Durbin Effects Manageable So Far for Small Banks—But Worse Is Expected

Now that the Durbin Amendment’s debit card interchange caps have been in effect for nearly a year, enough time has passed for community banks and credit unions to start to determine the impact, if any, the price ceilings have had on their income. Based on conversations Digital Transactions News has had with small-bank executives, the effect so far has been manageable—but a bigger impact is expected.

“It hasn’t affected us yet—but ‘yet’ is going to be the big word to emphasize,” says John Schulte, senior vice president and chief information officer for Mercantile Bank of Michigan, which has $1.4 billion in assets and serves the Grand Rapids, Holland, and Lansing Markets. “It’ll be a race to the bottom,” adds Brad Rose, vice president for information technology and security at The State Bank in La Junta, Colo., part of a banking company with $293 million in assets.

Durbin’s price ceilings, which were codified by Federal Reserve rules released in June 2011, took effect Oct. 1 but exempted debit card issuers with less than $10 billion in assets. Even so, the Independent Community Bankers of America, a small-bank trade group, and a wide range of executives with exempt institutions decried the regulation. They claimed merchants would discriminate against cards from small institutions and would use newly won routing freedom to send transactions to networks allowing lower interchange. Both prospects, they said, would hurt exempt institutions’ debit income and effectively nullify the benefit of the exemption.

The Fed capped interchange for both signature and PIN debit at 21 cents plus 0.05%, with an additional penny for fraud-prevention costs. Under the Fed regulation, the rule against interfering with merchants’ routing preferences, which was also part of Durbin, took effect Oct. 1 and applied to all issuers. Another Durbin rule related to routing, one that requires issuers to use at least two unaffiliated debit networks, also applies to all issuers but did not become effective until April 1.

So far, at least, the impact on exempt issuers has been muted. A major study released last month by the Pulse debit network, a unit of Discover Financial Services, indicates exempt issuers have seen their debit interchange income drop no more than 3% since Oct. 1, compared with a 30% to 60% slide for regulated issuers. The study, which collected results from 30 exempt issuers, shows PIN interchange for these institutions unchanged since Oct. 1 at 33 cents per transaction. Signature debit interchange has ticked down a penny, from 47 cents to 46 cents, a drop of 6 basis points.

Mercantile Bank, which has 18,500 debit cards issued, has seen its interchange per transaction decline “slightly,” but debit interchange income has exceeded the bank’s expectations, says Schulte. In part because of expected collateral effects from Durbin, the bank had budgeted income to drop more sharply, he says. He credits this result to growth in the deposit base and in card use.

Nor has he seen much of the card discrimination or lowest-cost routing many small banks feared. “The only folks who do that are the Wal-Marts of the world, they’re really good at routing,” Schulte notes. Still, he cautions that the network-affiliation rule, in effect now for just five months, hasn’t had a chance yet to make an impact.

Meanwhile, he says, while debit programs are becoming more costly for small banks to run, these costs are getting harder to recover. “It’s still hard for small banks to get their [debit] revenue in line with its costs,” he says. “What’s changed is the cost structure. That’s going to make it harder for us to offer a competitive product.”

The impact at The State Bank has been more pronounced, with a drop in debit card interchange ranging from 15 to 20 basis points in the months since January compared to the year-earlier months, according to Rose. He says this figure could fall another 15 to 20 points in coming months as merchant contracts expire and merchants switch to acquirers offering better rates. Also, Wal-Mart, which accounts for a large portion of the bank’s transactions, is especially likely to take advantage of the new routing freedom, he notes. Soon, he expects, smaller merchants will follow suit. “A lot of merchants are still sorting things out,” says Rose. “Being able to route transactions is going to be a big cost driver [for merchants].”

Like Schulte, Rose laments rising costs at the same time income has dipped. He expects fraud losses to rise, while at the same time fraud-prevention systems are “expensive to run,” he says. Overall, he says, “it’ll be a tough environment to operate in.”