Fed Interchange Fee Decision Shocks Retailers, But Consumers Will Pay the Price

A U.S. Federal Reserve decision Wednesday to cap debit card transaction fees at a higher level than expected angered retailers - but it may end up costing consumers much more.

Instead of lowering the "interchange fee" cap from the current $0.44 per transaction to the $0.12 proposed in the Dodd-Frank financial reform legislation, the Fed voted to set the cap at $0.21. Additional fees allowed by the rules would result in a charge of $0.24 for the average debit card transaction of $38.

Although retailers will now pay less, they are peeved the Fed did not stick with the much lower cap, which would have saved them twice as much. Retailers had argued that the high interchange fees have hurt smaller businesses, forcing them to raise prices for customers.

But many, including one of the primary proponents of financial reform, Rep. Barney Frank, D-MA, doubt that retailers will now put any of the near-50% reduction in the cap toward customer savings.

"I think they were fighting to raise their revenue," Frank told The Wall Street Journal.

Indeed, consumers stand to lose as a result of the Fed's decision. Few merchants are likely to lower prices, and banks may well raise customer fees to recoup some of their lost profits on debit transactions.

"I don't think the retailers would have spent millions of dollars lobbying for this law if they intended to pass along every single nickel of savings to consumers," Greg McBride, senior financial analyst for Bankrate Inc. (NYSE: RATE), told the Orlando Sentinel. "This was an issue of where the cash would flow - to the banks or the merchants. Ultimately, I'm afraid, the consumer is going to get stuck footing the bill."

Debit cards have grown more popular with consumers than credit cards; U.S. consumers chose debit for 37 billion transactions in 2010, compared to 19 billion transactions using credit cards and 18 billion using checks.

With billions of dollars at stake, retailers think banks made out in the Fed's decision.

"The Fed essentially took what had been a win and turned it into a loss,"National Retail Federationgeneral counsel Mallory Duncan told USA Today. "They took $6 billion a year away from the public and put it into the pocket of the biggest banks in the country."

The lower interchange fee cap, which becomes effective Oct. 1, will cost banks more than 40% of the revenue they get from such fees, about $20 billion annually. But a $0.12 cap would have hurt the banks far more.

"It's better than it was, but it is still below our cost," William Cooper, chief executive of TCF Financial Corp. (NYSE: TCB), told The Journal.

The banks say they need to recoup the cost of processing each transaction plus a "reasonable profit." The Credit Union National Association (CUNA) says it costs $0.25 to $0.35 to process each transaction, although a Fed study last year put the costs far lower -- $0.04 to $0.07 per transaction.

Changes for bank customers could include higher minimum account balances and daily limits on how much one can spend with their debit card. Some banks may scale back or phase out rewards programs on their debit cards.

"Everything from checking to savings to other retail and commercial bank products will be revaluated," Robert Hammer, who runs a payments consulting firm in Thousand Oaks, CA, told The Journal.

The banks most affected by the change are Bank of America Corp. (NYSE: BAC) and Wells Fargo & Co. (NYSE: WFC). Revenue from debit interchange fees constitutes 2.5% of both banks' total revenue.

The only clear winners are the major credit card companies, who would have been forced to lower the fees that they charge the banks to rout the transactions had the Fed held to the $0.12 limit.

After the announcement, MasterCard Inc. (NYSE: MA) rose 11% to $309.70 and Visa Inc. (NYSE: V). shot up 15% to $86.57. Other card issuers enjoyed a less-pronounced pop -- American Express Company (NYSE: AXP) was up 2.17% and Discover Financial Services (NYSE: DFS) 1.29%.

"The final rules are a clear positive as a higher interchange cap could lessen pricing pressure from large bank issuers," Robert W. Baird analyst David Koning told Reuters. "We believe Visa and MasterCard become more investable again, as the regulatorycloud lifts."

The bottom line is that unless you hold MasterCard or Visa stock, the Fed decision on interchange fees is bad for you.

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About the Author

David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.

Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.

Dave has a BA in English and Mass Communications from Loyola University Maryland.

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