If you’re a bank CEO or director, you’re probably getting a little tired of Uncle Sam reaching into your institution’s pocket and pulling out handfuls of cash. Last year it was the new federally-mandated restrictions on account overdraft fees, which threatened to deprive banks of an important revenue stream just as they were struggling to recover from the effects of a deep recession in the U.S. economy. Fortunately for the industry, a significant percentage of retail customers opted into their bank’s overdraft protection plan, so the economic impact has turned out to be less than feared.
But then along came the Dodd-Frank Act, which not only imposes a greater and more costly compliance burden on the banking industry, but also drastically reduces the interchange fee that big banks–defined as $10 billion in assets or larger–are permitted to charge merchants on debit card transactions. The Act directed the Federal Reserve to set the maximum rate for debit card transactions, and in December the Fed proposed a cap of 12 cents–down from an average of 44 cents per transaction today.
The Fed is still soliciting comments under its normal rule-making process, and is required by Dodd-Frank to finalize the new rate by April 21. A 12-cent cap would result in a 70 percent to 85 percent reduction in debit card income for large banks, according to an estimate by the consulting firm Raddon Financial Group.
As bad as that sounds (and it is bad), the outcome of this latest threat to bank profitability is far from clear.
Raddon Vice President Bill Handel says that large banks like J.P. Morgan Chase & Co. are already considering a variety of strategies to mitigate the impact. For example, J.P. Morgan is testing a monthly $3.50 debit card fee in Green Bay, Wisconsin. (Under the current system, merchants end up paying the interchange fee, while retail bank customers are able to use their debit card for free.) The bank is also testing a $15 monthly checking fee in Marietta, Georgia.
One possible outcome of the new fee cap is that large banks will have to start charging for things–like debit cards and checking accounts–that used to be given away for the purpose of attracting core deposits. “The ‘free’ environment that we have been operating under will cease to exist,” says Handel.
The only problem is, Raddon’s research shows that consumers have become so accustomed to getting their retail banking services for free that they will balk at paying a monthly debit card fee. Instead, they will be more likely to either reduce their debit card usage in favor of paper checks (which are more costly for the bank to process)–or look for a free debit card at a smaller bank that isn’t affected by the cap. And that would seem to give small banks a huge competitive advantage since they could still offer their debit cards and checking accounts for free.
Not so fast. Smaller banks might think they’re shielded by Dodd-Frank from the sharp economic impact that large banks will feel, but that protection might not hold up in the real world outside of Washington, D.C. Predicts Handel, “We don’t believe the less-than-$10 billion exemption will hold up over the long haul.”
Visa Inc., the country’s largest card payments company, has said it will adopt a two-tiered pricing system for debit card transactions, one for large $10-billion-plus banks that will reflect the new Federal Reserve mandated cap on fees, and a second system for smaller banks that does not place a cap on fees. But Visa and its smaller payments competitor – MasterCard Worldwide – are member associations dominated by the same mega-banks that will be most hurt by a 12-cent cap. Handel says it’s not logical to assume that large banks like J.P. Morgan Chase and Bank of America will passively sit by while they lose debit card and checking account customers to small banks that can afford to subsidize those products with their higher interchange income.
“[The card companies’] brands are backed by the big banks,” says Handel. “If the big banks say to Visa and MasterCard ‘You can’t continue to have a two-tiered system,’ they will have to listen.”
A company spokesman said yesterday that MasterCard had not yet made a decision on whether it will adopt a two-tiered system for debit card fees, but don’t be surprised if the 32-cent per debit card transaction advantage that smaller banks seem to enjoy thanks to Dodd-Frank ends up much, much less.