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Why the Durbin Amendment will Increase Credit Card Fraud

by on May 23, 2011

After a rash of credit card identity theft schemes, the movement to delay the implementation of the Durbin Amendment has gained momentum. Interchange fees are, after all, levied to prevent and recoup losses after fraud. After Sony revealed that some PlayStation users’ credit card information was compromised, and arts and crafts chain Michaels reported that thieves had tampered with its debit card PIN pads, opponents of the Durbin Amendment used fraud costs as a rallying point.

“[Michael’s] is a prime example of the role that debit interchange plays in ensuring the payment system operates smoothly and efficiently for consumers and financial institutions,” said Dan Berger of the National Association of Federal Credit Unions in a letter to Senate leaders. “These issues aren’t being dealt with by Michaels. They are being dealt with by the card issuers.”

The banks’ argument is slightly flawed, though. While smaller banks and credit unions do face higher fraud costs, and for the most part genuinely need interchange revenue to cover the expenses, larger banks do not. However, if the Durbin Amendment is implemented, banks will use their considerable influence to push their customers towards less secure cards. Whatever the faults and merits of Durbin, it may encourage greater credit card fraud, but not for the reasons that most banks contend.

When it’s better to have worse fraud protection

Interchange rates differ across types of credit and debit cards as well as merchants. The “safest” cards – debit cards verified by PIN – command the lowest interchange fees, while the “high-risk” ones – premium credit cards, for the most part – garner the highest. That’s why Consumers Credit Union requires you to use your debit card 12 times a month without entering your PIN in order to receive 3% APY checking. Now, if security were the only concern, banks and credit unions would push their customers to enter their PINs rather than signing for their purchases. Alternatively, the high-tech chip-and-PIN verification systems in place in Europe (and used by Visa abroad) would take root here.

However, there’s money to be made in less secure credit cards. Fraud prevention costs, after all, justify higher interchange rates. The major networks and banks have no incentive to make cards safer, because if they do, the justification for high swipe fees will disappear.

And lest lawmakers believe that, as a whole, the financial industry breaks even on fraud protection, the Federal Reserve has statistics to prove otherwise. In 2009, the entire industry lost about $1.4 billion due to fraud. It collected more than ten times that amount in swipe fees.

Higher risk means higher fees, and happier banks

Currently, PIN-verified debit swipe fees are 35-70% lower than those for the most expensive rewards credit cards. Even now, banks urge their customers towards the high earners with rewards as a percentage of spending and lump sum usage-dependent bonuses. If the Durbin Amendment is implemented with the 12-cent fee cap, debit swipe fees will be over 80% lower than those for signature credit cards. Banks will, then, have an even greater incentive to nudge consumers toward rewards credit cards.

The result of these efforts is a greater portion of plastic-users verifying their purchases by signing rather than entering a PIN. As the signature method is worse at preventing fraud, the rate of identity theft will likely rise.

Pushing customers toward credit cards

The effort to encourage credit card – or at least signature debit – use is already in full swing. An all-out rewards card signup bonus extravaganza is capped by a (now ended) 100,000-mile bonus from Capital One and British Airways. Monthly maintenance fees on checking accounts deter debit card users. Among others, Chase ended its debit rewards program only to back pedal after a Durbin setback. Multiple banks including Chase and Bank of America have threatened to implement a $50-$100 transaction limit on their debit cards. The limit, well below what the average family spends at a supermarket, is sure to encourage credit over debit.

Large banks argue that the Durbin Amendment won’t lower fraud costs associated with plastic transactions, but will choke the stream of revenue used to cover them. Durbin might well increase identity theft, but if it does, it will be because of the banks themselves.

The Senate will vote on a Durbin delay

Senator Jon Tester, Democrat of Montana, introduced a bill in late April to delay the Durbin Amendment’s implementation for two years to study its effects on small credit unions and community banks. Most thought the bill stood no chance when the majority leader opposed it and the second-ranking Democrat lent the original legislation his name. However, after an intense lobbying effort, on-the-record concerns from both Ben Bernanke and FDIC Chairwoman Sheila Bair, and Tester’s agreement to drop the delay period to 15 months from 24, Tester believes that he has the 60 votes to push the bill through the Senate.

In a surprising turn, Senate Majority Leader Harry Reid of Nevada allowed the bill to come up for a vote, though he has voiced his opposition. In the House, a bipartisan proposal to delay interchange regulation one year is in the works. In a floor speech Wednesday, Tester read, “Allowing the government to price-fix debit card swipe fees is a slippery slope.”

 

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