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Durbin, Part Deux

I have written time and again about interchange regulations. Last week, lawmakers in the U.S. Senate introduced legislation to bring some of the regulations around debit cards to credit cards. The bipartisan bill echos a nearly identical bill introduced last summer that didn’t receive a vote.

Every time these bills come up, the payments world reacts strongly. Why? Let’s start with a quick history refresher.

First: What are the fees we’re talking about? Merchants who choose to accept payment cards pay what is called the merchant discount fee. This amount is a percentage of the total bill that is paid to their merchant acquirer, which is a bank-affiliated (or bank-owned) company that provides the digital and physical means with which to accept a credit card. Examples include Chase Paymentech, Square, Toast, Vantiv, Elavon, and many others. The merchant acquirer keeps a portion of the fee, the network (e.g., Visa or Mastercard) keeps a portion of the fee, and the issuing bank earns the lion’s share, which is called interchange. (Note: American Express and Discover Cards can be issued by AMEX or Discover, respectively, and processed on their own network, reducing the player count from four to three, but we’ll focus on Visa and Mastercard.)

Visa and Mastercard set Interchange rates and fees. Following previous regulations and litigation, these are public. You can read Visa’s (PDF) or Mastercard’s (PDF) anytime. They can be a bit complicated to read as the rate varies based on factors such as the:

1. Type of card
2. Type of merchant
3. Method of card acceptance (e.g., person vs. online)

For example, the network Interchange Reimbursement fee for a Visa Signature Prefered card (a top-tier product) in travel is 2.40% + $0.10, whereas the “all other products” category for Visa credit (a low-end card) for travel is 1.75% + $0.10, a difference of 65 basis points or 37%.

Merchant acquirers mark up the Interchange rate because they have to pay the network plus all of their costs, including risk, merchant underwriting, etc. This higher amount is the Merchant Discount Rate. It’s called that because the merchant receives the net of the charged amount, and the total is discounted by the rate.

Traditionally, merchant acquirers, especially for small businesses, made this all very opaque (and Interchange rates used to be confidential), so merchants were confused by their fee statements and often paid more than 4% rates effectively.

In recent years, with the growth of online merchant acquirers and technology-drive platforms, merchant acquirer has landed at two models for most merchants: a blended rate or a fixed markup.

In blended rate examples, like with Square, merchants pay a fixed rate, such as 2.95% + $0.30 per transaction, regardless of the card used. Sometimes, like in our Visa Signature Preferred example, this results in a small margin for the acquirer. In others, like a Visa Classic, it has a healthy margin, and in regulated debit (more on this in a bit), it is a huge margin (interchange for regulated debit is 0.05% + $0.21).

In fixed markup rate, the acquirer passes through Interchange with a fixed fee markup like 0.10% on top of the Interchange rate, plus a flat fee per month or per transaction.

In our example of a $1,000 plane ticket, the network fees vary from $0.71 to $24.10. The merchant fee could be $29.80 or $1.71.

The disparity, in part, is due to the Durbin Amendment to the Dodd-Frank Act, which created regulated debit card interchange. Following the financial crisis 2008, there was a lot of anti-bank sentiment. National merchant coalitions, which pitch themselves as fighting for the small business, but which I think are mostly arguing on behalf of Walmart and other major corporations, argued that banks shouldn’t earn so much on debit cards because their actual processing costs are lower. There is a duopoly of major networks here (although there are quite a few competitive debit networks and credit ones like AMEX and Discover). In a compromise between small merchants and small banks, Congress only regulated interchange for banks with greater than $50B in assets.

If you bank with Bank of America, Interchange is regulated and small. If you bank with a neobank or your local small bank, they earn “exempt” Interchange, which is 1.19% + $0.10 in our travel example.

Did merchants reduce their prices due to this? There is no evidence to prove this.

Did banks recover this lost income by reducing or eliminating free checking or adding new fees to their checking accounts? Yes.

In addition to the rate regulation, all debit cards are required to be activated on a secondary network. If your debit card says Mastercard on the front, the bank that issues it must enable it to be routed over a network not owned by Mastercard, such as Accel or Shazam. These networks can compete for volume by offering lower interchange rates to retailers.

Now, Congress wants to force dual routing for credit cards. Why? Because small businesses hate paying credit card fees. Small businesses don’t have to–they can (and do) charge consumers (although consumers tend to hate this upcharge). Also, small businesses don’t have to accept cards. If small businesses accepted cash or provided their own credit, they would incur costs that far exceed 3%.

Every time this type of legislation comes up, people get quite concerned. I don’t see it passing, though, because if there is one thing most Americans agree on, it’s how much they love credit card rewards. I imagine this especially applies to Americans who vote.

Fighting for the small merchant sounds good, but I believe that any interchange regulation just shifts dollars from banks to merchants. I don’t know why politicians are picking winners here.

If you’re wondering, yes, I do accept credit cards at Totavi (I pay a blended rate with my acquirer). I’d rather pay 3% and get paid today than hound late payers for a payment. That’s part of the time value of money!

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Chase Rises to the Challenge

Yesterday Chase announced the launch of a new card in their Chase Freedom lineup: Chase Freedom Rise. The new card acts much like a Chase Freedom Unlimited, earning 1.5% cash back on all purchases. The bank says the card is designed for those who are new to credit. Consumers must apply in person at a Chase branch until 2024. Chase also says that consumers will be more likely to be approved if they open a Chase checking account with $250 or more prior to or within three days of applying.

Freedom Rise joins Freedom Unlimited and Freedom Flex in the Freedom Family. This product suite of everyday cards is among the most popular credit cards in the country.

More access to credit is a good thing! The new card is an indication that efforts by startups to develop credit underwriting for those with limited or no credit represent an opportunity for all issuers.

CFPB Takes Action at Citizens

The CFPB has been busy lately! A few weeks ago, the CFPB announced a $9 million penalty for Citizens Bank to “resolve allegations that Citizens Bank violated consumer financial protection laws and rules that protect individuals when they dispute credit card transactions.” The fine isn’t very big for Citizen Bank, which is one of the 15 largest banks in the country and has more than $222 billion in assets.

However, the bank was caught violating Regulation Z, which protects cardholders in disputes. The bank “failed to reasonably investigate and resolve billing error notices and claims of unauthorized use by making customers jump through unnecessary and burdensome hoops, which are not required under the Truth in Lending Act, to report fraud” and “the bank did not provide certain individuals who submitted billing error notices with required acknowledgment and denial notices, which inform them that their disputes have been received and, if applicable to a person’s case, that the dispute was denied.”

One of the best things about credit cards is that they have legally required protections to help consumers when their card is misused or they have a dispute around billing or with a merchant. There are always banks that try to cut corners, as managing disputes is expensive (typically costing $20 on average to process, let alone any losses on transactions the bank incurs). However, it is a critical feature of cards, especially because that is part of what Interchange is supposed to pay for (see above)!

Me, Elsewhere

I’ve recently been featured in a few different consumer publications. Check out these stories:

• Should You Get a Credit Card Just for the Sign-Up Bonus? BuySide from The Wall Street Journal
• Niche Credit Card Rewards Were Having a Moment — What Happened? NerdWallet
• Is The Platinum Card From American Express Worth its $695 Annual Fee? U.S. News & World Report

CardsFTW

Thanks for reading CardsFTW, a debit and credit newsletter by Matthew Goldman. Matthew is the founder of Totavi, LLC, which provides GSD Product Consulting with real operational value. Visit totavi.com to learn more and engage us.

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