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The Durbin Effect

The Durbin Amendment was touted as legislation that would help retailers lower their costs for processing debit cards transaction which in turn it was hoped, would allow the merchants to pass on those saving to their customers. In theory this may have been the intent, but in practice that may not happen. The Durbin Amendment in fact, may end out doing more harm than good to both consumers and merchants.

The Set Up:

Congress had been looking at regulating the bankcard industry for a number of years. Congressional hearings were held where retail merchant associations complained about the high fees they were being charged for processing debit and credit cards. These hearings went nowhere until the backlash grew against banks and financial institutions in the wake of our recent recession. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was the result of that backlash along with the Durbin Amendment to that Act, that was specifically targeted at our industry.

The Durbin Amendment has been touted as something that will directly impact the fees paid by merchants for debit card transactions. I had always thought that the Durbin Amendment would result in immediate reduction in the fees that merchants’ paid for processing debit transactions. But a review of the Durbin Amendment shows that may not be the case.

The Durbin Amendment:

A review of the Durbin Amendment reveals that its scope may be much more narrowly tailored than one would expect. The Amendment states “[t]he amount of any interchange transaction fee that an issuer may receive or charge with respect to an electronic debit transaction shall be reasonable and proportional to the cost incurred by the issuer with respect to the transaction.” An issuer is defined as “any person who issues a debit card, or credit card, or the agent of such person with respect to such card.” Arguably, given the wording of the statute the law only limits the fee that can be charged by the company that issued the card which is commonly known as the issuing bank.

The definition of the term “interchange transaction fee” in the Amendment supports that conclusion. The definition states the “term ‘internet transaction fee’ means any fee established, charged or received by a payment card network for the purpose of compensating an issuer for its involvement in an electronic debit transaction.” This definition makes it clear the payment card networks such as Visa and MasterCard are also regulated by the law.

The Real Impact:

The flaw in the law is that it regulates what we commonly call the “buy rates” for transaction fees and interchange. These are the wholesale prices charged to the card processors, agents, ISOs and sales agents in our industry by the issuers and payment card networks. But, the Amendment does not directly impact the retail prices that are charged to the merchants. So, as the law is currently written, does that mean that the net effect of the law will be to lower the wholesale prices that are charged to the card processors, agents, ISOs and sales agents in our industry only?

If that is the case, it would be a windfall for those card processors, agents, ISOs and sales agents. If they choose not to change the merchants’ pricing for debit card fees and interchange, all the money that the issuing banks and card associations have indicated they are going to lose, would go straight into the pockets of the card processors, agents, ISOs and sales agents, at least in the short term. So the Amendment may have no immediate effect on the prices that merchants are charged for processing debit cards.

This seems to be an oversight on the part of Congress. My impression was that the Amendment was supposed to benefit consumers. Congress in my opinion failed in that regard to the extent that it did not mandate that any reduction in debit fees would be passed on to consumers. For the most part, I find it hard to believe that merchants would pass on such savings. But, it seems Congress failed even more that I had thought because they did not even make sure that merchants will get any benefit from the Amendment.

Long Term Consequences:

This is not to say that the Amendment will not have a long-term impact. For merchants, the reduction in debit fees will likely be passed on over the long term. Our industry is in what many call “a race to the bottom” of competition for merchants based mainly on reducing merchants’ transaction and interchange pricing. Some of the more aggressive agents that sell on price will walk into merchants and offer considerable price reductions for debit transactions, given the new lower wholesale pricing that will be instituted as a result of the Amendment. So merchants will likely see a benefit but at what cost?

The costs to consumers looks to be considerable. The banks that are losing revenue as a result of the Amendment are working overtime in order to find new ways to make up their lost revenue. There are many reports of fees being increased for checking accounts and that the days of “free checking” are probably a thing of the past. In addition, rewards programs for debit cards seem likely to be cancelled. Banks continue to search for other ways to make up this revenue shortfall by adding other fees that are not precluded by all the recent laws such as the CARD Act.

The future looks very similar for merchants. With the continuing compression of profit margins on what used to be the two main sources of revenue, interchange and transaction fees, processors are looking to find new ways to sustain their profitability and to that end they are picking fees as the answer.

First it was annual fees that was a way to increase fee income from merchants. Lately there have been PCI fees that some have charged monthly, annually and/or per transaction, followed up closely by the PCI non-compliance fees for merchants that do not demonstrate they are PCI compliant. Most recently, the newest fee that is being charged to merchants is the IRS reporting fee, linked to the new reporting requirements for processors to the IRS. It appears that fee based income is here to stay and probably will be the best way for processors to remain profitable in light of the increasing competition based on price to the merchants.

Overall, it appears that the Durbin Amendment may have the exact opposite effect than that which was intended. Consumers and merchants may get very little financial benefit and will be paying a lot more in fees in the near future.

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