Interchange Income at Risk

CU360
February 5, 2009 | COMMENTS

Credit and debit cards generate little profit for most small financial institutions. If interchange rates are reduced as a result of legislation currently moving through Congress, many institutions could exit the credit card business and restructure their debit-linked checking accounts.

Of the approximately 90 million credit union members nationwide, 97% belong to credit unions offering debit cards and 83% belong to credit unions offering credit cards. An interchange fee is one of the fees merchants pay to debit and credit card issuers, such as credit unions, and the payment networks to support the system for debit and credit card transactions.

Community banks and credit unions have perhaps the most at stake in House (H.R. 5546) and Senate (S. 3086) bills that would standardize interchange rates and create an exemption to antitrust laws so merchants could bargain collectively with financial institutions and card networks on the fees.

Though card programs aren't big profit centers for most small financial institutions, they help them compete with larger institutions and foster relationships with consumers. Whatever revenue is generated helps cover losses and maintain the card system.

Interchange fees play a significant role in keeping card programs solvent at smaller institutions, which don't have the volume and product lines to offset the revenue loss the legislation would most likely create. Even a small reduction in interchange rates could hit small institutions hard. Interchange income is often the primary source of revenue from credit cards because many consumers pay off their card balances each month. Small institutions, lacking economies of scale, generally have higher per-transaction processing costs.

Retailers Lobby Hard

Retailers pressed Congress to take up the interchange legislation, saying they have been victims of price gouging by a financial services industry that dictates interchange rates without giving merchants an opportunity to negotiate. The financial industry counters that the fees barely cover the cost of running a card program, and that the legislation would constitute government price-fixing.

The legislation cleared a vote in the House Judiciary Committee in 2008, whose chairman--Rep. John Conyers, D-Mich.--is the bill's chief sponsor. The legislation, however, never made it to the House floor. The measure and a similar one in the Senate are expected to gain momentum in the new Congress later this year.

To try to ease opposition from community banks and credit unions, the House Judiciary Committee amended Rep. Conyers' bill to say institutions with less than $1 billion of assets don't have to participate in interchange negotiations. But many credit union CEOs say that would leave them with two unpalatable choices: Accept fees negotiated between merchants and the card networks, or try to negotiate independently with thousands of merchants.

The outlook for debit cards is different. Debit cards aren't a stand-alone product—they're an add-on to checking accounts and no institution looking to build deposits and retain members is going to get out of the checking account business.

But if revenue that financial institutions get from interchange on their debit cards were to be diminished, it would change the entire economics of checking accounts. Institutions would have to find other sources of revenue to make up the difference. The way checking accounts are offered and priced to the public would change dramatically and in unpredictable ways, according to one industry analyst speaking to American Banker.

Revenue at Risk

Analysts agree that financial institution revenue streams are at risk. “This will cut into revenue streams at a time when smaller institutions need to make ‘good' loans wherever and however they can,” Avivah Litan, research director at Gartner Research, tells American Banker. “With lower interchange fees, smaller institutions simply couldn't make a business case for issuing credit cards.”

Interchange supports a system enabling consumers to have a variety of choices in debit and credit cards from their credit unions, according to CUNA. The proposed government interference of H.R. 5546 and S. 3086 would likely result in cost-shifting from merchants to consumers, and increased fees for consumers to obtain debit and credit cards.

CUNA opposes statutory and rulemaking changes that would regulate interchange fees because such actions would limit consumer options, competition, and technological innovation. Interchange fees allow business costs, including the risk of consumer nonpayment, to be shared by payments participants. CUNA believes discussions concerning the value of electronic payments should be held within the scope of industry participants.