Reposted from The Straw Group, at http://www.thestrawgroup.com/newsfilter/
TSG Opinion & Analysis – July 9, 2010
By Mike Strawhecker
The Durbin Amendment included in the seemingly soon to be passed and signed into law Dodd-Frank Act (aka the Wall Street Reform and Consumer Protection Act), gives the Federal Reserve the authority to regulate “interchange transaction fees,” which are defined as “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.” (An electronic debit transaction means a transaction in which a person uses a debit or prepaid card.) Inclusion of the interchange amendment in the Dodd-Frank Act is reasoned by Congress to be appropriate and well-timed as they assume it will achieve two things: 1) lower fees to merchants; and, 2) merchants will then pass on these savings to consumers. These assumptions by Congress are not only narrow and short-sighted, but they grossly miscalculate the negative consequences of the amendment that far outweigh the perceived positives, while at the same time, are contrary to consumer trends and demands. Additionally, the GAO report on interchange provided to Congress last November discusses the outcomes of similar legislation enacted in Australia in 2003: “A study of the Australian reforms by several economists reported that because the actual decrease in merchant costs was very small, merchants may have hesitated to lower prices, especially when their other costs might have been changing.”
Arbitrarily regulating a portion of the fee merchants pay in order to accept debit cards will create an artificial marketplace for a service utilized by the vast majority of Americans. If the amendment is enacted, the largest 105 U.S. banks (those with at least $10 billion in assets that are regulated in the amendment) will immediately see their debit transaction revenue source greatly diminish, and will likely then focus on issuing credit cards and providing/developing credit card merchant services and technologies over debit services. The remaining 7,800 U.S. banks and credit unions that do not need to adhere to the regulation face their own problems. These smaller banks will face customer attrition as they are unable to compete with electronic payments rates at larger, fee regulated banks. They will also see a significant drop in debit transaction fee revenue as merchants are incented to promote acceptance of cards issued at regulated banks, resulting in higher operating costs as declines in debit transactions processed increases their cost of completing a transaction.
Beyond the banks involved in the transaction, the debit payment transaction is driven by thousands of companies that make up the payments supply chain, including card associations (VISA, MasterCard), processors (provide the rails on which the transaction moves), merchant acquirers (provide the ability to accept cards including back-office reporting, etc), independent sales organizations (sell on behalf of merchant acquirers to merchants), POS manufacturers, technology providers, and others who built the infrastructure and developed the technology that make not only debit, but all forms of electronic payments possible. These payments companies employ tens of thousands of people all around the country, with large pockets in Omaha, Atlanta, and Louisville; these cities have been estimated to each have more than 10,000 people working in the payments industry. From these suppliers’ perspectives (suppliers that all depend on revenue from all forms of electronic payments transaction fees), the new artificial marketplace favors cash, check, and credit card payments over debit payments. Consequently, like the aforementioned banks, payments companies will drive resources and sales initiatives towards merchants receiving credit card payments over debit. Inherently, over time, debit payments will stagnate or drop in number of transactions and in dollar volume. This would come despite consumers’ recent adoption of a “pay as you go” mentality, accomplished via debit card use – in late 2008, VISA debit card volume surpassed VISA credit card volume for the first time in response to the recession, as consumers experienced the pains of deleveraging from years of excessive credit card spending.
The immediate drop in debit supplier revenue as a result of the Durbin amendment will not only affect those who receive it, but it will affect consumers and merchants as well. Consequences for consumers range from the short-term, which include large increases in consumer banking fees (to make up for lost bank revenues) along with drastic reductions in credit card rewards, free checking offerings, and loyalty programs; for the long-term, consumers will have less debit payments options and other payments technologies available at the POS, as payments companies are less inclined and/or able to develop these technologies. Merchants will face unintended consequences as well, as with less debit payments, they lose efficiencies and abilities (labor cost, reporting capabilities, fraud/risk) provided by electronic payments versus cash or check payments. Additionally, less debit usage will have a negative impact on ecommerce and telephone sales, and merchants will see the loss of the ‘bump’ in average ticket size that accompanies debit card usage.
Congresses’ self-perceived infinite wisdom has once again blinded them from the complexity of an industry they do not understand; the amendment equates to regulation of one part of a fee, of one form of payment, of one size of bank. A single infiltration of the Federal Government’s clumsy hand into this highly competitive and innovative industry, armed with the ill-conceived intention to create “fairness”, will in fact have the opposite result. It will have deeply adverse effects not only on companies in the payments industry and their employees, but it will also create a less competitive marketplace that brings with it long-term negative consequences for consumers and merchants alike. Like usual in Washington, a perceived political ‘win’ (in this case for Dick Durbin and his colleagues) prevails over good policy. One might envision that good policy would include an overhaul of Fannie Mae and Freddie Mac, or at least something germane to the cause of the recession. A quote from a Wall Street Journal Europe opinion piece published last year comes to mind as the payments industry braces itself as it is about to be forced to enter uncharted territory: “The popular myth of a failure of free markets is easier told than the more complex truth: the failure to let free markets work.”
The Strawhecker Group (TSG) is a management consulting company focused on the merchant acquiring sector of the payments industry. The company specializes in providing financial institutions, acquirers, card associations, ISOs, processing companies and the investment community with advisory services to maximize their growth and profitability. TSG is also a resource of merchant acquiring industry research, benchmark studies and developing trends.