Pricing Apples and Oranges

There are some questionable assumptions in the Federal Reserve’s proposed debit card fee rules. These assumptions underlie the Fed’s calculation of what constitutes “reasonable” debit card interchange fees. These rules are the outgrowth of the Durbin Interchange Amendment.

For one thing, the Fed rules tend to group various types of card transactions under the rubric “debit cards.” Products like signature debit and PIN debit operate differently and carry different amounts of risk for the issuing bank. That risk is priced differently and carries different costs for card-accepting retailers.

Second, the rules seem to assume that paying by check is the benchmark form of payment against which debit cards should be measured in terms of cost for retailers. By that standard, the rules assume, debit card interchange fees are too high. But this is comparing apples to oranges.

Checks are a notoriously insecure form of payment. With the exception of electronic check conversion or perhaps negative files, check acceptance technology is pretty much unchanged from the 19th century. On the other hand, financial institutions and card companies have invested tens of millions of dollars to make their card products safer and easier to use. These benefits have given consumers the confidence and desire to use these products. With that has come the “ticket lift.” Ticket lift is the propensity of consumers to buy more when paying with plastic than with cash. Retailers have to admit card-driven ticket lift exists, or else they wouldn’t have accepted the cards for payment in the first place.

However, compensating the financial service industry for these investments in research, development and security was not factored into the Fed’s calculations. Neither were the offsetting benefits in more customers, bigger purchases, faster “throughput” (which cuts labor costs) and less check fraud to the retailers who accept the cards. Had these benefits been properly factored in, perhaps the Fed would have concluded that retailers are paying too little in interchange.

The Fed’s response would probably be that these are soft benefits and are too difficult to quantify. However, when you undertake to restructure a billion-dollar industry you owe it to all the parties to do what it takes to get it right.

In the Fed’s defense Congress handed it a short fuse. But that’s all the more reason to use the comment period to go back, rethink its interchange price controls and get it right this time.

Pricing Apples and Oranges