Analyst Speculate on Impact of Fed's Debit Card Proposal

On Thursday, the Fed issued a proposal to set a price cap on debit card Interchange fees under new powers from the Dodd-Frank Act. Since then there has been much speculation on its impact.

Interchange fees are paid to the banks that issue debit cards when they are accepted for payment. The fees that Visa and MasterCard charge are excluded from this regulation. Yet in question is their business model. Are the card brands value-added service providers or has their success turned them into just another type of utility company that should be regulated by the government?

Visa and MasterCard made headlines on the news with both experiencing major stock price declines. Merrill Lynch speculated that banks will seek financial concessions from Visa and MasterCard to make up for lost debit Interchange revenue. However, these attempts could be construed by the Fed to be a violation of the law that specifically prevents this type of transfer to be used to circumvent Interchange fee regulation.

Clearly the difficulties of implementation are concerning. How will Visa and MasterCard honor the exempted banks and card types by managing two sets of debit Interchange – the current debit Interchange and the new price as set by the government? And although the Durbin amendment prohibits merchants from discriminating against a card based on the issuer, will merchant steering efforts be effectively policed by the government to enforce this provision or will market forces make it infeasible to support managing these exemptions?

Perhaps more troubling is the requirement that debit cards carry at least two alternative signature debit networks and at least two alternative PIN-based networks. Trying to satisfy all these requirements on a piece of plastic with a mag-stipe is impractical. This is really the job of a smart chip and smart phone, neither of which are mature enough to be the solution for a law that takes effect in April 2011. Of course, under the current version of the law, consumer payment choice matters less since merchants will choose how to route the transaction. It will be interesting to see how the brands propose to route a Visa debit card through an alternative signature debit network like MasterCard or vice versa. Given that Visa signature debit Interchange and MasterCard signature debit Interchange are already price competitive, and remain similarly price competitive under government control, what’s the benefit of network routing anyway? And finally, has consideration been given to the possibility that any potential savings in routing would be offset by the increased costs from the unregulated processor networks and gateways that will need to provide this new routing service?

In addition to these concerns, of particular interest to small businesses is…how will banks react to make up for their lost Interchange revenue?

It seems reasonable that without a compelling financial incentive to develop debit that issuing resources will move away from this product line. Bank issuers are expected to focus on moving consumers back to unregulated credit cards, pouring creative into how to influence consumers to carry “charge cards” with more benefits. Interchange increases can be expected on credit products. Debit issuers are also contemplating substituting debit with exempt prepaid cards.

Will banks begin to charge consumers a fee every time they make a debit purchase? Many are in favor of this scheme because they say it is more transparent than having merchants embed the cost of providing debit card acceptance in the cost of goods and services consumers buy. Banks are also expected to increase cash, check and ACH processing fees. They have already started eliminating free checking while bill pay is likely the next free service to fall.

Of course, the final Fed proposal may change and some lawmakers are having second thoughts. And other outstanding questions remain. How many more banks will join the lawsuit in an effort to prevent this bill from taking effect? Will they successfully delay its enactment or repeal it altogether?

All this remains to be seen. But one has to question the strategy to rush through debit Interchange regulation with the idea that credit and reward card transaction costs would be addressed next.

The payment industry is the engine of commerce. It is complex, as everyone is learning, and it just goes to show that last minute amendments for political favor are a bad way to find the right solution to any problem. We’ve argued that any payment regulation deserved its own comprehensive legislation that addressed all the issues at once. A piece meal, reactionary approach based on the unintended consequences of debit regulation and subsequent free market adjustments to price caps only enriches lobbyist but does not best serve merchants, consumers or service providers.

Our goal at Vantage is to guide our clients through these changes. Vantage receives no part of Interchange. Our direct pass-through of all Interchange categories will result in immediate savings once any debit fee reductions are enacted. Our concerns have been, and remain, that our small business and community bank clients are not put at a competitive disadvantage and that the net result is beneficial.

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