debit card

The Fed rule on debit card fees could have far-reaching effects on how consumers spend and save.

The debit card battle between retailers and banks has reached epic proportions.   The plan by lawmakers is to slash the fees retailers pay banks every time a shopper uses a debit card.  Both sides are spending millions of dollars to convince lawmakers that they’re looking out for average Americans.


Financial institutions have blanketed the Washington, D.C., subway with ads calling the planned reduction in swipe fees a “$12 billion gift to retailers.” Retailers have characterized proposals to postpone the fee reduction as another bailout for the banking industry.

Caught in the cross hairs are consumers, who tend to have a dim view of banks but don’t have a lot of faith in retailers, either. A March poll sponsored by the Merchant Payments Coalition, a group representing retailers, found that 70% of likely voters favor a reduction in swipe fees, once the rule was explained to them. But a survey by Javelin Strategy & Research, a bank consulting firm, found that 60% of consumers don’t expect prices to fall if swipe fees are reduced.

Danielle Haskell, 41, of Monrovia, Calif., says retailers should pass on savings from lower debit card fees to their customers, but adds, “I’d be shocked out of this world if that ever happened.”

Sheila Sutherland, 61, of Upstate New York, says that if banks limit consumers’ use of debit cards — which some have threatened to do — she’ll go back to using cash: “I’m sick of bank robbery — and it’s the banks that are doing the robbing.”

The broad financial reform legislation that Congress enacted last year required the Federal Reserve to issue rules that place “reasonable” limits on debit card fees. In December, the Federal Reserve proposed capping fees at 12 cents per transaction, down from an average of 44 cents. Since releasing the proposal, the Federal Reserve has received more than 11,000 comment letters.

Amid the controversy, this much is clear: The Fed rule, scheduled to take effect July 21, could have far-reaching effects on how consumers spend and save, in ways that will be both welcome and distasteful.

Here are five ways a reduction in swipe fees could affect you:

Discounts and perks for debit card users. If the Federal Reserve’s proposed rule is enacted, debit card fees will be sliced by up to 70%, but the fees retailers pay when shoppers use credit cards won’t be affected. According to the National Retail Federation, debit card fees average 1% to 2% of the cost of a transaction and would go lower; credit card fees average 2% to 3% and wouldn’t change. That means retailers will have a huge incentive to encourage customers to use debit cards instead of credit cards. Possible enticements include:

  • Across-the-board discounts. Currently, many gas stations offer customers a discount for using cash. A reduction in swipe fees could lead to three prices at the pump: one for cash, one for debit and one for credit, says Mallory Duncan, general counsel for the National Retail Federation.
  • Enhanced loyalty rewards. Retailers that already offer special deals for loyalty card holders could offer even lower prices when members use debit cards, Duncan says. For example, consumers who use a grocery store club card might get an additional discount on steaks if they pay with their debit cards, he says.
  • Extra services. Consumers who purchase luxury items and high-end appliances typically use credit cards, and a small discount might not be enough to get them to switch to debit. As a result, retailers will look for other ways to add value, Duncan says. For example, a retailer might offer debit card users free delivery, or in the case of clothing, free alterations, he says.

Higher bank fees. Last month, Chase scrapped a pilot program to charge non-customers up to $5 to use its ATMs. But while a $5 ATM fee appeared to exceed what consumers will tolerate, many other fees will rise if the Fed proposal is enacted, bank analysts say. Most banks will end free checking unless customers maintain a minimum balance, predicts Robert Hammer, CEO of R.K. Hammer, a bank advisory firm. Customers who want paper credit card statements or copies of canceled checks will also have to pay a fee, he says.

Other services that are subsidized by debit card fees include 24/7 customer service and online banking, says the Financial Services Roundtable, a trade group. Without “reasonable” swipe fees, the group says, financial institutions “will be required to charge consumers for these services.”

Some consumer groups are concerned that banks’ efforts to make up for lost debit card fees could make it more difficult for low-income consumers to afford a basic bank account. The National Community Reinvestment Coalition, for example, has called on the Fed to delay the reduction in swipe fees until it analyzes the potential impact on low-income communities.

The fee increases won’t be limited to big banks, says Fred Becker, chief executive of the National Association of Federal Credit Unions. More than two-thirds of NAFCU members said they’re considering eliminating free checking if the swipe-fee proposal is adopted, Becker says, and more than half said they may lower interest rates on savings accounts.

Credit unions and small banks have been vociferous opponents of the swipe-fee provision, even though the legislation exempts institutions with assets of less than $10 billion. “We don’t think, as a practical matter, that a two-tiered system will work,” Becker says. It’s unclear whether processing systems can be adapted to accept two different fees for debit cards, he says. Credit unions and small banks also fear that retailers will refuse to accept their debit cards.

The Merchants Payments Coalition has dismissed that concern, arguing that it’s bad business to discriminate against customers based on the debit cards they use. The group also contends that MasterCard and Visa network rules require merchants to accept all their debit cards, without regard to the issuer.

Better credit card rewards. Faced with sharply diminished revenue from debit cards, financial institutions are seeking ways to encourage customers to use credit cards instead, says Bill Hardekopf, chief executive of One tried-and-true way is to offer airline miles, cash or other rewards.

In March, for example, Capital One offered to match up to 100,000 airline miles for customers who signed up for its Capital One Venture Rewards card (the program ended in early April after Capital One gave away the 1 billion miles it allocated for the program). Customers who sign up for the new Chase Freedom Visa can earn up to $100 in cash back if they spend up to $500 in the first three months. Other card issuers are offering up to 5% cash back on certain categories of purchases, such as gas or groceries.

To qualify for these attractive rewards, though, card holders need excellent credit. The economic downturn led to a jump in credit card defaults, and financial institutions are still unwilling to take risks, Hardekopf says. Their ideal customer, he says, is someone with a high credit score who uses credit cards frequently — generating lots of transaction fees — then pays the full bill every month. The way card issuers compete for that elusive customer, Hardekopf says, “is by upping rewards.”

Less favorable interest rates. More than half of credit unions are considering lowering rates on deposits if the swipe fee proposal is enacted, according to a NAFCU survey. A quarter said they would raise rates on loans.

Penalty interest rates for credit card holders could also skyrocket, Hammer says. Some banks are already charging penalty rates of up to 30% on new purchases when card holders make a late payment. A few charge even higher rates for delinquent customers, he says. Banks that haven’t already boosted penalty rates probably will do so in the future, depending on how much they lose in swipe-fee revenue, Hammer says.

Fewer rewards, higher fees for debit cards. In the past, banks had a strong incentive to reward customers for using their debit cards, says Ken Lin, chief executive of Credit, a website that helps consumers improve their credit scores. Debit cards generated nearly as much in swipe fees as credit cards, without the risk that customers wouldn’t pay the bill, he says.

But a cap on fees would make such rewards programs unprofitable, Lin says. SunTrust, Wells Fargo, JPMorgan Chase and PNC Bank have already informed customers of plans to curtail or phase out rewards programs.

In a letter to customers, SunTrust stated that the Fed proposal “will impact the economics of the industry’s check card programs. As a result, SunTrust will no longer offer the SunTrust Rewards Program for any SunTrust-issued check card.”

Once the cap on fees goes into effect, Lin says, “I don’t think you’ll see anymore rewards-based debit cards.”

Also, banks might charge debit card holders an annual fee unless they use their card a specific number of times a month, Hammer says. Sixty-seven percent of NAFCU members said they’re considering imposing an annual or monthly fee for debit card users.

While consumers may miss the rewards and grouse about annual fees, they’re unlikely to abandon debit cards in favor of credit cards any time soon. Debit card payment volume exceeded credit card volume for the first time in 2009, according to Javelin, a trend believed to have continued in 2010. With memories of the recession still fresh, debit cards have become the preferred payment choice for consumers who want to live within their means, analysts say.

“The thrift mentality has taken over,” Hammer says.

“Banks are going to have to figure out how to deal with it. ”

Photo credit:  General Business Solution

Via USA Today