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Credit unions get debit boost

By Claes Bell ·
Thursday, January 13, 2011
Posted: 10 am ET

Looks like small banks and credit unions might be more likely to keep free checking accounts around than large banks, thanks to a loophole in last year's Dodd-Frank financial reform bill.

The law caps debit interchange fees, the fees banks charge merchants to process debit card transactions, but only for banks with over $10 billion in assets. Interchange fees are a major source of revenue for banks, which use the money to effectively subsidize free checking accounts for customers. Because of Dodd-Frank, big banks won't be able to do that as much as they once did, but smaller banks and credit unions will.

When the law was passed, Visa, which owns one of the biggest networks for processing debit transactions, made noise about forcing all financial institutions they serve to charge the capped amount, thus eliminating small banks' and credit unions' advantage.

US Banker has an interesting article this month on how Visa has reversed its course and has decided to create a two-tiered system, capable of charging merchants the capped fee for big-bank transactions and an uncapped fee for smaller banks and credit unions:

Analysts say the move would give community banks and credit unions an advantage over larger institutions. Last month, the Federal Reserve Board published its proposal to restrict interchange fees on debit cards to about 12 cents per transaction for institutions with $10 billion or more in assets. Smaller companies would not be restricted.

"We will support a two-tiered debit interchange structure," a Visa spokesman said in an e-mailed statement Friday. "We expect to have a separate rate schedule for exempted institutions and products at the time of implementation" of the Fed's rule.

Though Visa is not required to create a two-tiered rate structure, it is "saying they are going to play ball," said Howard Polack, a senior analyst at Aite Group LLC, but "it's just not going to be fair."

If you're wondering why you should care, there are a couple of reasons besides free checking, which is pretty big. One is, if you have a debit rewards card from a credit union or small bank, it may just be safe, because they'll be able to continue funneling merchants' money into sweet, sweet frequent flyer miles or cash back for you.

The other reason is a little more macro, but still important. However you feel about the role of "too big to fail" institutions in shaping the financial crisis of 2008, this measure will clearly have the effect of driving more customers into smaller institutions and undermining the growth of TBTF institutions, at least in retail banking.

What do you think? Is this patently unfair to big banks? Or is it just deserts for big banks' role in the financial crisis?

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Claes Bell
January 14, 2011 at 11:59 am

Interesting points, Winter. I think you're right that the change looks a little out of place in a law that was supposed to be about improving the stability of the financial system.
As far as fairness, I'd say merchants might come back with the justification that the payment system was basically a monopoly, and so they didn't have any market power to seek out a more cost-effective alternative. Also, large retailers had vastly more leverage to negotiate favorable rates than smaller vendors, which most merchants would probably say was unfair.
What this change appears to do is transform the card payments system into more of a regulated utility, which can raise prices to cover rising costs, but can't do much else. It also has the net effect of shrinking TBTF banks, which is probably a side benefit from the perspective of the law's proponents.

Winter Prosapio
January 14, 2011 at 11:51 am

What's not fair is for merchants to get a free ride on the payment card system. Interchange had nothing to do with the financial crisis but this deal was just a political favor traded away when the industry was weak. There was no debate, and even the Fed has said the deadlines imposed are impossible to do proper research.

The costs of the system that merchants should be bearing (because they get the bulk of the reward) are now going to be passed onto consumers. At least not for profits, like credit unions, will still be a strong consumer option, IF the two teir system actually works and merchants don't try to steer consumers to what is the MERCHANT's best option.

And on the issue of "fairness"... don't big banks always have the advantage of size in terms of managing costs - is that fair?