Interchange is About to Change

The rules that govern how money changes hands during most debit card transactions is about to change, but it is anybody’s guess where things will stand once the marketplace finds its new equilibrium.

The Durbin Amendment to the Dodd-Frank legislation puts a price ceiling on how much retailers will pay on transactions where the card issuer has more than $10 billion in assets. Most financial institutions do not have $10 billion in assets, but the ones that do are the dominant in the debit card marketplace. Some accounts estimate their market share to be as high as 75 percent.

The pricing is driven by a principle that the ultimate cost of a debit card transaction should be at or below the cost of a paper check. There is some logic to that, because one of the attractions of an electronic banking system has been its potential to reduce transactional costs. Durbin’s office reported that check transactions imposed a per-check charge of about 89 cents. That price point is the guiding principal for the new framework.

Retailers pay between 1.5 and 3.3 percent on each transaction, according to a complex set of price algorithms that are influenced by a number of factors. There are approximately sixty different potential price outcomes for any sale.

Naturally, the retailers hate this system. In a low-margin business, giving up 1 to 3 percent of the sales price is a significant threat to profitability. Durbin has sited a comment that he says was made to him by the CEO of Walgreen’s. The CEO, Gregory Wasson, told him that interchange fees represent his firm’s fourth largest expense item. Only rent, salaries, and inventory cost more. Walgreen’s sentiment echoed the opinion of a large Arkansas retailer. That mart reached out and touched Blanche Lincoln. Apparently this retailer was able to get two points across. First, that interchange was too high, and second, that it should be lowered for banks with more than $10 billion in assets. The fact that a large Arkansas bank with some overlapping ownership to Wal-Mart has just less than $10 billion in assets is a curious coincidence. Never mind, the amendment is now here.

The retailers found some support from some unusual allies. Russell Simmons (RUSH CARD) whispered to the Congressional Black Caucus that prepaid debit cards needed relief from a ceiling. The prepaid GPRs were excluded. Most of the prepaid card issuers are smaller than $10 billion anyway. The action reflects the idea that cards for the underbanked need support, particularly in a time when so many consumers ae migrating away from the traditional bank branch format.

Interchange holds the potential to bring more participation in the unbanked sector. Firms like Green Dot and NetSpend are able to capture a significant amount of revenue from the interchange that is passed on to them downwind from the card issuer. For the former, interchange is about 27 percent of revenue. This helps unbanked people because it sets up a stream of cash flow that is independent of the needs to harvest fees from the card holders. The more interchange, the less extent to which prepaid card companies are making a living off the backs of the unbanked, and the more to which they are earning their keep on the degree to which those cards are useful to their customers. More transactions means more interchange. That explains why Green Dot is willing to waive fees for customers that use their card more than 30 times in one month.

Pushback from the Small Banks

Durbin was frustrated when he found out that the small bankers and the credit unions were not at all happy with his efforts to give them an advantage. The Independent Community Bankers Association (ICBA) calls it “price-fixing.” The ICBA, as wells as the credit union community, believes that retailers will not assent to a two-tiered pricing system, and will ultimately force VISA and Mastercard to put a ceiling on all debit card transactions. In a July letter published in the Washington Post, ICBA President Camden Fine wrote that the swipe-fee amendment pits small banks against the big-box retailers. It is a battle that the small banks will lose, says Fine, with the result that all interchange fees are lowered. Durbin had some pointed comments for the small bankers.

All of this underscores how much remains to be determined by the implementation of the new rules in the Durbin Amendment.