Is the Debit Card Revolution Finally Here?

Federal Reserve Bank of Kansas City - Economic Review, Fourth Quarter 1994 by Caskey, John P, Sellon, Gordon H Jr

Second, payment fees assessed by banks on merchants are rarely passed directly to consumers in the form of transaction charges. That is, retailers generally do not charge consumers different prices based on their choice of payment method (Barron and others). Rather, the cost is reflected in the general price structure of a retailer's goods and services, and all customers bear these costs regardless of the payment method they select.

While consumers are unlikely to be sensitive to the cost of alternative payment methods, price may be an important factor in a merchant's decision as to whether to offer a particular payment method. This occurs because merchants are more exposed to transaction-based pricing. For example, merchants' banks typically charge them for cash withdrawals and deposits, with the fee based on the currency and coin composition of a withdrawal and on the sorting a merchant does prior to the deposit. Similarly, merchants' banks charge a fee for processing each check as well as a fee for depositing a group of checks. [12] In the case of credit cards, the link to transactions is even more direct because merchants who accept credit cards pay a fee based on the value of the transaction. [13] Differences in these transaction costs can explain why some merchants refuse to accept checks or credit cards for retail payments. [14]

The current system of payment pricing has two important consequences. First, since consumers do not bear payments system costs directly, they have no financial incentive to select the lowest cost payment technology (Murphy 1977, 1991). Indeed, a consumer's choice of cash, check, or credit card for a retail transaction is unlikely to be dictated by a perceived difference in transactions costs. Second, because merchants often face transaction-based fees, their decision to accept or promote a given means of payment is more likely to be sensitive to the relative cost of payment alternatives.

How pricing may limit debit card growth

For the debit card to replace existing payment means, merchants have to accept it and consumers must be willing to use it for retail purchases. Debit card proponents have argued the card is likely to succeed because it is a more efficient, cost-effective means of payment. For example, processing a debit card payment would be less costly than a check since debit is completely electronic, while a payment by check requires considerably more processing and handling.

Nevertheless, this cost advantage is no guarantee the debit card will be used. Because of the way payment services have traditionally been priced, debit card promoters are unlikely to be able to use debit's cost advantage in gaining consumer acceptance. Existing payment methods cost so little for the consumer to use that it is difficult to establish a lower price for debit without an outright subsidy for its use. [15] Moreover, since existing consumer payment methods are largely account-based, any attempt to institute a per-transaction charge for debit would probably discourage its use. But, if debit pricing is also account-based, it will have no marginal cost advantage over alternative means, and the consumer's choice of payment methods will not be based on their relative costs.