Credit union study of swipe costs adds confusion to debit fee battle

Introduction

In tallying up how much it costs banks to process debit card swipes, every penny counts.

But even as the U.S. Senate prepares to vote on a measure to delay a fee cap that would eliminate about $16 billion in annual profits banks earn from debit cards, there is little consensus on a key question: How many pennies does it cost a bank or credit union to process a debit transaction?

Two government regulators have come out with significantly divergent cost figures, while those who will be affected by the cap say neither figure is accurate. Banks and credit unions closely guard the information as proprietary.

Ed Mills, a Washington policy analyst with FBR Capital Markets, says the lack of transparency is an advantage for card issuers and “a key part of the fight” now underway between bank and retail lobbyists.

The Federal Reserve, directed by the Dodd-Frank financial reform law to set a “reasonable and proportional” cap on debit fees, settled on 12 cents—a 70 percent cut from the 2009 average. It based the proposal on its own survey last autumn of large banks that issue debit cards, merchant banks and payment card networks.

The survey found that the median transaction cost was 7 cents. The Fed proposed the higher 12 cent threshold to account for other costs that are more difficult to estimate.

But a separate study by the National Credit Union Administration (NCUA), the federal regulator of credit unions, suggests that processing costs could be much lower.

The 14 largest credit unions in the NCUA study—those with assets greater than $1 billion—reported that the median cost to process debit cards requiring a PIN or signature was just 2 cents.

Not included in the NCUA study was the cost to process prepaid debit cards, which are a tiny part of the market and make up just 3 percent of all debit transactions. The Fed study included that category of debit cards.

A nickel difference between the Fed’s median cost and the NCUA’s median cost may sound like small change. But with nearly 40 billion debit transactions in 2009, each penny difference represents about $400 million in revenue that is either paying real costs to authorize, clear and settle swipes—or adding to bank profits.

But the NCUA data isn’t getting support from anyone outside the merchant’s lobby.

Trish Wexler, a spokeswoman for the Electronic Payments Coalition which represents banks and credit unions, calls the NCUA’s 2-cent estimate “inconceivable.” Credit union members of her organization have asked regulators to take a second look at the data, she said.

Even the regulator is backtracking.

After releasing the results of its survey in a letter to the Federal Reserve, the NCUA told iWatch News that its findings do not reflect the true processing costs for credit unions.

An NCUA spokesman said that the intention of the study was to show that there is a processing cost disparity between small and large credit unions. It is not comparable to the Fed study, he said, because the NCUA’s data “is limited in scope and timing” and that the figures “are not inclusive of card services program costs.”

A Federal Reserve spokeswoman said she could not explain the discrepancy and was unable to provide any additional information about the Fed study’s methodology. The Fed also denied a Freedom of Information Act request by iWatch News seeking copies of the survey data it used as the basis of the proposed fee ceiling.

Phone lines, infrastructure costs

As iWatch News previously reported, processing fees are set by card networks such as giants Visa and MasterCard. Card issuers eager to win new banks as customers raised fees in recent years, giving banks a bigger profit from each transaction. The banks then turn around and charge retailers the debit processing fee set by card issuers, according to Federal Reserve economists.

As the first step in setting a cap that would comply with the Dodd-Frank law, the Fed tried to pinpoint how much it cost banks and credit unions to process debit swipes. The Fed limited its definition of “cost” to authorization, clearance and settlement expenses.

But experts and analysts say that those three activities alone do not represent the true expense to banks of administering debit payment programs.

James Angel, a finance professor at Georgetown University’s McDonough School of Business, says the Fed’s estimate omits external system costs that the banks incur.

“On the processing side you’ve got this big cost overhead — all those phone lines are not free,” he says. “Then you have marketing costs, the big specter of fraud costs and the risk of a catastrophic breakdown” if the computer system is hacked.

To complicate the issue, Angel says, banks run their debit system over infrastructure shared with credit payment systems, and the Dodd-Frank law only caps debit transaction fees.

Banks and credit unions say 12 cents is far too low and fails to reflect system-wide costs such as security, customer service calls and cardholder rewards programs. They have suggested that their actual cost is closer to 27 cents for every card swipe.

“The Fed survey was done in a rush and filled out differently by each bank because they interpreted it differently,” said Oliver Ireland, a lawyer at the firm Morrison Foerster, who was hired by a group of large banks to collect and analyze debit processing fee data on a confidential basis. “The survey data needs to be rethought. It’s not good data.”

Retailers, who pay the processing fees to banks, say the Fed’s number may be too high.

David French, chief lobbyist for the National Retail Federation, said the Fed survey was voluntary, so the data may have been skewed if some of the lowest-cost financial institutions did not respond. “The NCUA data may be a more accurate snapshot of costs for the largest institutions,” French told iWatch News in an email.

Senate vote due soon

The murkiness about transaction costs has left the door open for all sides in the debate to make claims that are difficult to evaluate.

Banks and credit unions, which want to delay or kill the Fed’s proposed cap, have argued from the hallways of Capitol Hill to splashy ads on the Washington, D.C. Metro that the Fed’s proposed 12-cent cap means they will lose money on every transaction.

Bankers are backing a Senate bill introduced by Jon Tester, a Montana Democrat, which would delay a cap on debit fees for 15 months. The measure will probably need at least 60 votes to overcome a procedural hurdle and move to the floor for a vote.

After introducing his bill to delay the debit fee cap, Tester was immediately showered with nearly $60,000 in contributions from credit card companies and their allies, according to The Hill. Some of the campaign contributions came from employees of TCF Financial Corp., a bank that sued the Federal Reserve to try and block the plan; executives with Wells Fargo & Co.; and from PACs for Bank of America and Discover Financial Services.

American Bankers Association President Frank Keating warns that under the Fed cap, bank customers will pay more for services like checking accounts to make up for the loss in revenue. In a video recently prepared for members, Keating urged bank employees to write to lawmakers.

“This is the essential fight of the year,” Keating said in the video. “Stay focused, put on your armor, we need your help.”

If the government imposes the proposed cap, banks stand to lose a big chunk of the $16 billion they collect in annual debit card processing fees.

Retailers say that the banks are overstating their costs, and simply don’t want to lose a cash cow. Under the proposed cap, retailers would pocket an average of 32 cents more from each debit card sale, according to a Fed estimate, savings they could pass along to customers in the form of lower prices.

Illinois Sen. Dick Durbin, a Democrat who inserted the debit fee cap language in the Dodd-Frank law, said swipe fees are too high for what should be a low-cost transaction to withdraw money that already exists in a customer’s account.

“Most of those fees go to the largest banks in America,” Durbin said last month. “The [debit] interchange system has been designed in a way that normal market forces don’t apply. No transparency, no competition.”

Some 118 ex-government officials and aides are currently registered to lobby for banks in the brawl over the debit fee, according to Sunlight Foundation data compiled for a recent Huffington Post article. Retailers, meanwhile, have hired at least 124 lobbyists to make their case to lawmakers.

So far, lawmakers and policymakers seem less concerned with refereeing these arguments than with what they say will be an unintended consequence of the fee cap.

Federal Reserve Chairman Ben Bernanke recently said that the new price ceiling “could result in some smaller banks being less profitable or even failing.” That’s because while small banks and credit unions—those with assets under $10 billion—are exempt from the Fed’s proposed rule, competitive pressure could force them to lower their fees to an unsustainable level.

Senate Majority Leader Harry Reid recently said that he plans to hold a vote on Tester’s proposal to delay the debit fee cap in June.

“We’re going to try to get rid of the issue with swipe fees as soon as we can,” Reid said.

But even if the Fed starts over, it seems unlikely that the regulator, the merchants, and the banks will come to easy agreement on how much it costs to process debit swipes.

“This is not an exact science,” said Ireland, the banking lawyer.