Rising Debit Card Fees Bring Banks Back into the Spotlight

The financial services industry, after stealing the spotlight during the recession, is now making headlines once again. In response to recent regulatory legislation, banks nationwide have made the controversial decision to hand consumers a whole slew of new banking fees, namely a monthly charge for using debit cards.

The announcement has since ignited a public uproar, as exasperated consumers, who are still suffering from the aftermath of the financial crisis, have no intentions of welcoming the new additions to their monthly statements.

The new federal legislation that sparked this chain of events, known as the Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act, more strictly regulates the financial services industry. More specifically, the Federal Reserve now prohibits banks and credit card companies with assets over $10 billion from charging merchants more than 24 cents for processing each purchase made with a debit card.

By contrast, these banks charged retailers an average fee of 44 cents per debit card transaction prior to the new legislation. Although such a cap on interchange fees may not seem like much, it will collectively cost banks $6.6 billion in annual revenue.

By limiting the amount that banks and credit card companies can charge retailers on debit card purchases, the government ruling attempts to encourage competition and to counter the current monopolistic tendencies of the financial services industry.

However, banks have proven unwilling to accept such a substantial reduction in revenue. Still reeling from the financial crisis as well, banks like Bank of America have developed an ingenious way of thwarting the government’s attempt to slash their profits: pass the burden down to consumers. Through charging a monthly fee for debit card purchases, banks nationwide have been able to generate a new source of revenue that can counteract the Federal Reserve’s cap on interchange fees.

The larger trend of instituting a debit card fee includes even the most prominent banks. Bank of America, the nation’s biggest bank, recently announced its decision to charge a $5 monthly fee for debit card use.  Bank of America joins a growing list of financial firms that have already done the same. Other national banks, including Wells Fargo and Chase, are piloting $3 monthly debit card fees.

By instituting a $3 fee, Wells Fargo estimates it could recover over $200 million, which would partially offset the regulation’s impact. Similarly, regional banks like Regions Financial and SunTrust will be charging a $4 and $5 fee, respectively.

The most recent debit card charge is just one of several frustrating fees implemented by banks in an effort to recoup the revenues lost to legislation. Government restrictions have caused banks like Chase to now charge customers for paper statements, checking accounts, and even for online banking. In some regions, Chase levies a $15 charge for checking accounts, which is in addition to ending its debit rewards program. Bank of America is also considering applying the new debit card fee to customers who engage in automatic payments, such as monthly cable bills, gym membership fees, or car payments.

Others, like USAA Federal Savings Bank, have managed to abstain from charging such fees, but do so at the cost of having to end its debit rewards program. Citibank has avoided the fee too, though it decided to raise its monthly charge for basic checking accounts by $2. TD Bank and Bank of America now charge their customers $2 and $3, respectively, for using non-network ATM’s. Similarly, HSBC raised its ATM fee for customers using non-HSBC machines from $2 to $2.50, and is also charging a 35-cent debit card transaction fee per use.

Moreover, a string of banks have also raised the requirements necessary to qualify for services like free checking accounts, in order to amass more income in the form of fees.

The most recent legislation, while noble in theory, was accompanied by a series of unintended consequences that severely undermine its efficacy. On the one hand, the Durbin Amendment assists small businesses and retailers, by alleviating some of their financial woes.  These merchants, who are still struggling due to diminished consumer spending, aren’t passing down any of the savings to consumers, though. In doing so, merchants enjoy a reduction in costs as well as a boost in their own profit margins.

Meanwhile, consumers become the victims, and are made considerably worse off. They are left to bear the brunt of the policy’s financial repercussions, without seeing a decrease in prices. Unwittingly, the extra burden is transferred to the very people whose spending and investment have the potential to boost economic growth and put America back on its feet.

These $5 debit interchange fees, when considered collectively alongside the other new charges already put into place, will have a significant impact on consumer spending habits. In addition to being extremely irritating and exploitative, the accumulation of these additional fees will result in an unnecessary reduction in a household’s disposable income. In a time where stubborn unemployment is still an issue and households are struggling to make ends meet amid the current volatility, this disincentive to spend can considerably inhibit economic growth and recovery.

More importantly, because debit cards have become relatively more expensive, consumers will likely seek out cheaper alternatives.  However, at the moment, there doesn’t appear to be many viable options.

The inconvenience and cost of constantly using ATMs, especially out-of-network ones, coupled with fee-ridden checking accounts may cause consumers to more heavily rely on the use of credit. Doing so will likely cause a rise in household debt, particularly for those with bad credit.

The shift back to using credit rather than debit or cash could potentially be very dangerous given the current economic conditions. Furthermore, according to some estimates, the higher fees and minimum balance requirements will bring about a forced exodus of as many as 1 million low-income consumers from the banking system. Desperate for other options, a large proportion of this group will likely turn to check-cashers, credit unions, and other financial providers.

While the culprit in all of this may seem obvious at first, identifying the true perpetrator is actually more difficult. Contrary to what many consumers may believe, financial institutions should not necessarily be held entirely accountable for the spike in fees.

Yes, in an ideal world, large banks should simply accept the regulatory action and cope with decreased revenue and lower profit margins. However, in a capitalist system where firms seek to maximize profit, it can be reasonably expected that banks will lessen the financial burden by seeking new avenues of income, just as the airline industry did by charging for checked baggage. Despite what consumers are led to believe too, banks may be justified in charging high fees, in order to protect themselves against fraudulent transactions. Due to the increased restrictions, banks like Chase may have no choice but to limit debit card purchases to under $50 or $100.

America today suffers from a sluggish economy that features low consumer confidence and an unsustainable budget deficit.  Thus, in such a tenuous situation, the responsibility lies in the government’s hands to mediate all of this. The government must assume the role of overseer and ensure the more equal distribution of financial burdens during this critical stage of economic recovery.

Small business owners and consumers alike are not in secure enough positions to absorb the added costs. Thus, each segment of society must compromise and concede certain temporary sacrifices in order to benefit the greater society, such that it stimulates economic growth in all sectors in the long run. The government must also be more aware of the complexity and interconnectedness of the financial system. As shown by the extensive ripple effects stemming from this one government decision, policymakers need to more carefully assess the potential impacts of economic revitalization attempts prior to implementation.

There needs to be greater reform in the interchange network, mainly in the relationship between large banks and retailers. Under the current system, payment networks like Visa and MasterCard have managed to charge retailers processing fees that greatly exceed the actual cost of processing a transaction. According to some estimates, margins on these charges can reach as high as 400%.

Curiously, the processing fees are comparable to those in other countries, and yet the United States has one of the highest interchange fees in the industrialized world. In an effort to establish a more equitable financial burden, the financial services industry must endure lower margins, but not to the extent the Durbin Amendment calls for.

Additionally, the government must address the fallout and inequities from the new legislation. The financial services industry has evaded the cap by instead raising charges on lower-value purchases. Thus, the payment structure is such that some retailers actually endure higher fees for small-dollar transactions than they do for bigger purchases.

The government must also somehow induce retailers to lower their prices so that savings can be passed on to consumers, in order to induce greater consumer spending.  This can be accomplished either through some sort of subsidy program, by granting retailers some sort of tax incentive to do so, or by modifying the fee structures put into place by the new legislation.

Overall, the government needs to orchestrate more adjustments to break up monopolistic markets and inject a greater degree of competition into the flailing economy, so that small businesses do not continually fall victim to the larger players in the industry.

The effects of the legislation aren’t all bad, though. Consumers ultimately choose the lowest-cost provider, which could potentially galvanize the industry into having more competitive pricing schemes. Some have already withdrawn their money from banks to avoid their fees, in search of a cheaper alternative.

In theory, the market will eventually reach a competitive equilibrium that features banks charging more reasonable fees to consumers and retailers alike, which would be highly beneficial for economic stability. However, in reality, as evidenced by the repercussions from the Durbin Amendment, the expected outcome is not always realized.