The Impact of Dodd-Frank: Bank of America’s new debit fee and the Durbin Amendment

October 19, 2011

Dodd-Frank

(Editor’s note: On July 21, 2010, the Dodd–Frank Wall Street Reform and Consumer Protection Act was signed into law.  Dodd-Frank represented the largest financial regulatory reforms since the Great Depression, and many are still trying to figure out exactly how they are impacted by the 850-page Act.  Throughout the month of October, we’ll be looking at some of the major features of this complex law.)

For the first installment on the Consumer Financial Protection Bureau, click here.

For the second installment on whistleblower bounties, click here.

At the end of September, Bank of America announced that, starting next year, it would impose a monthly fee of $5.00 for any of its customers that used their debit cards at least once that month.

The change was met with immediate furor from the public, who saw it as a move motivated by relentless greed.

The fact that the public reacted with such anger against the bank represents a massive public relations miscalculation on BoA’s part.

Why?

Although the fee was intended to generate consumer anger, Bank of America had planned for the anger to be directed against the federal government, not the corporation actually imposing the fee.

Why the federal government?

Because of a provision in the Dodd-Frank Act, commonly called the Durbin Amendment, which required the Federal Reserve to regulate debit card interchange fees.

Some explanation of the debit card interchange system is required, but I promise to keep it as simple as possible.

When a consumer uses a debit card to buy something, the merchant doesn’t get the full purchase amount.

Instead, a percentage of the transaction amount is deducted by the parties who provide services for use of the card.

Specifically, the merchant’s acquiring bank (i.e. Visa or MasterCard), the customer’s bank that issued the card (i.e. Bank of America), and the card network that facilitates the transaction (i.e. PLUS, STAR, Pulse) all take part of the purchase amount.

The card’s issuing bank took most of the fees: according to a Fed survey, banks collected $11 billion of the $16.2 billion in revenue generated in 2009 by the fees.

That only explains how the system works, not why federal legislation was needed to cap these fees.

The “need” for the cap was pushed primarily by merchants’ groups, but not simply because of the fees’ existence, but because of the increase in the rates.

The increase in fees, though, is directly attributable to the increase in debit card usage among consumers, according, at least, to comments by Elizabeth Buse, Visa’s global head of product.

According to Buse, the fees are “not a cost-based calculation, but a value-based calculation,” meaning that the fees are adjusted based on how much merchants want (or need) to accept debit cards.

As debit card usage has become increasingly common (from $585 billion in transactions in 2003 to $1.45 trillion in 2009), merchants are increasingly forced to accept them to ensure a certain amount of business.

Merchants were feeling squeezed, and wanted someone to do something about it.

Enter: the Durbin Amendment.

At the time of the Amendment’s enactment through Dodd-Frank, the average debit fee charged per transaction was $0.44, with the average transaction being approximately $38.

According to a Fed survey, though, the actual average cost per transaction was $0.13 (but that average could be as low as $0.04 because of the cost advantages of larger banks).

The Durbin Amendment applies only to banks with over $10 billion in assets, and requires banks to charge debit fees that are “reasonable and proportional to the actual cost” of processing the transaction.

Originally, the Fed proposed a maximum fee of $0.12 per transaction, but eventually revised the number up to $0.21 plus .05% per transaction, and that final rule went into effect on October 1, 2011.

Depending on whom you ask, the cap is either a disaster or a boon for consumers and the economy.

Banks, of course, maintain that the change will lead to increased costs for consumers (imposed by none other than the banks themselves, though), and force massive layoffs nationwide.

Merchants, on the other hand, depict the change as a huge windfall for consumers, who will reap the rewards through lower prices on merchant products.

The truth, as usual, is somewhere in the middle, but probably closer to the merchants’ story.

With debit fees being a direct cost on merchants, it’s inevitable that consumer prices increase to pay for such costs.

That doesn’t necessarily mean that prices for consumers will instantly drop.

However, given how competitive most consumer products markets have become in these adverse economic conditions, merchants will seize on any drop in costs they can to offer lower prices to their customers.

The scenario is still playing out, though, so we still have to wait for the law’s true effects to manifest.

Bank of America’s example should serve as a lesson to other banks, though.

The American public has no sympathy for a bank who tries to recoup profits by directly assessing  fees against them.