Community Banks And Consumers Bear Cost Of New Legislation

By Nancy K. Crevier

The magnitude of halting or delaying implementation of the Durbin amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act, regarding the setting of price controls on debit card interchange transactions, could be seen in one man’s unusual schedule for three days in mid-March. For the first time in 40 years of banking, Newtown Savings Bank President and CEO John Trentacosta felt it necessary to make a personal appearance “on the hill” — in face to face conferences with both Senator Richard Blumenthal and Congressman Chris Murphy, in Washington D.C.

Along with 1,000 other bankers, Mr Trentacosta attended a two-day seminar in Washington, covering myriad subjects important to the banking industry. One of those issues was the repeal or delay of the Durbin amendment, in which the Federal Reserve was directed to determine a reasonable and proportional fee for merchants’ use of the debit card payment network. This resulted in a proposal to cap interchange fees (the amount of a purchase retailers pay to a bank), currently roughly one percent of a transaction, at 12 cents per transaction; or allow issuers to determine the maximum allowable fee based on cost, with the fee being no less than 7 cents per transaction nor more than 12 cents per transaction.

“I felt that I needed to hear what [the senators and congressmen and women] had to say, and to make sure they heard what we had to say,” Mr Trentacosta said.

Reuters News Service reported on March 16 that the Washington, D.C., meeting between Federal Deposit Insurance Corp (FDIC) Chairman Sheila Bair and bankers at the seminar was a contentious event, as executives from mostly smaller banks complained about the new restrictions on fees.

Ms Bair’s response to complaints, according to Reuters, was that the industry would benefit by trying to “work more with regulators on changes” and said, “Dodd-Frank was good for community banks because, among other things, it drives down small banks’ deposit insurance costs, while hammering larger firms with more restrictions.”

In response to bankers’ negative outlook of the Dodd-Frank legislation overall, Reuters reported that Ms Bair “argued that the biggest threat to the industry is a reluctance to embrace reforms that could restore its badly bruised reputation with the public and its proper role in the economy.”

Ms Bair also told the skeptical audience that “the new Consumer Financial Protection Bureau could help bankers eliminate some of the paperwork involved in mortgage disclosures.”

She did concede that the current Fed proposal could harm small banks, and told the bankers that the FDIC “advocated for changes to a crackdown on fees banks can charge merchants when debit cards are used.” While Ms Bair aligned herself as a friend to small banks, she reiterated that she believed that community banks do not bear the “brunt” of the reform law.

The result of the Dodd-Frank financial reform law, scheduled to go into effect in July 2011, could be a cut of “as much as 90 percent of current debit interchange revenue,” according to literature from the American Bankers Association, which represents large and small banks.

Despite the title of the Dodd-Frank legislation that includes “Consumer Protection,” it will be the consumer who suffers from the resulting increase in fees and decrease in services that banks, particularly smaller banks, will need to pass on to customers, said Mr Trentacosta, Monday, March 21.

The Dodd-Frank Bill is “massive legislation” that arose out of the need to regulate the large banks, in response to the banking crisis, he said.

“A lot of good came out of the Dodd-Frank Bill,” said Mr Trentacosta. “They said, ‘Let’s take care of these Too-Big-To-Fail banks,’ and it asked, ‘Are consumers being protected fairly?’” But the Durbin amendment, tacked on and passed without much studying of the proposal, said Mr Trentacosta, has negative consequences that should have been addressed.

According to a statement issued by Senator Dick Durbin, D-Illinois, in May, following the Senate approval of his amendment, “Passage of this amendment is a win for the public” on holding big banks accountable and for empowering consumers to make good financial choices. “Passage of this measure gives small businesses and their customers a real chance in the fight against the outrageously high ‘Swipe Fees’ charged by Visa and MasterCard,” continued Senator Durbin’s statement. “It will prevent the giant credit card companies from using anti-competitive practices, allow merchants to offer discounts to their customers and restore common sense and fairness to this broken system.”

Additional information at durbin.senate.gov noted that “An estimated $48 billion in swipe fees were charged by credit and debit card networks in 2008 — this money came out of the bottom line of small businesses and merchants across America, and 80 percent of this money went to just ten large banks.”

According to the website, “Small businesses and merchants always get shortchanged when they accept a debit card for a sale.” The Durbin amendment also “would not have the Federal Reserve set interchange prices…. Instead, the Fed would oversee the debit interchange fees set by card networks.”

That is not what happened, though, said Mr Trentacosta. “Clearly the Fed made the recommendation and essentially set the interchange prices. The Federal Reserve decided banks should not make more than 12 cents per transaction. What does that mean to the consumer? Very little,” Mr Trentacosta said.

The industry average debit card transaction, he said, is approximately $40, meaning that banks on average now make 40 cents per transaction. That money goes to cover fraudulent charges, and the cost of issuing debit cards, for example, said Mr Trentacosta, and fraudulent debit card issues “are huge.”

The theory behind the amendment is that consumers will benefit from the difference, about 28 cents per transaction, when the retailer passes on those savings.

“Those savings won’t go back to the consumer,” said Mr Trentacosta. “They will be shifted to the retailer, who is going to look at his bottom line.”

Merchants have many options for payment, including checks, credit cards, and debit cards. For the convenience of accepting a debit card — of which 491 million were used in 2008, and by 71 percent of US households in 2007, according to the American Bankers Association — retailers take no risks. Merchants also have the option of offering customers discounts for noncard purchases, thus avoiding any interchange fee. However, ease of payment for customers means faster checkouts, a secure form of payment, and quick access to their money with debit charges, thus making debit card payment desirable for most merchants.

Assuming The Risk

“Banks bear the risk,” said Mr Trentacosta. “Payment is guaranteed to the merchant.” The “reasonable charge” that the Fed came up with, he said, did not take into account that banks need to build in enough profit to protect against fraud and other costs of doing business. That, in turn, affects the customers.

The last three years have been the kind of strain that bankers have not endured since the Great Depression, Mr Trentacosta said. “I’m pleased to be here. It’s been difficult, and I’m proud of our team that has guided us through a financial disaster,” he said. With the economy still in the infancy of recovery, he would prefer not to revisit recent years, he said, and he is fearful that this amendment could undo the upturn.

The difference in what banks receive on interchange fees now and what is proposed may seem small, but it is a significant amount for banks, said Mr Trentacosta.

“You’ll see things like free checking and free ATMs disappear, debit card rewards, and rebates become a thing of the past,” he said, as banks try to find ways to recover the cost of doing business with debit cards. Banks that do not now charge monthly maintenance fees or debit card transaction fees will have to make up income loss from reduced interchange fees by instituting those fees. Banks could decide to increase fees to customers using ATMs outside of their own network, up to as much as $5 per transaction, he said, or attach additional requirements to procuring a debit card that would make it difficult for low- or moderate-income people to get one.

“Losses [to the banks] have to made up somewhere,” Mr Trentacosta said, and he believes it will be the consumer who suffers.

Consumers may also see banks attach a cap as low as $50 or $100 per debit card transaction, per day, in order that excessive and unrecoverable fraudulent charges are avoided.

“If debit cards disappeared [because it is no longer profitable for banks to issue them], traffic would go toward credit cards,” Mr Trentacosta surmised. “People with bad credit may lose the convenience [of a debit card] if they are not eligible for a credit card,” he said. Because charges made on a credit card do not have to be paid in full every month, unlike debit cards that extract the charge immediately from an account, consumers could find themselves falling more easily into debt.

Nor does Mr Trentacosta see society taking a step backward to check writing as the most common method of payment.

“If this legislation is allowed to go into effect, it will hurt the earnings of small banks,” Mr Trentacosta said. The Dodd-Frank legislation was looking for banks to increase capital, “but it actually could decrease capital,” he said.

Supporting Mr Trentacosta’s prophesy that the consumer will gradually see free services disappear, on March 25, Reuters News Service reported that Wells Fargo & Co. will cease enrollment in its debit card rewards program as of April 15, “citing financial regulations that will cut certain fees associated with the cards.” The stoppage will not affect customers already enrolled in the debit card reward program. The Wells Fargo announcement followed on the heels of an earlier, similar announcement by JP Morgan Chase & Co.

Banks fund debit reward programs from the processing fees targeted by the new law.

 

A Tiered System?

The Federal Reserve considers a small bank to be one with less than $10 billion in assets, but a community bank, such as Newtown Savings Bank, more commonly has assets of $1 to $3 billion dollars.

The amendment did propose a two-tier system for banks above and below the $10 billion dollar mark, meaning that small banks would not be required to adhere to the cap of 12 cents per transaction, Mr Trentacosta said, but there are difficulties with that proposal.

Mr Trentacosta is skeptical that credit card networks can manage two tiers effectively, and despite claims that the Durbin amendment would require merchants to accept all cards within their networks, he is concerned that big retailers will find a way to drive their business to the least costly network. Those cards issued by big banks would be capped at 12 cents per transaction, while the cards issued by smaller banks could continue to charge the current higher interchange fee. “It’s a supply and demand thing. That’s business,” admitted Mr Trentacosta.

The impact on community banks and the people that they serve would be a reduction in profitability, first of all. “That would diminish the amount of money we have to lend in a community,” he cautioned. Banks would also have fewer dollars to donate to causes within the community, and in extreme cases, poor profitability could lead to layoffs.

While the Dodd-Frank Reform Act and Durbin amendment goes into effect in July, the week that Mr Trentacosta and the other bankers arrived in Washington the Senate had already proposed a two-year delay, Senate Bill 575, in order to study the consequences of the implementation.

“While I was in Washington, I was able to meet with Blumenthal and Murphy. There were about 16 of us meeting with Blumenthal, and a smaller group of about eight bankers that met with Murphy, to explain this legislation and how it would affect community banking and the consumer. I felt they were up on it. We met with Congressman Murphy on Tuesday, and Tuesday night the House introduced their legislation [HR 1081]. So I felt we did make an impact,” said Mr Trentacosta.

Both Senate 575 and HR 1081 would “halt the implementation of the Fed’s proposal and give Congress and the banking regulatory agencies adequate time to study the impact of regulating debit interchange transaction fees,” according to the American Bankers Association, allowing Congress time to assess the action.

“Consumers should be aware of this legislation,” Mr Trentacosta said. “This money [from reduced interchange fees] is not going to go back to consumers. In fact, they will see a change in banking services,” he warned.

There is a lot of value for community banks to stay in business, Mr Trentacosta said. “We’re a big part of communities. If people feel strongly about this legislation, they should write to their congressman.”