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Days of Free Debit Card Use Could Be Coming to an End

FEBRUARY 2011

As published in the Mississippi Business Journal, written by Ted Carter.

Banks have to find ways to offset lower fees from merchants on debit card transactions

Achieving that critical balance between a viable revenue level and a satisfied customer base is about to get much more difficult for bankers in Mississippi.

They must make tough decisions  before the Federal Reserve's Board of Governors puts a cap on the fees that can be collected from merchants who accept a bank's debit card for purchases. Right now, the Fed is proposing a cap of 12 cents a transaction.

The cap would result in card issuers receiving transaction, or interchange, fees 70 percent lower than their 2009 average, according to Federal Reserve calculations.

The cap isn't the first bit of recent pain inflicted on the non-interest revenue of banks. The cap's arrival comes a year after a stiffening of the federal Regulation E, originally enacted in 1978 as the Electronic Funds Transfer Act.

The measure that went into effect last July requires banks to notify customers when an ATM or debit-card transaction will result in an overdraft or insufficient funds fee. Banks and credit unions can't pay debit-card and ATM overdraft transactions without allowing the customer to opt out at the time of the transaction, or to opt in by agreeing ahead of time that the bank will pay items into overdraft. The banking sector is reported to have generated more than $35 billion in over-draft fees in 2009.

Together, the Reg E and interchange cap have  forced bankers in Mississippi and elsewhere  to wonder how far they can go in offsetting the lost revenue and not cause customers to take their business to a competitor with lower fees.  You can't keep the status quo - not when a bank's cost of maintaining a checking account has reached upwards of $300 a year and costs associated with electronic transactions are rising as well, bankers and banking consultants say.

Until now, banks could cover the costs of "the bells and whistles" of an account through interchange fees, said Brandon Roberts, a banking economist and principal of Premier Insights, a Canton consulting firm.

"This is compounded by the fact than profit margins have already been squeezed," he said.

Thus, annual fees for ATM and debit card use as well as pre-paid debit accounts (which would not be subject to the 12-cents cap) are getting a look.

The key term is "fee-eligible."  If it can carry a fee, it's going into the mix for consideration, Roberts said.

He said he sees charges for debit card use and access to ATMs as a strong possibility by this time next year.

"I think that's on everybody's mind," he said, and fixed the likelihood of such fees at "at least 50 percent."

Hans Petit, head of HORNE CPAs' banking practice, said he expects caution will rule any decision a bank makes. "We're not going to see anybody jump out there on the edge," he said. "When rates (on deposits) are as low as they are and competition as competitive as it is, you don't want to jump out there in front of the competition."

Petit said a fee could cause customers to become fond of using brick-and-mortar bank facilities instead of electronic debit cards. "Unless it's going to be an industry-wide adoption, you could run off deposits," he said.

Birmingham-based Regions Bank is seeking that elusive balance, said Evelyn Mitchell, bank spokeswoman. Regions wants a way to meet customer needs "without compromising our ability to re-invest in our business for the long-term," she said.

At the 12-cents a transaction as proposed today, the cap on interchange fees "will have a significant impact" on non-interest revenues and force banks to come up with new ways to cover the cost of debit card administration, Mitchell said.

"It will change the way the industry does things," she said.

And for Regions and other banks, the changes would have to be implemented at a time debit cards are more popular than ever.

Regions' interchange and ATM income hit $368 million for the year, coming off a record quarter in that income category, President and CEO Grayson Hall said in the bank's fourth quarter earnings presentation.

The fees rose 18 percent over the same period a year ago, driven by an 8 percent increase in card use and 13 percent rise in spending levels, Hall said.

"Our new checking account customers are electing to have debit cards 87 percent of the time, a record level of penetration for this product," Hall said.

The growth in interchange fees last fiscal year largely offset the $57-million loss of revenue from the new Reg E overdraft rule, according to Regions CFO David Turner.

Those fees won't be at the level in 2011, which means Regions faces additional "income fee challenges in 2011," Hall noted.

The interchange fee changes, "obviously will impact the way we charge for banking services."

At the moment, added Hall, "We are trying to better understand both the intended and unintended consequences of these changes."

Jerry Host, new CEO of Jackson-based Trustmark Bank, said Reg E's damage to Trustmark's non-interest revenue last fiscal year was limited to about $1 million. "We feel like Trustmark executed a very successful education program with our clients" on the opt-in-opt-out overdraft rules.

Host, in Trustmark's 4Q earnings presentation, said he expects Reg E to cost the bank $6 million to $9 million in revenue next year.

With the proposed 12-cents cap on interchange fees, Trustmark projects it would lose between $4 million and $6 million for the slightly less than half year the new cap is in place in 2011, Host said.

"It's too early to project the revenue impact because there is a great deal of uncertainty that remains," he added. "However, we are well into the process of reviewing our options and to limit the impact" of the fee cap.

Brandon Roberts, the Canton banking economist, said the effects of Reg E and the interchange cap could be especially painful to a Mississippi banking sector that went into the banking recession somewhat later than banks elsewhere in the country. "Banks in Mississippi are still on the downside of it," he said. "There are still some things to unfold here."

Real estate loan charge-offs and non-performing loans came close to $2 billion in Mississippi last year, Roberts said. "That's a pretty good drain."

For example, he noted, "Say you get one-and-a- quarter return on assets and 4 percent of your loan volume is past due and you're charging off 1 percent a year. There go your earnings."

With July 21 on the horizon, added Roberts: "I think they all feel the pressure and are concerned about adding this additional burden at a time when they are struggling anyway."