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?

Shoveling Out From The Interchange Snowjob

If one of those big, bad companies (oh, for kicks, let’s just say it was a bank, our punching bag du jour) tried to mislead the public, what would the response be? Outrage. People would be up in arms, and politicians — especially the current administration — would be calling for legislation to punish the offender, and prevent it from happening again.

And, of course, our elected public officials would make a public spectacle out of it. Might even warrant dropping a few F-bombs, eh Carl Levin?

But what happens when those same elected officials, or some other politically-motivated individual, spews misleading information? Not only do they get a pass, but they get a platform to deliver those messages in publications like the New York Times and Huffington Post.

Examples: In a HuffPo article from February, California state assembly member Pedro Nava wrote:

On average, consumers pay $427 annually on interchange fees without even realizing it.”

Unfortunately, that’s simply not true, at least not literally. Consumers don’t pay an interchange fee. Merchants do. Whether or not that cost gets passed on to consumers is a different question of course, but if he’s going to expand the analysis to every cost a merchant incurs that works its way back to consumers, maybe Nava should start with the 8.25% sales tax that Californians pay.

More recently, the NY Times published an article written by Albert Foer, the president of the American Antitrust Institute, who wrote:

If the United States were to reduce the interchange rate from 2.0 percent to 0.5 percent, the savings would be $36 billion per year.”

That’s a true statement, kind of. $36 billion would be saved, but it’s really not clear who would reap those savings. With retailers’ profit levels declining, do you really think the savings they would accrue in interchange fees would be passed on to consumers? It’s possible. Just not on this planet.

The other fallacy in Foer’s analysis is that when companies are faced with revenue decline, most don’t sit back and do nothing. They try to find ways to recoup those shortfalls. This involves trying to find new customers, and/or offering new products, but may involve raising prices and fees in other areas. So, in the long run, those savings never materialize.

I’ll repeat that: Those savings never materialize.

If the same elected officials who are spewing falsehoods continue to (or try to) regulate firms’ ability to price their products and services, the outcome may be lower prices, but with a cost: Lower employment levels. As a firm’s revenue declines, so does its employment count.

But I should stop this rant — I’m probably preaching to the choir. If you’re reading this, you likely work in the financial services industry for a bank or credit union and agree with me.

The question that needs to be addressed: What should FIs do about this?

If there ever was a good opportunity for a national education/advertising campaign, this is it.

Callahan & Associates recently alerted credit unions to the potential impact of a cut in interchange fees:

If credit union’s interchange income was reduced in total by 75 percent (from Foer’s stated 2.0 to 0.5 percent), the lost revenue would drastically affect credit union non-interest income and the eventual value returned to members. Do your members know how interchange helps the credit union and subsidizes the true cost of providing debit and credit services?”

This is too narrow a view, though. The impact to credit union members is much broader than just the impact on their CU’s payout.

FIs — banks and CUs —  need to educate the public about what the interchange fee is. What it’s there for, who pays it, and how it helps pay for the rewards that consumers get on their credit and debit cards, and how it helps (will increasingly help) to keep checking account fees low, if not free. And how it’s a fee that merchants pay because it enables merchants to reduce the amount of cash they handle, reduces their billing costs, and helps prevent fraudulent activity.

As a VP of operations at a credit union was quoted as saying in American Banker “the current fee system puts financial institutions of all sizes on the same playing field in setting interchange rates. It allows the credit unions to compete with the largest national banks.”

This may cause a bit of a quandary for credit unions, however. After spending so much time and effort over the past 18 months distancing themselves from the larger institutions, I can’t help but wonder if this will cause some PR embarrassment for credit unions.

It doesn’t matter, though. This issue is too important.