Europe’s plan to cut card fees will hurt banks but may not help consumers; Retailers battling banks over debit-card transaction costs may benefit from lower fees after winning a court ruling on claims they were overcharged billions of dollars under an unlawful rate set by the Fed

Europe’s plan to cut card fees will hurt banks but may not help consumers

Jul 27th 2013 |From the print edition

TO POLITICIANS, banks are both incompetent behemoths waiting for public bail-outs and conniving profiteers pulling a fast one on their customers. Just as one arm of the European Commission has been finalising new rules that will force banks to have much more capital on their balance-sheets in order to make them safer, another arm has been writing rules to stop the “unjustifiably high” fees charged whenever a credit or debit card is used.A proposal released by the commission on July 24th (which it hopes will become law next spring) plans to cap “interchange fees”, charges levied on merchants by payment-card firms and their member banks whenever consumers use cards to pay for things. The commission wants to limit these fees to 0.2% of the value of the transaction for debit cards and 0.3% for credit cards. This compares with fees as high as 1.6% on credit-card transactions in countries such as Germany, and 0.8% in Britain, where card usage is higher.

The impact on banks from lower fees may be significant. A study conducted for MasterCard (which therefore comes with a big conflict-of-interest warning attached) by Europe Economics, a consultancy, estimated that British banks that issue cards receive some £2.3 billion ($3.5 billion) in interchange fees each year. It reckons that a cap on fees could trim the revenues of issuing banks by £1.1 billion.

The commission’s hope is that retailers will pass the savings they realise from lower fees on to consumers. It thinks that a cap is needed because market failures have prevented competition from pushing down prices. This, it argues, is because card companies such as Visa and MasterCard set uniform fees across their networks. Rules forbidding retailers from offering discounts for cash hamper competition. Consumers, too, are often incentivised to use cards that charge retailers higher interchange fees because they get more back in loyalty points or air miles.

The commission’s diagnosis of a competitive failure looks sound but its remedy may have passed its sell-by date. A decade ago it made sense to think of card companies as essential utilities that ought to be regulated like monopolies. Yet over the past few years the payments industry has started to bubble with new entrants. Start-ups like Square in America and iZettle in Europe, for instance, have dramatically lowered the barriers to people wanting to accept card payments. In San Francisco, where Square is based, people now routinely pay their yoga teachers and personal trainers by card instead of cheque.

More importantly, there is increasing competition for the card-payment networks from new plumbing. PayPal gives consumers the choice of paying using their credit cards or via direct debits from their bank accounts. Pingit, a service launched in Britain by Barclays, a bank, lets customers make payments using their mobile phones. The commission welcomes this competition and is passing some new rules to encourage it. But capping fees risks the worst of all worlds: the margins that start-ups can earn by undercutting the existing card-payment networks disappear, and retailers do not pass their savings on to consumers.

Swipe-Fee Rule Rejection to Help Merchants at Banks’ Cost

By Tom Schoenberg – Jul 31, 2013

Retailers battling banks over debit-card transaction costs may benefit from lower fees after winning a court ruling on claims they were overcharged billions of dollars under an unlawful rate set by the Federal Reserve.

U.S. District Judge Richard Leon in Washington ruled yesterday that the Fed considered data it wasn’t allowed to use under the Dodd-Frank law in setting the cap on debit-card transaction fees, known as swipe fees, at 21 cents, and neglected to bolster competition in card networks.

“The board’s final rule not only fails to carry out Congress’s intention; it effectively countermands it!” Leon wrote in his ruling.

The decision, unless overturned on appeal, will force regulators to revisit rules that bankers said would cost them 45 percent of their swipe-fee revenue. Lenders collected about $16 billion annually from those fees before the Fed’s regulation and responded by cutting back on perks such as rewards programs and free checking to soften the blow to their profits.

The Fed’s rule, in effect since October 2011, will stay in place until the central bank drafts new regulations or interim standards, Leon said.

‘Too Much’

“This is clearly saying 21 cents may be too much,” said Nancy Bush, a founder of NAB Research LLC, a bank research firm in New Jersey. “You’ll have to go back to the drawing board and figure out how much a debit-card transaction actually costs and is there going to be some kind of premium paid to that.”

More than 38 billion debit-card transactions took place in 2009 at retailers including grocery and electronics stores, gas stations and large chains such as Wal-Mart Stores Inc. (WMT) and Target Corp. (TGT), according to court documents. The Fed rule was written after merchants successfully lobbied for a measure pushed by Senator Dick Durbin, an Illinois Democrat, to limit the power of banks and payment networks to impose fees.

Swipe, or interchange, fees are set by Visa Inc. (V) and MasterCard Inc. (MA), the biggest electronic-payment networks, which collect the money and remit it to banks that issues the cards.

Visa, the biggest bank-card network, dropped the most since August 2011 on the ruling. Foster City, California-based Visa fell as much as 11 percent in New York trading before declining 7.5 percent to $177.01 yesterday. MasterCard, the second-biggest U.S. network, slid as much as 5.7 percent yesterday before gaining 1.5 percent to close at $610.61.

James Issokson, a spokesman for Purchase, New York-based MasterCard, had no immediate comment on the ruling. Joe Pavel, a spokesman for the Fed, said the central bank is reviewing the decision.

Harm Banks

Frank Keating, the president of the American Bankers Association, said the decision “will harm banks of all sizes and make it more difficult for institutions to serve their customers.”

“The price controls enacted as a result of the Durbin Amendment served one purpose — further lining the pockets of our nation’s big-box retailers at their own customers’ expense,” Keating said in a statement. “It was — and still is — all about trying to help retailers increase profit margins while providing no real benefit to consumers.”

Leon also agreed with the retailers’ contention the Fed hadn’t taken adequate steps to open up competition among payment networks that process transactions.

Network Fees

Total network fees exceeded $4.1 billion in 2009 in large part because of a lack of competition, he said. Leon criticized the rule for allowing a debit card to be limited to one network choice for signature transactions and one network choice for PIN transactions.

“Congress intended to put an end to exclusivity agreements and increase merchants’ choice among debit-processing networks, not restrict that choice or even preserve the status quo,” he said.

The retailer groups, who filed their suit in November 2011, said merchants would be “substantially harmed” by the Fed-established fees.

Yesterday’s “decision is the first step in setting these initial wrongs right and will ensure that swipe fee reform is done correctly,” National Retail Federation said in an statement.

Dodd-Frank, the regulatory overhaul enacted in July 2010, required the Fed to ensure that fees charged for debit-card purchases were “reasonable and proportional” to the cost of processing transactions.

Earlier Proposal

Merchants previously paid banks an average of 44 cents per transaction. The Fed first proposed cutting the sum to 12 cents before settling on 21 cents after bankers complained.

Yesterday’s ruling will lead to lower interchange rates for billions of debit card transactions each year, said Durbin, who filed a brief in the case supporting the retailers.

“The Fed’s 2011 decision to bend to the lobbying by the big banks and card giants cost small business and consumers tens of billions of dollars and did not do enough to rein in the anti-competitive, anti-consumer practices of Visa and MasterCard,” Durbin said.

In their complaint, the retailers alleged the Fed didn’t determine the incremental costs associated with a debit transaction and instead “invented” a category of costs not mentioned in the statute, giving the central bank unfettered discretion in setting the cap.

‘No Difficulty’

Leon said he had “no difficulty” concluding Congress intended to limit the Fed’s discretion in setting fees to the incremental cost associated with authorization, clearing and settlement of an electronic debit transaction.

Leon, who said the Fed rule raised costs for debit transactions under $12, said he was inclined to give the Fed “months, not years” to rewrite the rule.

“The starkest, most powerful evidence of how absurd this rule was is that it resulted in a price increase,” Jeffrey Shinder, an attorney at Constantine Cannon LLP in New York who filed a brief for a group of retailers including 7-Eleven Inc. and Wendy’s Co.

The case is NACS v. Board of Governors of the Federal Reserve System, 11-cv-02075, U.S. District Court, District of Columbia(Washington).

To contact the reporter on this story: Tom Schoenberg in Washington at tschoenberg@bloomberg.net