Peeling Back The Onion Of The Durbin Amendment

November 18, 2011

This is a guest post from Bill Hazelton, CEO of Credit Card Assist, where he gives tips, news, commentary and advice on credit- and debit cards.

The man to make all our dreams come true. (This is Durbin, not Bill.)

 

Last summer Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act.  At the last minute, Senator Dick Durbin introduced the “Durbin Amendment,” aimed at reforming debit card payment processing and fees.

The senior Senator from Illinois, Durbin has served in Congress since 1982, and since 1996 in the Senate.  He’s been Senate Majority Whip since 2007.

He introduced the amendment to protect retailers whom he believed were losing money to debit card-processing fees.  Some of his supporters claimed banks were colluding with credit card companies to extort exorbitant fees from merchants. Visa and MasterCard had had a stranglehold on payment processing and fee setting.

Senator Durbin anticipated merchants would pass savings along to consumers, especially in competitive markets.

The Federal Reserve estimated that capping processing fees at a reasonable level wouldn’t hurt banks unduly.  Chairman Ben Bernanke agreed that retailers would probably pass along savings to consumers. The Fed also wanted to increase competition in the payment processing system, and give merchants freedom of choice.

The amendment went into effect October 1, 2011.

What the amendment changed

The process hasn’t changed: retailers pay a swipe fee (also known as an interchange or exchange fee) for each transaction. The fee is shared by the card’s issuing financial institution and the payment processing network (usually Visa or MasterCard). Financial institutions get a much larger share.

The amendment’s key provisions:

  • The Fed sets a maximum transaction fee, of 21¢ + .05% .  Card issuers that offer fraud protection can receive an additional 1%.  This amount is roughly half of pre-amendment fees.
  • Card payment networks must allow processing on at least two independent networks, effective immediately. Card issuers must do so by this coming April 1 (except for issuers of certain health-related cards, benefit cards and general-use prepaid cards, who can wait a year beyond that.)
  • Merchants can institute a card-purchase minimum and/or offer discounts to cash or debit card purchasers, both of which were previously banned.

The way things were

Debit cards were generating more money and more transactions than credit cards. Debit cards’ use was also growing compared to checks and cash.

Card issuers typically received about 1.3% from each transaction. Swipe fees have increased, and now total about $48 billion annually.  Debit card fees represent about $17 billion of that.

Visa and MasterCard have long held a duopoly, letting them force smaller retailers to pay high fees while offering better deals to large clients.  A merchant’s only recourse was to refuse cards as a method of payment.

Financial institutions are unhappy

Even before the amendment went into effect, banks warned they’d have to tighten credit, and raise fees and interest rates, to make up for projected lost revenue.  Bank of America and Chase threatened to cap debit card charges at $50 to $100, which would have rendered the cards basically worthless for everyday use, possibly pushing customers to use credit cards instead.

Already, some banks have rescinded free or rewards checking programs.  And we’re all familiar with Bank of America’s ill-fated $5 per month debit card fee, now also rescinded after massive customer backlash.

The new interchange fee cap is much friendlier for banks than the originally proposed 12¢ cap.  Nonetheless, bank revenue is estimated to drop around 40-50%, costing banks around $6.6 billion.

Financial institutions with under $10 billion in assets — community banks and all but three credit unions — are exempt from the new fee limit.  Debit card transaction fees enable them to fund big-bank services.  But many fear the new two-tier pricing structure won’t work, and they’ll have to accept lower exchange fees despite their exemption.  Combined with the multiple processing network requirements, that could decrease revenue and force small banks to reduce services or increase fees.  This leads to calls to protect specific advantages offered by credit unions.

Merchants may even refuse to accept small-issuer cards that have a higher swipe fee.  This isn’t allowed, but it’s been hard to enforce and no one really expects that to change.

Small card issuers fear they’ll lose customers to big banks that can still offer broader services.  Big banks also say they’re being forced to either increase service fees and risk losing customers, or simply accept lower revenue.

When Congress established the new fee limits, they didn’t consider fraud and other costs related to debit card transactions. Banks say greatly reduced future revenue won’t cover expenses.  Critics argue that debit card fraud is much smaller than its credit card counterpart, so the lower risk supports lower fees.

Some large retailers claim “fraud risk coverage” is a smokescreen anyway, and that the credit card industry just doesn’t want to bother producing more secure cards, even though the technology exists.

The bottom line: income from debit card transactions will drop for all financial institutions. That’s about all we know.

Consumers may not benefit

Big institutions have or probably will:

  • Add or raise checking fees
  • Increase checking balance minima
  • Lower or eliminate debit card rewards
  • Raise out-of-network ATM fees
  • Even sell customer information to retailers

Smaller banks have capitalized on this, promoting that they’re keeping free checking and not making debit cards onerous to use.

Card issuers are likely to promote credit-based services and prepaid debit cards, neither of which are subject to the new lower swipe fee.  Some issuers are already offering low-interest credit cards and increased reward programs.  Some people argue that increased credit card use will increase consumer debt, and that low and moderate-income consumers may be hit hardest, as banks institute higher fees for necessary services.

In the past, merchants either absorbed swipe fees or raised prices to offset them.  Now, they can charge customers directly, adding a fee on top of the merchandise price.

Merchants may not benefit, either

Consumers have typically paid the same price regardless of payment method, but merchant rates vary considerably for debit, credit and premium cards such as reward credit cards.  Merchants may not gain much if consumers simply switch to credit cards or checks, because swipe fees are higher for credit cards and checks are slower and riskier.

Visa and MasterCard are predicted to increase credit card fees for “small ticket purchases,” so merchants may retaliate by refusing Visa debit cards.  Merchants can now set minimum or maximum transaction amounts, which could result in more use of cash or checks, or customers could take their business elsewhere.

Many financial industry thought leaders believe it’s unlikely retail prices will drop.  Others say merchants could actually increase sales by subsidizing debit-card holders, and they note that merchants benefit indirectly from bank advertising that encourages shopping.

Unintended consequences

In 2010 the Mercator Advisory Group published a report entitled “The Durbin Amendment: Impact Analysis”, before the amendment passed.

In addition to the issues noted above, the report identified unintended consequences that critics have disparaged:

  • Prepaid debit cards are now commonly used for payroll and government benefits.  If state and federal agency revenue drops, card recipients could be at risk for up-front fees.  If card programs are eliminated and agencies revert to using checks, recipients could pay check-cashing and bill-paying fees.
  • Profits from debit card transactions have funded development of new financial services products – like mobile payment, and next generation smart cards. This could diminish, jeopardizing America’s position as global market leader.
  • Processing networks may institute non-transaction-based fees to recoup lost revenue, or be slower to offer merchants new ways to receive payments electronically.
  • Diverting resources to implement the changes mandated by the amendment may hamper financial institutions’ participation in economic recovery efforts.
  • Regulating just one portion of the financial services industry could spawn entities that offer non-regulated services.

Debit card revenue has been a powerful profit center for financial institutions.  The electronic payment processing system is tremendously complex. Whether the provisions of the Durbin Amendment will benefit consumers and merchants, we still don’t know.

**This article is featured in the Carnival of Personal Finance (336th Edition)**

Filed Under: Capitalism, Consumer Debt, Credit Cards, Finance Tagged With: , , , ,

Free money. No strings attached.

October 28, 2011

These scammers operate in 190 countries.

There’s this amazing scam going on in our society, perpetrated by private industry, no less. And get this – it’s backfiring. The people behind the scam are the ones getting taken advantage of.  If you’ve ever cheered for an underdog against a Goliath, this is the ultimate comeuppance story. You’re not going to believe how this works:

The scammers act as an intermediary between you as a consumer, and whichever merchant you’re buying from. They take your money – well, even that’s not accurate. It’s not like they put it in an escrow account or anything. They actually front you the money to buy whatever it is you want, and then you pay them anytime you want in the next month. Given the time value of money, that means the scammers are losing on the deal. As for the merchants, they love this arrangement because as part of the front, the scammers pay out of their own pockets immediately. You could skip the country, die, or ring up debts all around town and the merchants wouldn’t care. They still get paid. And you can do this over and over again. As fast as you can shop, the scammers will be there, ready to front you whatever you want. Some of them will front you $6,000 out of the gate, others $15,000 or so, and still others don’t even set a maximum.

Okay, that technically isn’t a scam yet, just an indirect way of conducting business involving a willing and masochistic patsy. At this point, the scammers are merely Good Samaritans. You’d figure they’d have to have some sort of hidden agenda, but they don’t have any that we could find.

Here’s where it gets weird: not content with facilitating your transactions for no charge, the scammers will give you stuff, over and above fronting you the money. Stuff including, but not limited to:

  • flights, including first-class
  • priority seating for concerts and other events
  • roadside assistance, assuming you don’t have AAA and never learned how to change a tire
  • discounts.

When all that fails, they’ll tempt you with straight-up cash instead. Literal money for nothing. They’re like a neighborhood child molester who couldn’t decide between Skittles and Twix bars for bait and decided to just give away dollar bills instead. Except there’s no pederasty involved. They don’t lure you anywhere. Pay them the money they front you, and then next month they’ll let you do it again.

They don’t typically give away the flights and priority tickets all at once. The scammers aren’t that generous. An airline seat still costs a few hundred bucks, so the scammers are going to make you wait maybe 3 months, maybe longer, before giving it to you. It depends on how much they front you. But give it to you they will. By the way, you decide how much they front you. It’s not as if they give you a suitcase full of unmarked bills and order you not to lose it under punishment of death or dismemberment.

The cash, on the other hand, they’ll give to you almost immediately. Again, you don’t have to do anything to earn this cash. They just give it to you. The amount they give you is a fraction of how much they front you, but once more, you’re the one who decides how much they front you. To the penny. You don’t even have to keep records of how much they owe you. The scammers do the bookkeeping, too.

It doesn’t even seem fair to call them scammers. “Facilitators” is more accurate and less insulting. They don’t insist on anything in return for this extreme generosity. You can keep on taking advantage of them for your entire life, exploiting their naïvete until you get bored. But unlike a puppy who falls victim to the hidden-ball trick over and over again, the facilitators of this odd enterprise love to give away money and prizes. If you do decide to work towards earning one of their big-ticket rewards, like a cruise, there’s usually no set period in which you have to act. You can take years to earn whatever reward they’re offering: it’s not like you start again at zero if you don’t earn it quickly enough.

It gets better. (Better for you, worse for them.) Because there’s a competitive market for these scammers, the major ones and even the minor ones have to undercut each other to get your attention. If you buy a defective product, or need a big refund on something a crooked merchant sold to you (it happens), the scammers will take the hit. We’re not kidding. They will give you your money back and chase down the dishonest merchants themselves. And if some criminal gets between you and the scammers, buying stuff in your name, the scammers will take the hit for that, too. You don’t even have to call the police and get them involved. There’s no downside for you whatsoever. Free money, free stuff, and protection. It’s the most amazing deal of all time, and it’s available to just about anyone with an address and a full-time job.

The big players in this bizarre industry are hiding in plain sight. You won’t find them in obscured storefront windows in bad parts of town. They operate out of gigantic shiny office buildings in New York City, San Francisco, suburban New York and suburban Chicago. They’ve even incorporated, and all trade on the New York Stock Exchange. What’s really strange is that they have a purported combined market value of $176 billion. Which must be a mistake, because we’ve been taking advantage of these companies for years and can’t imagine why anyone would ever give them a nickel.

 **This article is featured in the Baby Boomers Blog Carnival One Hundred-sixteenth Edition**

**This article is featured in the Carnival of Financial Camaraderie #6**

**This article is featured as one of the Top Personal Finance Posts for the Week of November 11, 2011**

Filed Under: Credit Cards Tagged With:

A Big Hand For The Idiots

October 19, 2011

Instead of 22.9%, he’s now paying 19.9%. Who’s winning? <This guy>

In 2009, Congress passed the Credit Card Accountability Responsibility and Disclosure Act, the latest in a series of clever acronyms to become law. (Which, at 4 letters, is brief as these acronyms go. It’s all but inconceivable that anything will ever beat the 10-letter Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001.)

Congress passed the Credit CARD Act because, in short, consumers who vote (or more to the point, voters who consume) are moronic and would rather complain than rein in their spending. The Credit CARD Act required issuers to:

  • mail statements out 3 weeks in advance instead of 2, because with so many good things on TV it’s impossible to devote one day out of a mere 14 to scratching a check that you know you’re going to have to scratch anyway (“Mail”, if you’re wondering, is this laughably archaic method by which people used to send documents);
  • reduce rates for anyone whose rates they’d raised and who’d then paid on time for 6 consecutive months. Yes, a government-sanctioned rewards program;
  • offer cardholders fixed limits;
  • cap the fees they charge to cardholders who exceed their credit limits, i.e. cardholders who couldn’t be bothered to remember their credit limits in the first place;
  • provide a toll-free number on their statements that people who shouldn’t hold cards in the first place can call to get free credit counseling;
  • perform several other requirements, which we won’t get into because we try to keep these posts around 1000 words.

The bill also ordered the Federal Trade Commission to spend your money determining whether it’d be feasible to create a technology that lets an ATM user who’s “under duress” enter a PIN that would call the cops. Seriously. Section 508(a).

No one disputes that as a result of these requirements, banks’ credit card revenues would fall. Banks, like every other business in the history of the universe, seek to maximize profits. When our elected representatives reduced the banks’ ability to profit off their core customers, those same representatives forced the banks to find other customers to gouge. Which they did. You and me, the responsible ones.

Bank of America recently announced that it’s going to start charging its debit card holders $5 a month. You may remember that 2 short years ago, consecutive Secretaries of the Treasury took $135 from each of us (or if you prefer, 27 months’ worth of future debit card fees) and awarded it to Bank of America for its inability to assess risk before lending money.

Bank of America might be effectually a Soviet state-controlled enterprise whose losses the citizens cover – a modern-day GUM department store or Aeroflot – but it’s still going to seek revenue within whatever legal bounds it’s been afforded. Among all the Credit CARD Act’s byzantine stipulations, there isn’t a word in there about how much banks can charge customers for using debit cards. Therefore, banks chose to, because they can.

The good news is that you won’t pay the $5 fee if you manage to go the entire month without using your debit card. Instead, you can either go Montana Freeman and print your own money, or you can make as many (free) ATM visits as you want and pay cash; the same outdated activity that debit cards were supposed to make obsolete.

There’s a secondary reason for banks charging debit card fees. People respond to incentives. A debit card fee gives a consumer a compelling reason to use a different method of payment. You know, like a credit card. If banks can’t profit by charging high-revenue customers as much as possible, they’ll make do (and abide by a federal mandate) by charging less, but to more customers. At least a few of the people who wouldn’t otherwise have used credit cards will start incurring balances. As for those of us who’d never consider carrying credit card balances, well, we’re welcome to pay that $5 fee.

To recap: the government gives banks incentive not to mine their profligate customers for profit, so those banks are forced to hit up the responsible customers. Which gives those same responsible customers incentive not to spend. Because economic activity is the last thing you want to encourage during a recession.

What recourse do we have as responsible consumers? Well, there remain other banks to do business with. Petitioning Congress to rescind the law would be a colossal waste of time and effort. Resorting to the ridiculous practice of writing checks is a possibility, too. As is carrying big fat wads of cash. In the meantime, find yourself a debt-laden consumer who thought the Credit CARD Act was a necessary protection against a banking industry run amok, and kick that person in the shins. The cosmos will thus regain balance.

Filed Under: Bad Examples, Consumer Debt, Credit Cards, Making Smart Choices Tagged With: , , , ,
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