Online retailers could reduce their costs by about $500 million a year as a result of the steep cuts in debit card fees proposed last week by the Federal Reserve Board.
It’s not yet a done deal, however. The Fed has requested comments on its proposal by Feb. 22, and could back off the sharp reduction. And a new Congress that takes office next month may have something to say about this significant reduction in the fees merchants pay banks that issue debit cards.
But, as it stands now, the Fed proposal represents a stunning win for retailers, and especially online merchants.
“It’s absolutely fantastic for merchants,” says Jason Pavona, executive vice president of sales and marketing at Litle & Co., which specializes in handling payments for online and other retailers that don’t sell through physical stores.
To calculate just how fantastic this could be for e-retailers, Internet Retailer did the math, and comes up with a potential saving of $500 million in the interchange fees web merchants pay each year from accepting debit cards.
Here’s how that figure was calculated: Debit cards account for 29% of online retail volume, according to Javelin Strategy & Research. Applying that 29% to 2009 e-commerce sales of $134 billion in the U.S. as reported by the Department of Commerce, that suggests nearly $39 billion of e-retail volume was charged to debit cards last year.
Now let’s look at debit card interchange, a fee set by Visa and MasterCard that merchants effectively pay to debit card-issuing banks. Almost all online debit card transactions go through the Visa and MasterCard networks, and Visa accounts for most of it, so this calculation considers Visa’s interchange rates for e-commerce. The basic rate is 1.60% of the transaction amount plus 15 cents, while bigger merchants pay 1.55% plus 15 cents. Blending those two rates together and applying it to the typical online debit card transaction of $68, according to Javelin, that yields an average interchange fee of $1.22, or 1.8% of the amount of the typical e-retail debit ticket. The Fed has proposed a flat cap of 12 cents per transaction, or just 0.18% of a $68 average ticket.
Using those figures, e-retailers would have paid $697.8 million in debit interchange fees on 2009 sales, a figure that would go down to $68.6 million at the 12-cent level, a savings of $629.2 million. And those savings will increase as e-retail sales increase, as they have been in 2010.
The Fed proposal is especially good news for online retailers because hardly any web transactions are made with PIN-debit, for which today’s interchange rates are much lower, typically 35-50 cents per transaction. Virtually all online debit transactions are what’s called signature debit, subject to the Visa and MasterCard interchange rates that are much higher than those of PIN-debit networks.
Before e-retailers celebrate, however, here are some caveats. The 2009 legislation that mandated the Fed to examine debit card interchange—the Durbin amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act—exempts banks with assets of under $10 billion from the new law. Those banks account for about 20% of debit card volume, says Beth Robertson, director of payments research at Javelin, so that could reduce e-retailers’ savings to about $503 million.
One other adjustment could come from the Fed raising the interchange cap to account for what the banks spend to prevent debit card fraud. The Durbin amendment requires the Fed to consider issuers’ fraud costs, and the Fed did not make a proposal on how much that should add to the interchange rate, instead asking for comments on that question by Feb. 22. By law, the Fed must issue its final rule by April 21, 2011, and the rule must take effect by July 21.
What happens next is very much up in the air, although it’s very likely the Fed will get a lot of comments from the banking industry. That’s because the Fed proposal would deprive banks of more than $10 billion a year in debit interchange fees, counting offline as well as online retail sales. Banks will certainly try to persuade the Fed that they need higher interchange fees.
And Congress could reconsider the legislative mandate the 2009 law gave the Fed, says Robertson of Javelin. “There’s a whole new Congress coming in and there’s been a lot of talk that the Durbin amendment will come under review,” she says.
Others, however, do not foresee major changes in the Fed proposal. Pavona of Litle says the Fed has been gathering information for months and is not likely to hear anything new between now and Feb. 22.
And payments industry consultant Steve Mott of BetterBuyDesign, who provided the Fed with some of the cost data it used in its analysis, says the Fed proposal is in line with the actions of regulators in other regions. In both Australia and the European Union, Mott says, regulators have reduced both debit and credit card interchange rates in the past decade, deciding that those fees were unreasonably high given the banks actual transaction costs. Those regulators have imposed debit card interchange rates in the range of 8 to 12 cents per transaction, and Mott says it’s likely the Fed will stay near that range.
“The fundamental philosophical assertion is that the money in a debit account is the customer’s money, not the bank’s, and banks shouldn’t be profiting from providing access to those funds,” Mott says.
Mott says U.S. regulators and legislators likely also will follow the lead of their European and Australian counterparts in pushing Visa, MasterCard and the banks to lower interchange rates on credit cards, as well. While banks do take on risks with credit cards, which add to their costs, Mott predicts credit card interchange will come down substantially in coming years.