WASHINGTON, D.C. — Bank of America's announcement that it will impose a $5 monthly surcharge on account holders who use debit cards has sparked both consumer protests and political uproar.
The financial giant is trying to justify the move as a consequence of new federal regulations limiting the amount banks can charge for debit transactions, casting the entire episode as an epic battle between free markets and government price-fixing. Its rationalization might play inside the Beltway, but it misses the point.
In order to function fairly and effectively, markets require competition and transparency.
Before swipe fee reform, however, the debit card market had neither. Instead of competing on the basis of price, the two dominant players, Visa and MasterCard and their banks, each effectively fixed the fees banks receive on debit transactions. Rather than charging these fees openly, they hid them by requiring merchants to pay a "swipe" fee on every transaction.
For years, this opaque, non-competitive market created a cozy profit center for the banking industry. A 2010 study conducted by the Federal Reserve found the actual cost to banks for processing a debit card transaction was approximately 4 cents.
Yet until the new regulations took effect Oct. 1, banks were charging merchants an average 44 cents per transaction — a hidden tax that generated $20 billion a year for the banks but cost the average household more than $175. Between 2001 and 2010, the annual cost to merchants and their customers for debit and credit card swipe fees combined more than tripled, to an estimated $50 billion.
The charge that the new rules established by the Federal Reserve amount to government price-fixing simply doesn't pass the laugh test.
Notwithstanding the protests of the banks, the new regulations do not "fix" debit card swipe fees. They merely establish an upper limit of 21 cents on the typical transaction. Under these "draconian" new rules, banks will still be able to charge a 425 percent markup on debit card transactions. Merchants who are required to collect these fees, on the other hand, earn an average net profit of about 2 percent.
The principle at stake is critical because the fight over debit card swipe fees is likely just the opening salvo in a long-running debate about how open and transparent banks should be .
Next on the agenda will be reform of credit card fees, which are even more excessive than debit fees and just as obscure.
In 2010, the banking industry raked in about $30 billion in swipe fees on credit card transactions. Not only do banks require merchants to collect fees averaging 2-3 percent of each credit card transaction, until swipe fee reform passed they effectively prevented retailers from offering discounts to customers who paid with cash.
Obviously, the banks' goal is not a fair, market-driven return on the cost of processing a card transaction. Instead, banks want to keep their fees hidden in order to pad their profits. If banks can continue to conceal their fees on debit and credit card transactions, imagine how easy it will be for them to electronically bury fees in the "tap and go" future when more consumer purchases migrate to mobile devices.
As long as banks are permitted to hide fees and avoid competition, consumers will continue to be gouged by higher prices for every product they purchase. Perhaps on some level, Bank of America is to be commended for finally coming clean about at least one of its fees.
Let's see if other banks compete to offer lower fees by scaling their profit margin on debit transactions from 425 percent to 300 or even 200 percent — or whether the entire industry continues to seek political cover.
Mallory Duncan is Senior Vice President and General Counsel of the National Retail Federation.