One of the major consumer provisions of the new financial regulations reduces the interchange fee for debit cards. This change could significantly benefit retailers, but it will hurt banks and possibly harm consumers.

Under the legislation, the interchange fee that retailers must pay issuers and banks for debit card transactions would be decreased. Currently, that fee is about 2% of every transaction. According to a recent study by the Nilson Report, interchange fees paid by merchants for MasterCard and Visa debit transactions totaled nearly $20 billion in 2009. The legislation would not effect the interchange fee levied on credit cards.

How will interchange regulations on debit cards affect consumers, retailers and banks?

* Less convenient payments for small purchases. Payment with credit cards make payments fast and easy, and we use them for the majority of our purchases regardless of the amount. Interchange regulations will allow retailers to set the minimum purchase price at $10 for card purchases. Shoppers must use cash for small purchases.

While minimum payments may be inconvenient for consumers, permission to set minimum payments is good news for small retailers. Currently, retailers are required to accept cards for all purchases no matter how small the price. The minimum fees are so high that retailers often lose money on the small purchases with small profit margins.

* Consumers may save money with cash discounts. Merchants will be able to offer discounts to people who pay with cash, checks or debit cards. However, the regulations do not require merchants to pass savings to consumers.

* Lower prices could lead to lower debt. Interchange fees add approximately 2% to the price of goods. Ideally, merchants will lower prices if the don’t have to pay the fee. But, again, retailers are not required to pass the savings on to consumers.

* New or higher fees for bank accounts. Banks will lose billions of dollars from this change in interchange fees and they will look for new ways to replace that revenue. It is possible the decrease in interchange fee revenue could mean higher fee payments for consumers with bank accounts. Wells Fargo ends free checking account on July 1, and Bank of America is testing new fees to be added by the end of the year. Other banks may follow.

In July 2010, Jaime Dimon, JPMorgan’s CEO, acknowledged that new rules passed last year curbing the banks’ ability to charge its banking and credit card customers certain fees and penalties. This would cut into its bottom line more than it had expected and would ultimately mean that clients would end up paying more for services.

“You know, if you’re a restaurant and you can’t charge for the soda,
you’re going to charge more for the burger,” Mr. Dimon said. “I just
my guess that over time it will all be repriced into the business.”

* A reduction or elimination of rewards for debit cards. Since some issuers have claimed that interchange fees fund the rewards programs, expect rewards from debit cards to shrink. Banks will likely not fund rewards out of their own pocket.

* A possible reduction in rewards for tax and college tuition payments. Governments and colleges can set maximums for credit card payments to reduce their own interchange fees. This will limit the points or cash rebates available for those who pay taxes or tuition with a credit card.

“The interchange regulation would be a huge win for retailers and a significant loss for the banking industry. Depending on what the retailers do, it could also result in an overall loss for some consumers,” says Bill Hardekopf, CEO of LowCards.com and author of The Credit Card Guidebook.

Congress is attempting to regulate these billions of dollars, but there is uncertainty about how much lower the fee will be. The bill requires that it be “reasonable and proportional” to the cost of processing the transaction. The Fed has the fee-setting authority and has not announced what it will be. The Fed will not directly regulate the network transaction fees that Visa and MasterCard charge banks. (Debit card transactions currently have uncapped fees, which sometimes reach 2% or more of the amount purchased.)

The bill was signed by President Obama in July. It will be sent to the Fed. to draft regulations within nine months. The new rates will go into effect 12 months after the bill is signed.