Small banks will continue to receive high swipe fees

That exemption will ensure that these smaller debit card issuers are able to continue to get the same high level of swipe fees they get today. This is not a theory. It is demonstrable. Let’s look at why: The law permits it.  The networks intend to offer it.  The smaller banks have the ability to cut off any network that doesn’t continue to pay them high swipe fees. MasterCard and Visa prohibit merchants from discriminating.  Merchants have no practical way to discriminate anyway. And, finally, a merchant who turned away a customer to save on swipe fees would be cutting off his nose to spite his face. Let’s look at the details.

The law permits it. The Durbin Amendment was expressly written to protect the debit card swipe fee revenue of all but the very largest banks. Nothing in the Federal Reserve Board’s regulations can override this exemption. If the Fed limits the big banks to 7 to 12 cents per transaction, the smaller ones can continue to receive an average of 44 cents per transaction.

The networks intend to offer it. Almost all the debit card networks have already said they will offer two tiers of interchange when the Durbin Amendment takes effect – capped rates for big banks and higher rates for smaller ones. This isn’t a matter of network generosity to small banks. Under the Durbin Amendment, each card issuing bank will decide which networks can process its transactions. A network that offers only the capped rate will cut itself off from over 20 percent of debit cards which are issued by small banks.  This would be especially disastrous for the smaller networks that rely heavily on the business of smaller banks.

Some have suggested that it will be impractical for networks to charge merchants two different rates for the same service over a sustained period. Wrong. The Visa and MasterCard networks have for years charged merchants hundreds of different rates for credit cards that differ at most in only a handful of meaningful ways.

A network that doesn’t pay small banks high swipe fees will lose their business. Because the new law gives each merchant some say in which network will process its debit card transactions, some claim that networks will have to lower small bank swipe fees so merchants will route to them. That’s just wrong again. A merchant can only route transactions to a network that has been chosen by the issuer. The choice of networks under Durbin has two components. First, the issuer will choose a small number of networks that can process its debit card transactions. Then, a merchant can choose which one of that limited group of networks will receive that merchant’s transactions. In other words, the issuer chooses first and the merchant then has a choice among that limited group of networks.

Smaller banks (under $10 billion), acting alone or through their associations, will strike long-term deals for high swipe fees with networks that want to be on small bank cards. If a network thinks it can become the preferred network for a big merchant by bringing its small bank rates into line with the large bank caps, it will be in breach of contract, exposed to enormous damages, and it will no doubt be summarily cut off from processing small bank debit card transactions. Adding or eliminating a network’s access to an issuer’s card base is not a major undertaking.

MasterCard and Visa prohibit merchants from discriminating among issuers. To accept Visa and MasterCard debit cards merchants must sign contracts that bind them to comply with the networks’ so-called honor-all-cards rules, which expressly forbid them from favoring one issuer’s Visa or MasterCard debit card over another. Violations of these rules carry very heavy penalties. Visa and Mastercard have already spent millions in legal fees defending these rules, so their enforcement is no idle threat.

Merchants have no practical way to distinguish between small and large bank debit cards at the point of sale. Merchants don’t even know the rates associated with cards they accept until they receive their monthly statements. Moreover, it would be impossible to train employees to distinguish in a timely manner among cards issued by thousands of banks, especially because most cards today are swiped by consumers themselves and never handled by merchants.

Finally, only a mad merchant would turn away a customer who wants to pay with debit. Most customers have only one debit card; if a rejected customer switched to a credit card, the swipe fee would be even higher, not to mention that a rejected customer may be gone forever.

Conclusion. The Durbin Amendment is a boon to smaller banks who will continue to receive high swipe fees when their big bank competitors’ debit card fees are capped.

Henry Polmer was legal counsel to the Cirrus System.  David Balto was legal counsel to the NYCE, PULSE, Star, FISERVE and Shazam networks.