Congress Considering More Credit Card “Reform,” Watch Out Consumers

The Senate isn’t quite finished regulating the credit card industry.

Senators have surprised the industry with unexpected, tough amendments that would limit interchange fees and allow caps on interest rates. The amendments that pass will be included in the financial reform bill being debated in Congress. Both would be significant blows to the bottom line of credit card issuers.

On Monday, Senator Sheldon Whitehouse (D-R.I.) introduced an amendment that would require credit cards to follow the laws of the state where a customer resides rather than the laws of the state where the credit card company builds its headquarters.

Many issuers have their headquarters in South Dakota or Delaware which have fewer consumer protections and laws that enable issuers to charge higher interest rates.

Banks warn that of the difficulty of complying and the “avalanche of lawsuits” that will arise with differing state laws. It could also mean that less credit would be available for banks and small businesses.

Last week, the Senate passed an amendment sponsored by Senator Dick Durbin (D-Ill.) that could reduce interchange fees that credit card processors charge to merchants and allow stores to give customers discounts for paying with cash, check or debit cards.

The Durbin amendment is good news for retailers, but bad news for issuers, processors such as Visa and MasterCard, and some cardholders.

“The CARD Act reminded us that regulations have consequences. When the government adds new rules and regulations that cost banks money, banks find

ways to charge the consumer more in other areas to make up the lost revenue,” says Bill Hardekopf, CEO of LowCards.com and author of The Credit

Card Guidebook.

“Banks warned that the CARD Act would bring higher rates and fees. And they did. Issuers weren’t bluffing then and they aren’t bluffing now. If this passes, consumers may not be happy with what the regulations mean for them.”

The interchange fee is a stealth fee that receives little attention from the average consumer, but it provides important revenue to credit card issuers.

Each time a consumer uses a credit card to make a purchase, the bank and card processor charge a fee that is approximately 2% of the purchase price.

If a consumer makes a $100 purchase with a credit card, the retailer gets approximately $98. The remaining $2 is the interchange fee and is divided three ways: about $1.75 goes to the card issuing bank, $0.18 goes to the Visa or MasterCard association, and the remaining $0.07 goes to the retailer’s merchant account provider.

In 2008, banks collected an estimated $50 billion in interchange fees. The interchange fees provided vital revenue for issuers during a time of high defaults and losses.

According to The Nilson Report, consumers made 36 billion debit and prepaid card transactions and 20 billion credit card transactions in 2009.

Last year, the interchange fees averaged 2.23% for American Express, 2.06% for Visa and MasterCard and 1.88% for Discover.

Retailers have lobbied Congress against the interchange fee for years, complaining that the fee is too high.

Provisions of the Durbin Amendment

The amendment will allow stores to give customers discounts for paying with cash, check or debit cards. The seller can also decline credit cards for small dollar purchases (interchange fees exceed profits on some sales).

The amendment will direct the Federal Reserve to issue rules to ensure that debit interchange fees are “reasonable and proportional” to processing costs. It does not give the Fed the power to set interchange fees.

“Keep in mind that ‘reasonable and proportional’ is open-ended. It does not put a cap on the fee,” says Hardekopf.

Cost of Reform for Cardholders

Banks say they charge the interchange fee to cover operating costs to process credit card transactions, to maintain the processing network, and to

protect against fraud. They warn that if the interchange fees are cut, they will have to find other ways to recoup these costs. This could force them to

once again squeeze credit and raise the cost of credit cards at a time when economists and retailers are hoping for looser credit to boost the economic

recovery.

Interchange fees are used to underwrite “free” credit card loans and credit card rewards. If the funding dries up, so could the benefits for many

cardholders.

“The interchange fee has helped subsidize credit cards for people who pay their balance in full every month. The interchange fee allows issuers to make money from every cardholder, even for those who pay off their balance every month and do not pay an annual fee. If issuers can’t make money on these accounts, they are likely to add fees to make these accounts profitable or close the accounts.

Issuers aren’t charities that give away free loans, cash and airline tickets” says Hardekopf. “Consumers that have a rewards card with no annual fee or debit cards with rewards may be the first to see the changes.”

Retailers will save money, but will they pass these savings onto consumers?

“It would be surprising if retailers significantly cut prices because of this. Many retailers and merchants are also struggling and need every dime

they can get. If consumers currently don’t know they are paying this fee, there will probably not be a large outcry if the price doesn’t change,” says Hardekopf. “Consumers may find the biggest savings with merchants that give discounts for alternative payments.”

Effect on Smaller Banks and Credit Unions

The amendment’s debit fee requirement exempts banks and credit unions with assets under $10 billion (99% of banks and credit unions), allowing them to

collect the higher fee. However, these cards will cost more for merchants to accept.

While merchants have to accept all cards in the Visa and MasterCard network, they can set a higher minimum payment for a community bank-issued card, encouraging consumers to use another card or form of payment.

This could hurt the smaller banks and credit unions because the interchange fees are an important source of revenue for their own credit cards, which typically charge lower rates and fees than the big banks.

Results of Similar Legislation

In 2003, Australia’s central bank required that the interchange fee be cut in half, to less than 1 cent. According to the New York Times, banks and credit card companies claim the lower fees have cost them about $1 billion Australian dollars annually, or $919 million, and there have been several changes in Australia’s credit card industry.

Banks have reduced credit card reward programs. Banks now require customers to pay their credit card bill faster. Annual fees have increased for reward programs.

The Senate could vote on the Financial Reform Bill on Wednesday. If it passes, leaders of the Senate and the House (which has passed its own

bill in December 2009 that does not include these amendments) will meet the following week to negotiate differences between the two bills. The Senate

and House would each vote one more time on this compromise bill before President Obama signs it.

LowCards.com ( http://www.lowcards.com ) simplifies the confusion of

shopping for credit cards. It is a free, independent website that helps

consumers easily compare credit cards in a variety of categories such as

lowest rates, rewards, rebates, balance transfers and lowest introductory

rates. It also gives an unbiased ranking and review for each card. The

LowCards.com Complete Credit Card Index

( http://www.lowcards.com/CreditCardIndex.aspx ) is the most objective

and comprehensive resource on the Internet which allows consumers to compare

rates for all 1060 credit cards offered in this country. Created by Hampton

& Associates, the company has been analyzing the credit card industry and

supplying objective websites on various consumer expenses for ten years.

For more information, contact Bill Hardekopf at

billh@LowCards.com

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