The (Non-)Impact Of The Interchange Amendment

Well, I didn’t think it would happen, but what do I know about Washington. They managed to pass an amendment regulating interchange fees.

A shining example of how low the financial literacy rate is in DC, the amendment instructs the Federal Reserve to regulate interchange fees and requires that the fees be reasonable and proportional to the costs of the issuer or the payment network.

To prove what a slippery political slope this amendment was, most senators uncharacteristically gave up their right to be heard on the amendment before its vote, leaving only Dick Durbin to tout it on the Senate floor.

But it passed, and that has led some observers to comment on what the impact of the amendment will be. A recent post on Mint.com’s blog listed five potential impact points. Here’s the list with my take on them:

1. Happy shopkeepers. The blog post claims that both small and large retailers feel gouged by card issuers and networks and are happy about the amendment.

My take: The amendment means potentially happy shopkeepers. Potentially, because, in the short term there’s no guarantee of a rate decrease. Remember, the amendment instructs the Fed to establish a rate that is “reasonable and proportional to the costs of the issuer or payment network.” Do you know what those costs are? Neither do I. And I bet that the issuers and networks don’t know what those costs are either. The interchange rate is a fee for a bundle of services that the issuers and networks provide. Unwinding those costs will be messy, and it will be a while before new rates are established, unless all parties simply agree to bow to political pressures and compromise (or more accurately, capitulate).

2. Lower prices. According to the Mint blog “when flour gets cheaper, bread gets cheaper.”

My take: Ain’t gonna happen. Retailer profitability has been in the dumps, and they’re desperate to show increased profitability. If they really wanted to lower prices, they could find other ways to reduce their cost structure. The retailers decided to fight the interchange war, and scored a victory in one battle.  But this misses the even more important point on why prices ain’t coming down: As I said in the previous point, the fee represents a bundle of services — services like fraud detection/protection, risk management, money movement, etc. If the issuers/networks don’t get compensated for these services, they will stop providing them. And retailers/merchants will have to pay separate charges for those services. And those charges might turn out to exceed the current level of fees.  Consumer prices aren’t coming down, folks.

3. More cash-only transactions. One of the things the amendment does is allow merchants to establish minimum charge amounts on card transactions, so they don’t end up paying outrageously priced fees for 50-cent transactions. Mint’s thinking is that retailers will jump on this, and set up minimum charge amounts (retailers who do this today violate their Visa/Mastercard agreements).

My take: Ain’t gonna happen. Two reasons driving my thinking here. First, retailers are loathe to force customers into payment options. Retailers know that customers have choices, and would rather pay a fee on a transaction than lose the transaction altogether. The other reason is that younger Gen Yers have no clue what cash is.

4. Fewer rewards. Mint’s logic on this is: “debit card reward programs, financed by interchange fees, have traditionally been less generous than those offered by credit cards, because banks collect lower interchange fees on debit transactions. If the Durbin amendment stays on the bill once it becomes law, these programs will probably be toast.”

My take: Sorry, I disagree again. Mint’s logic misses some critical points: That competition for checking relationships still goes on, and banks will compete for new accounts using rewards programs as a competitive lever. Why? Because consumers are conditioned to expect something in return for their business. And because even if the interchange fee ends up being lower, with the restrictions on overdraft fees, banks will turn to the interchange fee as a driver of revenue on checking accounts. In a shining example of strange bedfellows, it will actually end up being the merchants themselves who will end up providing much of the funding for rewards programs.

5. The end of the world.

My take: And you think I’m cranky?

Credit Unions' Credit Card Chimera

I don’t have stats to back this assertion, but it seems to me that credit unions are looking at the credit card market as a growth opportunity these days.

Anecdotally, after linking to a news story about how Chase would drop 15% of its cardholders as a result of the new regulations, one of my Twitter buddies tweeted “time to find a credit union card.” And the CU twittersphere jumps on every mention of CUs from Suze Orman, like this one:

Don’t get me started with these credit card companies….here’s the answer: Credit unions. So many credit unions are giving you no balance-transfer fees, low interest rates. [And] most credit unions aren’t staffed by the dumbest people you will ever meet.”

As a side comment here, I’m not sure why Ms. Orman thinks card issuers employ the “dumbest people you will ever meet.” Personally, I’m very impressed that my card issuer can detect fraudulent patterns in card use, and called me when they noticed that my card was used in both Massachusetts and Texas on the same day.

But the bigger question here is this: Why do credit unions think that the customers that the big issuers will drop are such a great business opportunity? Does it occur to credit unions that the reason why the large issuers are dropping these people is that they’re not profitable customers?

There’s a new definition of “good customer” in the credit card industry these days. The old definition: Someone who revolves balances and pays late. Translation: Someone who pays a lot in interest and late fees.

New definition: People who use their credit card a lot. These folks often don’t revolve, and if they do, don’t do it for long, and make way more than the minimum payment. They drive profits for the issuer through interchange fees, not interest fees. And they’re way more concerned about the quality of the rewards program than they are interest rates or balance transfer fees.

Translation: The card customers that credit unions are likely to obtain by digging through the large issuers’ trashcans may not be very profitable.

If credit unions see this a springboard to obtaining new members and growing the relationship, then why are so many CUs so proud of letting deposit accounts walk out the door when the member wants a good or better rate?

Credit unions can beat their chests all they want about how superior their card programs are. The reality is that only certain types of the cards they offer are a better deal. On the rewards front, the CUs are lagging. And that’s what luring and retaining the “best” cardholders today.