Debit Spending Is Increasing, but What Are the Implications?
Contactless payments have soared during the pandemic as consumers looked for safer, cleaner and easier ways to make payments. Debit card usage has also increased in popularity as debt-wary consumers prefer to spend money in their accounts instead of running tabs on credit cards.
According to Vasant Prabhu, Visa’s CFO and Vice Chairman, the US market is back to its pre-pandemic payment volume growth trajectory. The rise in debit payments in the U.S. during Covid-19 was enough to offset credit card underperformance. But will this growth in debit card usage continue to overshadow credit card usage? And what does this shift to debit card usage mean for merchants and banks?
Debit and credit card trends
The growth of debit during the pandemic is attributed to several factors, foremost among them was people’s perception of cash as unhygienic. For a while, merchants opted not to accept cash payments out of fear of transmitting the disease, which accelerated the adoption of contactless card payments. Discussions of how contactless card payments affected cash usage were already ongoing before the pandemic as the migration had already started. However, COVID-19 put contactless card payments at the top of consumers’ minds as they sought to reduce the things they touched.
Visa had over 300 million contactless cards in the US by the end of the first quarter of fiscal 2021. This is a big increase from less than 15 million contactless cards in the US in 2017 when the migration to contactless card use first started.
So how does debit card usage compare to credit card usage? Well, according to the Federal Reserve Payments Study of 2019, debit cards (both non-prepaid and prepaid) were used twice as often as credit cards in 2018. However, the value of credit card payments surpassed the value of debit card payments by about 30%.
Fast forward to December 2020, the tables seem to have turned. Visa, in its Operational Performance Data reported $741 billion debit transaction volume and $542 billion in credit card volume in the U.S. in the last quarter of 2020. A report from Consumer Finance also found that average credit card balances gradually declined during the Covid-19 pandemic. This decline may have been motivated by the distribution of stimulus checks to consumers, who used it to pay down debt.
Though there are some differences in chargebacks between debit cards and credit cards for consumers, no significant difference in chargeback protection for merchants was caused by the shift from credit to debit.
The Durbin Amendment
Though the rise of debit was most pronounced during the COVID-19 pandemic, it first emerged earlier. If anything, the move was a long time coming owing to several factors, one of which was the passage of the Durbin Amendment.
The Durbin Amendment, part of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, was birthed as a response to the 2008 global financial crisis to improve consumer welfare. The amendment intended to restrict debit card interchange fees from an average of $0.44 per transaction to $0.21 + 0.05% of transaction amount for banks with assets worth $10+ billion. Though the amendment was well-intentioned, it led to unintended consequences for the banks and merchants.
The intended impact was to help merchants save money on debit card transaction fees and it was thought that the merchants would then pass on the savings to their consumers by reducing prices. According to a study published by the University of Pennsylvania, this is how the reform played out in markets where merchants faced much competition and debit card usage was high.
Unfortunately, many merchants in less competitive markets opted to keep the savings to themselves. In addition, sometimes merchants didn’t process enough debit card transactions to amass significant savings to justify price reduction.
Why is this? Well, the structure of the Durbin Amendment didn’t take smaller transactions into account. The new interchange price structure comprised a lower percentage and a higher flat transaction fee that took a bigger bite out of smaller transactions than larger transactions. Retailers who experienced an increase in costs hiked prices, defeating the intended purpose of the Durbin Amendment.
Issuing banks took a hit as well, as their revenues fell by $6.5 billion yearly after the amendment became law. As a result, banks tried to recoup lost revenue by requiring higher monthly account balances for free accounts and charging consumers more for checking accounts.
Impact on Banks, Merchants and Consumers
Since Durbin capped debit interchange rates, banks were incentivized to encourage credit use to help offset their losses in the long run. One way they did this was by getting rid of rewards for debit cards and increasing them for credit card accounts. But with the rise of debit card use over credit card, they will need to find a new way to offset lost revenue. They may do this by continuing to increase checking account fees which will disproportionately impact low income consumers who cannot maintain minimum balances.
Merchants that have benefited most from lower debit fees were those that didn’t operate under low interchange rates negotiated with the card networks based on a large volume of forecasted sales. According to the University of Pennsylvania study, merchant savings were concentrated in bookstores, gas stations, truck and auto dealerships and miscellaneous retail stores (primarily smaller department store chains). Merchants that sell low ticket items lost from the shift to debit as the $0.21 +0.05% interchange cap (plus $0.01 for fraud prevention) became the floor for debit transactions.
But even if there had been a full pass-through of merchant savings, the net result would have been zero impact on consumer welfare, as the banks increased checking account fees to make up for the loss in interchange income. Anything less than full pass through of savings, would have resulted in consumers losing as merchants raise profits and banks cover costs. In the end, the largest beneficiaries of the shift to debit payments from credit will be merchants selling medium and high-ticket items, who will be paying less in interchange fees.