It’s “I-told-you-so” time for the bank lobbyists. They predicted that the price controls on the “interchange” debit card fees charged to merchants would automatically lead to higher fees somewhere else – in this case, as fixed monthly fees on debit card holders.
This Whac-a-Mole model of pricing may not explain everything about how banks have responded. But there’s more than a little truth to it because banks operate in “two-sided” markets in which services sold to some (debt card users) are inextricably tied to services sold to an entirely different group (retailers). And while competition among banks probably limits the sum of the two charges to the overall cost of facilitating debit card transactions, economics offers no particular reason why the charges should be divided among the parties according to the separate cost they exact on the system.
Indeed, two-sided markets lead to widely varying divisions of fees. “Free” TV exacts 100 percent of the cost from advertisers and nothing from TV watchers. Microsoft, by contrast, charges application developers nothing to piggyback on the Windows PC operating system, getting all its Windows revenue from consumers. Apple and Google split the baby, charging 30 percent of the price of smartphone apps to developers and the rest to consumers.
But back to banks. Big retailers have been howling for years about the unfair division of transactions fees – usually 100 percent of the total fees — that they paid banks each time a debit card was used. And they managed to shoehorn in an amendment in the financial reform bill that directed the Fed to limit those fees to the cost of providing the service on the merchants’ side of the market. The ceiling was set at about 24 cents per transaction – more than merchants wanted, but just a bit more than half of what banks were averaging until the September 1 deadline.
Not surprisingly, then, banks are looking to the other side of the debit card services market to recoup revenues lost on the merchant side. Hence the decision by the big banks (with the conspicuous exception of Citibank) to charge a flat $3-5 per month for the privilege of using a debit card. They’re hoping/expecting that account holders will moan and whine awhile, then think no more about it. Small banks and credit unions, which are not covered by the ceiling and don’t seem to be planning to charge account holders, will presumably do their best not to let card users forget.
As a general principle, we think any limitation on how banks generate revenue in a competitive market is bad policy as long as the fees are adequately disclosed. And we think price regulation is especially unfortunate where a two-sided market is functioning.
This is not based on affection for all those nice folks in the banking business. There could be very tangible costs to society as a whole in fixing debit card prices. Debit cards, don’t forget, are the edge of the wedge in the transition from paper-based banking to far more efficient electronic banking. And shuffling fees in a way that inhibits the use of debit cards is certainly a step in the wrong direction, if the goal is to wean consumers from writing checks for small sums.
War, we all know, is too important to be left to the generals. By the same token, two-sided markets are too complicated to be left to lobbyists and regulators.
(This post was also published on Forbes.com.)