THE BLOG

New Interchange Rules for Debit Cards: A Perceived 'Win' Is Really a Loss

01/20/2011 01:11 pm ET | Updated May 25, 2011

Some recent media reports have said small banks and credit unions are the big winners in the regulatory battle over how much revenue financial institutions should derive from the use of debit cards. (In industry terms, this is known as debit interchange revenue). Credit unions and small banks have a deserved reputation for being consumer-friendly. So logic would dictate that if you're a credit union member or a small-bank customer, you should be feeling pretty good, right?

Here's the problem. No financial institution -- and more importantly, none of the millions of Americans who use their services -- is a winner here. The coming changes to the debit card interchange rules, esoteric though they may be, are going to have real and negative consequences that will unfortunately hit consumers directly in the pocketbook.

Consumers can expect higher fees or diminished debit card services as financial institutions deal with the new reality that is expected to ensue if a regulatory proposal now being circulated by the Federal Reserve is allowed to go into effect.

The big retailers and other merchants -- who are the real winners -- claim they are going to help consumers from their end by passing their savings on in the form of lower prices because their own debit interchange costs will be lower (i.e., merchants will pay lower fees to financial institutions to cover their end of the debit card transaction). But those claims are spurious at best. In countries where these types of interchange rules have been adopted, like Australia, consumers have seen no benefit.

I hear from credit union executives and volunteer board members around the country every day. To a person, they detest the notion of having to raise or impose new fees on the people they serve. But based on how these new debit interchange rules are shaping up, they feel they have no other choice.

That goes against our normal practice. Today we calculate that consumers save about $7.3 billion a year in lower fees and better rates by using credit unions.

I'll leave it to the banks to talk about their own situation, but I can tell you first hand that, at credit unions, which are not-for-profit and designed to help everyday consumers, the Federal Reserve's proposed debit interchange rate of 12 cents (and possibly as low as 7 cents) a transaction could reduce credit unions' interchange revenue by an estimated 70%.

As not-for-profits, credit unions depend on that revenue to underwrite the cost of offering debit cards to their members. (We're member-owned cooperatives; we do not issue stock and so cannot raise money that way to fund operations as banks do.)

Deprived of so much of this needed revenue, credit unions will either have to stop offering the cards (a prospect most will resist because their members value using their debit cards) or, more likely, they will have to offset the lost income by imposing new fees on checking, debit transactions or other services. Credit unions would rather not do this. But the Fed's proposal, which implements the interchange provisions of the Dodd-Frank financial reform law, stands to leave them no recourse.

How can that possibly make credit unions or the consumers who look to them for affordable financial services 'winners'?

Proponents of the new interchange law and the Federal Reserve's proposed rules will point to the "exemption" from the new debit interchange fee schedule for banks and credit unions with under $10 billion in assets. And they will cite recent reports that VISA plans to follow a two-tier interchange fee structure when the regulations take effect this summer.

However, our concern all along has been that nothing in the law or the Fed's proposal provides a mechanism to enforce, or maintain, a meaningful two-tiered system. Even if VISA were to go forward with its plans, market forces (from the numerous debit networks or large issuers or large merchants) will likely erode the gap between the two tiers of debit revenue over time.

All of this is going to have a harmful impact on Main Street, one that ultimately will prove costly to millions of American consumers.

That is why the new 112th Congress ought to look deeper into this issue, and at a minimum hold the type of in-depth hearings that were lacking before the debit interchange provisions were tacked onto the Dodd-Frank bill at the 11th hour on the Senate floor last year.

A huge new regulatory burden, whose true costs end up falling on the shoulders of millions of consumers, cannot possibly be what the Congress intended. Consumers ought to be the winners, not the losers.