A new story on American Banker highlights the problems inherent to Durbin amendment enforcement: the apparent opacity with which payments networks conduct their business. According to the story, banks need more data from payments networks to even understand whether they are complying with Durbin or not.

What this gets back to is the confusing world of interchange fees, and how they work, and we feel it’s high time for a review of how this system works.

To refresh your memory, interchange fees is the amount your bank collects from a merchant when you pay with your debit or credit card at that merchant. The exchange of funds between your bank account and the merchant’s bank account is mediated by a payments network — likely Visa or Mastercard — and they determine what the interchange fee will be, based on the size of the purchase, the type of business the merchant conducts, and how the card is handled. Charities pay higher percentages to banks than gas stations, and supermarkets pay more than either. And it is even more expensive if your card is not present for the transaction.

On top of the interchange fee, the payments networks charge a processing fee of their own, and this, along with interchange, make up what is known as the merchant discount rate.

Those in the payments industry insist that interchange has a natural check on growing too expensive, because it is a two-sided business: it is driven low by the need for merchants to accept cards, and driven high by banks who need to be able to offer consumers fee-free cards so that they will use them. This is why Durbin was so upsetting to banks — it affected what they thought was a nice equilibrium.

Anyone else can see that, with two dominant payments networks setting the cost of interchange and the broad acceptance of plastic in virtually all sectors, interchange fees got out of hand. The downward pressure that should have been exerted on fees was negated by the simple fact that Americans expect to be able to use their cards everywhere and merchants who don’t accept get punished. Americans pay the highest percentage in interchange anywhere in the world because of this.

Which brings us back to Durbin — which limited interchange on debit swipes to 21 cents — and the compliance problems that American Banker reported on. While Visa and Mastercard’s interchange fees are publicly available, and appear Durbin-compliant, the agreements they have with specific banks are not. And because payments networks, not banks, determine the fees, banks are reliant on Visa and Mastercard to comply with Durbin even though Durbin is a law that aimed to regulate banks, not payments networks.

So not only did Durbin cut into a massive revenue stream, but now banks are dependent on payments processors to help them comply with the law, and payments networks aren’t even being forthcoming enough with their data. Durbin has been rough on consumers, too, who narrowly avoided getting slapped with high monthly fees on debit card use, and are now facing higher prices at some retailers.

A better version of Durbin, we think, would have done something to break up the payments processing duopoly that Mastercard and Visa have. Then, other players in the market could compete to bring down the interchange and payments processing fees that have been driven artificially high by the wide acceptance of plastic — merchants can no longer reasonably opt out, and therefore have no bargaining power. Until then, both us and the banks have to deal with it.

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  • The duopoly you mention in the final paragraph is the real problem. These two players — Visa and Mastercard — would win business from banks by bidding up the interchange rate. If Visa promised to pay banks X cents per transaction, then Mastercard would promise X+1 cents, so Visa would promise X+2 cents. That money, of course, came directly from retailers/merchants. As interchange fees spiraled higher and higher, retailers felt like helpless pawns, so they built up a lobbying warchest and started pounding on legislators. Retailers finally got their way when banks put themselves in the doghouse following the financial meltdown. Banks became Congressional whipping boys.

    That’s how money and power works. If Americans don’t like it, then they need to focus on another duopoly: Republicans vs. Democrats.

    If there’s any lesson here, it’s that a two-party system really only benefits the two parties an no one else.

  • Sunshine25

    I take it you read my temporary reply from yesterday? 😉

    > duopoly
    There is Discover and American Express as well. We have four payment cards now and we have other businesses like PayPal and Dwolla expanding their market share every day.

    > So not only did Durbin cut into a massive revenue stream

    A revenue stream that never should have existed in the first place. Look, debit cards are the evolution from paper checks. When banks tried to charge for paper checks (because they were the replacement to cash), the government put a stop to it. There’s very little risk to accepting a debit card because the funds have to be present in the bank account. Now with overdraft opt-in required, the extension of credit is further reduced. So, if there is little risk for the bank to settle an debit swipe, why were they collecting similar fees to a credit card that offers a line of credit? People will ruin their credit score, but you can choose not to pay your credit card balance at any time. 

    > Durbin has been rough on consumers, too, who narrowly avoided
    > getting slapped with high monthly fees on debit card use

    You can’t blame Durbin for that. The banks made a threat, carried it out, and faced a political and public nightmare. That’s on the banks, not Durbin. Durbin can only set up the structure. How banks decide to whine and react to it is up to them. 

    • Sunshine – That there are other, smaller players in the payments space does not change the economics of interchange pre-Durbin. The point is that retailers had zero negotiating power with whatever payment network they chose; they were obligated to carry one of the payment networks regardless of cost. This allowed those running the payments network — whether that be Visa, Mastercard, Amex or Discover — to compete for banks’ business by bidding up interchange rates.

      Neither PayPal nor Dwolla (nor any other payment startup) represent a serious threat to the 2-4 companies dominating retail interchange.

      • Sunshine25

        > Neither PayPal nor Dwolla (nor any other payment startup) represent a serious threat

        You may be right about Dwolla since it is a very new player. PayPal, I am not sure, you can make that claim. PayPal has a huge user base and is continually looking to expand. All merchants need is a payment method that undercuts the traditional four and you have acceptance from merchants. It is as simple as entering in your phone number and PIN to make a PayPal payment.

        • Possible, yes. Plausible, no.

          • Sunshine25

            You say it is not plausible because?