The controversial practice of surcharging for automated teller machine transactions could have far-reaching effects on the electronic banking industry and its customers.

These implications were discussed in the first installment of this article, which appeared Wednesday. A summary:

Surcharging will turn competition on its head. Perhaps the most harmful result will be on competition for retail deposits. ATMs are an important component in terms of access and price. Surcharging may diminish the incentives to compete on price.

Consider a typical metropolitan area where "McBank" has a 30% share of retail deposits. McBank seeks to woo depositors from competitors by offering ATM access at a lower price. Other banks may respond by lowering their prices. But McBank could achieve the same result by imposing surcharges on customers of competing banks, but not its own cardholders. When the cost of access reaches a certain level, competitors' customers would migrate to McBank.

Competing by lowering prices is what the free enterprise system is about. Surcharging introduces a perverse form of competition - driving out rivals by raising costs.

Small banks and credit unions will be harmed.

Because of their small card bases, these institutions deploy few, if any, ATMs. Instead they rely on the shared networks they belong to. Although small financial institutions bear a cost for ATM access, they often offer it free. Surcharging provides a new tool for larger banks to drive depositors from smaller banks.

Cardholders of these smaller banks, tired of paying surcharges, will move their accounts to the large banks or stop using ATMs.

Even now, smaller banks complain that dominant banks discriminate against them in ATM access policies.

To cite an intriguing, if imperfect, analogy, many smaller airlines went out of business or were acquired during the 1980s. One of their complaints was that the big airlines, which controlled the computerized reservation networks, either denied access or raised the cost of these networks to handicap the smaller airlines.

ATM networks can still restrict or prohibit surcharges without running afoul of the antitrust laws. Some networks may claim they were effectively forced to abandon surcharging because of the threat of litigation. But Judge Sam Pointer's decision in Southtrust Bank's challenge to Plus System makes clear that a surcharge prohibition is efficient and pro-consumer.

Moreover, there are several alternative approaches to controlling ATM fees. A network could cap surcharges or limit them to off-premises locations. The Consumer Finance Project has suggested preventing an ATM owner from collecting both a surcharge and interchange fee. This would at least reduce the costs of the card-issuing bank and perhaps benefit consumers through a reduction in the "foreign fees" that stem from the basic interchange fee.

Plus System considered this proposal about a year ago, but it was not enacted by the parent Visa board.

One might argue that a price cap or other restrictions could be construed as price fixing. Though the issue is not entirely clear, there is plenty to suggest such caps would be upheld. As Supreme Court Justice Stephen Breyer held in a case involving price caps on doctors' fees, Congress intended that the Sherman Antitrust Act protect consumers "against prices that were too high, not too low. (Courts) should be cautious - reluctant to condemn too speedily - an arrangement that, on its face, appears to bring low-price benefits to the consumer."

Surcharging will lead to more state regulation and antitrust litigation. Network officials who contend that permitting surcharges will reduce the threat of antitrust litigation and state regulation may be sadly mistaken.

Consumer groups are calling for controls on surcharges. Congress (led by Sen. Alfonse D'Amato of New York and Rep. Bernard Sanders of Vermont) is considering banning surcharges or requiring stiff consumer disclosures. Although these proposals may not pass, ATM networks can expect future battles in Washington and many state capitals.

The threat of costly, time-consuming, and high-risk antitrust litigation will not go away. Interchange fees have been attacked in the past as illegal price fixing. They survived only because they allowed ATM owners to recover costs. If ATM owners can do the same through surcharges, interchange seems unnecessary. Card-issuing banks could challenge the interchange fee as illegal price fixing and, if successful, collect three times the amount of the interchange fees as damages.

There would also be some impact on networks. Here the outcome is most uncertain.

Surcharges may reduce network transactions because consumers may increasingly seek out their own banks' ATMs to save money. On the other hand, if surcharges lead to more deployment of off-premises ATMs, network volumes may grow.

Even more unclear is the effect of surcharging on network governance and on the delicate balance between card issuer and ATM owner. Until now, those interests did not diverge because practically all members were both issuers and owners.

Nonbanks, whose main interest is in acquiring interchange and surcharge revenue, will alter that equilibrium. Moreover, surcharging offers some banks the opportunity to impose costs on the other members of the venture. If these networks become conduits for raising rivals' costs, rather than sharing in savings, the long-term utility of networks may diminish.

Surcharging will distort the balance of network costs and benefits, providing an opportunity for new costs to fall on smaller banks and their cardholders. In turn, surcharging may lead to more disputes between network members that may ultimately be resolved by legislatures and courts.

Mr. Balto is the attorney adviser to Robert Pitofsky, chairman of the Federal Trade Commission. This article reflects Mr. Balto's own views.

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