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Debit Interchange: Those Who Can Least Afford It Will Be Hurt Most

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It's easy and popular to demonize the big banks of Wall Street. In many cases, they deserve it. But the attempt by retailers, big and small, to cast the current political battle over debit card interchange as a fight between Wall Street and Main Street (with merchants, of course, claiming the Main Street mantle), is grossly inaccurate and misleading.

When smaller card issuers -- like the credit unions my association represents -- express their deep concern about the impact of interchange, we are painted by proponents of the new law restricting interchange fees as fronting for the big Wall Street banks that they say are the true targets of the legislation and related rules proposed by the Federal Reserve Board.

Credit unions are cooperatives, locally based and owned by their 93 million members -- the people who do the saving and borrowing. Many are teachers, firefighters, police officers, members of the military. That's as Main Street as you can get.

Our industry has no allegiance to the banks, which have a history of opposing pretty much everything credit unions try to do. We are only aligned with the banks on interchange because in this case our members will be harmed by the effects of the legislation and pending Fed proposal.

What's the concern? Well, you've heard the old line about the businessman who is selling a product for less than it cost him to produce it, and when asked what he plans to do, responds: "Don't worry, we'll make it up on volume."

That encapsulates what's going to happen if the Fed's interchange proposal is allowed to take effect.

Credit unions receive on average about 44 cents per debit card transaction as interchange revenue. The Fed proposal would chop that to 12 cents, a figure that doesn't begin to account for the actual debit card service costs, such as those related to fraud and systems support.

The 12-cent rate puts us in the same boat as that businessman trying to make up his losses on volume. We estimate that up to two out of every three credit unions would lose money on their debit card programs if the interchange regulations reduced interchange-related revenue by 40 percent.

Remember, credit unions are member-owned cooperatives. Their business model is all about passing savings onto their consumer-members. Last year, for example, consumers saved $6.5 billion using credit unions rather than banks. In this case, however, credit unions will have absolutely no choice but to pass the higher interchange costs on to their members, most likely by adding fees to debit cards or other services. And the people who can afford it least are the ones likely to be hurt most.

"No worries!" say the merchants and their supporter on Capitol Hill. "The interchange law exempts most community banks and credit unions" (those with assets under $10 billion).

But the exemption is fatally flawed. Larger institutions account for the majority of debit transactions. Over time, smaller institutions will lose out, too. Market pressures will force the interchange price that smaller institutions receive toward the lower, 12-cent rate.

Influential regulators like Fed Chairman Ben Bernanke and FDIC Chairman Sheila Bair have voiced doubts about the efficacy of the small institution exemption. The need to address the inherent flaws in the exemption is why Sen. Jon Tester (D-MT) and Rep. Shelley Moore Capito (R-WV) have introduced legislation to delay and further study the Fed's implementation of interchange.

And the call for delay, further study or both is coming from other quarters, too: The National Community Reinvestment Coalition, the Hispanic Chamber of Commerce, the NAACP, and most recently, the National Education Association. All share a concern that the ones who can least afford it -- low- and moderate-income consumers -- will be hurt the most by added fees.

Those of us working to help Sen. Tester and Rep. Capito to delay and study this troubling issue are admittedly, as the Wall Street Journal terms us, a "collection of strange bedfellows." But it is a grouping brought together by shared concern about the unintended yet potentially harmful consequences of the interchange restrictions.

And this unlikely conglomeration demonstrates that attempting to narrowly cast interchange as some type of deserved comeuppance for Wall Street banks misses a much broader and consumer-oriented picture.

Put another way: In the zeal to reform interchange, don't hurt consumers and the financial institutions that they own in the process.