the eighth is Sweden] with the highest per-capita use of debit cards.”

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