Debit Interchange Cuts May Drive More Consumers To Credit Cards, Report Suggests

New Federal Reserve Board rules that on Oct. 1 will reduce debit card interchange revenue for larger issuers may cause banks to raise fees associated with using debit cards, and that could drive consumers to use credit cards more, a new research paper from the Federal Reserve Bank of Boston contends.

Although banks typically do not charge debit cardholders explicit fees, it is “feasible” they may begin to do so or add per-transaction charges to compensate for lost interchange revenue, Joanna Stavins, a senior economist and policy adviser at the Federal Reserve Bank of Boston, wrote in the report “Potential Effects of an Increase in Debit Card Fees.”

The Fed on July 29 approved limiting how much issuers may receive from merchant acquirers when their debit cards are used to make payments (see story). In most cases, the fees will drop to about 21 to 24 cents per purchase transaction from the current average of 44 cents. Issuers with less than $10 billion in assets are exempt.

Certain banks, including Wells Fargo & Co. and JPMorgan Chase & Co., already are testing in some states a $3 monthly fee applied to any customers who use their debit card, she noted (see story).

If banks widely adopt new debit fees, they “are likely to be spread out over time,” Stavins adds.

Consumers’ perceptions of debit cards as relatively low-cost payment instruments likely will change if issuers begin to charge customers to have a debit card and apply fees when they use it, Stavins wrote.

Moreover, it is “probable” that younger, less-educated and lower-income consumers would feel the effects of potential new debit fees more profoundly than would other groups, so they most likely would change their payment behavior, Stavins wrote.

Some consumers might avoid using debit cards entirely if banks apply fees to them, but consumers more likely would reduce their debit card use, she wrote.

Consumers also might shift from using debit cards to other payment methods, including cash, checks, credit cards, prepaid cards, electronic funds transfers, and online bank sites that support bill payments and purchases, Stavins suggested.

But the most significant shift would involve consumers who routinely use debit cards switching to rewards-based credit cards that carry no annual fee, Stavins concluded.

“Consumers who (in a 2009 Fed survey) viewed the cost of debit as high relative to the cost of credit cards had a significantly higher share of credit card transactions,” Stavins writes.

So “it is reasonable to expect that an increase in the cost of debit (cards and the charges applied when they are used) would lead to an increase in the use of credit cards,” she wrote.

Issuers already are beginning to encourage more credit card use through debit card policy changes resulting from the new Fed rule. Starting Nov. 16, brokerage clients no longer will earn rewards when using Bank of America Corp.’s Merrill Lynch deferred debit card, which links to a customer’s brokerage account and deducts funds for transactions at the end of each month. The bank is urging customers who wish to continue to earn rewards to apply for a Visa-branded credit card (see story).

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