The newly ratified Durbin Amendment — which gives the Federal Reserve power to regulate the interchange fees that banks can charge merchants for debit card transactions — stands to cost the banking industry between $3.6 billion and $9.6 billion annually, according to a CardHub.com study. Card Hub estimates that the losses will come as a result of the Fed lowering these debit card processing fees by as much as 50% in the coming year.
The intended purpose of this legislation — which also allows merchants to offer consumers discounts for cash payments — is to provide financial relief to a retail market hit hard by the great recession. Theoretically, the interchange regulation and encouragement of cash spending will lower merchant costs and result in trickle-down consumer savings, thereby stimulating purchasing and providing aid to the reeling economy.
In fact, these changes should incur a noticeably positive effect on merchants’ balance sheets, in the short-term, with major retailers like Target (TGT), Home Depot (HD) and Wal-Mart (WMT) experiencing significant financial gains. However, such increased profits will be relatively short-lived because of the effects of revenue-saving bank maneuvers and the loopholes inherent within the legislation — neither small banks nor prepaid cards are included within its scope.
A number of factors will negate any merchant savings over the long-term and make a restructuring of the credit and debit card markets and a rise in the prevalence of prepaid cards the true legacies of the Durbin Amendment. More specifically:
- To compensate for the loss in interchange fees, banks are likely to decrease the overall benefits of debit cards, thus making them less appealing to consumers and widening the overall rewards chasm between credit and debit card categories. Credit cards were unaffected by the Durbin Amendment and will therefore become even more prevalent amongst the highest spenders.
- Since the legislation only applies to banks with at least $10 billion in assets, small banks will be able to continue offering consumer-friendly debit cards, thereby increasing their standing in the market.
- Large banks are likely to market prepaid cards as replacements for debit cards because they stand to garner more profits than regulated debit cards, which now face competition from unregulated small bank offerings. Such a move is possible because prepaid cards have the same functionality as debit cards, save for the ability to write physical checks. Capital One (COF) — the country’s eighth largest bank — already offers a prepaid card option.
Overall, the Durbin Amendment signals initial savings for merchants that will dissipate over time as a result of bank reaction and legislative omissions. In addition, depending on how quickly banks react to loss of interchange revenue, the effect on them could range from nonexistent to fleetingly significant. In the end, however, the Durbin Amendment will lead to increased bank profitability because of the expected market restructuring, which we are already seeing with the introduction of monthly fees and higher minimum balance requirements on checking accounts. Ultimately, foresight of the impending ebb and flow of benefit as well as the expected industry restructuring provides market players basis for sound investment as well.
Disclosure: Long COF