The financial institution world is abuzz with wildly varying predictions for the future of fee income in light of the Federal Reserve's proposed rulemaking on the Durbin Amendment.
In the business of growing checking account revenue, we see clear winners and losers as a result of these changes, and some for whom the status quo will continue to exist.
The Losers
It's easiest to start with the losers - those would be the financial institutions (FIs) with more than $10 billion in assets. Right or wrong, there is clear public sentiment against the "big banks" that permeated creation of Dodd-Frank, and the Durbin Amendment is additional proof. If you believe some widely-published estimates, the Fed's proposed rules mean that the average large FI's debit interchange revenue will decline by 70% to 80%, equating to billions of dollars of lost interchange income.
The $10-billion cap is arbitrary, and the legislation may violate constitutional provisions around due process, unlawful regulatory takings and equal protection. See the TCF lawsuit for details. However, for now, these institutions will have to develop a fallback plan if their legal and legislative routes do not create the changed result they desire.
So, what is a big bank to do? The answer will be to re-price. The big players are doing this already in subtle as well as direct ways. The direct ways are clearly stating monthly fees if one or more minimum requirements are not met (a certain number of debit card transactions, one or more monthly direct deposits, or a minimum balance, for example), and the subtle ones are no longer giving refunds for use of other FIs' ATMs, and stopping many services previously included for free on some accounts, such as free checks, safe deposit box rentals, etc.
More Losers
As a result, the other big losers under the Durbin Amendment are consumers. Presumably this result was not intended, but it is all but certain. Because of the re-pricing of accounts, a significant number of consumers will be driven out of the banking system.
Account fees that may seem modest at first blush over a year equate to days of net wages for minimum-wage workers. The current world of free checking accounts derives in part from some consumers spending tens of thousands of dollars on their debit cards and generating substantial interchange for FIs, which subsidizes accounts for those who don't generate any fees at all for their FIs. This will change after July of this year if the proposed rules implementing the Durbin Amendment become reality, and every consumer will feel the impact of additional fees, whether he or she can afford them or not.
The Winners
The obvious winners here are the merchants. They get the benefit of lower interchange costs and have absolutely no obligation to pass on any of those savings to consumers. Australia tried this and had the same experience. If you think for a minute that a big-box retailer (or Walgreens, which complained to Sen. Durbin to spark the legislation) is going to lower its prices to consumers just because its interchange rates went down, then I'll help you back up on the turnip truck.
Now comes a surprise: who we think the other winners are. Despite fear that has run rampant through under-$10-billion FIs, we think they are winners. Sen. Durbin thinks so too:
"Visa confirmed that it would respond...by establishing separate interchange rate schedules for large regulated banks and for smaller institutions that are exempt from regulation. … Visa's recent announcement confirms what I have consistently argued: that small banks and credit unions will not be hurt by this regulation and will in fact see benefits from it." (Letter from Sen. Durbin to various Illinois banking groups, Jan. 18, 2011.)
Have Your Cake, And Eat It, Too
While it's too early to tell for sure, it appears at least in concept very feasible for smaller institutions to have their cake and eat it too, seeing very little drop-off in interchange income because of protections for FIs their size, coupled with the ability to benefit from an overall move in the marketplace to re-price checking accounts.
The ability to charge more for checking accounts allows smaller FIs to offer richer rewards and spend more on marketing themselves to prospective account holders. They will have a significant competitive advantage in being able to charge lower fees, and can bring back some of the services for free that the bigger FIs now have to charge for again.
In addition, financial institutions still can offer "free checking" accounts and charge a fee for a debit card. This is a route many of the smaller FIs should consider as a hedge against possible loss of interchange income despite the promised protections for under-$10 billion FIs.
We have seen little resistance from account holders of institutions that charge a $1-$2 monthly fee for the debit card. For heavy debit card users who are fee-resistant, offering the ability to have the fee rebated creates a win-win.
Finally, those credit unions and other institutions that can fund rewards and retention tools through alternative means such as merchant-funded rewards programs will be winners and leaders in this space.
Status Quo
We think that Visa and MasterCard will ultimately come out about neutral here, as will the merchant acquirers. They will find ways to preserve margin, at least until they are put under the microscope.
Other payments companies will be largely unaffected also - PayPal for example, although there remains the possibility that they could suffer somewhat if banks try to charge PayPal higher ACH fees to make up for the debit interchange revenue they are losing.
The other side of the coin for PayPal would be potential increased business if the larger FIs start imposing a per-debit-transaction fee, which would drive more consumers to PayPal. Discover and American Express are largely in the clear for now since credit card interchange is not subject to the Durbin Amendment.
How to Still Win, Even if...
Even if you are one of the few credit unions of more than $10-billion, or more likely a smaller one that still feels like you will get caught in the crossfire and lose because of the Durbin Amendment, we still think you have a way to win.
At the end of the day, you still will be a winner if you control the largest quantity possible of the single most valuable touch point in a consumer's financial life: the checking account. Revenue far beyond interchange is driven by that relationship.
Look at the success Google has had by getting itself to be the first stop for consumers on the Internet. When you have the power to get consumers to make you their first stop in their financial thinking, you have won the war. With the right tools and strategies, you can harness this relationship as the consumer's primary financial institution for boundless cross-sale opportunities, many of which have not yet even been invented.
Good Bye To The Non-PFI
If or when free checking goes away, you will lose all of those consumers who are not using you as their primary financial institution, because they aren't going to pay a monthly fee to any FI that isn't their primary one. Therefore, creating and deepening the primary FI relationship with your existing account holders is key.
Maybe somewhat ironically, where the consumer uses his or her debit card is still the primary indicator of which FI holds that consumer's primary relationship.
So, your credit union should not give up on the power or profit potential of the debit card quite yet.
Mr. Leonard is Chief Operating Officer and General Counsel for Velocity Solutions, Inc., a provider of checking account profit strategies to credit unions.
