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Who'll Pay for Free Consumer Checking? Merchants, Again

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For decades, a seesaw struggle has raged over who's going to pay for consumer checking accounts.

Such accounts are alleged to cost banks $250 to $300 per year, when you throw in irrelevant branch expenses and the kitchen sink. Many consumers pay via monthly fees, others pay overdraft fees outrageous enough to generate huge profits. But lots of small checking accounts still don't pay their way, especially at those hardy community banks that still offer "free checking."

Now, with the Bluebird account (a checking account advertised as a prepaid card), Amex gives us a new but familiar answer as to who'll pay: The merchants from whom these consumers make debit card purchases will pay, via high interchange on those purchases. 

That's good for Amex. A customer who spends only $20 per day will generate $15 a month in interchange, assuming a 2.5% interchange rate.  More than the average monthly fee incurred by consumers who paid for checking.

For banks, that'll be a hard act to follow. For all their expensive lobbying and credulous attachment to Sen. Jon Tester's gyrations, banks missed the boat on one key provision of the Fed's Reg. II. This provision—which was still up for grabs in the preliminary version of the regulation—turned out to excuse cards paying through "three-party networks" from the interchange ceiling set by Reg. II for "debit cards." So, Bluebird can generate unlimited interchange.  

Merchants have been equally misdirected and clueless. They can most likely thank PayPal (not Amex) for this utterly illogical regulatory provision, testimony to the truism that regulatory complexity spawns gaming and unfairness.

Want to establish your own three-party network and emulate Amex? It might have seemed impossible back when I advised Phil Purcell, then at Sears, to offer a credit card that was not Visa or MasterCard—resulting in the birth of Discover. But, Sears achieved it. Still, maybe a big card issuing bank could try.Under Reg. II, being a three-party network does not necessarily require excluding other issuers. It requires that the network operator also be an issuer—and only the network operator's own cards will be exempt from the Durbin interchange ceiling.

So, this could be a natural for Discover if it stopped focusing on student loans, mortgages and other distractions—and paid attention to its primary business. This, despite all the hand waving, continues to be cards.

It would also be possible for Visa or MasterCard to start issuing cards.  Most likely they won't see how.

These developments, and the resultant opportunity to make merchants pay for their customers' checking accounts, might arouse a vague sense of history repeating itself. Yes! In the early years of debit cards, banks, through Visa and MasterCard, imposed high interchange for debit card purchases, relying on the "accept all cards" rule. This iniquitous structure was broken only through merchant litigation, and the 2003 "Walmart Settlement," which resulted in much reduced interchange on Visa and MasterCard debit cards—though still twice as high as Durbin now allows banks to receive.

Amex can set the interchange as it wishes on the Bluebird card, which in substance is simply a debit card on what will be a full-feature checking account. The company can "negotiate" interchange with large merchants individually, unlike Visa and MasterCard, which at least claim to abide by their standard published rates (albeit with a Swiss cheese of exceptions). Bluebird is also seemingly exempt from bank regulation since, unlike the others, it's not issued by a bank but by Amex's Travel Related Services unit. Remember those travelers checks from the old television commercials? Hurrah for "shadow banking!"

What rate is Amex going to charge on Bluebird? According to its merchant site as of Friday, "the same rate would apply to all card types." Sounds like that's the credit card rate, but according to a company spokeswoman, "The prepaid discount rate is lower than charge/credit rates." But she won't disclose that rate, so draw your own conclusion.  In any event, very few debit or prepaid cards were issued on the Amex network until now. The possibility of having to pay high interchange on Amex debit cards didn't, up to now, faze merchants.

Since Amex has long charged materially higher average credit card interchange than Visa and Master Card, recently averaging 2.5%, merchants are going to be paying a lot for their customers' Bluebird checking accounts. 

Maybe merchants should go back to Constantine Cannon, the law firm that won the 2003 Walmart settlement. However, without help from Congress or the Fed, the new case will be much harder to win. And they surely won't have Walmart, now partnering with Amex, as lead plaintiff.

Andrew Kahr is a principal in Credit Builders LLC, a financial product development company, and was the founding chief executive of First Deposit, later known as Providian.

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